<PAGE>
As filed with the Securities and Exchange Commission on May 12, 1999
Registration No. 333-74719
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
AMENDMENT NO. 3 TO
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
---------------
ZANY BRAINY, INC.
(Exact name of registrant as specified in its charter)
---------------
<TABLE>
<CAPTION>
<S> <C> <C>
Pennsylvania 5945 23-2663337
(State or other jurisdiction (Primary Standard Industrial (IRS Employer
of incorporation or organization) Classification Code No.) Identification No.)
</TABLE>
---------------
308 East Lancaster Avenue
Wynnewood, PA 19096
(610) 896-1500
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
---------------
Keith C. Spurgeon
Chief Executive Officer
308 East Lancaster Avenue
Wynnewood, PA 19096
(610) 896-1500
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies of all communications to:
ALAN SINGER THOMAS C. SADLER
Morgan, Lewis & Bockius LLP Latham & Watkins
1701 Market Street 633 West 5th Street, Suite 4000
Philadelphia, PA 19103-2921 Los Angeles, CA 90071
(215) 963-5000 (213) 485-1234
---------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
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<CAPTION>
Proposed Maximum Proposed Maximum
Title of Each Class Amount to be Offering Price Aggregate Amount of
of Securities to be Registered Registered(1) Per Share(2) Offering Price(2) Registration Fee
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $0.01 par value... 7,015,000 shares $12.00 $84,180,000 $23,403
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</TABLE>
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(1) Includes 915,000 shares of common stock which may be purchased by the
underwriters to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457 under the Securities Act of 1933.
---------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended, or until this Registration Statement
shall become effective on such date as the Commission, acting pursuant to such
Section 8(a), may determine.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+We will amend and complete the information in this prospectus. Although we +
+are permitted by US federal securities law to offer these securities using +
+this prospectus, we may not sell them or accept your offer to buy them until +
+the documentation filed with the SEC relating to these securities has been +
+declared effective by the SEC. This prospectus is not an offer to sell these +
+securities or our solicitation of your offer to buy these securities in any +
+jurisdiction where that would not be permitted or legal. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION--May 12, 1999
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Prospectus
, 1999
Logo
Zany Brainy, Inc.
6,100,000 Shares of Common Stock
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The Offering:
Zany Brainy:
.We are a leading .We are offering
specialty retailer of 3,807,669 of the
high quality toys, shares and existing
games, books and shareholders are
multimedia products offering 2,292,331 of
for children. the shares.
.Zany Brainy, Inc. .The underwriters have
308 East Lancaster Avenue an option to purchase
Wynnewood, PA 19096 an additional 915,000
(610) 896-1500 shares from Zany
Brainy.
Proposed Symbol and .This is our initial
Market: public offering, and
no public market
currently exists for
our shares.
.ZANY/Nasdaq National
Market
.We plan to use the
proceeds from this
offering to repay bank
debt, open our new
distribution center
and additional stores,
implement new
enterprise software,
develop an internet
shopping site and for
other working capital
and general corporate
purposes. We will not
receive any proceeds
from the shares sold
by the selling
shareholders.
.Closing: , 1999
---------------------------------------------------
<TABLE>
<S> <C> <C>
Per Share Total
-----------------------------------------------------------
Public offering price: $10.00 - $12.00 $
Underwriting fees:
Proceeds to Zany Brainy:
Proceeds to the selling shareholders:
</TABLE>
---------------------------------------------------
This investment involves risks. See "Risk Factors" beginning on page 5.
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Neither the SEC nor any state securities commission has determined whether this
prospectus is truthful or complete. Nor have they made, nor will they make, any
determination as to whether anyone should buy these securities. Any
representation to the contrary is a criminal offense.
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Donaldson, Lufkin & Jenrette
BT Alex. Brown
William Blair & Company
U.S. Bancorp Piper Jaffray
The undersigned is facilitating Internet distribution.
DLJdirect Inc.
<PAGE>
[Depicted on the front cover page is a jumping child]
[Depicted on the inside front cover page are photographs of Zany Brainy stores,
customers and a picture of a young girl painting with the following text: "Zany
Brainy on a Mission To provide a unique retail environment where Inter-Activity
reigns... where connections flourish. Between parents and children. Kids and
toys. Staff and families. Store and community. Friends and peers. And, most
importantly, between the ZANYNESS of play and the BRAINYNESS of learning.
Through the experience of Inter-Activity, we spark the imagination and nurture
the sense of accomplishment so vital to every child's future."]
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary................................................. 1
Risk Factors....................................................... 5
Forward-Looking Statements......................................... 14
Use of Proceeds.................................................... 15
Dividend Policy.................................................... 15
Capitalization..................................................... 16
Dilution........................................................... 17
Selected Consolidated Historical Financial and Operating Data...... 18
Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 19
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Our Business.......................................................... 28
Management............................................................ 38
Certain Transactions.................................................. 43
Principal and Selling Shareholders.................................... 45
Description of Capital Stock.......................................... 48
Shares Eligible for Future Sale....................................... 51
Underwriting.......................................................... 52
Experts............................................................... 55
Legal Matters......................................................... 55
Additional Information................................................ 55
Index to Our Financial Statements..................................... F-1
</TABLE>
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We have not authorized any dealer, salesperson or other person to give you
written information other than this prospectus or to make representations as
to matters not stated in this prospectus. You must not rely on unauthorized
information. This prospectus is not an offer to sell these securities or our
solicitation of your offer to buy the securities in any jurisdiction where
that would not be permitted or legal. Neither the delivery of this prospectus
nor any sales made hereunder after the date of this prospectus should create
an implication that the information contained in this prospectus or the
affairs of Zany Brainy have not changed since the date of this prospectus.
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<PAGE>
PROSPECTUS SUMMARY
The following summarizes information in other sections of our prospectus,
including our consolidated financial statements and the notes to these
statements. You should read the entire prospectus carefully. Generally,
references to "Zany Brainy," "we," "us" and "our" mean Zany Brainy, Inc. and
our subsidiaries. Our fiscal year ends on the Saturday nearest to January 31
and is named for the calendar year ending closest to that date. For example,
our fiscal year ended January 30, 1999 is called "1998."
Zany Brainy
Zany Brainy is a leading and rapidly growing specialty retailer of high
quality toys, games, books and multimedia products for kids. We are a different
kind of toy store with a unique product mission and a passionate commitment to
our customers. We believe that learning should be fun. Our products entertain,
educate and spark the imaginations of children up to 12 years of age. Zany
Brainy combines this distinctive merchandise offering with superior customer
service and daily in-store events to create an interactive, "kid-friendly" and
exciting shopping experience for children and adults. We opened our first store
in Pennsylvania in 1991 and, as of May 1, 1999, we operated 82 stores in 23
states. We opened 23 new stores last year and plan to add approximately 25
stores in 1999, seven of which we have already opened, and approximately 25
stores in 2000. Our sales grew 36.6% in 1998 to $168.5 million and we
experienced comparable store sales growth of 9.1% in 1997, 9.9% in 1998 and
9.0% in the first quarter of 1999.
Our Unique Product Mission
We carefully select products that encourage children's educational,
emotional or physical development. Zany Brainy does not sell products that are
inconsistent with our mission, such as toys that may reinforce gender
stereotypes or encourage violence. In addition, we generally do not offer TV-
promoted, mass marketed items. Our extensive selection of over 15,000 stock
keeping units includes:
. Toys, games and puzzles . Infant development toys
. Books, audio cassettes and videotapes . Arts and crafts
. Computer software and electronic learning aids
. Building toys and trains
. Plush and dolls . Sport-theme toys
Many manufacturers of the specialty products we offer currently do not sell
their products through discounters or mass market retailers. Excluding books
and multimedia, we believe that generally less than 30% of the stock keeping
units that we carry are available at Toys "R" Us.
1
<PAGE>
Our Inviting and Interactive Stores
Our prototype 10,600 square foot stores are bright, colorful and inviting
and present our product offering in 11 major categories. Large banners with
unique graphics identify each of these categories to help customers find
specific items quickly. Our stores are fully-carpeted and have low shelving to
encourage children to see, touch and play with our products. Children can read
books in our reading area, try software products and play with electronic
learning aids at one of our interactive demonstration stations or watch movies
in our Zany Showtime Theater. Our stores also feature free fun every day,
offering scheduled events such as creative arts and crafts activities,
character and author appearances and mini-concerts by children's performers. We
believe these elements make our stores an attractive destination for children
and adults.
Our Knowledgeable and Highly-Trained Associates
Our highly-trained sales associates provide knowledgeable and enthusiastic
service that we believe helps us maintain the confidence, loyalty and trust of
our customers. Zany Brainy seeks employees that have a passion for addressing
the needs of our customers, enjoy working with children and appreciate how kids
learn through play. Accordingly, we actively recruit educators, child care
providers and back-to-work parents as sales associates. We train our sales
associates to proactively advise customers on product features, benefits and
age-appropriateness. In addition, we staff our stores with book, multimedia and
other specialists who have an in-depth knowledge of their product categories.
Principal Executive Offices
Zany Brainy, Inc.
308 East Lancaster Avenue
Wynnewood, PA 19096
Phone: 610-896-1500
Incorporation
We were incorporated in 1991 in Pennsylvania under the name Children's
Concept, Inc. and, in March 1999, we changed our name to Zany Brainy, Inc.
2
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered by:
Zany Brainy................ 3,807,669 shares
Selling shareholders....... 2,292,331 shares
----------------------
Total.................... 6,100,000 shares
Common stock to be
outstanding
after this offering......... 20,468,350 shares
Use of proceeds.............. We plan to use the proceeds from this offering
to repay bank debt, open a new distribution
center and additional stores, implement new
enterprise software, develop an internet
shopping site and for other working capital and
general corporate purposes. We will not receive
any proceeds from the shares sold by the selling
shareholders.
Proposed Nasdaq National
Market symbol............... ZANY
</TABLE>
The number of shares of common stock to be outstanding after this offering
is based on shares outstanding at May 1, 1999:
. excluding 3,600,710 shares of common stock issuable upon the exercise of
options and warrants outstanding as of May 1, 1999 at a weighted average
exercise price of $5.45 per share and 2,068,758 shares reserved for
future grants under our 1993 stock incentive plan and our 1998 equity
compensation plan; and
. including 25,000 shares to be sold in this offering, which shares are to
be issued in connection with the exercise of stock options immediately
prior to completion of this offering.
Generally, the information in this prospectus:
. assumes there is no exercise of the underwriters' over-allotment option;
and
. gives effect to the conversion of all outstanding shares of preferred
stock into shares of common stock.
3
<PAGE>
Summary Consolidated Financial Data
You should read the data set forth below together with our "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes included elsewhere in
this prospectus. Our fiscal year consists of 52 or 53 weeks, ends on the
Saturday nearest January 31 and is named for the calendar year ending closest
to that date. All fiscal years presented include 52 weeks of operations, except
1995, which includes 53 weeks. When reading this summary, you should be aware
that:
. Gross profit represents net sales less cost of goods sold, which
includes buying, distribution and store occupancy costs.
. A store becomes comparable in the 14th full month of store operations.
. Sales per square foot and average sales per store are based on stores
opened for the entire period.
. Pro forma, as adjusted balance sheet data represents actual data, as
adjusted, to give effect to (1) the conversion of all preferred stock
into 11,250,273 shares of common stock, (2) the sale of 3,807,669 shares
of common stock offered by us at an assumed initial public offering
price of $11.00 less underwriting fees, estimated offering expenses and
the application of the estimated net proceeds and (3) the issuance of
25,000 shares to be sold in this offering, which are to be issued
immediately prior to completion of this offering in connection with the
exercise of stock options with an aggregate exercise price of $16,750.
<TABLE>
<CAPTION>
Thirteen
Fiscal Year Weeks Ended
--------------------------------------------- ----------------
May 2, May 1,
1994 1995 1996 1997 1998 1998 1999
(in thousands, except per share, number of stores and
sales per square foot data)
Statement of Operations
Data:
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales............. $23,471 $54,372 $92,563 $123,345 $168,471 $27,452 $40,577
Gross profit.......... 6,446 13,400 23,358 33,893 50,318 7,315 11,190
Selling, general and
administrative
expenses............. 13,310 21,110 28,732 33,581 46,376 9,659 12,986
Operating income
(loss)............... (6,864) (7,710) (5,374) 312 3,942 (2,344) (1,796)
Net income (loss)..... (6,658) (7,828) (6,023) (153) 8,999(a) (2,470) (1,378)
Net income (loss) per
common share:
Basic................ $ (1.35) $ (1.55) $ (1.19) $ (0.03) $ 1.67(a) $ (0.46) $ (0.26)
Diluted (b).......... (1.35) (1.55) (1.19) (0.03) 0.51(a) (0.46) (0.26)
Weighted average
shares outstanding:
Basic................ 4,930 5,065 5,068 5,085 5,373 5,363 5,384
Diluted (b).......... 4,930 5,065 5,068 5,085 17,770 5,363 5,384
Store Data:
Number of stores at
end of the period.... 16 31 43 52 75 53 82
Total square feet at
end of the period.... 189 387 538 630 868 641 942
Comparable store sales
increase............. 17.3% 0.3% 4.3% 9.1% 9.9% 6.8% 9.0%
Sales per square
foot................. $ 245 $ 202 $ 183 $ 203 $ 227 $ 43 $ 45
Average sales per
store................ 2,502 2,382 2,286 2,523 2,746 525 522
Operating Data:
Gross profit margin... 27.5% 24.6% 25.2% 27.5% 29.9% 26.6% 27.6%
Operating margin
(loss)............... (29.2) (14.2) (5.8) 0.3 2.3 (8.5) (4.4)
Capital expenditures.. $ 5,432 $ 7,377 $ 6,276 $ 6,420 $ 7,309 $ 779 $ 2,497
Depreciation and
amortization......... 730 2,115 3,713 5,017 6,859 1,385 1,888
</TABLE>
<TABLE>
<CAPTION>
At May 1, 1999
-------------------
Pro Forma,
Actual As Adjusted
<S> <C> <C>
Balance Sheet Data:
Inventories............. $52,375 $52,375
Working capital......... 22,899 61,084
Total assets............ 94,052 118,809
Short-term borrowings... 12,402 --
Capitalized lease
obligations, including
current portion........ 4,047 4,047
Total shareholders'
equity................. 46,919 84,539
</TABLE>
- --------
(a) Net income for 1998 includes a net income tax benefit of $6,187 due to the
$7,166 benefit recorded for our net operating loss carryforward, partially
offset by income tax expense of $979.
(b) Stock options, warrants and preferred stock convertible into common stock
were excluded from the calculation of diluted net loss per common share
for 1994 through 1997 and the 13 weeks ended May 2, 1998 and May 1, 1999
as they were anti-dilutive due to the losses in each of those periods.
4
<PAGE>
RISK FACTORS
You should carefully consider the following factors and other information in
this prospectus before deciding to invest in shares of our common stock.
Risks Relating to Our Business
We have a history of net losses
Since our inception in 1991, we have reported net losses for each year
except for 1998, when we reported net income for the first time. Our net losses
were $6.0 million in 1996 and $153,000 in 1997. Our net income was $9.0 million
in 1998 and included net income tax benefit of $6.2 million due to the $7.2
million benefit recorded for our net operating loss carryforward, partially
offset by income tax expense of $1.0 million. We may incur additional net
losses in the future, which could cause our stock price to decline.
We have limited experience with the performance of our prototype stores, and
these stores may not perform up to our expectations
Our current prototype store is 10,600 square feet. Most of the stores we
opened in 1997 and 1998, as well as most of the approximately 25 stores to be
opened in 1999, are based on this prototype store, which is smaller than many
of our older stores. Our actual experience with these newer stores is generally
limited to one full year or less. Not all of our new stores have performed up
to our expectations. If our new stores fail to generate income at a level that
meets our expectations, the price of our stock could decline.
Our business is highly seasonal, and our annual results are highly dependent
on the success of our Christmas selling season
Seasonal shopping patterns affect our business. A significant portion of our
sales occur in the fourth quarter, coinciding with the Christmas holiday
shopping season. Therefore, our results of operations for the entire year
depend largely on our fourth quarter results. Factors that could negatively
affect us during the fourth quarter include:
. the availability of and customer demand for particular products;
. adverse weather conditions;
. unfavorable economic conditions;
. inability to hire adequate temporary personnel;
. inability to maintain appropriate inventory levels; and
. a late Thanksgiving, which reduces the number of days between
Thanksgiving and Christmas.
We have never been profitable in any fiscal quarter other than the fourth
quarter
Since inception, we have never been profitable in any quarter other than the
fourth quarter of any fiscal year. We expect to continue to incur losses in
every quarter other than the fourth quarter.
5
<PAGE>
If we do not successfully implement our store expansion program, our
financial growth and profitability will be adversely affected
Our success depends in large part on our ability to open and profitably
operate new stores in both existing and new geographic markets. We plan to open
approximately 25 stores during 1999, seven of which we have already opened, and
approximately 25 stores in 2000. We may not be able to achieve our planned
expansion. We plan to open approximately 14 stores in 1999 in markets where we
do not currently have a presence, four of which we have already opened. The
opening of stores in new geographic markets could present competitive and
operational challenges different from those we currently face or previously
faced in entering our existing geographic markets. For example, we may incur
higher costs related to advertising, administration and distribution as we
enter these new markets. Because our continued growth is dependent, in part, on
our ability to increase sales in our existing stores, our overall profitability
will suffer if the opening of new stores in existing markets draws business
from our existing stores. We generally prefer to open new stores in the first
three quarters of the year. Our failure to open stores on schedule may have
particularly adverse effects because of our dependence on the Christmas holiday
shopping season.
Our success in opening and profitably operating new stores will depend on a
number of factors, including our ability to:
. identify suitable sites;
. negotiate acceptable leases at attractive rents;
. access adequate capital to fund store expansion;
. construct and open stores on schedule;
. obtain acceptance in markets in which we currently have limited or no
presence; and
. locate, hire, train and retain competent managers.
On average, the net cost of opening a new store in 1996, 1997 and 1998 was
approximately $826,000, $842,000 and $750,000, respectively.
We may not have sufficient management, operational, distribution, financial
and information systems resources to accommodate our planned growth. Our
expansion strategy also presents some cultural risks, including our ability to
maintain our product mission, customer service commitment and quality control
as we become larger in size. In addition, if our new stores do not perform as
expected, we may curtail our store expansion, which would adversely affect our
financial growth and profitability.
Our comparable store sales will fluctuate
Changes in our comparable store sales results could affect the price of our
common stock. A number of factors have historically affected, and will continue
to affect, our comparable store sales results, including:
. competition;
. our new store openings;
. general regional and national economic conditions;
. consumer trends and preferences;
6
<PAGE>
. changes in our co-tenants;
. new product introductions and changes in our product mix;
. timing and effectiveness of promotional events; and
. weather.
Comparable store sales may not increase at the rates achieved in 1997 and
1998.
We may not develop an internet shopping site that is profitable
We intend to implement an internet shopping site although we have not yet
reached any formal arrangement or plan. We currently anticipate that our
internet shopping site may be developed through a joint venture arrangement and
could require significant financial, personnel and other resources, as well as
include substantial participation, both for capital or other resources, of the
management and affiliates of Zany Brainy. Any joint venture would likely reduce
Zany Brainy's equity ownership of, and decrease its ability to control, the
internet business. Electronic commerce is new and evolving and most internet
retail businesses are currently not profitable. In addition, selling our
products on the internet could divert customers from our stores and depress
existing store sales. We cannot assure that we will implement an internet
shopping site or that, if implemented, we will generate profits from our
internet business. In addition, in the event we establish an internet business,
we may have to recognize all or a portion of any losses associated with the
business and consolidate such losses into our financial statements.
The relocation of our distribution center and corporate headquarters could
disrupt our operations
In 1999, we intend to close our distribution center in Delaware and relocate
to a larger facility in New Jersey. Approximately 80% of our products are
distributed through our Delaware facility. This transition to a new
distribution center could disrupt the receipt and distribution of our
merchandise, particularly if there are any unforseen delays or interruptions in
the transition process. Any disruption in distribution could materially
adversely affect our business operations. In addition, if we are unable to
generate increased sales and profit sufficient to absorb increased overhead and
other costs associated with our relocation, we would likely experience lower
operating profit margins.
In 1999, we also plan to relocate our corporate headquarters to a larger
facility in Pennsylvania. Any delay in relocating our headquarters or
disruption to our operations as a result of the move could have a negative
impact on our business.
We may need additional financing, the terms of which could adversely affect
our business and shareholders
We currently expect that our available cash resources, including the net
proceeds from this offering and funds available under our credit facility, will
be sufficient to meet our working capital requirements for at least the next
twelve months. However, we may need additional financing to support more rapid
growth than currently anticipated or to respond to competitive pressures or
unanticipated events. Additional financing, if needed, may not be available on
satisfactory terms or at all. Any additional equity financing may cause
dilution to existing investors. Any debt financing may result in additional
restrictions on our spending or ability to pay dividends.
7
<PAGE>
Restrictive loan covenants may limit our ability to take various corporate
actions
Our credit facility contains covenants which require us to satisfy ongoing
financial requirements and which limit our ability to borrow additional money,
pay dividends, divest assets and make additional corporate investments. If we
are unable to meet any of our debt service obligations or to comply with these
covenants, our lenders can accelerate our debt. If that were to occur and we
are unable to obtain alternative financing, our business may be materially
adversely affected.
If we are unable to execute our private label program, our profit margins
could decline
We have been expanding our selection of private label products. In 1998,
approximately 3.0% of sales were attributable to our private label products. If
consumers do not perceive our private label products to be of high quality, our
efforts to increase private label sales may not succeed. Moreover, if we are
unable to execute our private label program, our profit margins could decline.
Year 2000 issues may disrupt our operations
Many existing computer systems and software products do not properly
recognize dates after December 31, 1999. This Year 2000 issue could result in
system failures or miscalculations causing disruptions of operations,
including, among others, a temporary inability to receive shipments, process
financial information or credit card transactions, deliver products or engage
in similar normal business activities.
We have recently upgraded our enterprise software system, Systems For
Retailers (SFR). SFR is a product from Creative Data Systems (CDS), which has
recently discontinued operations. Using consultants who are former employees of
CDS, we have upgraded to version 7.0, which is Year 2000 compliant. However,
because CDS is no longer in business, we may be particularly vulnerable if the
new version of SFR does not operate properly on January 1, 2000. In late 1998,
we agreed to purchase new enterprise software from JDA Software, Inc. (JDA),
which is intended to replace SFR. Although the JDA software has been certified
as Year 2000 compliant, and will entail vendor support, we decided to defer
implementation until after the Christmas selling season. If the SFR system
fails to operate on January 1, 2000 and we are unable to implement the JDA
software, our business operations could be disrupted.
We are also engaged in efforts to upgrade certain in-store systems which are
not Year 2000 compliant. If our various store systems cease to operate on
January 1, 2000, we believe that we would be able to perform necessary
functions through manual intervention. However, the use of the manual
intervention would significantly disrupt store operations.
We have initiated formal communications with many of our significant
suppliers to determine our vulnerability if these third parties fail to remedy
their own Year 2000 problems. We believe that Year 2000 issues faced by our key
suppliers, credit card processors and telecommunication providers, if not
effectively remediated, could adversely affect our business. Moreover, while we
would seek to migrate to other third parties if service providers with whom we
currently have a relationship are not Year 2000 compliant, we may not be able
to identify suitable third party substitutes on a basis that would avoid
disruptions to our operations.
We have not developed a formal contingency plan. Therefore, if we confront
significant Year 2000 issues, we could experience extended disruptions and a
drain on our financial and personnel resources.
8
<PAGE>
Our business could be materially adversely affected if our information
systems fail
Our business depends on the efficient and uninterrupted operation of our
computer and communications software and hardware systems. We regularly make
investments to upgrade, enhance and replace our systems. We must appropriately
expand the capacity of our information systems to accommodate our anticipated
growth.
SFR, the current provider of our enterprise software system, is no longer in
business. Although we have the source code and have hired former SFR employees
as consultants, we intend to replace SFR with a new software system from JDA
early in the year 2000. Any disruptions affecting our information systems or
any delays or difficulties in transitioning to JDA or other new systems could
make it more difficult to effectively operate our business.
We have no formal disaster recovery plan to prevent delays or other
complications arising from information systems failure. Our business
interruption insurance may not adequately compensate us for losses that may
occur.
We are dependent on executive management and other personnel
We believe that our success depends on the continued employment of our
management team. If one or more members of our executive management team were
unable or unwilling to continue in their present positions, our business could
be materially adversely affected. We do not carry key person life insurance on
any member of our executive management team.
Our success also depends on hiring and retaining quality managers and sales
associates in our stores. We plan to expand our employee base to manage our
anticipated growth. Competition for personnel, particularly for employees with
retail expertise, is intense. Additionally, our ability to maintain consistency
in the quality of customer service in our stores is critical to our success. If
we are unable to hire and retain sales associates capable of providing a high
level of customer service, our business could be materially adversely affected.
Risks Relating to Our Industry
The intense competition we face from other retail companies may adversely
affect our financial results
Competition from mass market retailers and discounters, which have
greater brand recognition and financial and other resources
Many mass market retailers and discounters, such as Toys "R" Us, Wal-Mart
and Target, have much greater brand recognition and greater financial,
marketing and other resources than ours. We could be at a disadvantage in
responding to these competitors' merchandising and pricing strategies,
advertising campaigns and other initiatives. In addition, an increase in focus
on the specialty retail market or the sale by these competitors of more product
similar to ours could adversely affect our merchandising strategy.
Competition from smaller format, specialty educational and creative toy
retailers, whose growth can adversely affect our sales growth
Our direct competitors are smaller format, specialty educational and
creative toy and game retailers, including Noodle Kidoodle and LearningSmith.
These retailers are continuing to expand and could affect our ability to
increase our sales.
9
<PAGE>
Competition from non-toy specialty retailers, which compete with our
children's book and software businesses and could limit our ability to
expand in these categories
Non-toy specialty retailers, such as Barnes & Noble and CompUSA, are
competing with our children's book and software businesses. We believe that
some of these competitors have exclusivity restrictions in their leases that
restrict co-tenants from selling similar products. Such restrictions could
hinder our expansion strategy by limiting our ability to sell some products at
those sites.
Competition from internet-only retailers, which may have a cost advantage
and reach a broader market
We also face growing competition from internet-based retailers, such as
eToys and Amazon.com. Because internet-based retailers do not operate retail
stores, they may enjoy an overall operating cost advantage. In addition, due to
the nature of electronic commerce, they may reach a broader market.
With respect to all of our competitors, our sales and profitability could
suffer if:
. new competitors enter markets in which we are currently operating;
. our competitors implement aggressive pricing strategies;
. our competitors expand their operations;
. our suppliers sell their products directly or enter into exclusive
arrangements with our competitors; or
. our competitors adopt innovative store formats, retail sales methods or
merchandising strategies that are similar to ours.
If our suppliers and distributors do not provide us with sufficient
quantities of our products, our sales and profitability will be adversely
affected
Products supplied to us by our top ten suppliers represented approximately
40% of purchases in 1998. Our dependence on our principal suppliers involves
risk, and if there is a disruption in supply from a principal supplier or
distributor, we may be unable to obtain the merchandise we desire to sell.
While no one supplier represented greater than 10% of purchases in 1998, a
disruption in the operations of any of our key suppliers could adversely affect
our available inventory.
Our sales could decline if key specialty suppliers sell more products
through mass market retailers.
Many of our suppliers currently provide us with certain incentives,
including return privileges, volume purchasing allowances and cooperative
advertising. A reduction or discontinuation of these incentives could reduce
our profits.
In mid-1998, we entered into a relationship with a subsidiary of Ingram
Industries Inc. (Ingram Books) to be our principal book distributor. We
previously purchased books from numerous publishers and distributors, including
Ingram Books. In 1998, our purchases from book suppliers accounted for
approximately 12% of all our purchases. Barnes & Noble recently announced that
it will acquire Ingram Books. We are unable to predict whether this acquisition
will affect the distribution of books to our stores.
10
<PAGE>
If we are unable to predict or react to changes in consumer demand, our sales
and profitability will be adversely affected
Our success depends on our ability to anticipate and respond in a timely
manner to changing consumer demand and preferences regarding toys, games, books
and multimedia products for children. Our products must appeal to a broad range
of consumers whose preferences cannot be predicted with certainty and are
subject to change. If we misjudge the market for our merchandise, we may
overstock unpopular products and be forced to take significant inventory
markdowns, which may have a negative impact on our profitability.
It is also common in the toy industry for some popular products, such as
Beanie Babies, Crazy Bones and yoyos, to achieve high sales, but for
unpredictable periods of time. In 1998, Beanie Babies represented over 5% of
our sales and in the first quarter of 1999, Beanie Babies and Crazy Bones
represented over 10% and over 5% of our sales, respectively. Consumer demand
for these products or others could decrease significantly and without warning.
If we are unable to identify new products that will enjoy strong consumer
demand, our sales may decline. In addition, the introduction of new products
may depress sales of existing products. Moreover, because we sell only those
products that conform to our product mission, we may choose not to sell some
products that our customers desire and thus lose potential sales.
If a shipment of products that we import is interrupted or delayed, our
inventory levels and sales could be adversely affected
We do not own or operate any manufacturing facilities. Instead, we buy all
of our products from manufacturers and distributors. In 1998, we imported
approximately 9% of our purchases, including most of our private label
products, directly from foreign manufacturers. In addition, we believe that a
significant portion of the products that we purchase from domestic suppliers
are manufactured abroad. We anticipate that our dependence on foreign-sourced
merchandise will increase. We are subject to the following risks inherent in
relying on foreign manufacturers:
. the inability to return products;
. fluctuations in currency exchange rates;
. economic and political instability;
. transportation delays;
. restrictive actions by foreign governments;
. the laws and policies of the United States affecting importation of
goods, including duties, quotas and taxes;
. foreign trade and tax laws;
. foreign labor practices;
. trade infringement claims; and
. increased liability as importer of record.
Interruptions or delays in our imports could cause shortages in our product
inventory and adversely affect our sales unless we secure alternative supply
arrangements. Even if we could locate alternative sources, their products may
be of lesser quality or more expensive than those we currently purchase. We
could also be affected if our suppliers experience similar problems with
foreign manufacturers.
11
<PAGE>
We are subject to inventory shrinkage, which could adversely affect our
business
As is the case in our industry generally, we are subject to loss resulting
from, among other things, theft of our products, breakage and paperwork errors.
In 1998, this inventory shrinkage represented approximately 1% of total sales.
Although we have implemented loss prevention procedures, we remain susceptible
to inventory shrinkage, which could have a negative impact on our
profitability.
Our intellectual property may not be protected
Our success depends in part on our ability to protect our intellectual
property. To protect our proprietary rights, we rely generally on copyright,
trademark and trade secret laws, confidentiality agreements with employees and
third parties and license agreements with consultants and suppliers. However, a
third party could, without authorization, copy or otherwise appropriate
information from us. Employees, consultants and others who participate in
development activities could breach their confidentiality agreements, and we
may not have adequate remedies for any such breach. Our failure or inability to
protect our proprietary rights could materially adversely affect us.
We may be exposed to product liability lawsuits and are subject to government
regulation
Children can sustain injuries from toys. We may be subject to claims or
lawsuits resulting from such injuries. We maintain liability insurance in an
amount we believe to be adequate. However, there is a risk that claims or
liabilities may exceed our insurance coverage. Moreover, we may be unable to
retain adequate liability insurance in the future. We are subject to regulation
by the Consumer Product Safety Commission and similar state regulatory
agencies. If we fail to comply with government and toy industry safety
standards, we may be subject to claims, lawsuits, fines and adverse publicity.
Risks Relating to this Offering
Provisions of Pennsylvania law and our articles of incorporation could delay
or prevent the acquisition or sale of Zany Brainy
Section 1751 of the Pennsylvania Business Corporation Law provides that our
directors are not required to regard the interests of the shareholders as being
dominant or controlling in considering the best interests of Zany Brainy.
Therefore, it could be more difficult for a third party to acquire control of
us, even if such change in control would be beneficial to shareholders. Our
articles of incorporation provide that our board of directors may issue
preferred stock without shareholder approval. The issuance of preferred stock
could make it more difficult for a third party to acquire us.
Future sales by our current shareholders may adversely affect the market
price of our stock
The market price of our common stock could decline as a result of sales of a
large number of shares in the market after this offering or the perception that
such sales could occur. These factors also could make it more difficult for us
to raise funds through future offerings of common stock.
There will be 20,468,350 shares of common stock outstanding immediately
after this offering. Of these shares, the shares sold by us in this offering
and 16,626,592 additional shares will be freely transferable without
restriction or further registration under the Securities Act of 1933, except
for any shares held by our affiliates. The remaining 34,089 shares will be
restricted and may be sold in the future only pursuant to an exemption under
the Securities Act. The holders of 13,492,604 shares of
12
<PAGE>
common stock have agreed not to sell any such securities for 135 days after the
date of this prospectus and not to sell two-thirds of such securities until
January 31, 2000 without the prior written consent of Donaldson, Lufkin and
Jenrette Securities Corporation (DLJ). DLJ may, however, in its sole
discretion, release all or any portion of the securities subject to such lock-
up agreements.
The holders of approximately 8.2 million shares of common stock, all of
which are subject to the lock-up agreements described above, have registration
rights. If they exercise such rights, shares covered by a registration
statement can be sold in the public market. We also intend to register
approximately 5.6 million shares of common stock that we have issued or may
issue under our benefit plans or pursuant to option agreements. After such
registration statement is effective, shares issued upon exercise of stock
options to persons other than affiliates will be eligible for resale in the
public market without restriction, which could adversely affect our stock
price. Absent such registration, such shares could nevertheless be sold,
subject to limitations on the manner of sale. Sales by affiliates could also
occur, subject to certain limitations, under Rule 144 of the Securities Act.
Investors will be subject to market risks typically associated with initial
public offerings
There has not been a public market for our common stock. We cannot predict
the extent to which a trading market will develop or how liquid that market
might become. If you purchase shares of common stock in this offering, you will
pay a price that was not established in the public trading markets. The initial
public offering price will be determined by negotiations among the
underwriters, the selling shareholders and us. You may not be able to resell
your shares at or above the initial public offering price and may suffer a loss
on your investment.
The market price of our common stock is likely to be highly volatile as the
stock market in general has been highly volatile. Factors that could cause
fluctuation in the stock price may include, among other things:
. actual or anticipated variations in quarterly operating results;
. changes in financial estimates by securities analysts;
. conditions or trends in our industry;
. changes in the market valuations of other retail companies;
. announcements by us or our competitors of significant acquisitions,
strategic partnerships, divestitures, joint ventures or other strategic
initiatives;
. capital commitments;
. additions or departures of key personnel; and
. sales of common stock.
Many of these factors are beyond our control. These factors may cause the
market price of our common stock to decline, regardless of our operating
performance.
13
<PAGE>
FORWARD-LOOKING STATEMENTS
We have made statements under the captions "Prospectus Summary," "Risk
Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and elsewhere in this
prospectus that are forward-looking statements. You can identify these
statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "estimate," and "continue" or similar words. Forward-
looking statements may also use different phrases. Forward-looking statements
address, among other things: (1) our future expectations; (2) projections of
our future results of operations or of our financial condition; or (3) other
"forward looking" information.
We believe it is important to communicate our expectations to our investors.
However, there may be events in the future that we are not able to accurately
predict or which we do not fully control that could cause actual results to
differ materially from those expressed or implied by our forward-looking
statements, including:
. our inability to manage our growth, open new stores on a timely basis and
successfully expand in new and existing markets;
. changes in general economic and business conditions and in the specialty
retail or toy industry in particular;
. actions by our competitors;
. the level of demand for our products;
. changes in our business strategies; and
. other factors discussed under "Risk Factors."
14
<PAGE>
USE OF PROCEEDS
The net proceeds we will receive from the sale of 3,807,669 shares in this
offering will be approximately $37.6 million. This is based upon an assumed
initial public offering price of $11.00 per share and after deducting estimated
underwriting fees and expenses payable by us estimated at $4.3 million. We will
receive additional net proceeds of up to approximately $9.4 million if the
underwriters exercise the option granted to them in connection with this
offering to purchase additional shares of our stock to cover over-allotments.
We will not receive any proceeds from the sale of shares by the selling
shareholders.
We plan to use $15.0 million of the proceeds from this offering to repay
bank debt, $13.0 million to open our new distribution center and additional
stores, $2.0 million to implement new enterprise software and the balance for
other working capital and general corporate purposes. Our bank debt consists of
a $35.0 million revolving credit facility. At May 1, 1999, the outstanding
balance under our credit facility was $12.4 million. Borrowings under the
credit facility bear interest at variable rates, and the weighted average
interest rate at May 1, 1999 was 7.75%. Although the initial term of the credit
facility expires on October 8, 2000, it is anticipated that our current credit
facility will be replaced effective upon completion of this offering with a new
$30.0 million revolving credit facility. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources." A portion of the proceeds from this offering may be used to
implement an internet shopping site. We may also use a portion of the proceeds
to acquire other companies. Although Zany Brainy from time to time is engaged
in negotiations related to possible acquisitions, no agreements relating to
acquisitions are pending.
Pending uses of the net proceeds, we intend to invest the net proceeds in
short-term investment grade securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock and do
not anticipate paying any cash dividends in the foreseeable future. We
currently intend to retain future earnings, if any, to finance operations and
the expansion of our business. Our current credit facility prohibits payment of
any dividends, as will our planned new credit facility when implemented.
15
<PAGE>
CAPITALIZATION
The following table sets forth our actual and pro forma, as adjusted cash,
short term debt and total capitalization May 1, 1999. Our pro forma, as
adjusted, capitalization gives effect to:
. the conversion of all outstanding shares of preferred stock into
11,250,273 shares of common stock upon the consummation of this offering;
. the issuance and sale of the 3,807,669 shares of common stock offered by
us in this offering;
. the application of the estimated net proceeds from the sale of our common
stock based on an assumed initial public offering price of $11.00 per
share and after deducting underwriting fees and estimated offering
expenses payable by us; and
. the issuance of 25,000 shares to be sold in this offering, which are to
be issued immediately prior to the completion of this offering in
connection with the exercise of stock options for an aggregate purchase
price of $16,750.
You should read this table in conjunction with the consolidated financial
statements and the notes to those statements and the other financial
information included in this prospectus.
<TABLE>
<CAPTION>
At May 1, 1999
--------------------
Pro Forma,
Actual As Adjusted
(in thousands)
<S> <C> <C>
Cash..................................................... $ 923 $26,246
======= =======
Short term debt and current portion of capitalized lease
obligations............................................. $14,057 $ 1,655
======= =======
Capitalized lease obligations, net of current portion.... $ 2,392 $ 2,392
------- -------
Shareholders' equity:
Preferred stock......................................... 24 --
Common stock (a)........................................ 54 205
Additional paid-in capital.............................. 60,832 98,325
Accumulated deficit..................................... (13,991) (13,991)
------- -------
Total shareholders' equity............................. 46,919 84,539
------- -------
Total capitalization................................. $49,311 $86,931
======= =======
</TABLE>
- --------
(a) The table above excludes an aggregate of 3,600,710 shares issuable upon
exercise of stock options and warrants outstanding at May 1, 1999, plus an
additional 2,068,758 shares reserved for issuance in connection with
future stock options and other awards under our 1993 stock incentive plan
and 1998 equity compensation plan.
16
<PAGE>
DILUTION
Our pro forma net tangible book value as of May 1, 1999 was $46.8 million or
$2.81 per share. Our pro forma net tangible book value per share is determined
by subtracting the total amount of our liabilities from the total amount of our
tangible assets and dividing the remainder by the number of shares of our
common stock outstanding after giving effect to the conversion of preferred
stock into 11,250,273 shares of common stock and the issuance of 25,000 shares
of common stock to be sold in the offering, which are to be issued immediately
prior to the completion of this offering in connection with the exercise of
stock options with an aggregate exercise price of $16,750. The pro forma net
tangible book value per share after this offering will be $4.12 less than the
price per share to the public in this offering, based on an assumed initial
public offering price of $11.00 per share. Therefore, purchasers of shares of
common stock in this offering will realize immediate dilution of $6.88 per
share. The following table illustrates this dilution.
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $11.00
Pro forma net tangible book value per share as of May 1, 1999... $2.81
Increase in net tangible book value per share attributable to
new investors.................................................. 1.31
-----
Pro forma net tangible book value per share after this offering... 4.12
------
Dilution per share purchased in this offering..................... $ 6.88
======
</TABLE>
The following table presents, as of May 1, 1999 and assuming an initial
public offering price of $11.00 per share, for our existing shareholders and
our new investors:
. the number of shares of our common stock purchased from us;
. the total cash consideration paid;
. the average price per share paid before deducting estimated underwriting
fees and our estimated offering expenses; and
. the average price per share paid by the existing holders of common stock
including the holders of common stock after giving effect to the
conversion of preferred stock into 11,250,273 shares of common stock.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ -------------------- Price
Number Percent Amount Percent Per Share
---------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders......... 16,660,681 81.4% $ 64,763,329 60.7% $ 3.89
New investors................. 3,807,669 18.6 41,884,359 39.3 11.00
---------- ----- ------------ -----
Total....................... 20,468,350 100.0% $106,647,688 100.0%
========== ===== ============ =====
</TABLE>
The tables on this page exclude all outstanding options and warrants. See
"Management--Stock Option Plan" and note 9 to our consolidated financial
statements. The exercise of outstanding options and warrants having an exercise
price less than the initial public offering price would increase the dilution
effect to new investors that is shown on the tables. Also, the second table on
this page does not give effect to sales of shares by the selling shareholders.
Sales by the selling shareholders in this offering will reduce the number of
shares held by existing shareholders to 14,368,350 shares, or 70.2% of the
shares outstanding, and will increase the number of shares held by new
investors to 6,100,000 shares, or 29.8% of the shares outstanding.
This offering will benefit our existing shareholders. Based on an assumed
initial public offering price of $11.00 per share, the selling shareholders
will receive approximately $23.5 million in net proceeds. In addition, the
current shareholders, including members of management, will benefit from the
creation of a public market for our common stock and any increase in the market
value of any shares they hold. Upon consummation of this offering, the
unrealized appreciation in the value of the common stock held by existing
shareholders will be $98.1 million.
17
<PAGE>
SELECTED CONSOLIDATED HISTORICAL FINANCIAL AND OPERATING DATA
Our statement of operations data for 1996, 1997 and 1998 and the balance
sheet data as of January 31, 1998 and January 30, 1999 have been derived from
the consolidated financial statements, which have been audited by Arthur
Andersen LLP, independent public accountants, and are included in this
prospectus. Our statement of operations data for fiscal 1994 and 1995 and the
selected balance sheet data as of January 28, 1995, February 3, 1996 and
February 1, 1997 have been derived from our audited consolidated financial
statements which are not included in this prospectus. You should read the data
set forth below together with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and the notes relating to those statements appearing in the
prospectus.
When reading this data, you should be aware that:
. Our fiscal year consists of 52 or 53 weeks, ends on the Saturday nearest
January 31 and is named for the calendar year ending closest to that
date. All fiscal years presented include 52 weeks of operations, except
1995, which includes 53 weeks.
. A store becomes comparable in the 14th full month of store operations.
. Sales per square foot and average sales per store are based on stores
opened for the entire period.
<TABLE>
<CAPTION>
Thirteen
Fiscal Year Weeks Ended
---------------------------------------------- ----------------
May 2, May 1,
1994 1995 1996 1997 1998 1998 1999
(in thousands, except per share, number of stores and
sales per square foot data)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net sales............. $23,471 $54,372 $ 92,563 $123,345 $168,471 $27,452 $40,577
Cost of goods sold,
including occupancy
costs................ 17,025 40,972 69,205 89,452 118,153 20,137 29,387
------- ------- -------- -------- -------- ------- -------
Gross profit......... 6,446 13,400 23,358 33,893 50,318 7,315 11,190
Selling, general and
administrative
expenses............. 13,310 21,110 28,732 33,581 46,376 9,659 12,986
------- ------- -------- -------- -------- ------- -------
Operating income
(loss).............. (6,864) (7,710) (5,374) 312 3,942 (2,344) (1,796)
Interest income
(expense), net....... 206 (118) (649) (465) (1,130) (126) (427)
------- ------- -------- -------- -------- ------- -------
Income (loss) before
income tax benefit.. (6,658) (7,828) (6,023) (153) 2,812 (2,470) (2,223)
Income tax benefit.... -- -- -- -- 6,187 -- 845
------- ------- -------- -------- -------- ------- -------
Net income (loss).... $(6,658) $(7,828) $ (6,023) $ (153) $ 8,999(a) $(2,470) $(1,378)
======= ======= ======== ======== ======== ======= =======
Net income (loss) per
common share:
Basic................ $ (1.35) $ (1.55) $ (1.19) $ (0.03) $ 1.67(a) $ (0.46) $ (0.26)
Diluted (b).......... (1.35) (1.55) (1.19) (0.03) 0.51(a) (0.46) (0.26)
Weighted average
shares outstanding:
Basic................ 4,930 5,065 5,068 5,085 5,373 5,363 5,384
Diluted (b).......... 4,930 5,065 5,068 5,085 17,770 5,363 5,384
Store Data:
Number of stores at
end of the period.... 16 31 43 52 75 53 82
Total square feet at
end of the period.... 189 387 538 630 868 641 942
Comparable store sales
increase............. 17.3% 0.3% 4.3% 9.1% 9.9% 6.8% 9.0%
Sales per square
foot................. $ 245 $ 202 $ 183 $ 203 $ 227 $ 43 $ 45
Average sales per
store................ 2,502 2,382 2,286 2,523 2,746 525 522
Operating Data:
Gross profit margin... 27.5% 24.6% 25.2% 27.5% 29.9% 26.6% 27.6%
Operating margin
(loss)............... (29.2) (14.2) (5.8) 0.3 2.3 (8.5) (4.4)
Capital expenditures.. $ 5,432 $ 7,377 $ 6,276 $ 6,420 $ 7,309 $ 779 $ 2,497
Depreciation and
amortization......... 730 2,115 3,713 5,017 6,859 1,385 1,888
Balance Sheet Data:
Inventories........... $11,097 $20,538 $ 24,278 $ 29,822 $ 43,252 $34,713 $52,375
Working capital....... 9,509 15,220 21,599 20,085 25,542 18,158 22,899
Total assets.......... 25,238 41,393 56,376 59,552 82,141 59,683 94,052
Capitalized lease
obligations, less
current portion...... 422 2,231 2,620 1,407 2,860 1,239 2,392
Total shareholders'
equity............... 16,535 28,372 38,547 39,219 48,291 36,761 46,919
</TABLE>
- --------
(a) Net income for 1998 includes a net income tax benefit of $6,187 due to the
$7,166 benefit recorded for our net operating loss carryforward, partially
offset by income tax expense of $979.
(b) Stock options, warrants and preferred stock convertible into common stock
were excluded from the calculation of diluted net loss per common share for
1994 through 1997 and the 13 weeks ended May 2, 1998 and May 1, 1999 as
they were anti-dilutive due to the losses in each of those periods.
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the "Selected Consolidated Financial Data" and our consolidated financial
statements and the related notes which are included in this prospectus.
Overview
Zany Brainy is a rapidly growing specialty retailer of high quality toys,
games, books and multimedia products for children, with 82 stores operating in
23 states as of May 1, 1999. From 1995 to 1998, our net sales grew at a
compound annual growth rate of 45.8%, while our operating income increased from
a loss of $7.7 million to income of $3.9 million. These increases were
principally due to the opening of new stores and comparable store sales growth.
We achieved comparable store net sales growth of 4.3%, 9.1% and 9.9% in 1996,
1997 and 1998, respectively, and 6.8% and 9.0% for the 13 weeks ended May 2,
1998 and May 1, 1999, respectively.
We opened our first store in 1991 and embarked on an aggressive store
opening strategy in 1994. We opened 11 stores in 1994, 15 stores in 1995 and 12
stores in 1996; however, our operating results in 1995 and 1996 were
disappointing. At this time we hired our current management team, which
evaluated Zany Brainy's business strategies and reached the following
conclusions:
. sales per store did not materially differ based on store size, but our larger
stores had higher expenses;
. the clustering of stores in the same markets led, in some instances, to
significant sales cannibalization;
. our merchandise selection did not include several key product categories and
was not updated frequently enough;
. we had a poor price image; and
. our marketing efforts did not effectively reach our target customers.
To address these problems, our new management reduced the size of our
prototype store to 10,600 square feet and modified our expansion strategy to
emphasize entering new markets and opening fewer stores in any single market.
We began to update the merchandise in our stores more frequently to attract
repeat customers and added new product categories. We also took steps to
improve our price image by focusing our advertising and in-store communications
on competitive pricing and overall value. Finally, we revised our marketing
strategy by developing an enhanced and enlarged customer database. With the
information provided by this database, we used direct mail to more effectively
target our marketing efforts and expand our customer base. These strategies
have resulted in improved operating results.
With our new prototype store in place, we opened nine stores in 1997 and 23
in 1998, increasing our store base from 43 stores at the end of 1996 to 75
stores at the end of 1998. We plan to open approximately 25 new stores in 1999,
seven of which we have already opened, and approximately 25 new stores in 2000.
19
<PAGE>
Over the last three years, we have decreased the average size of the new
stores we have opened from 12,476 square feet for those opened during 1996 to
10,447 square feet for those opened during 1998. As a result, our chain-wide
average store size has decreased. During the same period, our average sales per
store increased from $2.3 million to $2.7 million, and our sales per square
foot increased from $183 to $227. In addition, because smaller stores typically
have lower occupancy costs, our new stores have contributed to improved gross
margins.
Our fiscal year includes 52 or 53 weeks, ends on the Saturday closest to
January 31 and is named for the calendar year ending closest to that date. The
fiscal years ended February 1, 1997, January 31, 1998 and January 30, 1999
include 52 weeks. For purposes of calculating comparable store sales, a store
is deemed to become comparable in its 14th full month of operations in order to
eliminate grand opening sales distortions. Also, cost of goods sold includes
buying, distribution and store occupancy costs.
Results of Operations
The following table presents our financial data expressed as a percentage of
net sales and store data for the periods indicated:
<TABLE>
<CAPTION>
Thirteen Weeks
Fiscal Year Ended
--------------------- -------------------
May May
2, 1,
1996 1997 1998 1998 1999
<S> <C> <C> <C> <C> <C> <C>
Net sales................... 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold.......... 74.8 72.5 70.1 73.4 72.4
----- ----- ----- ----- -----
Gross profit.............. 25.2 27.5 29.9 26.6 27.6
Selling, general and
administrative expenses.... 31.0 27.2 27.6 35.1 32.0
----- ----- ----- ----- -----
Operating income (loss)... (5.8) 0.3 2.3 (8.5) (4.4)
Interest expense, net....... (0.7) (0.4) (0.6) (0.5) (1.1)
----- ----- ----- ----- -----
Income (loss) before
income taxes............. (6.5)% (0.1)% 1.7 % (9.0)% (5.5)%
===== ===== ===== ===== =====
Comparable store sales
increase................... 4.3 % 9.1 % 9.9 % 6.8 % 9.0 %
===== ===== ===== ===== =====
</TABLE>
Thirteen Weeks Ended May 1, 1999 Compared to the Thirteen Weeks Ended May 2,
1998
Net Sales. Net sales increased by $13.1 million, or 47.8%, to $40.6 million
for the 13 weeks ended May 1, 1999 from $27.5 million in the comparable 1998
period. This increase resulted from a comparable store sales increase of $2.5
million, or 9.0%, $9.2 million in sales from stores opened in 1998 not included
in our comparable sales base, and sales of $1.4 million from seven new stores
opened during the period. The sales growth was primarily due to an increase in
customer transaction level as well as strong sales of popular items such as
Beanie Babies and Crazy Bones.
Gross Profit. Gross profit increased by $3.9 million, or 53.0%, to $11.2
million during the period, from $7.3 million in the same period last year. As a
percentage of net sales, gross profit increased to 27.6% for the thirteen weeks
ended May 1, 1999 from 26.6% in the comparable 1998 period. The increase in the
gross profit percentage was primarily due to greater leveraging of store
occupancy expenses partially offset by a slight decrease in product margins.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses increased by $3.3 million to $13.0 million for the
thirteen weeks ended May 1, 1999, from $9.7 million in the same period last
year. The dollar increase in these expenses was primarily attributable
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<PAGE>
to an increase of $2.0 million in store payroll and other selling expenses
primarily associated with an additional 29 stores open over the same period
last year. As a percentage of net sales, selling, general and administrative
expenses decreased by 3.1% to 32.0% of net sales for the thirteen weeks ended
May 1, 1999, from 35.1% in the comparable 1998 period. Preopening expense
increased $526,000 over the same period last year due to the opening of seven
new stores, an increase of six stores from the same period last year. Corporate
expenses increased $307,000 to support the additional store growth. The
percentage decrease in selling, general and administrative expenses was
primarily related to the leveraging of corporate expenses over a larger revenue
base.
Interest Expense, Net. Net interest expense was $427,000 for the period, an
increase of $301,000 from the comparable period in 1998. This increase was due
to greater borrowing to fund working capital needs and open an additional seven
stores during the period.
Income Tax Benefit. For the 13 weeks ended May 1, 1999, we recorded a net
income tax benefit of $845,000 primarily related to the Federal tax benefit of
the net loss. For the 13 weeks ended May 2, 1998, no benefit was recorded with
respect to the net operating loss carryforward because we established a
valuation allowance.
1998 Compared to 1997
Net Sales. Net sales increased by $45.2 million, or 36.6%, to $168.5 million
in 1998 from $123.3 million in 1997. Sales for the 23 stores opened in 1998
contributed $25.7 million of the increase in net sales. Comparable store net
sales increased 9.9% over the prior year and contributed $11.7 million of the
increase in net sales. The growth in comparable store sales was due primarily
to an increase in the number of customer transactions. Stores open prior to
February 1, 1998 but not qualifying as comparable stores contributed $7.8
million of the increase in net sales.
Gross Profit. Gross profit increased by $16.4 million to $50.3 million in
1998 from $33.9 million in 1997. As a percentage of net sales, gross profit
increased to 29.9% in 1998 from 27.5% in 1997. The increase in the gross profit
percentage was primarily attributable to improved product margins and
leveraging store occupancy, buying and distribution costs over a higher revenue
base. Product margins increased by 1.0% of net sales in 1998 primarily due to
an increase in sales of products with a higher gross margin. The decrease in
store occupancy expense of 0.9% of net sales is primarily due to the 9.9%
increase in comparable store sales and the timing of new store openings. The
decrease in the buying and distribution costs of 0.6% of net sales was due to
the application of fixed costs over a higher revenue base.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $12.8 million to $46.4 million in 1998
from $33.6 million in 1997. The dollar increase in these expenses was due
principally to an increase of $4.3 million in store payroll and $1.2 million in
store preopening costs primarily due to an increase in the number of stores in
1998, an increase of $2.7 million in corporate expenses associated with the
expansion of our store base and corporate infrastructure to support our
continued growth and an increase of $1.9 million in marketing and promotion
expenditures primarily related to the opening of stores in new market areas. In
addition, in 1998 we incurred a $450,000 charge related to the write-down of
certain assets. (See Note 1 to the consolidated financial statements.) As a
percentage of net sales, selling, general and administrative expenses increased
by 0.4% to 27.6% of net sales in 1998 from 27.2% of net sales in 1997. This
percentage increase was primarily related to an increase of 0.7% of net sales
in marketing and promotion and an increase of 0.5% of net sales in store
preopening expenses associated with opening 23 stores in 1998 versus nine
stores in 1997. These were partially offset by a decrease of 0.5% of net
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sales in store payroll and other selling expenses due to an increase in
comparable store sales during 1998.
Interest Expense, Net. Net interest expense, principally attributable to
borrowings under our credit facility, increased by $665,000 to $1.1 million in
1998 from $465,000 in 1997, due to an increase in the average outstanding loan
balance to $6.4 million in 1998 from $1.5 million in 1997. The increase in
average borrowings in 1998 reflected the opening of 23 new stores and
additional working capital requirements to support those stores.
Income Tax Benefit. In 1998, we recorded a net income tax benefit of $6.2
million due to the $7.2 million benefit recorded for our net operating loss
carryforward, partially offset by the 1998 income tax expense of $979,000. In
previous years, no benefit was recorded with respect to the net operating loss
carry forward because we established a valuation allowance. We reversed the
valuation allowance as a result of management's assessment that it is more
likely than not that our net deferred tax assets will be realized through
future taxable earnings. Management's assessment was based on the trend toward
income in 1996 and 1997, the utilization of $5.8 million of the net operating
loss carryforward in 1998, and 1999 and 2000 financial projections.
1997 Compared to 1996
Net Sales. Net sales increased by $30.7 million, or 33.3%, to $123.3 million
in 1997 from $92.6 million in 1996. Sales for the nine stores opened in 1997
contributed $14.8 million of the increase in net sales. Comparable store net
sales increased 9.1% over the prior year and contributed $7.9 million of the
increase in net sales. We believe the increase in comparable store sales in
1997 was primarily the result of an increase in the size of our average
customer transaction. Stores open prior to 1997 but not qualifying as a
comparable store contributed $8.0 million of the increase in net sales.
Gross Profit. Gross profit increased by $10.5 million to $33.9 million in
1997 from $23.4 million in 1996. As a percentage of net sales, gross profit
increased to 27.5% in 1997 from 25.2% in 1996. This increase was primarily due
to a reduction in store occupancy, buying and distribution expense as a
percentage of net sales. The decrease in store occupancy expense of 1.2% of
sales was primarily due to the 9.1% increase in comparable store sales and the
timing of new store openings. The decrease in buying and distribution costs of
0.9% of net sales was due to the application of fixed costs over a higher
revenue base.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased by $4.9 million to $33.6 million in 1997 from
$28.7 million in 1996. The dollar increase in these expenses was primarily
attributable to $3.2 million in store payroll and other selling expenses
associated with the opening of nine stores in 1997. As a percentage of net
sales, selling, general and administrative expenses decreased by 3.8% to 27.2%
of net sales in 1997 from 31.0% of net sales in 1996. This decrease was
primarily due to a 2.2% decrease as a percent of net sales in corporate
expenses, reflecting the application of fixed costs over a higher revenue base,
and a 1.2% decrease as a percent of net sales in store payroll and other
expense.
Interest Expense, Net. Net interest expense, principally attributable to our
credit facility, decreased by $184,000 to $465,000 in 1997 from $649,000 in
1996.
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<PAGE>
Quarterly Results of Operation and Seasonality
The following table presents certain unaudited results of operations for our
nine fiscal quarters ended May 1, 1999. The unaudited quarterly information
includes all normal recurring adjustments which we consider necessary for a
fair presentation of the information shown. We do not believe that these
quarterly results are necessarily indicative of future results.
<TABLE>
<CAPTION>
1997 1998 1999
------------------------------------- ------------------------------------- -------
First Second Third Fourth First Second Third Fourth First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- ------- -------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............... $22,382 $21,943 $23,446 $55,574 $27,452 $29,654 $30,661 $80,704 $40,577
As a % of full year.... 18.1 % 17.8 % 19.0 % 45.1% 16.3 % 17.6 % 18.2 % 47.9% N/A
Gross profit............ $ 5,252 $ 4,992 $ 6,331 $17,318 $ 7,315 $ 7,544 $ 8,590 $26,869 $11,190
As a % of full year.... 15.5 % 14.7 % 18.7 % 51.1% 14.5 % 15.0 % 17.1 % 53.4% N/A
As a % of net sales.... 23.5 22.8 27.0 31.2 26.6 25.4 28.0 33.3 27.6
Operating income
(loss)................. $(2,420) $(2,677) $(1,916) $ 7,325 $(2,344) $(4,048) $(3,485) $13,819 $(1,796)
As a % of net sales.... (10.8)% (12.2)% (8.2)% 13.2% (8.5)% (13.7)% (11.4)% 17.1% (4.4)%
Number of stores:
Opened during period... 2 1 5 1 1 4 8 10 7
Open at end of period.. 45 46 51 52 53 57 65 75 82
Comparable store sales
increase............... 9.5 % 8.2 % 7.0 % 10.4% 6.8 % 13.4 % 9.1 % 10.0% 9.0%
</TABLE>
We have experienced, and we expect to continue to experience, substantial
seasonal fluctuations in our sales and operating results, which is typical of
many retailers. This is primarily due to the Christmas holiday shopping season
as well as the contribution of new stores opened during the year. We have
historically experienced net operating losses in the first three quarters of
each year, which we expect to continue. In addition, the timing of new store
openings and related preopening expenses and the revenue contributions of new
and existing stores may cause our quarterly results to fluctuate.
Liquidity and Capital Resources
Our main sources of liquidity have been cash flows from operations,
borrowing under our credit facilities, and proceeds from equity financings. We
require cash principally to finance capital investment in new stores, new store
inventories, and seasonal working capital. We opened 12 stores in 1996, nine
stores in 1997, 23 stores in 1998, and seven stores during the 13 weeks ended
May 1, 1999 versus one store opened during the 13 weeks ended May 2, 1998.
Cash flows used in operating activities were $11.6 million for the 13 weeks
ended May 1, 1999, compared to $3.9 million for the 13 weeks ended May 2, 1998.
Cash flows used in operating activities for the 13 weeks ended May 1, 1999 were
primarily due to a net loss, adjusted for depreciation and amortization and the
deferred portion of the income tax benefit, an increase in inventories and
prepaid expenses and a decrease in accrued liabilities. Cash used in operating
activities for the 13 weeks ended May 2, 1998 was primarily due a net loss,
adjusted for depreciation and amortization and an increase in inventories and
prepaid expenses partially offset by an increase in accounts payable.
Cash flows provided by our operating activities were $5.4 million in 1998,
compared to $3.5 million in 1997. Cash flows provided by operating activities
in 1998 were primarily from net income, adjusted for depreciation and
amortization and the deferred portion of the income tax benefit, and an
increase in accounts payable partially offset by an increase in inventories.
Cash provided by
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<PAGE>
operating activities in 1997 reflects increases in payables, accrued
liabilities and depreciation and amortization partially offset by an increase
in inventories. Cash flows used in operating activities were $2.7 million in
fiscal 1996 primarily due to a loss of $6.0 million offset by the impact of
depreciation and amortization.
Cash flows used in investing activities were $2.5 million for the 13 weeks
ended May 1, 1999, compared to $779,000 for the 13 weeks ended May 2, 1998. Our
cash used in investing activities primarily represents our capital expenditures
in opening new stores and continued infrastructure development. Cash used in
investing activities in 1998 was $7.3 million, compared to $6.4 million in 1997
and $6.3 million in 1996. Our cash used in investing activities primarily
represents our capital expenditures in opening new stores and continued
infrastructure development.
Cash flows provided by financing activities were $13.3 million for the 13
weeks ended May 1, 1999, compared to $191,000 for the 13 weeks ended May 2,
1998. Our cash provided by financing activities in 1999 primarily represents
borrowings under our credit agreement. Cash used in financing activities in
1998 was $1.4 million and $782,000 in 1997. Cash provided by financing
activities was $15.2 million in 1996. Over the last three years our primary
financing activities have involved borrowings and repayments under our credit
agreement and sales of equity securities. Cash used in financing in 1997 and
1998 was primarily from the repayment of capital leases partially offset in
1997 by proceeds from the exercise of warrants. Our cash provided by financing
activities in 1996 was from the sale of $16.2 million of preferred stock.
Our principal use of operating cash is to purchase inventory for our stores.
Our need for working capital to purchase inventory is reduced by supplier
credit terms that allow us to finance a portion of our purchases.
Our primary long-term capital requirement is for the opening of new stores.
We lease all of our stores. We currently expect to open approximately 25 stores
in 1999, seven of which we have already opened, and approximately 25 stores in
2000. The average net cost of opening a store in 1998 was approximately
$750,000. This amount included approximately $320,000 of inventory, net of
accounts payable, $340,000 for leasehold improvements and fixtures, net of
landlord allowances, and $90,000 for pre-opening expenses. We expense our pre-
opening expenses as they are incurred. Our actual cost to open new stores
varies widely and depends on factors such as the extent and expense of required
construction, changes in store format and any landlord allowances.
We estimate that capital expenditures for 1999 will be approximately $17.0
million, and will be used to develop new stores, enhance our management
information systems and purchase fixtures and equipment for our new
distribution facility. This estimate does not include any expenditure that we
may make to develop an internet shopping site.
We currently have a credit facility that provides for revolving loans in an
aggregate outstanding principal amount of up to $35 million, including up to
$7.5 million in the form of letters of credit, with an option to increase the
total available to $60 million under certain conditions. The actual
availability under our credit facility is limited to a seasonally-based
calculation of 55% to 65% of our eligible inventory, less any letters of credit
outstanding. At May 1, 1999, the total borrowing limit, including the letters
of credit, was $27.5 million. At May 1, 1999, $12.4 million of borrowings and
$656,000 of letters of credit were outstanding. Interest on outstanding
indebtedness under the revolving credit facility accrues at the lender's prime
commercial lending rate or, if we elect, at LIBOR plus 2.5%. Our obligations
under the loan agreement are secured by interests in substantially
24
<PAGE>
all of our personal property, including, our accounts receivable, inventories,
equipment, machinery, contract rights and chattels. The credit facility matures
on October 8, 2000. We use our credit facility to meet our seasonal working
capital requirements.
Upon completion of this offering, we plan to obtain a new $30.0 million
unsecured revolving line of credit, a portion of which may be in the form of
letters of credit. The proposed line bears interest at prime or LIBOR plus
1.75% at our option.
The credit facility contains a tangible net worth covenant and other
restrictions regarding our ability to merge, consolidate or acquire non-
subsidiary entities, make loans, incur debts or liens, pay cash dividends, or
engage in substantial asset sales. As of May 1, 1999, we were in compliance
with the terms of the credit facility.
At May 1, 1999, we had a deferred tax asset of $5.7 million for net
operating loss carryforwards which is available for use in future periods.
We believe that cash flow from operations, funds available under our credit
facilities and the net proceeds from this offering will be sufficient to
satisfy our capital requirements for at least the next 12 months.
Year 2000 Compliance
Zany Brainy is conducting a comprehensive review of its computer systems and
other microprocessor-based equipment to identify how we may be affected by the
Year 2000 issue. The Year 2000 issue results from the writing of computer
programs using two digits, rather than four, to define the applicable year. As
a result, commencing in 2000, date-sensitive software may recognize a date
using "00" as 1900 rather than 2000. This could result in a systems failure or
miscalculations causing disruptions of operations, including a temporary
inability to receive shipments, process financial information, process credit
card transactions, deliver products or engage in other normal business
activities.
Our Year 2000 Readiness
Information Technology Systems. Our core business is run on SFR, an
enterprise software system. The functions supported by SFR include buying,
replenishment, physical distribution, general ledger and payables. SFR is a
product from CDS, a subsidiary of Sterling Software. CDS has recently
discontinued operations. The upgrade to version 7.0, which is Year 2000
compliant, was completed in the first quarter of 1999.
Late in 1998, we agreed to purchase new enterprise software from JDA. This
software will replace SFR for all of the functional areas currently served by
SFR. This software has been certified Year 2000 compliant by the Information
Technology Association of America and runs on IBM AS400 hardware which has been
certified by IBM to be Year 2000 compliant. We intend to have the conversion
process completed and ready for implementation in December 1999. However, given
the increased business volume during the Christmas season, we have decided to
defer implementation until after the Christmas selling season. In the event the
SFR system fails to operate on January 1, 2000, we believe we will be
positioned to implement the Year 2000 compliant JDA software.
Our in-store systems consist of two application suites and a common
Microsoft NT server network which is Intel based. The application suites are
supplied by ICL Retail, Inc. (ICL), and provide point-of-sale (POS) and store
inventory systems (SIS) support for store management
25
<PAGE>
functions. We have determined that our POS and SIS systems are not Year 2000
compliant, but are currently assessing whether the Year 2000 issues are raised
by the application suites themselves or by certain Microsoft tools that we use
with the application suites. We expect to complete this assessment in May 1999.
Due to potential compatibility issues, we plan to upgrade the Microsoft NT
operating systems in all stores. The new operating system has been certified by
Microsoft to be Year 2000 compliant. We are currently testing the new operating
system, and expect to complete testing in the second quarter of 1999. Some of
the store register hardware is not Year 2000 compliant, but we believe that we
can achieve compliance by rebooting the system and adjusting time and date
parameters. We intend to take these measures prior to the opening of businesses
following December 31, 1999. We are engaged in a project with ICL that is
designed to achieve Year 2000 compliance by the third quarter of 1999.
We are currently assessing the Year 2000 readiness of our server, SIS
workstation hardware, email applications, and software demonstration stations.
We anticipate that this assessment will be completed in the second quarter of
1999. We plan to have our store systems achieve Year 2000 compliance for
software, operating systems and hardware in the third quarter of 1999.
Non-Information Technology Systems. Non-information technology systems
include the security systems in our stores, headquarters and distribution
centers, faxes and voicemail. Based on our assessment of these systems, we have
determined that these systems do not raise Year 2000 issues.
Significant Third Party Relationships. We have initiated formal
communications with our significant suppliers to determine our vulnerability if
these third parties fail to remedy their own Year 2000 problems. We believe
that Year 2000 issues faced by our key suppliers, credit card processors and
telecommunications providers, if not effectively remediated, could adversely
affect our business. We are not currently able to assess the scope of such
issues as they may affect these suppliers and providers or the effect of such
issues on us.
Possible Consequences of Year 2000 Issue
If store systems should cease to operate on January 1, 2000, we have several
options available to continue to process sales and receipts in our stores. In a
worst case scenario, the existing disaster procedure to hand-write receipts
would be put into place. The receipt of purchase orders and transfers would
also be recorded manually. If the situation were a result of the registers' and
servers' failure to recognize the new year, the capability exists to set the
system dates back to 1999 and continue to process sales transactions. Sales
receipts would need to be date stamped by hand. Additional effort would be
required to ensure sales and receipt data is subsequently processed correctly.
This would require incremental manual intervention. While the cost of manual
intervention would not be material, the use of manual intervention would
significantly disrupt store operations.
If our telecommunications and credit card processing service providers are
not Year 2000 compliant on a timely basis, our operations could be materially
adversely affected. If our telecommunications providers are not compliant, we
would be required to migrate our service to a compliant vendor. If our credit
card processor is not compliant, we would be required to approve and settle
credit requests manually.
Anticipated Costs of Year 2000 Compliance
We have incurred approximately $25,000 in costs associated with Year 2000
issues, all of which is attributable to software upgrades, including version
7.0 of SFR. The total cost associated with
26
<PAGE>
modifications, upgrades and/or replacements to become Year 2000 compliant is
not expected to be material to our financial position. We currently estimate
that we will incur costs of approximately $150,000 relating to Year 2000
compliance, including $110,000 for software and operating system compliance and
$40,000 for hardware compliance. These costs will be expensed as incurred. We
intend to use funds from operations to cover our Year 2000 costs.
Lack of Contingency Plans
We have not developed a formal contingency plan. If Year 2000 problems are
discovered, we will address these issues as they occur.
Inflation
We do not believe that inflation has had a material effect on our financial
position or results of operations during the past three years. However, we
cannot predict the future effects of inflation.
27
<PAGE>
OUR BUSINESS
Zany Brainy is a leading and rapidly growing specialty retailer of high
quality toys, games, books and multimedia products for kids. We are a
different kind of toy store with a unique product mission and a passionate
commitment to our customers. We believe that learning should be fun. We sell
over 15,000 products that entertain, educate and spark the imaginations of
children up to 12 years of age. Zany Brainy combines this distinctive
merchandise offering with superior customer service and daily in-store events
to create an interactive, "kid-friendly" and exciting shopping experience for
children and adults.
We opened our first store in Wynnewood, Pennsylvania in 1991. The current
management team assumed leadership during 1995 and 1996. This team refined our
store model and operating strategies and, starting in 1997, accelerated our
store growth. We opened 23 new stores last year and, as of May 1, 1999, Zany
Brainy operated 82 stores in 23 states. We plan to add approximately 25 stores
in 1999, seven of which we have already opened, and approximately 25 stores in
2000. Our sales grew 36.6% in 1998 to $168.5 million and we experienced
comparable store sales growth of 9.1% in 1997, 9.9% in 1998 and 9.0% in the
first quarter of 1999.
Our Strategies
Our goals are to establish Zany Brainy as the leading specialty retailer of
high quality toys, games, books and multimedia products for kids and to build
Zany Brainy into a national brand that represents the "best stuff for kids."
The key elements of our growth and operating strategies to achieve these goals
include:
Pursue Store Expansion Program
We believe that Zany Brainy has nationwide appeal and significant new store
expansion opportunities over the next several years. We anticipate opening
approximately 25 stores in 1999, seven of which we have already opened, and
approximately 25 stores in 2000. Our expansion strategy is to continue to open
new stores in markets where we believe we can become the dominant retailer of
high quality toys, games, books and multimedia products for children as well
as to open more stores in our existing markets. In 1999, we plan to open
approximately 14 stores in new markets, four of which we have already opened,
and to open approximately 11 stores in existing markets.
Increase Sales Productivity of Existing Store Base
We are committed to increasing productivity in existing stores through the
following initiatives:
. frequently updating our merchandise presentation and selection to attract
repeat customers;
. utilizing advertising to attract and retain customers and expand consumer
awareness of our brand;
. continuing to invest in the training of sales associates; and
. further improving our in stock position and speed-to-market with new
products by upgrading our distribution and management information systems
infrastructure.
28
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Offer a Unique Merchandise Mix
We strive to carry a product selection that addresses the needs of our
customers and which meaningfully differs from that of our competitors. We
believe that our selection represents a comprehensive offering for customers
seeking products that enable their children to have fun while learning. We do
not sell products that we believe are inconsistent with our mission, such as
toys that may reinforce gender stereotypes or encourage violence. In addition,
we generally do not offer TV-promoted, mass marketed items. Excluding books and
multimedia, we believe that less than 30% of the stock keeping units that we
carry are available at Toys "R" Us. We seek to keep our merchandise selection
new and exciting, and to satisfy our customers' changing preferences.
Accordingly, we seek to update at least 20% of our merchandise each year. To
further differentiate our merchandise selection, we work closely with several
specialty suppliers to secure exclusive product or licensing arrangements.
Provide Exceptional Customer Service
We believe that our high level of service differentiates the shopping
experience at our stores, enables us to attract customers and creates customer
loyalty and trust. We actively recruit educators, child care providers and
back-to-work parents as sales associates because we believe they have a respect
and affection for children and an appreciation of how children learn through
play. Our employees participate in an extensive training program and learn to
proactively assist our customers in selecting products. In addition, we staff
our stores with book, multimedia and other specialists who have an in-depth
knowledge of their specific areas. We also provide convenient services, such as
free gift wrapping and shipping at cost.
Provide a Destination Store Environment
We design our stores to be a destination for both children and adults to
enjoy free fun every day. We offer daily, in-store events such as mini-
concerts, story time, face-painting, character appearances and a summer reading
club. We provide a hands-on shopping experience and encourage children to play
with our products in the store. Our "kid-friendly" stores are colorful,
welcoming and exciting with attractive carpeting and designated play areas
located throughout the store.
Develop an Internet Sales Channel
We intend to implement an internet shopping site. We currently anticipate
that our internet shopping site may be developed through a joint venture
arrangement.
Industry and Competition
We believe that the market for our product categories was approximately
$14.0 billion in 1998. However, we do not sell some of the products included in
these categories because they are inconsistent with our product mission or
inappropriate for children 12 years and under.
The toy retailing market is comprised of:
. mass market retailers, including superstores such as Toys "R" Us and
discounters such as Wal-mart and Target;
. smaller format specialty educational and creative toy and game retailers
such as Noodle Kidoodle and LearningSmith;
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<PAGE>
. non-toy specialty retailers, such as traditional book, music, video and
software retailers;
. internet-only retailers; and
. a variety of other retailers offering a subset of our products including
card and gift shops, craft stores and department stores.
The mass market retailers have traditionally offered a broad range of
products with a particular focus on TV-promoted products. We believe that mass
market retailers' emphasis on these products, combined with the impersonal
environment and reduced service levels typical of a large format superstore,
limits their ability to meet the needs of our customers.
Some of the smaller format specialty educational and creative toy and game
retailers offer products similar to ours. However, we generally operate larger
stores, which enables us to carry a wider product assortment. In addition, some
of these competitors supplement their product offering with items that we
believe are inconsistent with our mission to sell the "best stuff for kids."
Moreover, we provide a broader program of special events than these
competitors.
Many non-toy speciality retailers, such as traditional book and software
retailers, offer an extensive selection of products in specific categories.
However, we believe our comprehensive merchandise offering of toys, games,
books and multimedia products for kids satisfies our customers' need for a
variety and selection of products. Internet-only retailers provide customers
with an on-line shopping forum. We believe we differentiate ourselves from
internet competitors by providing a high level of customer service and a "kid
friendly" environment in which children are encouraged to see, touch and play
with our products.
Our Merchandising Approach
We believe that our customers trust us to provide high quality merchandise
for kids at the right price. We carefully select products that encourage
children's educational, emotional or physical development. We do not sell
products that we believe are inconsistent with our mission, such as toys that
reinforce gender stereotypes or encourage violence. In addition, we generally
do not offer TV-promoted, mass marketed items. We believe that this
merchandising philosophy has enabled us to earn the confidence, loyalty and
trust of our customers.
30
<PAGE>
Our Distinctive Merchandise Selection
We purchase over 15,000 stock keeping units from more than 400 suppliers in
20 different countries. While our products generally range in price from less
than one dollar up to $200, the average price paid for a single product is less
than $10. We present our merchandise across 11 product categories to satisfy a
broad spectrum of customer needs. Our extensive selection of merchandise
includes:
<TABLE>
<CAPTION>
Category Description
- -------- -----------
<S> <C>
Toys and Games
Brainy Games and Puzzles......... Board games and puzzles.
Bright Start..................... Toys for ages up to three.
Creativity....................... Arts and crafts supplies and kits.
Good Sports...................... Indoor and outdoor sport-theme toys.
Kidtronics....................... Electronic learning aids and musical
instruments.
Let's Pretend.................... Pretend play, dress up and doll houses.
Our Planet....................... Science-related toys.
Plush and Dolls.................. Stuffed animals and dolls.
Young Builders................... Building toys and trains.
Books................................ Extensive selection of over 7,000 titles.
Multimedia........................... Software, audio and video.
</TABLE>
We regularly offer numerous limited distribution, innovative products. In
many cases, we have worked with suppliers to first introduce their products in
our stores. We believe many manufacturers of specialty products do not sell
their products through discounters or mass market retailers. To further
differentiate our merchandise offering, we also work closely with several
specialty suppliers to secure exclusive product or licensing arrangements. We
also supplement our merchandise offering with our own product development
efforts. We sell our private label products under such brand names as "Ready,
Set, Grow!" and "Kidstruments."
Our Competitive Pricing
We generally position ourselves to be competitive in price, but we do not
attempt to be the discount leader in a given market. We do, however, maintain a
policy of matching our competitors' advertised prices.
31
<PAGE>
Store Operations
Our Store Design
We design our stores to be bright, colorful and inviting for children and
adults. Our current store prototype is 10,600 square feet and contains 11 major
categories of products. Large banners with unique graphics identify each of
these categories to enable customers to find specific items quickly. Our stores
are fully carpeted and have low shelving to encourage children to see, touch
and play with our products. Departments are located around the perimeter of the
store in a "racetrack" style to promote browsing and impulse sales. We have a
play center in the middle of our stores that is surrounded with large red
pillars so children can locate it easily. We also provide seating in the play
center so adults can comfortably play with their children. We typically locate
our Zany Showtime Theater, which is used to show the latest video releases,
adjacent to the play center so we can combine the two spaces to accommodate
larger special events. A reading area is situated next to our book department,
and software demonstration stations are placed near our multimedia department
to encourage sampling of these items.
[Store layout graphic]
Our Store Associates
We strive to complement our innovative store design with superior customer
service to provide an enjoyable shopping experience. We believe our prompt,
knowledgeable and enthusiastic service fosters the confidence and loyalty of
our customers and differentiates us from our competitors. We actively recruit
educators, child care providers and back-to-work parents as store employees
because we believe that these people are most likely to have a respect and
affection for children, and an appreciation of how children learn through play.
Because we consider customer relations and product knowledge to be critical
components of our merchandising strategy, we emphasize product and customer
service training. Our sales associates receive approximately 25 hours of
training within their first month of employment and are tested before they are
designated a "Certified Kidsultant." We train our sales associates to
proactively advise customers on product features, benefits and age-
appropriateness.
32
<PAGE>
In addition, some of our sales associates receive supplemental training to
become specialists in various areas including books, multimedia and events. We
also provide an abbreviated form of training for seasonal employees. Once a
year, all store managers attend a "Play Day" where they are introduced to and
trained in the features and benefits of various new products. The store
managers then train our sales associates in these products.
Our stores are typically staffed with a general manager, three assistant
managers, four specialists, and a varying number of part-time sales associates,
depending on store volume and time of year. A general manager and three
assistant managers, who may be specialists, typically manage each store, and
are responsible for building relationships within the community. The operations
of each store are supervised by one of 11 district managers who each in turn
report to one of three regional managers. Each regional manager reports to the
vice president of stores.
Zany Brainy stores are open seven days a week, generally from 10:00 a.m. to
9:00 p.m. Monday through Saturday and 11:00 a.m. to 6:00 p.m. on Sunday.
Store Locations
We select geographic markets and store sites on the basis of demographic
information, quality and nature of co-tenants store visibility and
accessibility. Key demographics include population density, household income,
the number of households with children and education level. We locate our
stores primarily in suburban strip or power centers as well as in selected
free-standing locations. We typically seek sites with co-tenants that are
strong, destination and lifestyle-oriented retailers such as Borders, Old Navy,
PETsMART, Bed, Bath & Beyond or upscale supermarkets.
33
<PAGE>
The map and store list below present the stores we operated as of May 1,
1999:
[Map of United States showing store locations]
1996 Openings
-------------------------
City, State Sq. Footage
---------------- -----------
Naperville, IL 12,481
Oak Brook, IL 12,996
Orland Park, IL 13,614
Durham, NC 13,010
Raleigh, NC 12,701
Marlton, NJ 15,520
Edison, NJ 14,000
Springfield, NJ 12,530
Akron, OH 10,052
Columbus, OH 12,015
Mayfield
Heights, OH 9,556
Fairless Hills,
PA 11,236*
Pre-1995 Openings
- ------------------------
City, State Sq. Footage
- ---------------- -----------
Wilmington, DE 8,400
Marietta, GA 12,500
Sandy Springs,
GA 13,500
Annapolis, MD 12,045
Columbia, MD 12,000
Rockville, MD 12,368
East Brunswick,
NJ 12,000
Mount Laurel, NJ 10,208
Wayne, NJ 13,500
Jenkintown, PA 12,460
Lancaster, PA 12,150
Newtown, PA 10,846
Strafford, PA 8,500
Wynnewood, PA 10,875
Fairfax, VA 13,801
Sterling, VA 12,421 1998 Openings
-------------------------
City, State Sq. Footage
---------------- -----------
Brea, CA 10,350
Concord, CA 10,500
Mission Viejo,
CA 11,116
Montclair, CA 10,816
Newport Beach,
CA 10,876
Orange, CA 10,644
Pasadena, CA 10,600
San Mateo, CA 10,687
Valencia, CA 10,081
Overland Park,
KS 10,600
Lexington, KY 12,850
Gaithersburg, MD 10,500
Ballwin, MO 10,600
Brentwood, MO 10,418
Scarsdale, NY 9,207
Winston-Salem,
NC 8,249
Columbus, OH 10,600
Cool Springs, TN 10,650
Brentwood, TN 10,088
Fredericksburg,
VA 8,039
Redmond, WA 10,479
Tukwila, WA 11,200
Brookfield, WI 11,122
-----------------------------------------
Average Sq.
Footage......... 12,476
1997 Openings
-------------------------
City, State Sq. Footage
---------------- -----------
Birmingham, AL 10,000
San Diego, CA 10,500
Thousand Oaks,
CA 10,440
Torrance, CA 10,500
Indianapolis, IN 10,016
Louisville, KY 11,841
Charlotte, NC 12,500
Madison, WI 10,000
Milwaukee, WI 9,885
- -----------------------------------------
Average Sq.
Footage........ 11,723
1995 Openings
- ------------------------
City, State Sq. Footage
- ---------------- -----------
Alpharetta, GA 13,582
Marietta, GA 11,100*
Norcross, GA 15,001 -----------------------------------------
Northbrook, IL 15,058
Schaumburg, IL 15,000 Average Sq.
Wheaton, IL 12,499 Footage........ 10,447
Eatontown, NJ 13,044 1999 Openings
Princeton, NJ 11,372 -------------------------
Warrington, PA 12,500
Huntingdon City, State Sq. Footage
Valley, PA 12,500 ---------------- -----------
Bailey's
Crossroads, VA 13,329 Dublin, CA 10,500
Woodbridge, VA 12,593 Huntington
Fairfax, VA 12,814 Beach, CA 10,625
Reston, VA 12,716 Colorado
Springfield, VA 12,000 Springs, CO 9,108
Timonium, MD 10,184
Roseville, MN 10,607
Omaha, NB 10,500
Murray, UT 9,470
-----------------------------------------
Average Sq.
Footage........ 10,631
- -----------------------------------------
Average Sq.
Footage........ 13,007 -----------------------------------------
- --------
*Excludes square footage licensed to a third party.
Average Sq.
Footage........ 10,142
34
<PAGE>
Marketing
Advertising
We use direct mail and newspaper advertising to promote Zany Brainy products
and increase awareness of our stores and brand. We primarily rely on direct
mail advertising, which allows us to capitalize on our growing, internally-
generated database. A variety of direct mail pieces, including our large, color
"Zany Zone" catalog, are mailed throughout the year to both current and
prospective customers. We also use full color newspaper inserts for broader
consumer reach during our peak selling periods. We advertise most heavily
during the Christmas holiday and back-to-school seasons. Our suppliers
contribute to some of our advertising costs through co-op advertising.
We use grand opening events to create traffic in new stores and to introduce
Zany Brainy to the community. Through a combination of advertising promotions,
public relations efforts and community outreach activities, we seek to generate
strong opening weekend sales, significant media exposure and community
involvement with Zany Brainy. For example, we design our grand opening events
to enable our store employees to initiate relationships with children-focused
organizations such as schools, museums, zoos and daycare centers.
Free Fun Every Day
The Zany Brainy store environment and special events program are integral
parts of our marketing strategy. We believe they provide an exciting shopping
and learning experience for kids and adults. Our stores always feature several
interactive areas, including play centers and software demonstration stations.
In addition, we show movies throughout the day at our Zany Showtime Theater. We
publish a monthly calendar of free events for our stores. Each of our stores
hosts regular daily activities for kids, including creative arts and crafts
activities, character and author appearances and mini-concerts by children's
performers. In order to enhance customer loyalty, we established a summer
reading club in 1993. In 1998, the summer reading club had approximately 26,000
members. The National Geographic Society and America Online are among the
organizations that have sponsored our summer reading club. We believe that
these activities create an enjoyable shopping experience and strengthen our
position as a family-oriented destination store.
Purchasing and Suppliers
We purchase merchandise from over 400 suppliers in 20 different countries.
We believe that our buying power and ability to make centralized purchases
enable us to acquire products on favorable terms.
In mid-1998, we entered into a relationship with Ingram Books to be our
principal book distributor. We believe that this arrangement provides a
comprehensive, cost-effective alternative to purchasing books from multiple
publishers and distributors. In addition, Ingram ships directly to each of our
stores, improving our in-stock position and ensuring that we carry current,
popular titles.
Additionally, we host vendor-supported in-store programs to increase
customer product knowledge in a friendly, hands-on environment. For example, we
periodically schedule "Young Builders Days," when representatives from
suppliers provide children with the opportunity to play with and learn about
their products.
Our central buying staff is comprised of one vice president, two divisional
merchandise managers and seven buyers, each of whom is responsible for
purchasing selected categories of our
35
<PAGE>
products. Our buyers generally have extensive purchasing experience with major
toy or other speciality retailers. We also maintain an in-house private label
product development team that develops products which are unique to Zany Brainy
and offer higher profit margins. In addition, we have a merchandise planning
team that manages inventory levels and the flow of merchandise through our
stores. This team works closely with our buying staff to react quickly to sales
trends and improve in stock levels at our stores.
Distribution
We currently operate one distribution center in Delaware that contains
approximately 120,000 square feet. Approximately 80% of our products are
distributed through this facility and the balance is shipped to the stores
directly by the manufacturer or supplier. Our automated inventory replenishment
system optimizes the inventory levels at each of our stores. This computerized
system retrieves sales information from our stores, enabling us to pick, price
and ship products to each of our stores on a weekly basis. This method of
allocation and distribution improves our operating performance by reducing
overall inventory costs while maintaining high in stock percentages.
After analyzing our distribution facilities and systems in light of our
anticipated growth, we decided to close our two distribution centers in
Delaware, one of which closed in April 1999, and consolidate distribution
center operations in a new 250,000 square foot facility in Swedesboro, New
Jersey. We anticipate closing the other Delaware facility in connection with
the opening of our new Swedesboro facility, which is scheduled to occur in the
summer of 1999. The new distribution center will be automated to increase
productivity. We also plan to implement a new warehouse management system as
part of the JDA software installation that we anticipate completing in the
first quarter of 2000. This more sophisticated system should enable us to
accept smaller but more frequent deliveries from suppliers, reducing inventory
in the distribution center and stockouts at our stores.
Management Information Systems
Our management information systems include a business-wide software package,
SFR, that supports our major back-office functions, including buying,
replenishment, physical distribution, general ledger and payables. In late
1998, we agreed to purchase a more sophisticated software package from JDA to
replace SFR. JDA will support the same business functions as SFR, but it also
includes forecasting capabilities and more advanced replenishment and trend
algorithms. We believe the implementation of JDA, which we anticipate
completing in the first quarter of 2000, will further increase our operating
efficiencies.
At the store level, we utilize a point-of-sale system to capture sales
transactions that includes a price look-up, UPC scanning, check and credit
authorization and zip code capture. Our store systems interface with our
business-wide software system to automatically replenish inventory, by stock
keeping unit, to each store. We also analyze this information to tailor our
merchandise assortment, determine markdowns, generate forecasts and evaluate
product and supplier performance.
Proprietary Rights
To protect our proprietary rights, we generally rely on copyright, trademark
and trade secret laws, confidentiality agreements with employees and third
parties and license agreements with consultants and suppliers. Each of "Zany
Brainy," "A Zillion Neat Things for Kids," "Zany Zone" and "Price Chomper" has
been registered as a service mark and/or trademark with the United States
36
<PAGE>
Patent and Trademark Office. In addition, we have numerous pending applications
for trademarks. "ZanyBrainy.com" has also been registered as an internet domain
name.
Employees
As of May 1, 1999, we employed approximately 1,700 employees, approximately
750 of whom were employed full-time. We also employ additional personnel during
peak selling periods. We consider our relationships with our employees to be
good. None of our employees are covered by collective bargaining agreements.
Properties
Our corporate headquarters are located at 308 East Lancaster Avenue in
Wynnewood, Pennsylvania, where we lease approximately 36,000 square feet. Our
lease expires June 30, 1999. We plan on relocating our corporate headquarters
to King of Prussia, Pennsylvania in June 1999 to increase our office space to
approximately 52,000 square feet. We have an option to lease another 10,000
square feet in the new location. The lease has an initial term of ten years
with two five-year renewal options.
We also currently lease one distribution center in New Castle, Delaware
consisting of approximately 120,000 square feet. This lease will expire in
March 2000. We plan on closing our New Castle distribution center and moving
into a facility in Swedesboro, New Jersey in the summer of 1999. The lease for
the distribution center in New Castle will be assumed by our new landlord
following our occupancy of the new facility in Swedesboro. The new distribution
center consists of approximately 250,000 square feet, and we have an option to
expand the distribution center by a minimum of 100,000 and up to 250,000 square
feet. The new distribution center lease has an initial term of five years with
two five-year renewal options. We closed a smaller distribution center in April
1999 when its lease expired.
We lease all of our stores. Initial lease terms are generally for ten years,
and most leases contain multiple five-year renewal options. We generally select
a new store site six to 18 months before its opening. Our stores are primarily
in suburban strip or power shopping centers as well as in selected free-
standing locations. As of May 1, 1999, we had 25 signed leases for stores we
plan to open in 1999, seven of which we have already opened, and two signed
leases for stores we plan to open in 2000.
Legal Proceedings
We are from time to time involved in litigation that we believe ordinarily
accompanies a retail business. We do not believe that any of our pending or
threatened litigation will result in an outcome that would materially affect
our business.
37
<PAGE>
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors are:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Keith C. Spurgeon......... 44 Chairman of the Board and Chief Executive Officer
Thomas G. Vellios......... 44 President
Robert A. Helpert......... 55 Chief Financial Officer, Secretary and Treasurer
C. Donald Dorsey.......... 57 Director
Robert A. Fox............. 69 Director
Gerald R. Gallagher....... 58 Director
Henry Nasella............. 52 Director
Yves B. Sisteron.......... 43 Director
David V. Wachs............ 73 Director
</TABLE>
The current executive officers and directors, along with their backgrounds,
are set forth below:
Keith C. Spurgeon has served as our Chairman of the Board and Chief
Executive Officer since January 1998. He served as our President and Chief
Executive Officer from June 1996 to January 1998. Prior to joining us, Mr.
Spurgeon was at Toys "R" Us for over ten years where he served in various
capacities, most recently as Vice President for Asia and Australia.
Thomas G. Vellios has served as our President since January 1998. He joined
Zany Brainy in November 1995 as Executive Vice President of Merchandising and
Marketing. Prior to joining us, Mr. Vellios was at Caldor, Inc. for nine years,
where he served in various capacities, most recently as Senior Vice President
and General Merchandise Manager.
Robert A. Helpert has served as our Chief Financial Officer, Secretary and
Treasurer since May 1995. Prior to joining us, from February 1994 to May 1995,
Mr. Helpert was the Executive Vice President and Chief Financial Officer for
Trans World Entertainment Corporation. Prior to joining Trans World, from 1988
to 1994, he was President and Chief Operating Officer of W.H. Smith, Inc., an
operator of hotel and airport newsstands and gift shops.
C. Donald Dorsey has served as one of our directors since June 1994. Mr.
Dorsey has served as Executive Vice President of PETsMART, Inc. since 1994.
From 1989 to February 1997 and November 1997 to March 1998, Mr. Dorsey also
served as PETsMART's Chief Financial Officer.
Robert A. Fox has served as one of our directors since January 1993. Mr. Fox
is the President of R.A.F. Industries, Inc. and affiliates, diversified
manufacturing, distribution and service companies, which he founded in 1979.
Mr. Fox also currently serves as a director of Safeguard Scientifics, Inc. and
Prime Bancorp, Inc.
Gerald R. Gallagher has served as one of our directors since June 1994. Mr.
Gallagher has been a general partner of Oak Investment Partners, a venture
capital firm, since 1987. Before joining Oak Investment Partners, he was Vice
Chairman of Dayton Hudson Corporation. Currently, Mr. Gallagher serves as a
director of P.F. Chang's China Bistro, Inc.
38
<PAGE>
Henry Nasella has served as one of our directors since October 1993. Mr.
Nasella has been the Chairman, Chief Executive Officer and President of Star
Markets Company, Inc., a Boston-based grocery retailer since September 1994.
From January 1994 to September 1994, he was a principal of Phillips-Smith
Specialty Venture Capital. Mr. Nasella formerly served as President and Chief
Operating Officer of Staples Inc. He currently serves as a director of Au Bon
Pain Co., Inc.
Yves B. Sisteron has served as one of our directors since June 1994. Mr.
Sisteron has been a principal of Global Retail Partners, L.P., an investment
fund, since January 1996 and a manager of U.S. investments for Carrefour S.A.
since 1993. Mr. Sisteron currently serves as a director of P.F. Chang's China
Bistro, Inc.
David V. Wachs has served as one of our directors since October 1993. Mr.
Wachs currently serves as a consultant to Charming Shoppes, Inc., a retail
company he co-founded.
Mr. Nasella was elected to our board pursuant to a provision of our
shareholders agreement that entitles David Schlessinger, the founder and former
chairman of Zany Brainy, to designate two directors to our board. In August
1998, Mr. Schlessinger waived his right to designate directors in the future.
Messrs. Fox and Wachs were elected to our board pursuant to a provision of our
shareholders agreement that entitles Mr. Fox to designate one director, in
addition to himself, to our board. Messrs. Gallagher and Sisteron were elected
to our board pursuant to a provision of our shareholders agreement that
entitles Oak Investment Partners V Limited Partnership and Fourcar B.V.,
respectively, to designate directors to our board. The shareholders agreement
terminates upon consummation of this offering.
Committees of the Board of Directors
The board of directors has established an audit committee, a compensation
committee and a nominating committee.
Messrs. Dorsey, Fox and Wachs comprise the audit committee. The audit
committee reviews with management our internal financial controls, accounting
procedures and reports. The audit committee also reviews the engagement of our
independent auditors, makes recommendations to the board of directors regarding
the selection of independent auditors and reviews the scope, fees and results
of any audit.
Messrs. Gallagher, Nasella and Sisteron comprise the compensation committee.
The compensation committee administers all of our salary and incentive
compensation policies. The compensation committee also administers our stock
option plans and establishes the terms and conditions of all stock option
grants.
Messrs. Nasella and Spurgeon comprise the nominating committee. The
nominating committee evaluates board performance and recommends nominees to the
board of directors.
Director Compensation
Directors do not receive any cash compensation for service as directors,
however, they are reimbursed for the expenses they incur in attending meetings
of the board or board committees. All directors are eligible to participate in
our stock option plans.
39
<PAGE>
Executive Compensation
The following table sets forth information concerning the compensation
earned by our chief executive officer and our two other executive officers for
services rendered in all capacities to us in the year ended January 30, 1999.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual
Compensation
----------------- All Other
Name and Principal Position Year Salary Bonus Compensation(a)
- --------------------------- ---- ------ -------- ---------------
<S> <C> <C> <C> <C>
Keith C. Spurgeon, Chairman and Chief
Executive Officer..................... 1998 $300,000 $135,000 $2,335
Thomas G. Vellios, President........... 1998 275,000 110,000 2,466
Robert A. Helpert, Chief Financial
Officer, Secretary and Treasurer...... 1998 262,500 91,875 6,666
</TABLE>
- --------
(a) Represents premiums paid by us with respect to term life insurance for the
benefit of the named executive officer.
Stock Option Information
There were no stock option grants to any of the executive officers named in
the Summary Compensation Table during fiscal year 1998.
In April 1999, Messrs. Spurgeon, Vellios and Helpert received options to
purchase 100,000, 125,000, and 25,000 shares of common stock, respectively, at
an exercise price of $11.75 per share. Each of the options vests in four equal
installments commencing on the first anniversary of the date of grant and
expires ten years from the date of grant.
The following table sets forth information with respect to the number and
value of outstanding options held by the executive officers named in the
Summary Compensation Table at the end of 1998.
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Year End(#) at Year End ($)(a)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Keith C. Spurgeon........... 237,500 462,500 1,796,500 3,472,000
Thomas G. Vellios........... 175,000 275,000 1,325,500 2,059,000
Robert A. Helpert........... 113,750 161,250 866,600 1,219,200
</TABLE>
- --------
(a) Based on an assumed initial public offering price of $11.00 per share,
minus the exercise price, multiplied by the number of shares underlying the
option.
Stock Option Plans
1993 Stock Incentive Plan
We have a 1993 stock incentive plan, under which we have reserved for
issuance 2,500,000 shares of common stock. The 1993 plan provides for grants of
incentive stock options, nonqualified
40
<PAGE>
stock options, stock appreciation rights and stock awards to our key employees
and non-employee directors. The compensation committee of the board of
directors administers and interprets the plan.
The exercise price of common stock underlying an option may be greater, less
than or equal to fair market value. However, the exercise price of an incentive
stock option must be equal to or greater than the fair market value of a share
of common stock on the date such incentive stock option is granted, and the
exercise price of an incentive stock option granted to an employee who owns
more than 10% of the common stock may not be less than 110% of the fair market
value of the underlying shares of common stock on the date of grant.
The maximum term of an option is ten years from the date of grant except
that the term of an incentive stock option granted to an employee who owns more
than 10% of the common stock may not exceed five years from the date of grant.
The compensation committee may accelerate the exercisability of any or all
outstanding options in the event of a dissolution, liquidation or change in
control.
As of May 1, 1999, 2,450,487 options were outstanding under the 1993 plan.
Zany Brainy does not anticipate that any additional stock options will be
granted under the 1993 plan after the date of the offering.
1998 Equity Compensation Plan
We have a 1998 equity compensation plan under which we have reserved for
issuance 3,000,000 shares of common stock. The 1998 plan provides for grants of
incentive stock options, nonqualified stock options, stock appreciation rights,
restricted stock and performance units to our designated employees, advisors
and consultants, and to non-employee directors. The 1998 plan provides that no
more than 500,000 shares in the aggregate may be granted to any individual in
any calendar year. The compensation committee of the board of directors
administers and interprets the plan.
The exercise price of common stock underlying an option may be greater, less
than or equal to fair market value. However, the exercise price of an incentive
stock option must be equal to or greater than the fair market value of a share
of common stock on the date such incentive stock option is granted, and the
exercise price of an incentive stock option granted to an employee who owns
more than 10% of the common stock may not be less than 110% of the fair market
value of the underlying shares of common stock on the date of grant.
The maximum term of an option is ten years from the date of grant except
that the term of an incentive stock option granted to an employee who owns more
than 10% of the common stock may not exceed five years from the date of grant.
The compensation committee may accelerate the exercisability of any or all
outstanding options at any time for any reason.
Upon a change of control, the compensation committee may determine that:
. 50% of all unvested options shall immediately vest;
. the restrictions and conditions on all outstanding restricted stock shall
immediately lapse; and
. holders of performance units shall receive a payment in settlement of
such units, in an amount determined by the compensation committee in its
sole discretion.
As of May 1, 1999, 941,600 options were outstanding under the 1998 plan.
41
<PAGE>
Section 162(m). Under Section 162(m) of the Internal Revenue Code, we may be
precluded from claiming a federal income tax deduction for total remuneration
in excess of $1,000,000 paid to the chief executive officer or to any of the
other four most highly compensated officers in any one year. Total remuneration
would include amounts received upon the exercise of stock options granted under
the plan and the value of shares received when the shares of restricted stock
became transferable or such other time when income is recognized. An exception
does exist, however, for "performance-based compensation," including amounts
received upon the exercise of stock options pursuant to a plan approved by
shareholders that meets certain requirements. The 1998 plan has been approved
by shareholders and is intended to make grants of options thereunder meet the
requirements of "performance-based compensation." Awards of restricted stock
generally will not qualify as "performance-based compensation."
Nonqualified Stock Options
Prior to the adoption of the 1993 stock incentive plan and subsequent to the
1993 plan's adoption with respect to certain persons or entities unable to
receive grants under the 1993 plan, we granted to certain employees,
consultants and advisors non-qualified stock options under individual
agreements with the grantees. As of May 1, 1999, 130,000 options were
outstanding under these separate agreements. All of these options expire ten
years after the date of grant.
Employment Agreements
In 1996, we entered into employment agreements with each of Keith C.
Spurgeon, Thomas G. Vellios and Robert A. Helpert. Under these employment
agreements, Messrs. Spurgeon, Vellios and Helpert are entitled to receive a
base salary, which may be increased from time to time, and such additional
compensation as may be awarded to them. In addition, Messrs. Spurgeon, Vellios
and Helpert received stock option grants under these employment agreements for
400,000 shares, 200,000 shares and 140,000 shares, respectively, at an exercise
price of $4.00 per share. These stock option grants were subsequently repriced
to $3.33 per share and are governed by the terms of our 1993 stock incentive
plan. The 1999 base salaries for Messrs. Spurgeon, Vellios and Helpert are
$300,000, $300,000 and $275,000, respectively.
Each of the employment agreements contains the following principal terms:
. severance payment equal to six months of the employee's base salary if
the employee is terminated for any reason other than for cause or a
change of control.
. severance payment equal to one year of the employee's base salary, if the
employee is terminated or the employee's responsibilities are
significantly reduced after a change in control.
. the option to resign and still receive a severance payment equal to one
year of the employee's base salary within one year after a change of
control if, after the change in control, the successor organization does
not offer to extend the employee's employment agreement for two years on
substantially the same terms.
Each of the employment agreements may be terminated at will by either party.
42
<PAGE>
CERTAIN TRANSACTIONS
Issuance of Capital Stock
In September and November 1996, we issued 525,025 shares and 224,959 shares,
respectively, of series C convertible preferred stock for an aggregate of
$16,874,640. In order to encourage our existing shareholders to participate in
the series C financing, we also offered them the opportunity, in some
circumstances, to exchange their shares of series B preferred stock for an
equal number of shares of series BB preferred stock, which has a more favorable
conversion rate to common stock. As a result, in September 1996, we issued
748,334 shares of series BB convertible preferred stock in exchange for an
equal number of shares of series B convertible preferred stock. In addition, as
set forth below, one of our former shareholders also sold all of its shares of
common stock on a pro rata basis to the investors in the series C financing.
All of the shares of convertible preferred stock will convert to common stock
at the closing of this offering.
Specifically, in connection with the series C preferred stock sale, we
issued:
. 8,940 shares of common stock to the C. Donald Dorsey and Lydia Dorsey
Family Trust dated August 5, 1993, for which C. Donald Dorsey, one of our
directors, serves as trustee;
. an aggregate of 164,590 shares of common stock to Robert A. Fox, one of
our directors, for himself and for a voting trust in his name;
. 121,755 shares and 2,740 shares of common stock to Oak Investment
Partners V, L.P. and Oak V Affiliates Fund, L.P., respectively,
partnerships in which Gerald R. Gallagher, one of our directors, is a
general partner;
. 810,805 shares, 131,530 shares and 51,050 shares of common stock to
Fourcar, B.V., Lacomble Retailing, SA and Fondation Consuelo,
respectively, each of which is an entity affiliated with Carrefour S.A.,
for which Yves Sisteron, one of our directors, serves as the manager of
U.S. investments;
. 70,620 shares of common stock to Frontenac VI Limited Partnership, one of
our greater than 5% shareholders;
. 1,015,455 shares and 5,040 shares of common stock to Nassau Capital
Partners II L.P., one of our greater than 5% shareholders, and NAS
Partners I L.L.C., respectively;
. 993,375 shares of common stock to Vulcan Ventures, Inc., one of our
greater than 5% shareholders; and
. an aggregate of 5,605 shares of common stock to employees of DLJ.
In connection with the exchange of series B convertible preferred stock for
series BB convertible preferred stock, we issued:
. 4,571 shares of common stock to the C. Donald Dorsey Trust;
. an aggregate of 448,388 shares of common stock to Mr. Fox, for himself
and for a voting trust in his name;
. 372,571 shares and 8,379 shares of common stock to Oak Investment
Partners V, L.P. and Oak V Affiliates Fund, L.P., respectively;
. 321,152 shares, 71,195 shares, 35,597 shares, 35,597 shares, 28,571
shares, 13,714 shares and 28,571 shares of common stock to Fourcar, B.V.,
Lacomble Retailing, SA, Fidas
43
<PAGE>
Business S.A., SG Cowen, Fundacion Juan March, Fundacion Appomatox and
Daniel Bernard, respectively, each of which is an entity affiliated with
Mr. Sisteron and which Fourcar, B.V. and Lacomble Retailing, SA are
entities affiliated with Carrefour S.A.;
. 761,911 shares of common stock to Frontenac VI Limited Partnership;
. 257,526 shares of common stock to Vulcan Ventures, Inc; and
. an aggregate of 2,550 shares of common stock to employees of DLJ.
Recent Sales of Securities by Shareholders
In September and November 1996, one of our former shareholders sold an
aggregate of 600,000 shares of common stock to certain of our shareholders for
an aggregate purchase price of $2.0 million, or $3.33 per share, including:
. 1,430 shares of common stock to the C. Donald Dorsey Trust;
. an aggregate of 26,334 shares of common stock to Mr. Fox, for himself and
for a voting trust in his name;
. 19,481 shares and 438 shares of common stock to Oak Investment Partners
V, L.P. and Oak V Affiliates Fund, L.P., respectively;
. 129,729 shares, 21,045 shares and 8,168 shares of common stock to
Fourcar, B.V., Lacomble Retailing, SA and Fondation Consuelo,
respectively;
. 11,300 shares of common stock to Frontenac VI Limited Partnership;
. 162,474 shares and 807 shares of common stock to Nassau Capital Partners
II L.P. and NAS Partners I L.L.C., respectively;
. 158,940 shares of common stock to Vulcan Ventures, Inc.; and
. an aggregate of 898 shares of common stock to employees of DLJ.
In July and August 1998, Mr. Schlessinger sold an aggregate of 410,000
shares of common stock to certain of our shareholders for an aggregate purchase
price of $2,460,000, or $6.00 per share, including:
. an aggregate of 40,261 shares of common stock to Mr. Fox, for himself and
for a voting trust in his name;
. 28,149 shares and 633 shares of common stock to Oak Investment Partners
V, L.P. and Oak V Affiliates Fund, L.P., respectively;
. 1,081 shares of common stock to Henry Nasella, one of our directors;
. 36,783 shares and 229 shares of common stock to Nassau Capital Partners
II L.P. and NAS Partners I L.L.C., respectively;
. 65,247 shares of common stock to Vulcan Ventures, Inc.; and
. 105,549 shares of common stock to DLJ and 1,071 shares of common stock to
an employee of DLJ.
In December 1998, DLJ transferred the 105,549 shares of common stock it
purchased from Mr. Schlessinger to Global Retail Partners, L.P., an investment
partnership of which Mr. Sisteron, one of our directors, is a principal, and to
its affiliates.
44
<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock by:
. our chief executive officer, other executive officers and directors;
. each selling shareholder;
. all directors and executive officers as a group; and
. each person known to us to own beneficially more than 5% of our
outstanding shares.
A person has beneficial ownership of shares if he has the power to vote or
dispose of the shares. This power can be exclusive or shared, direct or
indirect. In addition, a person is considered by SEC rules to beneficially own
shares underlying options that are presently exercisable or will become
exercisable within 60 days. The shares listed in this table below under "Number
of Shares Underlying Options" include shares issuable upon the exercise of
options that are presently exercisable or will become exercisable within 60
days of May 1, 1999.
As of May 1, 1999, there were 16,635,681 shares of our common stock
outstanding, after giving effect to the conversion of all shares of preferred
stock into common stock. To calculate a shareholder's percentage of beneficial
ownership, we must include in the numerator and denominator those shares
underlying options that the shareholder is considered to beneficially own.
Shares underlying options held by other shareholders, however, are disregarded
in this calculation. Therefore, the denominator used in calculating beneficial
ownership among our shareholders may differ. Shares beneficially owned after
this offering include 25,000 shares to be sold in this offering, which shares
are to be issued in connection with the exercise of stock options immediately
prior to the completion of this offering.
<TABLE>
<CAPTION>
Shares
Beneficially
Shares Beneficially Owned Prior to Owned After
Offering Offering
---------------------------------------- Number of -----------------
Number of Shares of
Number of Shares Common Stock
Outstanding Underlying to be Sold
Name of Beneficial Owner Shares Options Total Percent in Offering Number Percent
------------------------ ----------- ---------- ----- ------- ------------ --------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Executive Officers and Directors
Keith C. Spurgeon .............. 0 337,500 337,500 2.0% 0 337,500 1.6%
Thomas G. Vellios .............. 0 175,000 175,000 1.0 0 175,000 *
Robert A. Helpert .............. 0 148,750 148,750 * 0 148,750 *
C. Donald Dorsey (a)............ 19,512 34,000 53,512 * 0 53,512 *
Robert A. Fox (b)............... 1,840,912 4,000 1,844,912 11.1 148,604 1,696,308 8.3
Gerald R. Gallagher (c)......... 1,316,047 84,000 1,400,047 8.4 0 1,400,047 6.8
Henry Nasella .................. 8,336 41,500 49,836 * 0 49,836 *
Yves B. Sisteron (d)............ 3,220,836 4,000 3,224,836 19.4 0 3,224,836 15.8
David V. Wachs (e).............. 217,558 34,000 251,558 1.5 35,821 215,737 1.1
All executive officers and
directors as a group
(9 persons).................... 6,623,201 862,750 7,485,951 42.8 184,425 7,301,526 34.2
Five Percent Holders
Frontenac VI Limited
Partnership (f)................ 843,831 0 843,831 5.1 210,957 632,774 3.1
Fourcar, B.V. (g)............... 2,438,154 4,000 2,442,154 14.7 0 2,442,154 11.9
Nassau Capital
Partners II L.P. (h)........... 1,220,788 0 1,220,788 7.3 305,197 915,591 4.5
David Schlessinger (i).......... 2,054,550 0 2,054,550 12.4 1,200,000 854,550 4.2
Vulcan Ventures, Inc. (j)....... 2,141,757 0 2,141,757 12.9 0 2,141,757 10.5
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
Shares
Beneficially
Shares Beneficially Owned Prior to Owned After
Offering Offering
-------------------------------------- Number of ---------------
Number of Shares of
Number of Shares Common Stock
Outstanding Underlying to be Sold
Name of Beneficial Owner Shares Options Total Percent in Offering Number Percent
- ------------------------ ----------- ---------- ----- ------- ------------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Selling Shareholders
Robert S. Adelson....... 224,928 0 224,928 1.4% 39,428 185,500 *
Thomas A. Adelson....... 50,115 0 50,115 * 10,679 39,436 *
Arabella................ 76,187 0 76,167 * 19,046 57,141 *
Rosa Aukburg............ 0 30,000 30,000 * 25,000 5,000 *
Deanmore Holdings Ltd... 9,552 0 9,552 * 2,380 7,142 *
Dulverton Holdings Ltd.. 9,552 0 9,552 * 2,380 7,142 *
Craig J. Foley.......... 27,444 0 27,444 * 6,861 20,583 *
IPP95, L.P.............. 297,375 0 297,375 1.8 74,343 223,032 1.1%
Brener International
Group, LLC............. 118,849 0 118,849 * 29,712 89,137 *
Alan Mirken 1997 Three-
Year
Trust (k).............. 467,376 0 467,376 2.8 116,844 350,532 1.7
David M. Rubenstein..... 10,559 0 10,559 * 2,639 7,920 *
Anthony L. Schaeffer.... 60,340 0 60,340 * 15,085 45,255 *
James R. Schaeffer (l).. 60,340 0 60,340 * 15,085 45,255 *
Robert D. Schaeffer..... 99,663 0 99,663 * 24,915 74,748 *
Shoemaker Family
Partners............... 29,423 0 29,423 * 7,355 22,068 *
</TABLE>
- --------
* Percentage of shares of common stock beneficially owned does not exceed one
percent.
(a) 19,512 outstanding shares of common stock held by the C. Donald Dorsey and
Lydia Dorsey Family Trust Dated August 5, 1993.
(b) Outstanding shares include 594,416 shares held by Robert A. Fox, as Voting
Trustee pursuant to a Voting Trust Agreement Dated January 20, 1993, of
which 148,604 shares will be sold in this offering. Mr. Fox's address is
One Pitcairn Place, Suite 2100, 165 Township Line Road, Jenkintown, PA
19046.
(c) Includes (1) 1,287,099 shares owned by Oak Investment Partners V, Limited
Partnership, (2) 82,152 shares of common stock underlying presently
exercisable options held by Oak Investment Partners V, Limited Partnership,
(3) 28,948 shares owned by Oak V Affiliates Fund, Limited Partnership and
(4) 1,848 shares of common stock underlying presently exercisable options
held by Oak V Affiliates Fund, Limited Partnership. The address for Oak
Investment Partners V, Limited Partnership is 4550 Norwest Center,
Minneapolis, MN 55401. Mr. Gallagher is a partner of Oak Investment
Partners with certain voting and investment power over such shares.
Although Mr. Gallagher may be deemed to be a beneficial owner of such
shares, he disclaims all such beneficial ownership, except to the extent of
any pecuniary interest therein which he may have.
(d) Outstanding shares include (1) 2,023,085, 414,119, 130,774, 130,769,
154,390, 104,708, 51,784 and 104,708 shares of common stock held by
Fourcar, B.V., Lacomble Retailing, SA, Fidas Business S.A., SG Cowen,
Fondation Consuelo, Fundacion Juan March, Fundation Appomatox and Daniel
Bernard, respectively (collectively, the "Sisteron Affiliates") and (2)
67,672, 4,399, 4,659, 20,165, 7,489 and 1,165 shares of common stock held
by Global Retail Partners, L.P., GRP Partners, L.P., Global Retail Partners
Funding, Inc., DLJ Diversified Partners, L.P., DLJ Diversified Partners-A,
L.P. and DLJ ESC II, L.P., respectively (collectively, the "GRP
Affiliates"). Mr. Sisteron is a manager of U.S. investments of Carrefour
S.A. and has certain voting rights with respect to the shares owned by each
of the Sisteron
46
<PAGE>
Affiliates. Although Mr. Sisteron may be deemed to be a beneficial owner
of the shares owned by the Sisteron Affiliates, he disclaims all such
beneficial ownership, except to the extent of any pecuniary interest
therein which he may have. Mr. Sisteron is also a principal of Global
Retail Partners, L.P. Global Retail Partners, L.P. and the other GRP
Affiliates are affiliated with DLJ. Although Mr. Sisteron may be deemed a
beneficial owner of the shares owned by the GRP Affiliates, he disclaims
all such beneficial ownership, except to the extent of any pecuniary
interest therein which he may have.
(e) Outstanding shares include 142,558 shares of common stock held by Wachs
Partners, of which 8,571 will be sold in this offering. Mr. Wachs is the
general partner of Wachs Partners. Mr. Wachs is selling 27,250 shares in
this offering.
(f) Frontenac's address is 135 S. LaSalle Street, Suite 3800, Chicago,
Illinois 60603. Frontenac's general partners are Paul D. Carbery, James E.
Cowie, James E. Crawford, III, Rodney L. Goldstein, M. Laird Koldyke,
Martin J. Koldyke, Roger S. McEnvy, Laura P. Pearl and Jeremy H.
Silverman.
(g) Outstanding shares include (1) 414,119 shares of common stock held by
Lacomble Retailing and (2) 950 shares of common stock held by Yves
Sisteron. The address for Fourcar B.V. is Gebouw Autumn, Overschiestraate
No. 184P, 1062XK Amsterdam Netherlands.
(h) Outstanding shares include 6,076 shares of common stock held by NAS
Partners I L.L.C., of which 1,519 shares will be sold in this offering.
Nassau Capital Partners II L.P. is selling 303,678 shares in the offering
and its address is 22 Chambers Street, Princeton, NJ 08542. The two
managing members of NAS Partners are John G. Quigley and Randall A. Hack.
The general partner of Nassau Capital Partners is Nassau Capital LLC whose
members are Messrs. Quigley and Hack, Jonathan Sweemer and Robert L.
Honstein.
(i) Mr. Schlessinger resigned as one of our directors in August 1998. His
address is 125 Lincoln Avenue, Suite 400, Santa Fe, NM 87501.
(j) Vulcan Ventures' address is 110--110th Avenue, N.E., Suite 550, Bellevue,
WA 98004.
(k) Mitchell J. Rubin is the Trustee of the Alan Mirken 1997 Three Year Trust.
(l) Mr. Schaeffer's shares are held jointly with his spouse.
47
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 100,000,000 shares of common stock,
par value $.01 per share, and 5,000,000 shares of preferred stock, par value
$.01 per share.
Common Stock
As of May 1, 1999, our outstanding common stock consisted of 16,635,681
shares of common stock, after giving effect to the conversion of all shares of
preferred stock into common stock upon the closing of this offering, held by
163 shareholders of record. Holders of common stock are entitled to one vote
for each share held of record on all matters on which shareholders may vote,
and do not have cumulative voting rights in the election of directors. Holders
of common stock are entitled to receive, as, when and if declared by the board
of directors from time to time, such dividends and other distributions in cash,
stock or property from our assets or funds legally available for such purposes
subject to any dividend preferences that may be attributable to our outstanding
preferred stock.
No preemptive, conversion, redemption or sinking fund provisions apply to
the common stock. All outstanding shares of common stock are fully paid and
non-assessable. In the event of our liquidation, dissolution or winding up,
holders of common stock are entitled to share ratably in the assets available
for distribution.
Preferred Stock
Upon the closing of this offering, we will have no outstanding shares of
preferred stock. Our board of directors, without further action by the
shareholders, is authorized to issue an aggregate of 5,000,000 shares of
preferred stock. We have no plans to issue a new series of preferred stock. Our
board of directors may issue preferred stock with dividend rates, redemption
prices, preferences on liquidation or dissolution, conversion rights, voting
rights and any other preferences, which rights and preferences could adversely
affect the voting power of the holders of common stock. Issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions or other corporate purposes, could have the effect of making it
more difficult for a third party to acquire, or could discourage or delay a
third party from acquiring control.
Common Stock Warrants
We have issued warrants which entitle the holders to purchase an aggregate
of 103,623 shares of common stock at exercise prices ranging from $4.00 to
$6.00 per share. These warrants expire between June 1999 and January 2003. Some
of these warrants will be exercised in connection with this offering.
The exercise price and number of shares of common stock issuable upon the
exercise of each of the warrants may be adjusted upon the occurrence of certain
events, including stock splits, stock dividends, reorganization,
recapitalization, merger, or sale of all or substantially all of our assets. In
addition, some of the warrants and shares of stock issuable upon exercise of
those warrants have registration rights as described under "Registration
Rights" below.
Indemnification of Directors and Officers
Section 1741 of the Pennsylvania Business Corporation Law, as amended (BCL),
provides us with the power to indemnify any officer or director acting in his
or her capacity as a representative of
48
<PAGE>
Zany Brainy who was, is or is threatened to be made a party to any action or
proceeding for expenses, judgments, penalties, fines and amounts paid in
settlement in connection with such action or proceeding. The indemnity
provisions apply whether the action was instituted by a third party or arose by
or in our right. Generally, the only limitation on our ability to indemnify our
officers and directors is if the act violates a criminal statute or if the act
or failure to act is finally determined by a court to have constituted willful
misconduct or recklessness.
Our bylaws provide a right to indemnification to the full extent permitted
by law for expenses, attorney's fees, damages, punitive damages, judgments,
penalties, fines and amounts paid in settlement actually and reasonably
incurred by any director or officer whether or not the indemnified liability
arises or arose from any threatened, pending or completed proceeding by or in
our right by reason of the fact that such director or officer is or was serving
as our director, officer or employee or, at our request, as a director,
officer, partner, fiduciary or trustee of another corporation, partnership,
joint venture, trust, employee benefit plan or other enterprise, unless the act
or failure to act giving rise to the claim for indemnification is finally
determined by a court to have constituted willful misconduct or recklessness.
Our bylaws provide for the advancement of expenses to an indemnified party upon
receipt of an undertaking by the party to repay those amounts if it is finally
determined that the indemnified party is not entitled to indemnification.
Our bylaws authorize us to take steps to ensure that all persons entitled to
the indemnification are properly indemnified, including, if the board so
determines, purchasing and maintaining insurance.
Limitation of Liability
Our bylaws provide that none of our directors shall be personally liable to
us or our shareholders for monetary damages for any action taken or failure to
take any action, unless:
. such director has breached or failed to perform such person's duties
under the Pennsylvania corporate laws; and
. the breach or failure to perform constitutes self-dealing, willful
misconduct or recklessness.
We maintain directors and officers' liability insurance to provide directors
and officers with insurance coverage for losses arising from claims based on
breaches of duty, negligence, error and other wrongful acts. At present, there
is no pending litigation or proceeding, and we are not aware of any threatened
litigation or proceeding, involving any director, officer, employee or agent
where indemnification will be required or permitted under our bylaws.
Pennsylvania Takeover Laws
The BCL contains provisions applicable to publicly held Pennsylvania
corporations that may be deemed to have an anti-takeover effect. We have
specifically opted out of all but Section 1715 of the BCL, which remains
applicable to us.
Under Section 1715 of the BCL, our directors are not required to regard the
interests of the shareholders as being dominant or controlling in considering
the best interests of Zany Brainy. The directors may consider, to the extent
they deem appropriate, such factors as:
. the effects of any action upon any group affected by such action
(including our shareholders, employees, suppliers, customers and
creditors and upon communities in which we have stores, offices or other
establishments);
49
<PAGE>
. the short term and long term interests of Zany Brainy (including benefits
that may accrue to us from our long term plans and the possibility that
these interests may be best served by our continued independence);
. the resources, intent and conduct of any person seeking to acquire
control of Zany Brainy; and
. all other pertinent factors.
Section 1715 of the BCL further provides that any act of our board of
directors, a committee of the board or an individual director relating to or
affecting an acquisition or potential or proposed acquisition of control to
which a majority of our disinterested directors have assented will be presumed
to satisfy the standard of care set forth in the BCL, unless it is proven by
clear and convincing evidence that our disinterested directors did not consent
to such act in good faith after reasonable investigation. As a result of this
and the other provisions of Section 1715 of the BCL, our directors are provided
with broad discretion with respect to actions that may be taken in response to
acquisitions or proposed acquisitions of corporate control.
Section 1715 of the BCL may discourage open market purchases of our common
stock or a non-negotiated tender or exchange offer for our common stock and,
accordingly, may be considered disadvantageous by a shareholder who would
desire to participate in any such transaction. In addition, Section 1715 of the
BCL may have a depressive effect on the price of our common stock.
In addition, the ability of the board of directors to establish the rights
of, and to issue, substantial amounts of preferred stock without the need for
shareholder approval may discourage, delay or prevent a change in control. Such
preferred stock, among other things, may be used to create voting impediments
with respect to any changes in control or to dilute the stock ownership of
holders of common stock seeking to obtain control.
Registration Rights
After the consummation of this offering, the holders of approximately 8.2
million shares of common stock will be entitled to certain registration rights
with respect to the registrable securities. These rights are provided under the
terms of the registrable securities and agreements between us and the holders
of such securities. Such agreements and registrable securities provide, in
certain instances, demand registration rights. In addition, pursuant to these
agreements, the holders of such securities are entitled, subject to certain
limitations, to require us to include their registrable securities in
registration statements we file under the Securities Act of 1933. Registration
of shares of common stock pursuant to the exercise of registration rights under
the Securities Act of 1933 would result in such shares becoming freely tradable
without restriction under the Securities Act of 1933 immediately upon the
effectiveness of such registration.
Transfer Agent
The transfer agent for our common stock is StockTrans, Inc.
50
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of common stock in the public market following
the offering could adversely affect the market price of the common stock and
adversely affect our ability to raise capital at a time and on terms favorable
to us.
Of the 20,468,350 shares to be outstanding after the offering, the 3,807,669
shares of common stock offered by us and an additional 16,626,592 shares of
common stock will be freely tradeable without restriction in the public market
unless such shares are held by "affiliates," as that term is defined in Rule
144(a) under the Securities Act. For purposes of Rule 144, an "affiliate" of an
issuer is a person that, directly or indirectly through one or more
intermediaries, controls, or is controlled by or is under common control with,
such issuer. The remaining 34,089 shares of common stock to be outstanding
after the offering are "restricted securities" under the Securities Act and may
be sold in the public market upon the expiration of certain holding periods
under Rule 144, subject to the volume, manner of sale and other limitations of
Rule 144.
In addition, as of May 1, 1999, there were outstanding warrants to purchase
103,623 shares of common stock and options to purchase 3,497,087 shares of
common stock excluding 25,000 options to be exercised immediately prior to the
completion of this offering. An additional 2,068,758 shares were reserved for
issuance under our option plans. We intend to register the shares of common
stock issued, issuable or reserved for issuance under our option plans or
separate option agreements as soon as practicable following the date of this
prospectus.
Certain holders of approximately 8.2 million shares of common stock and
holders of warrants to purchase 56,073 shares of common stock are entitled to
certain registration rights with respect to such shares for resale under the
Securities Act. If such holders, by exercising their registration rights, cause
a large number of shares to be registered and sold in the public market, such
sales could have an adverse effect on the market price for the common stock.
Lock-Up Arrangements
Along with our officers and directors, and certain other shareholders, we
have agreed not to sell or otherwise dispose of any shares of common stock for
a period of 135 days after the date of this prospectus and not to sell two-
thirds of such securities until January 31, 2000, without the prior written
consent of DLJ. See "Underwriting."
51
<PAGE>
UNDERWRITING
Subject to the terms and conditions contained in an underwriting agreement,
dated , 1999, the underwriters named below, who are
represented by Donaldson, Lufkin & Jenrette Securities Corporation, BT Alex.
Brown Incorporated, William Blair & Company, L.L.C. and U.S. Bancorp Piper
Jaffray Inc. have severally agreed to purchase from the selling shareholders
and from us the respective number of shares of common stock set forth opposite
their names below.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Donaldson, Lufkin & Jenrette Securities Corporation.............
BT Alex. Brown Incorporated.....................................
William Blair & Company, L.L.C..................................
U.S. Bancorp Piper Jaffray Inc..................................
---------
Total......................................................... 6,100,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase and accept delivery of the shares of common stock
included in this offering are subject to approval of legal matters by their
counsel and to customary conditions, including the effectiveness of the
registration statement, the continuing correctness of our representations and
those of the selling shareholders, the receipt of a "comfort letter" from our
accountants, the listing of the common stock for quotation on the Nasdaq
National Market and no occurrence of an event that would have a material
adverse effect on Zany Brainy. The underwriters are obligated to purchase and
accept delivery of all the shares of common stock, other than those covered by
the over-allotment option described below, if they purchase any of the shares
of common stock.
The underwriters propose to initially offer some of the shares of common
stock directly to the public at the initial public offering price set forth on
the cover page of this prospectus and some of the shares of common stock to
dealers (including the underwriters) at the initial public offering price less
a concession not in excess of $ per share. The underwriters may allow,
and such dealers may re-allow, a concession not in excess of $ per
share on sales to other dealers. After the initial offering of the common stock
to the public, the representatives of the underwriters may change the public
offering price and such concessions. The underwriters do not intend to confirm
sales to any accounts over which they exercise discretionary authority.
DLJdirect Inc., an affiliate of DLJ and a member of the selling group, is
facilitating the distribution of the shares sold in this offering over the
internet. The underwriters have agreed to allocate a limited number of shares
to DLJdirect Inc. for sale to its brokerage account holders.
52
<PAGE>
The following table shows the underwriting fees to be paid to the
underwriters by the selling shareholders and by us in connection with this
offering. These amounts are shown assuming both no exercise and full exercise
of the underwriters' option to purchase additional shares of common stock.
<TABLE>
<CAPTION>
No Full
Exercise Exercise
-------- --------
<S> <C> <C>
Zany Brainy:
Per share............................................. $ $
Total................................................. $ $
Selling shareholders:
Per share............................................. $ $
Total................................................. $ $
</TABLE>
Zany Brainy has granted to the underwriters an option, exercisable for 30
days after the date of the underwriting agreement, to purchase up to 915,000
additional shares of common stock at the initial public offering price less the
underwriting fees. The underwriters may exercise such option solely to cover
overallotments, if any, made in connection with this offering. To the extent
that the underwriters exercise such option, each underwriter will become
obligated, subject to conditions, to purchase a number of additional shares
approximately proportionate to such underwriter's initial purchase commitment.
We estimate expenses relating to this offering will be $1,350,000.
The selling shareholders, the underwriters and Zany Brainy have agreed to
indemnify each other against liabilities, including liabilities under the
Securities Act of 1933.
Each of Zany Brainy, our executive officers and directors and some of our
shareholders (including the selling shareholders) has agreed that, for a period
commencing on the date of the final prospectus and ending on January 31, 2000
and subject to certain exceptions, they will not, without the prior written
consent of DLJ, do either of the following:
. offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase or otherwise transfer or dispose of,
directly or indirectly any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock; or
. enter into any swap or other arrangement that transfers all or a portion
of the economic consequences associated with the ownership of any common
stock;
provided, however, that with respect to one-third of the shares of common stock
held by each such shareholder, the restrictions set forth above shall lapse 135
days after the date of the final prospectus.
Either of the foregoing transfer restrictions will apply regardless of
whether a covered transaction is to be settled by the delivery of common stock
or such other securities, in cash or otherwise. In addition, during such period
and subject to certain exceptions, we have agreed not to file any registration
statement with respect to, and each of our executive officers and directors and
the selling shareholders, has agreed not to make any demand for, or exercise
any right with respect to, the registration of any shares of common stock or
any securities convertible into or exercisable for common stock without the
prior written consent of DLJ.
At our request, the underwriters have reserved up to five percent of the
shares offered by this prospectus for sale at the initial public offering price
to our employees, officers and directors and other individuals associated with
us and members of their families. Individuals who purchase these
53
<PAGE>
reserved shares must hold such shares for a minimum of three months after this
offering. The number of shares of common stock available for sale to the
general public will be reduced to the extent these individuals purchase or
confirm for purchase, orally or in writing, such reserved shares. Any reserved
shares not purchased or confirmed for purchase will be offered by the
underwriters to the general public on the same basis as the other shares
offered by this prospectus.
We have applied to list our common stock for quotation on the Nasdaq
National Market under the symbol "ZANY."
Other than in the United States, no action has been taken by the selling
shareholders, the underwriters or us that would permit a public offering of the
shares of common stock included in this offering in any jurisdiction where
action for that purpose is required. The shares of common stock included in
this offering may not be offered or sold, directly or indirectly, nor may this
prospectus or any other offering material or advertisement in connection with
the offer and sale of any shares of common stock be distributed or published in
any jurisdiction, except under circumstances that will result in compliance
with the applicable rules and regulations of such jurisdiction. Persons who
receive this prospectus are advised to inform themselves about and to observe
any restrictions relating to this offering of the common stock and the
distribution of this prospectus. This prospectus is not an offer to sell or a
solicitation of an offer to buy any shares of common stock included in this
offering in any jurisdiction in which that would not be permitted or legal.
DLJ and certain of its affiliates, including Global Retail Partners, L.P.,
are shareholders of Zany Brainy. In June 1994, DLJ acquired a five-year warrant
to purchase 56,073 shares of common stock at an exercise price of $6.00 per
common share in connection with a transaction in which it acted as placement
agent and performed other services for Zany Brainy. DLJ intends to exercise
this warrant on a cashless basis in connection with this offering by exchanging
the warrant for shares of common stock. DLJ and its employees and affiliates
own an aggregate of less than three percent of the issued and outstanding
common stock.
Yves Sisteron, who is a principal of Global Retail Partners, L.P., and a
director of Zany Brainy, has been elected to the board of directors pursuant to
the provisions of a shareholders agreement which entitles Fourcar, B.V. to
elect two of the directors of Zany Brainy. Such shareholders agreement
will terminate upon consummation of this offering. See "Certain Transactions."
DLJ or its affiliates have provided and may in the future provide investment
banking or other financial services to us and our affiliates in the ordinary
course of business, for which they have received and are expected to receive
customary fees and expenses.
Stabilization
In connection with this offering, any of the underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
common stock. Specifically, the underwriters may overallot this offering,
creating a syndicate short position. The underwriters may bid for and purchase
shares of common stock in the open market to cover such syndicate short
position or to stabilize the price of the common stock. In addition, the
underwriting syndicate may reclaim selling concessions from syndicate members
and selected dealers if DLJ repurchases previously distributed common stock in
syndicate covering transactions, in stabilization transactions or otherwise or
if DLJ receives a report that indicates that the clients of such syndicate
members have "flipped" the common stock. These activities may stabilize or
maintain the market price of the common stock above independent market levels.
The underwriters are not required to engage in these activities, and may end
any of these activities at any time.
54
<PAGE>
Pricing of this Offering
Prior to this offering, there has been no established market for the common
stock. The initial public offering price for the shares of common stock offered
by this prospectus will be determined by negotiation among the selling
shareholders, the representatives of the underwriters and Zany Brainy. The
factors to be considered in determining the initial public offering price
include:
. the history of, and the prospects for, the industry in which we compete;
. our past and present operations;
. our historical results of operations;
. our prospects for future earnings;
. the recent market prices of securities of generally comparable companies;
and
. the general conditions of the securities market at the time of this
offering.
EXPERTS
Our consolidated financial statements as of January 31, 1998 and January 30,
1999, and for the three fiscal years in the period ended January 30, 1999,
included in this prospectus have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said report.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Latham & Watkins,
Los Angeles, California, has acted as counsel for the underwriters in
connection with this offering.
ADDITIONAL INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act of 1933 with respect to the common stock offered in this
prospectus. This prospectus omits certain information set forth in the
registration statement and the exhibits and schedules thereto. For further
information with respect to Zany Brainy and the common stock offered in this
prospectus, reference is made to such registration statement, exhibits and
schedules.
The registration statement, including the exhibits and schedules filed
therewith, may be inspected free of charge at the public reference facilities
maintained by the SEC at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549 and at its regional offices located at 7 World Trade
Center, New York, New York 10048 and Northwest Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of such material can be
obtained from the Public Reference Section of the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates and
from the SEC's internet site at http://www.sec.gov. We intend to list our
common stock on the Nasdaq National Market. Reports, proxy statements and other
information concerning Zany Brainy can be inspected at the National Association
of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.
55
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS .................................. F-2
CONSOLIDATED BALANCE SHEETS ............................................... F-3
CONSOLIDATED STATEMENTS OF OPERATIONS ..................................... F-4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ........................... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS ..................................... F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Zany Brainy, Inc.:
We have audited the accompanying consolidated balance sheets of Zany Brainy,
Inc. (formerly Children's Concept, Inc.) (a Pennsylvania corporation) and
subsidiaries as of January 31, 1998 and January 30, 1999 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended January 30, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Zany
Brainy, Inc. and subsidiaries as of January 31, 1998 and January 30, 1999, and
the results of their operations and their cash flows for each of the three
years in the period ended January 30, 1999 in conformity with generally
accepted accounting principles.
/s/ARTHUR ANDERSEN LLP
Philadelphia, Pa.,
March 5, 1999
F-2
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands except share data)
<TABLE>
<CAPTION>
January 31, January 30, May 1,
ASSETS 1998 1999 1999
------ ----------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................ $ 5,030 $ 1,695 $ 923
Receivables, net......................... 1,631 3,390 3,039
Inventories, net......................... 29,822 43,252 52,375
Deferred tax asset....................... -- 4,313 5,158
Prepaid expenses......................... 672 940 2,728
-------- -------- --------
Total current assets................... 37,155 53,590 64,223
PROPERTY AND EQUIPMENT, net................ 21,996 25,905 26,514
DEFERRED TAX ASSET......................... -- 2,024 2,024
OTHER ASSETS, net.......................... 401 622 1,291
-------- -------- --------
$ 59,552 $ 82,141 $ 94,052
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of capitalized lease
obligations............................. $ 1,199 $ 1,682 $ 1,655
Line of credit........................... -- -- 12,402
Accounts payable......................... 8,596 16,161 18,708
Income taxes payable..................... -- 150 --
Accrued liabilities...................... 7,275 10,055 8,559
-------- -------- --------
Total current liabilities.............. 17,070 28,048 41,324
-------- -------- --------
DEFERRED RENT.............................. 1,856 2,942 3,417
-------- -------- --------
CAPITALIZED LEASE OBLIGATIONS, net of
current portion........................... 1,407 2,860 2,392
-------- -------- --------
COMMITMENTS AND CONTINGENCIES (Note 10)
SHAREHOLDERS' EQUITY
Convertible Preferred stock, $.01 par
value, 4,000,000 shares and 5,000,000
shares authorized at January 30, 1999
and May 1, 1999, respectively, 2,402,955
shares issued and outstanding,
liquidation value of $56,546 at January
30, 1999 and May 1, 1999................ 24 24 24
Common stock, $.01 par value, 25,000,000
shares and 100,000,000 shares authorized
at January 30, 1999 and May 1, 1999,
respectively, 5,361,523, 5,383,571 and
5,385,408 shares issued and outstanding,
respectively............................ 54 54 54
Additional paid-in capital............... 60,753 60,826 60,832
Accumulated deficit...................... (21,612) (12,613) (13,991)
-------- -------- --------
Total shareholders' equity............. 39,219 48,291 46,919
-------- -------- --------
$ 59,552 $ 82,141 $ 94,052
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
<TABLE>
<CAPTION>
Thirteen
For the Fiscal Year Ended Weeks Ended
----------------------------------- ----------------
February 1, January 31, January 30, May 2, May 1,
1997 1998 1999 1998 1999
----------- ----------- ----------- ------- -------
<S> <C> <C> <C> <C> <C>
(unaudited)
NET SALES............... $92,563 $123,345 $168,471 $27,452 $40,577
COST OF GOODS SOLD,
including occupancy
costs.................. 69,205 89,452 118,153 20,137 29,387
------- -------- -------- ------- -------
Gross profit......... 23,358 33,893 50,318 7,315 11,190
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 28,732 33,581 46,376 9,659 12,986
------- -------- -------- ------- -------
Operating income
(loss).............. (5,374) 312 3,942 (2,344) (1,796)
INTEREST INCOME......... 153 253 81 33 11
INTEREST EXPENSE........ (802) (718) (1,211) (159) (438)
------- -------- -------- ------- -------
Income (loss) before
income tax benefit.. (6,023) (153) 2,812 (2,470) (2,223)
INCOME TAX BENEFIT...... -- -- 6,187 -- 845
------- -------- -------- ------- -------
NET INCOME (LOSS)....... $(6,023) $ (153) $ 8,999 $(2,470) $(1,378)
======= ======== ======== ======= =======
NET INCOME (LOSS) PER
COMMON SHARE:
Basic................. $ (1.19) $ (0.03) $ 1.67 $ (0.46) $ (0.26)
Diluted............... $ (1.19) $ (0.03) $ 0.51 $ (0.46) $ (0.26)
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic................. 5,068 5,085 5,373 5,363 5,384
Diluted............... 5,068 5,085 17,770 5,363 5,384
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(dollars in thousands)
<TABLE>
<CAPTION>
Convertible Preferred Stock
--------------------------- Additional
Series Series Series Series Common Paid-In Accumulated
A B BB C Stock Capital Deficit Total
------ ------ ------ ------ ------ ---------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, FEBRUARY 3,
1996................... $ 8 $ 8 $-- $-- $51 $43,741 $(15,436) $28,372
Exercise of stock
options............... -- -- -- -- -- 18 -- 18
Sale of 749,984 shares
of Series C and
conversion of 748,334
shares of Series B to
Series BB, net of
expenses of $715...... -- (7) 7 8 -- 16,152 -- 16,160
Issuance of warrants to
a consultant.......... -- -- -- -- -- 20 -- 20
Net loss............... -- -- -- -- -- -- (6,023) (6,023)
--- --- --- --- --- ------- -------- -------
BALANCE, FEBRUARY 1,
1997................... 8 1 7 8 51 59,931 (21,459) 38,547
Issuance of warrants to
a consultant.......... -- -- -- -- -- 40 -- 40
Exercise of stock
options............... -- -- -- -- -- 35 -- 35
Exercise of warrants... -- -- -- -- 3 747 -- 750
Net loss............... -- -- -- -- -- -- (153) (153)
--- --- --- --- --- ------- -------- -------
BALANCE, JANUARY 31,
1998................... 8 1 7 8 54 60,753 (21,612) 39,219
Exercise of stock
options............... -- -- -- -- -- 73 -- 73
Net income............. -- -- -- -- -- -- 8,999 8,999
--- --- --- --- --- ------- -------- -------
BALANCE, JANUARY 30,
1999................... 8 1 7 8 54 60,826 (12,613) 48,291
Exercise of stock
options (unaudited)... -- -- -- -- -- 6 -- 6
Net loss (unaudited)... -- -- -- -- -- -- (1,378) (1,378)
--- --- --- --- --- ------- -------- -------
BALANCE, MAY 1, 1999
(unaudited)............ $ 8 $ 1 $ 7 $ 8 $54 $60,832 $(13,991) $46,919
=== === === === === ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Thirteen Weeks
For the Fiscal Year Ended Ended
----------------------------------- ----------------
February 1, January 31, January 30, May 2, May 1,
1997 1998 1999 1998 1999
----------- ----------- ----------- ------- -------
<S> <C> <C> <C> <C> <C>
(unaudited)
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss)....... $(6,023) $ (153) $ 8,999 $(2,470) $(1,378)
Adjustments to reconcile
net income (loss) to
net cash provided by
(used in) operating
activities--
Depreciation and
amortization.......... 3,713 5,017 6,859 1,385 1,888
Provision for deferred
rent.................. 294 700 1,086 12 475
Issuance of warrants to
consultants........... 20 40 -- -- --
Deferred income tax
benefit............... -- -- (6,337) -- (845)
Changes in assets and
liabilities--
(Increase) decrease
in--
Receivables.......... (625) (457) (1,759) 903 351
Inventories.......... (3,740) (5,544) (13,430) (4,890) (9,123)
Prepaid expenses..... 107 840 (268) (1,326) (1,788)
Other assets......... (6) 33 (270) 79 (669)
Increase (decrease)
in--
Accounts payable..... 473 1,680 7,565 1,963 1,180
Accrued liabilities.. 3,132 1,388 2,780 436 (1,496)
Income tax payable... -- -- 150 -- (150)
------- ------- -------- ------- -------
Net cash provided by
(used in) operating
activities......... (2,655) 3,544 5,375 (3,908) (11,555)
------- ------- -------- ------- -------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchases of property
and equipment, net..... (6,276) (6,420) (7,309) (779) (2,497)
------- ------- -------- ------- -------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds on line of
credit, net............ -- -- -- -- 12,402
Net proceeds from sale
of convertible
preferred stock........ 16,160 -- -- -- --
Increase in bank
overdrafts -- -- -- 445 1,367
Payments on capitalized
lease obligations...... (1,002) (1,309) (1,379) (266) (495)
Debt issuance costs..... -- (258) (95) -- --
Proceeds from exercise
of stock options....... 18 35 73 12 6
Proceeds from exercise
of warrants............ -- 750 -- -- --
------- ------- -------- ------- -------
Net cash provided by
(used in) financing
activities......... 15,176 (782) (1,401) 191 13,280
------- ------- -------- ------- -------
NET INCREASE (DECREASE)
IN CASH AND CASH
EQUIVALENTS............. 6,245 (3,658) (3,335) (4,496) (772)
CASH CASH EQUIVALENTS,
BEGINNING OF PERIOD..... 2,443 8,688 5,030 5,030 1,695
------- ------- -------- ------- -------
CASH AND CASH
EQUIVALENTS, END OF
PERIOD.................. $ 8,688 $ 5,030 $ 1,695 $ 534 $ 923
======= ======= ======== ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Background
Zany Brainy, Inc. (formerly Children's Concept, Inc.) was incorporated in
Pennsylvania on August 19, 1991. As of January 30, 1999, Zany Brainy, Inc.
operated 75 stores in 19 states, under the name "Zany Brainy," offering toys,
games, books and multimedia products for children. As of May 1, 1999, Zany
Brainy operated 82 stores in 23 states.
Subsequent Event (unaudited)
In March 1999, Children's Concept, Inc. changed its name to Zany Brainy,
Inc. All references have been updated to reflect this change.
Principles of Consolidation
The consolidated financial statements include the accounts of Zany Brainy,
Inc. and its wholly owned subsidiaries, Children's Products, Inc. and
Children's Development, Inc. (collectively, the "Company"). All significant
intercompany transactions and accounts have been eliminated in consolidation.
Fiscal Year-End
The Company operates under a 52-53-week fiscal year ending the Saturday
nearest January 31. The financial statements for the years ended February 1,
1997 (fiscal 1996), January 31, 1998 (fiscal 1997), and January 30, 1999
(fiscal 1998) each include 52 weeks.
Interim Financial Statements
The accompanying consolidated financial statements as of May 1, 1999 and for
the 13 weeks ended May 2, 1998 and May 1, 1999 are unaudited and in the opinion
of management include all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the financial position and
results of operations for those interim periods. The results of operations for
the 13 weeks ended May 2, 1998 and May 1, 1999 are not necessarily indicative
of the results to be expected for any other interim period or the full year.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, accounts payable, accrued liabilities and
debt instruments. The carrying values of these assets and liabilities are
considered to be representative of their respective fair values.
Business and Credit Risk Concentration
Financial instruments which potentially subject the Company to
concentrations of credit risk are cash and cash equivalents and accounts
receivable. The Company limits its credit risk associated with cash and cash
equivalents by placing its investments in highly liquid funds. Receivables
associated
F-7
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
with third party credit cards are processed by financial institutions which are
monitored for financial stability. The Company is dependent on key suppliers to
provide sufficient quantities of inventory at competitive prices. No single
supplier represented 10% or more of purchases in 1998 and one supplier, Ingram
Books, represented 10.5% of purchases during the 13 weeks ended May 1, 1999. In
addition, one product represented greater than 10% of sales for the 13 weeks
ended May 1, 1999.
Use of Estimates
The presentation of these financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Included in cash and
cash equivalents are $3,489,000 and $672,000, of overnight investments in
repurchase agreements at January 31, 1998 and January 30, 1999, respectively.
At January 30, 1999, and May 1, 1999 cash and cash equivalents include $196,000
and $296,000, respectively, of funds held by a bank as collateral for
outstanding standby letters of credit.
Inventories and Cost of Goods Sold
Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method based on moving average and includes
certain buying and distribution costs relating to the processing of
merchandise. Buying and distribution costs charged to cost of goods sold were
$5,142,000, $5,752,000, $6,833,000 and $1,227,000 and $1,717,000 during fiscal
1996, 1997, 1998 and for the 13 weeks ended May 2, 1998 and May 1, 1999,
respectively. Buying and distribution costs remaining in inventories at January
31, 1998, January 30, 1999 and May 1, 1999 were $1,423,000, $2,093,000, and
$2,497,000, respectively. Store occupancy costs include store rental, utilities
and maintenance expenditures and are included in cost of goods sold.
Property and Equipment
Property and equipment are stated at cost. Additions and improvements are
capitalized, while repairs and maintenance are charged to expense as incurred.
The straight-line method of depreciation is used for financial reporting
purposes. The estimated useful lives are three to ten years for furniture and
fixtures, computers and equipment and the shorter of ten years, or the lease
term, for leasehold improvements. Certain personnel costs and out-of-pocket
costs directly associated with the construction or remodeling of stores are
capitalized and amortized over the lease term.
Long-Lived Assets
The Company has adopted Statement of Financial Accounting Standards ("SFAS")
No. 121 "Accounting for Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of."
F-8
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles to be held and used by the Company be reviewed for possible
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. If changes in circumstances
indicate that the carrying amount of an asset that an entity expects to hold
and use may not be recoverable, future cash flows expected to result from the
use of the asset and its disposition must be estimated. If the undiscounted
value of the future cash flows is less than the carrying amount of the asset,
impairment is recognized. A write-down of $450,000 of the carrying value of
certain racking, and lighting that are used in the Company's distribution
center was recorded in fiscal 1998 due to the plan of abandonment of these
assets in connection with the move to a new facility in fiscal 1999. The write-
down was based on the estimated unrecovered carrying value of the assets at the
planned date of abandonment and is included in selling, general and
administrating expenses. Management believes that there has been no other
impairment of the Company's long-lived assets as of January 30, 1999 and May 1,
1999.
Store Pre-opening Costs
Pre-opening costs incurred at new store locations are charged to expense as
incurred.
Debt Issuance Costs
Debt issuance costs of $258,000 and $51,000 were incurred in fiscal 1997 and
1998, respectively, in connection with the line of credit agreement and are
amortized on a straight-line basis over the life of the related debt. These
costs are included in other assets on the accompanying consolidated balance
sheets, net of accumulated amortization of $42,000, $186,000 and $229,000 at
January 31, 1998, January 30, 1999 and May 1, 1999, respectively.
Deferred Rent
Rent expense on leases is recorded on a straight-line basis over the lease
period. The excess of rent expense over the actual cash paid is recorded as
deferred rent.
Revenue Recognition
Revenue is recognized at the point of sale.
Advertising Costs
Advertising costs are charged to expense the first time the advertising
takes place. Advertising expense, including grand opening advertising, was
$2,082,000, $2,301,000, $5,036,000, $1,124,000 and $1,188,000 net of certain
vendor reimbursements, in fiscal 1996, 1997, 1998 and the 13 weeks ended May 2,
1998 and May 1,1999, respectively.
Supplemental Cash Flows Information
For fiscal 1996, 1997, 1998 and for the 13 weeks ended May 2, 1998 and May
1, 1999, the Company paid $802,000, $718,000, $1,211,000, $128,000 and $303,000
respectively, for interest
F-9
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
expense. For fiscal 1998 and for the 13 weeks ended May 2, 1998 and May 1,
1999, the Company paid $57,000, $45,000 and $193,000 for income taxes.
Capitalized lease obligations of $1,911,000, $45,000 and $3,315,000 were
incurred on equipment leases entered into in fiscal 1996, 1997 and 1998,
respectively. There were no capital lease obligations incurred for the 13 weeks
ended May 2, 1998 and May 1, 1999.
Recently Issued Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income." This statement establishes standards
for reporting and disclosure of comprehensive income. In June 1997, the FASB
issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." This statement establishes standards for reporting of information
about operating segments and requires the reporting of selected information
about operating segments in interim financial statements. These statements were
adopted by the Company on February 1, 1998 and had no impact as the Company has
no other comprehensive income and operated as a single segment.
2. PROPOSED INITIAL PUBLIC OFFERING:
The Company is in the process of preparing a registration statement for the
sale of common stock to the public in an initial public offering (the
"Offering"). Upon the closing of the Offering, the outstanding shares of
Preferred stock will be converted into Common stock.
3. NET INCOME (LOSS) PER SHARE:
Net income (loss) per share is calculated utilizing the principles of SFAS
No. 128, "Earnings per Share" ("EPS"). Basic EPS excludes potentially dilutive
securities and is computed by dividing net income available to common
shareholders by the weighted-average number of common shares outstanding for
the period. Diluted EPS is computed assuming the conversion or exercise of all
dilutive securities such as preferred stock, options and warrants.
F-10
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
Under SFAS No. 128, the Company's granting of certain stock options,
warrants and convertible preferred stock resulted in potential dilution of
basic EPS. The following table summarizes the differences between basic
weighted average shares outstanding and diluted weighted average shares
outstanding used to compute diluted EPS.
<TABLE>
<CAPTION>
Thirteen
Fiscal Year Ended Weeks Ended
----------------------------------- -------------------
February 1, January 31, January 30, May 2, May 1,
1997 1998 1999 1998 1999
----------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
(unaudited)
Basic weighted average
number of shares
outstanding............ 5,068,223 5,085,153 5,373,365 5,363,493 5,384,307
Incremental shares
from assumed exercise
or conversion of:
Stock options....... -- -- 1,118,803 -- --
Warrants............ -- -- 27,496 -- --
Preferred stock..... -- -- 11,250,273 -- --
--------- --------- ---------- --------- ---------
Diluted weighted average
number of shares
outstanding............ 5,068,223 5,085,153 17,769,937 5,363,493 5,384,307
========= ========= ========== ========= =========
</TABLE>
The number of incremental shares from the assumed exercise of stock options
and warrants is calculated applying the treasury stock method. Stock options,
warrants and Preferred stock convertible into common shares were excluded from
the fiscal 1996 and 1997 and the 13 weeks ended May 2, 1998 and May 1, 1999
calculation as they were anti-dilutive.
4. PROPERTY AND EQUIPMENT (in thousands):
<TABLE>
<CAPTION>
January 31, January 30, May 1,
1998 1999 1999
----------- ----------- -----------
<S> <C> <C> <C>
(unaudited)
Furniture and fixtures............. $ 13,796 $ 18,739 $ 19,896
Computers and equipment............ 9,625 12,596 13,253
Leasehold improvements............. 10,459 13,158 13,880
-------- -------- -----------
33,880 44,493 47,029
Less--Accumulated depreciation and
amortization...................... (11,884) (18,588) (20,515)
-------- -------- -----------
$ 21,996 $ 25,905 $ 26,514
======== ======== ===========
</TABLE>
5. ACCRUED LIABILITIES (in thousands):
<TABLE>
<CAPTION>
January 31, January 30, May 1,
1998 1999 1999
----------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
Payroll and related expenses.......... $2,079 $ 3,163 $1,740
Other................................. 5,196 6,892 6,819
------ ------- ------
$7,275 $10,055 $8,559
====== ======= ======
</TABLE>
F-11
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
6. LINE OF CREDIT AND MASTER LEASE AGREEMENT:
In fiscal 1996, the Company had a demand line of credit with a bank. The
Company could borrow up to $9,000,000, limited to a percentage of inventories,
as defined. The line bore interest at prime and was secured by substantially
all of the assets of the Company. At February 1, 1997, there were no borrowings
outstanding on the line.
In October 1997, the Company entered into a new line of credit agreement
with a bank. The Company can borrow up to $35 million (including up to $7.5
million in the form of letters of credit) limited to a percentage of
inventories, as defined, with an option to increase to $60 million under
certain conditions. Amounts may be borrowed on the line through October 8,
2000. The line bears interest at the lender's prime commercial lending rate or,
if the Company elects, at an annual rate of LIBOR plus 2.5% and is secured by
substantially all of the assets of the Company. At January 30, 1999, there were
no borrowings outstanding. At May 1, 1999, there was $27,500,000 available
under the line of which $12,402,000 was outstanding at an interest rate of
7.75%.
Under these lines, the highest amount outstanding was $8,039,000,
$12,207,000, $22,872,000, $741,000 and $12,344,000 in fiscal 1996, 1997, 1998
and for the 13 weeks ended May 2, 1998 and May 1, 1999, respectively. The
average amount outstanding was $2,400,000, $1,527,000, $6,388,000, $14,000 and
$7,308,000, and the weighted average interest rate was 8.25%, 8.92%, 9.04%,
8.50% and 8.33% in fiscal 1996, 1997, 1998 and for the 13 weeks ended May 2,
1998 and May 1, 1999, respectively. At January 31, 1998, January 30, 1999 and
May 1, 1999, there were $388,000, $914,000 and $656,000, respectively, in
outstanding letters of credit issued against the line. The line requires the
Company to comply with various covenants, as defined, and restricts the payment
of dividends.
In fiscal 1998, the Company entered into a master lease agreement with a
bank which provides for $5,000,000 for leasing new and used equipment. The
agreement requires that the leases be capital in nature and is subject to
certain covenants, as defined. In fiscal 1998, the Company financed $3,315,000
of equipment under the agreement. This agreement expired in March 1999 and
there were no additional financings under the agreement.
7. INCOME TAXES:
The Company files a consolidated Federal income tax return. The Company has
adopted SFAS No. 109, "Accounting for Income Taxes." The effect of this
statement is to take principally a balance sheet approach to providing deferred
income taxes. Deferred tax balances are regularly adjusted through the income
statement to reflect the current year estimate of future tax payments.
F-12
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
Income tax benefit consists of the following components (in thousands):
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal........................... $ -- $ -- $ 136
State............................. -- -- 14
------ ---- -------
-- -- 150
------ ---- -------
Deferred:
Federal........................... 2,038 39 829
State............................. 210 4 --
------ ---- -------
2,248 43 829
------ ---- -------
Increase (decrease) in valuation
allowance.......................... 2,248 43 (7,166)
------ ---- -------
Income tax benefit................ $ -- $ -- $(6,187)
====== ==== =======
</TABLE>
The deferred tax effect of temporary differences giving rise to the
Company's deferred tax assets and liabilities consists of the following
components (in thousands):
<TABLE>
<CAPTION>
January 31, January 30,
1998 1999
----------- -----------
<S> <C> <C>
Deferred tax assets:
Deferred rent................................... $ 615 $ 984
Inventory reserves.............................. 194 613
Other........................................... 619 503
Net operating loss carryforwards................ 7,636 5,652
AMT credit carryforwards........................ -- 159
------- ------
Gross deferred tax asset...................... 9,064 7,911
------- ------
Deferred tax liabilities:
Depreciation.................................... (1,018) (694)
Other........................................... (200) (200)
------- ------
Gross deferred tax liabilities................ (1,218) (894)
------- ------
Gross deferred tax asset, before valuation........ 7,846 7,017
Less--Valuation allowance....................... (7,846) (680)
------- ------
Net deferred tax asset........................ $ -- $6,337
======= ======
</TABLE>
Valuation allowances, primarily attributable to the Federal net operating
loss carryforward, were established in fiscal 1996 and 1997 in accordance with
the provisions of FASB Statement No. 109, "Accounting for Income Taxes". The
Company reversed $7,166,000 of the valuation allowance in fiscal 1998 based on
management's assessment that it is more likely than not that the net deferred
tax assets will be realized through future taxable earnings.
F-13
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
The reconciliation of the Federal statutory rate to the Company's effective
income tax rate is as follows:
<TABLE>
<CAPTION>
Thirteen Weeks
Fiscal Year Ended Ended
----------------------------------- -------------------
February 1, January 31, January 30, May 2, May 1,
1997 1998 1999 1998 1999
----------- ----------- ----------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Tax provision (benefit)
at Federal statutory
rate................... (34.0)% (34.0)% 34.0% (34.0)% (34.0)%
State taxes, net of
Federal benefit........ (3.5) (2.7) 0.3 (2.7) (4.0)
Other................... 0.2 8.1 0.5 -- --
Increase (decrease) in
valuation allowance.... 37.3 28.6 (254.8) 36.7 --
----- ----- ------ ------ ------
-- % -- % (220.0)% --% (38.0)%
===== ===== ====== ====== ======
</TABLE>
The Federal net operating loss carryforward expires as follows (in
thousands):
<TABLE>
<CAPTION>
Fiscal
------
<S> <C>
2014................................................ $ 501
2015................................................ 7,636
2016................................................ 6,391
-------
$14,528
=======
</TABLE>
8. CONVERTIBLE PREFERRED STOCK:
The components of preferred stock as of January 31, 1998, January 30, 1999
and May 1, 1999 are as follows:
<TABLE>
<CAPTION>
Common
Preferred Stock
Stock Price/ Shares Shares Conversion Liquidation
Series Share Authorized Outstanding Rate Preferences
--------- ------ ---------- ----------- ---------- -----------
(in thousands)
<S> <C> <C> <C> <C> <C>
A....................... $24.00 1,000,000 806,559 4.57143 $19,357
B....................... 24.00 1,000,000 98,078 4.0 2,354
BB...................... 24.00 846,412 748,334 4.57143 17,960
C....................... 22.50 750,000 749,984 5.0 16,875
Unallocated............. -- 403,588 -- --
--------- --------- -------
4,000,000 2,402,955 $56,546
========= ========= =======
</TABLE>
The series A, B, BB and C preferred stock (collectively, the Preferred
stock) is convertible into Common stock based on a defined conversion rate and
must be converted upon the closing of a public Common stock offering, as
defined. The Preferred stock has voting rights equal to the number of Common
shares into which it is convertible, participates in dividends to the extent
they are declared on the Common stock and has preference in liquidation which
includes dividends accrued
F-14
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
but not yet paid. Upon liquidation, the series C holders would receive $11.25
per share plus accrued but unpaid dividends before any other distributions,
with the remainder paid in parity with the series A, B and BB preferred
holders.
9. COMMON STOCK OPTIONS AND WARRANTS:
The Company's 1993 Stock Incentive Plan provides for the granting of Common
stock, Common stock options and stock appreciation rights to key employees and
members of the Board of Directors. The Company's 1998 Equity Compensation Plan
provides for the granting of Common stock options, restricted stock, stock
appreciation rights and performance units to employees, Board members and
consultants. Required disclosure information regarding the 1993 Stock Incentive
Plan and the 1998 Equity Compensation Plan (collectively, the "Plans") have
been combined due to similarities in the Plans.
The Company had reserved 3,700,000 shares and 5,500,000 shares of its Common
stock for awards under the Plans as of January 31, 1999 and May 1, 1999,
respectively. The Company accounts for the Plans under APB Opinion No. 25,
under which no compensation cost has been recognized. Had compensation cost for
the options issued under the Plans and 20,000 options issued in fiscal 1995
outside the Plans been determined consistent with SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net income (loss), basic EPS and
diluted EPS would have been equal to the pro forma amounts indicated below (in
thousands except per share data):
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income (loss)...... As reported........ $(6,023) $ (153) $8,999
Pro forma.......... (6,246) (626) 8,102
Basic EPS.............. As reported........ $ (1.19) $(0.03) $ 1.67
Pro forma.......... (1.23) (0.12) 1.51
Diluted EPS............ As reported........ $ (1.19) $(0.03) $ 0.51
Pro forma.......... (1.23) (0.12) 0.46
</TABLE>
The weighted average fair value of options granted in fiscal 1996, 1997 and
1998 was $0.92, $0.78 and $2.60, respectively. The fair value of each option
grant is estimated on the grant date using the Black-Scholes option pricing
model with the following assumptions:
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Expected dividend rate..................... -- -- --
Expected volatility........................ -- -- 45.0%
Weighted average risk-free interest rate... 6.5% 6.4% 5.3%
Expected lives (years)..................... 4 4 4
</TABLE>
A volatility factor was utilized in fiscal 1998, as the financial statements
were prepared in conjunction with an initial public offering.
F-15
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
Because the SFAS No. 123 method of accounting is not required to be applied
to options granted prior to January 29, 1995, the resulting pro forma
compensation charge may not be representative of that to be expected in future
years.
In fiscal 1996, 1997 and 1998, the Company granted 758,101, 1,169,507 and
472,497 options, respectively, under the Plans to employees and directors to
purchase Common stock at prices ranging from $3.33 to $9.00 per share. Options
to purchase 400,000 shares of Common stock vest 100% after three years and
remaining options primarily vest over a four-year period from the date of
grant. All options were issued with exercise prices equal to or greater than
the fair market value on the grant date. The options are exercisable over a
maximum of 10 years.
Information with respect to all options outstanding, including options to
purchase 130,000 shares of Common stock issued outside the Plans prior to
fiscal 1996, is as follows:
<TABLE>
<CAPTION>
Weighted
Option Price Average Price
Shares Per Share Per Share
---------- ------------ -------------
<S> <C> <C> <C>
Options outstanding, February 3, 1996.. 1,047,093 $ 0.67-4.00 $3.79
Granted.............................. 758,101 4.00 4.00
Exercised............................ (4,878) 3.33-4.00 3.66
Canceled............................. (217,116) 3.33-4.00 3.97
---------- ----------- -----
Options outstanding, February 1, 1997.. 1,583,200 0.67-4.00 3.79
Granted.............................. 1,169,507 3.33-4.00 3.56
Exercised............................ (10,392) 3.33-4.00 3.46
Canceled............................. (186,583) 3.33-4.00 3.40
Change in exercise price--
Original price..................... (1,222,685) 4.00 4.00
New price.......................... 1,222,685 3.33 3.33
---------- ----------- -----
Options outstanding, January 31, 1998.. 2,555,732 0.67-4.00 3.39
Granted.............................. 472,497 4.00-9.00 6.26
Exercised............................ (22,048) 3.33 3.33
Canceled............................. (153,319) 3.33-9.00 3.83
---------- ----------- -----
Options outstanding, January 30, 1999.. 2,852,862 0.67-9.00 3.84
Granted (unaudited).................. 719,400 11.75 11.75
Exercised (unaudited)................ (1,837) 3.33-4.00 3.41
Canceled (unaudited)................. (48,338) 3.33-11.75 6.20
---------- ----------- -----
Options outstanding, May 1, 1999
(unaudited) .......................... 3,522,087 $0.67-11.75 $5.42
========== =========== =====
</TABLE>
At January 30, 1999, the weighted average contractual life of all options
outstanding was 7.8 years, there were 1,006,767 options vested at a weighted
average exercise price of $3.38 and there were 939,820 shares reserved under
the Plans which were not covered by stock options granted.
In fiscal 1996 and fiscal 1997, the Company granted warrants to purchase
15,000 shares and 32,550 shares of Common stock, respectively, to certain
consultants. The warrants have an exercise
F-16
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
price of $4.00 per share and are exercisable on various dates through January
2003. The agent who placed the series A preferred purchased for $561 warrants
to purchase 56,073 shares of Common stock at a price of $6.00 per share. The
warrants expire in June 1999.
10. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases retail, distribution and office space and equipment under
various operating leases. Most store leases typically have an average initial
term of ten years, with two five-year renewal options. Certain leases provide
for additional rent contingent upon store sales levels. Base rent expense for
fiscal 1996, 1997, 1998 and for the weeks ended May 2, 1998 and May 1, 1999 was
approximately $9,654,000, $11,468,000, $13,927,000, $3,062,000 and $4,264,000,
respectively.
The Company has entered into several leases for store and distribution
center equipment and fixtures that have been accounted for as capital leases.
The capitalized cost of $5,034,000 and $6,961,000 and related accumulated
amortization of $1,970,000 and $2,336,000 has been included in property and
equipment at January 31, 1998 and January 30, 1999, respectively. The present
value of the minimum lease payments is as follows (in thousands):
<TABLE>
<CAPTION>
As of
January
30, As of
1999 May 1, 1999
------- -----------
<S> <C> <C>
(unaudited)
Total minimum lease payments.............................. $5,100 $ 4,511
Less-- Amount representing interest....................... (558) (464)
------ -----------
Present value of minimum lease payments................... $4,542 $ 4,047
====== ===========
</TABLE>
Future minimum lease payments under the Company's operating and capital
leases, including leases for stores, a distribution facility and office space
opening in fiscal 1999 which were entered into before the period indicated, are
as follows (in thousands):
<TABLE>
<CAPTION>
As of As of
January 30, 1999 May 1, 1999
----------------- -----------------
<S> <C> <C> <C> <C>
(unaudited)
<CAPTION>
Fiscal Operating Capital Operating Capital
- ------ --------- ------- --------- -------
<S> <C> <C> <C> <C>
1999........................................ $ 19,168 $2,075 $ 15,766 $1,349
2000........................................ 21,288 1,598 22,561 1,775
2001........................................ 21,688 1,022 22,943 1,025
2002........................................ 22,021 405 23,263 362
2003........................................ 22,400 -- 23,642 --
2004 and thereafter......................... 58,904 -- 78,398 --
-------- ------ -------- ------
$165,469 $5,100 $186,573 $4,511
======== ====== ======== ======
</TABLE>
F-17
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information as of May 1, 1999 and for the 13 weeks ended May 2, 1998 and May
1, 1999 is unaudited)
401(k) Plan
On October 1, 1996, the Company adopted a 401(k) plan for its employees (the
"Plan"). The Plan, as amended, allows participants to contribute up to 15% of
their compensation and permits a discretionary employer match, subject to
certain defined limitations. Employer contributions vest 20% per year. No
employer contributions were made in fiscal 1996, 1997, 1998, and for the 13
weeks ended May 1, 1999.
General
From time to time, the Company is named as a defendant in legal actions
arising from its normal business activities. Although the amount of any
liability that could arise with respect to currently pending actions cannot be
estimated, in the opinion of the Company, any such liability will not have a
material adverse effect on its financial position, operating results or
liquidity.
F-18
<PAGE>
[Depicted on the inside back cover page is a picture of a smiling child. The
text reads as follows: "Our Product Mission: The Best Stuff for Kids! Zany
Brainy will provide the best merchandise for children at the right price. We
seek interactive products that encourage a sense of wonder and stimulate
creativity. We believe that learning should be fun!"]
[Depicted on the outside back cover is a collage of icons representing our
major product categories and corresponding category names]
<PAGE>
, 1999
6,100,000 Shares of Common Stock
----------------
PROSPECTUS
----------------
Donaldson, Lufkin & Jenrette
BT Alex. Brown
William Blair & Company
U.S. Bancorp Piper Jaffray
----------------
DLJdirect Inc.
- --------------------------------------------------------------------------------
Until , 1999 (25 days after the date of this prospectus), all dealers,
whether or not participating in this offering, that affect transactions in
these securities may be required to deliver a prospectus. This is in addition
to the dealer's obligation to deliver a prospectus when acting as an
underwriter in this offering and when selling previously unsold allotments or
subscriptions.
- --------------------------------------------------------------------------------
<PAGE>
Part II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than
underwriting discounts and commissions. All of the amounts shown are estimated
except the Securities and Exchange Commission registration fee, the NASD filing
fee and the Nasdaq National Market listing fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee........... $ 27,174.50
National Association of Securities Dealers, Inc. filing fee... 10,275.00
Transfer Agent's fees and expenses............................ 5,000.00
Printing and engraving expenses............................... 175,000.00
Legal fees and expenses....................................... 325,000.00
Blue sky fees and expenses.................................... 7,500.00
Nasdaq National Market listing fee............................ 95,000.00
Accountants' fees and expenses................................ 300,000.00
Miscellaneous................................................. 405,050.50
-------------
Total Expenses................................................ $1,350,000.00
=============
</TABLE>
Item 14. Indemnification of Directors and Officers.
The Pennsylvania Business Corporation Law and Zany Brainy's Amended and
Restated Bylaws limit the monetary liability of directors to Zany Brainy and to
its shareholders and provide for indemnification of Zany Brainy's officers and
directors for liabilities and expenses that they may incur in such capacities.
In general, officers and directors are indemnified with respect to actions
taken in good faith in a manner reasonably believed to be in, or not opposed
to, the best interests of Zany Brainy, and with respect to any criminal action
or proceeding, actions that the indemnitee had no reasonable cause to believe
were unlawful. In addition, Zany Brainy's Amended and Restated Bylaws provide
that Zany Brainy shall indemnify its officers and directors to the fullest
extent permitted by Pennsylvania law, including some instances in which
indemnification is otherwise discretionary under Pennsylvania law. Reference is
made to Zany Brainy's Amended and Restated Bylaws filed as Exhibit 3.2 hereto.
Zany Brainy has an insurance policy which insures the directors and officers
of Zany Brainy against certain liabilities which might be incurred in
connection with the performance of their duties.
Item 15. Recent Sales of Unregistered Securities
During the past three years, Zany Brainy has issued and sold unregistered
securities in the transactions described below.
Shares of Preferred Stock
1. Pursuant to a Purchase Agreement dated September 24, 1996 and November 27,
1996, Zany Brainy issued an aggregate of 749,984 shares of Series C
Convertible Preferred Stock to 39 accredited investors for a purchase price
of $22.50 per share, or an aggregate purchase price of $16,874,640.
II-1
<PAGE>
2. Pursuant to a Purchase Agreement dated September 24, 1996, Zany Brainy
issued an aggregate of 748,334 shares of Series BB Convertible Preferred
Stock to 35 holders of Zany Brainy's Series B Convertible Preferred Stock in
exchange for these holders' shares of Series B Convertible Preferred Stock.
Options to Purchase Common Stock
3. The Company from time to time has granted stock options to employees,
directors and consultants. The following table sets forth certain
information regarding such grants:
<TABLE>
<CAPTION>
No. of Range of
Shares Exercise Prices
--------- ---------------
<S> <C> <C>
1996............................................... 758,101 $4.00
1997............................................... 1,169,507 $3.33 to $4.00
1998............................................... 472,497 $4.00 to $9.00
1999............................................... 719,400 $11.75
</TABLE>
4. The following table sets forth certain information regarding option
exercises:
<TABLE>
<CAPTION>
No. of Range of
Shares Exercise Prices
------ ---------------
<S> <C> <C>
1996.................................................. 4,878 $3.33 to $4.00
1997.................................................. 10,392 $3.33 to $4.00
1998.................................................. 22,048 $3.33
1999.................................................. 1,837 $3.33 to $4.00
</TABLE>
Zany Brainy believes that the issuance of shares and under the Purchase
Agreements described above did not involve a public offering and were exempt
from registration under Section 4(2) of the Securities Act because such
issuances were made to a limited group of persons, each of whom was believed to
have been a sophisticated investor or had a pre-existing business or personal
relationship with Zany Brainy or its management and because each such person
was purchasing for investment without a view to further distribution.
Restrictive legends were placed on stock certificates and are contained in
stock option agreements evidencing the securities described above. Shares
issued upon exercise of options were exempt from registration under Rule 3(b)
of the Securities Act and Rule 701 promulgated thereunder.
II-2
<PAGE>
Item 16. Exhibits and Financial Statement Schedules.
(a) The following exhibits are filed as part of this registration statement:
EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
------- ---------------------------------------------------------------------
<C> <S>
1* Form of Underwriting Agreement
3.1* Form of Amended and Restated Articles of Incorporation
3.2 Form of Amended and Restated Bylaws
5 Opinion of Morgan, Lewis & Bockius LLP regarding the legality of the
shares of common stock being registered
10.1* 1993 Stock Incentive Plan
10.2* 1998 Equity Compensation Plan
10.3* Form of Stock Purchase Agreement providing registration rights to
certain shareholders
10.4* Employment Agreement with Keith C. Spurgeon
10.5* Employment Agreement with Thomas G. Vellios
10.6* Employment Agreement with Robert A. Helpert
10.7* Amended and Restated Loan and Security Agreement dated October 9,
1997, as amended, between Zany Brainy, Inc. and First Union
Corporation, as successor in interest to CoreStates Bank, N.A.
10.8 Commitment Letter dated May 5, 1999 between First Union National Bank
and Zany Brainy
21* Subsidiaries
23.1 Consent of Arthur Andersen LLP
Consent of Morgan, Lewis & Bockius LLP (included in its opinion filed
23.2 as Exhibit 5 hereto)
Power of Attorney (included on signature page to this Registration
24.1* Statement)
27* Financial Data Schedule
</TABLE>
- --------
* Previously filed.
(b) Financial statement schedules have been omitted because they are
inapplicable, are not required under applicable provisions of Regulation S-X,
or the information that would otherwise be included in such schedules is
contained in the registrant's financial statements or accompanying notes.
Item 17. Undertakings.
(a) The undersigned Registrant hereby undertakes to provide to the
Underwriters at the closing specified in the Underwriting Agreement
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a
II-3
<PAGE>
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
(c) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant
to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall
be deemed to be part of this Registration Statement as of the time
it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering
thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment No. 3 to the Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in
Wynnewood, Pennsylvania on May 11, 1999.
ZANY BRAINY, INC.
/s/ Keith C. Spurgeon
By:
----------------------------------
Keith C. Spurgeon
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 3 to the Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
<S> <C>
/s/ Keith C. Spurgeon Chairman of the May 11, 1999
- ---------------------------------- Board and Chief
Keith C. Spurgeon Executive Officer
(principal executive officer)
* Chief Financial May 11, 1999
- ---------------------------------- Officer (principal
Robert A. Helpert financial and
accounting officer)
* Director May 11, 1999
- ----------------------------------
C. Donald Dorsey
* May 11, 1999
- ---------------------------------- Director
Robert A. Fox
* Director May 11, 1999
- ----------------------------------
Gerald R. Gallagher
* May 11, 1999
- ---------------------------------- Director
Henry Nasella
* Director May 11, 1999
- ----------------------------------
Yves B. Sisteron
* Director May 11, 1999
- ----------------------------------
David V. Wachs
/s/ Keith C. Spurgeon
By__________________________________
Attorney-in-Fact
</TABLE>
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- ---------------------------------------------------------------------
<C> <S>
1* Form of Underwriting Agreement
3.1* Form of Amended and Restated Articles of Incorporation
3.2 Form of Amended and Restated Bylaws
5 Opinion of Morgan, Lewis & Bockius LLP regarding the legality of the
shares of common stock being registered
10.1* 1993 Stock Incentive Plan
10.2* 1998 Equity Compensation Plan
10.3* Form of Stock Purchase Agreement providing registration rights to
certain shareholders
10.4* Employment Agreement with Keith C. Spurgeon
10.5* Employment Agreement with Thomas G. Vellios
10.6* Employment Agreement with Robert A. Helpert
10.7* Amended and Restated Loan and Security Agreement dated October 9,
1997, as amended, between Zany Brainy, Inc. and First Union
Corporation, as successor in interest to CoreStates Bank, N.A.
10.8 Commitment Letter dated May 5, 1999 between First Union National Bank
and Zany Brainy
21* Subsidiaries
23.1 Consent of Arthur Andersen LLP
Consent of Morgan, Lewis & Bockius LLP (included in its opinion filed
23.2 as Exhibit 5 hereto)
Power of Attorney (included on signature page to this Registration
24.1* Statement)
27* Financial Data Schedule
</TABLE>
- --------
* Previously filed.
<PAGE>
Exhibit 3.2
AMENDED AND RESTATED
BYLAWS OF
ZANY BRAINY, INC.
<PAGE>
BYLAWS
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
-----
<S> <C>
ARTICLE I - OFFICES
Section 1-1. Registered Office............................................... 1
Section 1-2. Other Offices................................................... 1
ARTICLE II - MEETINGS OF SHAREHOLDERS - ANNUAL FINANCIAL STATEMENTS
Section 2-1. Place of Meetings of Shareholders............................... 1
Section 2-2. Annual Meeting of Shareholders.................................. 1
(a) Time........................................................... 1
(b) Election of Directors.......................................... 1
Section 2-3. Special Meetings of Shareholders................................ 1
Section 2-4. Notices of Meetings of Shareholders............................. 2
Section 2-5. Quorum of and Action by Shareholders............................ 2
(a) General Rule................................................... 2
(b) Action by Shareholders......................................... 2
(c) Withdrawal..................................................... 2
(d) Election of Directors at Adjourned Meetings.................... 3
(e) Conduct of Other Business at Adjourned Meetings................ 3
Section 2-6. Adjournments.................................................... 3
(a) General Rule................................................... 3
(b) Lack of Quorum................................................. 3
(c) Notice of an Adjourned Meeting................................. 3
Section 2-7. Voting List, Voting and Proxies................................. 3
(a) Voting List.................................................... 3
(b) Voting......................................................... 4
(c) Proxies........................................................ 4
(d) Judges of Election............................................. 4
Section 2-8. Participation in Meetings by Conference Telephone............... 4
Section 2-9. Action by Unanimous Consent of Shareholders..................... 4
Section 2-10. Action by Less than Unanimous Consent of Shareholders.......... 5
Section 2-11. Annual Financial Statements.................................... 5
ARTICLE III - BOARD OF DIRECTORS
Section 3-1. 5
(a) General Rule................................................... 5
(b) Qualifications................................................. 6
(c) Power to Select Directors...................................... 6
(d) Notice of Shareholder Business and Nominations................. 6
(e) Election of Directors.......................................... 8
</TABLE>
-i-
<PAGE>
<TABLE>
<S> <C>
(f) Number......................................................... 8
(g) Term of Office................................................. 8
(h) Resignation.................................................... 9
(i) Vacancies...................................................... 9
(j) Removal of Directors........................................... 9
Section 3-2. Place of Meetings............................................... 9
Section 3-3. Regular Meetings................................................ 9
Section 3-4. Special Meetings................................................ 9
Section 3-5. Participation in Meetings by Conference Telephone............... 9
Section 3-6. Notices of Meetings of Board of Directors....................... 10
(a) Regular Meetings............................................... 10
(b) Special Meetings............................................... 10
Section 3-7. Quorum and Action by Directors.................................. 10
Section 3-8. Informal Action by the Board of Directors....................... 10
Section 3-9. Committees...................................................... 10
(a) Establishment and Powers....................................... 10
(b) Alternate Members.............................................. 11
(c) Term........................................................... 11
(d) Status of Committee Action..................................... 11
ARTICLE IV - OFFICERS
Section 4-1. Election and Office............................................. 11
Section 4-2. Term............................................................ 11
Section 4-3. Powers and Duties of the Chief Executive Officer................ 12
Section 4-4. Powers and Duties of the President.............................. 12
Section 4-5. Powers and Duties of the Secretary.............................. 12
Section 4-6. Powers and Duties of the Treasurer.............................. 12
Section 4-7. Powers and Duties of the Chairman of the Board.................. 13
Section 4-8. Powers and Duties of Vice Chairmen of the Board, Vice
Presidents
and Assistant Officers......................................... 13
Section 4-9. Delegation of Office............................................ 13
Section 4-10. Vacancies...................................................... 13
ARTICLE V - CAPITAL STOCK
Section 5-1. Share Certificates.............................................. 13
(a) Execution...................................................... 13
(b) Designations, etc.............................................. 13
(c) Fractional Shares.............................................. 14
Section 5-2. Transfer of Shares.............................................. 14
Section 5-3. Determination of Shareholders of Record....................... 14
(a) Fixing Record Date............................................. 14
(b) Determination when No Record Date Fixed........................ 14
(c) Certification by Nominee....................................... 15
</TABLE>
-ii-
<PAGE>
<TABLE>
<S> <C>
Section 5-4. Lost Share Certificates......................................... 15
Section 5-5. Uncertificated Shares........................................... 15
ARTICLE VI - NOTICES - COMPUTING TIME PERIODS
Section 6-1. Contents of Notice.............................................. 16
Section 6-2. Modification of Proposal Contained in Notice.................... 16
Section 6-3. Method of Notice................................................ 16
Section 6-4. Bulk Mail....................................................... 16
Section 6-5. Computing Time Periods.......................................... 16
(a) Days to be Counted............................................. 16
(b) One Day Notice................................................. 17
Section 6-6. Waiver of Notice................................................ 17
ARTICLE VII - LIMITATION OF DIRECTORS' LIABILITY AND INDEMNIFICATION
OF DIRECTORS, OFFICERS AND OTHER PERSONS
Section 7-1. Limitation of Directors' Liability.............................. 17
Section 7-2. Indemnification and Insurance................................... 17
(a) Indemnification of Directors and Officers................... 17
(b) Indemnification of Employees and Other Persons................. 18
(c) Non-Exclusivity of Rights...................................... 18
(d) Insurance...................................................... 19
(e) Fund For Payment of Expenses................................... 19
Section 7-3. Amendment....................................................... 19
Section 7-4. Changes in Pennsylvania Law..................................... 19
ARTICLE VIII - FISCAL YEAR
Section 8-1. Determination of Fiscal Year.................................... 20
ARTICLE IX - AMENDMENTS
Section 9-1. 20
(a) Shareholders................................................... 20
(b) Board of Directors............................................. 20
ARTICLE X - INTERPRETATION OF BYLAWS -- SEPARABILITY
Section 10-1. Interpretation................................................. 20
Section 10-2. Separability................................................... 20
ARTICLE XI - DETERMINATIONS BY THE BOARD
Section 11-1. Effect of Board Determinations................................. 20
ARTICLE XII - ADOPTION OF BYLAWS AND RECORD OF AMENDMENT
Section 12-1. Adoption....................................................... 21
</TABLE>
-iii-
<PAGE>
BYLAWS OF
ZANY BRAINY, INC.
ARTICLE I-OFFICES
Section 1-1. Registered Office. The registered office of the Corporation
-----------------
shall be located within the Commonwealth of Pennsylvania at such place as the
Board of Directors (hereinafter referred to as the "Board of Directors" or the
"Board") shall determine from time to time.
Section 1-2. Other Offices. The Corporation may also have offices at
-------------
such other places within or without the Commonwealth of Pennsylvania as the
Board of Directors may from time to time appoint or the business of the
Corporation may require.
ARTICLE II-MEETINGS OF SHAREHOLDERS -
ANNUAL FINANCIAL STATEMENTS
Section 2-1. Place of Meetings of Shareholders. Meetings of
---------------------------------
shareholders shall be held at such places, within or without the Commonwealth of
Pennsylvania, as may be fixed from time to time by the Board of Directors. If no
such place is fixed by the Board of Directors, meetings of the shareholders
shall be held at the registered office of the Corporation.
Section 2-2. Annual Meeting of Shareholders.
------------------------------
(a) Time. A meeting of the shareholders of the Corporation shall be
----
held in each calendar year at such date and time as the Board of Directors may
determine, or if the Board of Directors fails to set a time, on the third
Wednesday in May in such year at 10:00 o'clock a.m., if not a legal holiday, and
if such day is a legal holiday in Pennsylvania, then such meeting shall be held
on the next business day and at said meeting the shareholders then entitled to
vote shall elect directors and shall transact such other business as may
properly be brought before the meeting. If the annual meeting is not called and
held within six months after the designated time, any shareholder may call the
meeting at any time thereafter.
(b) Election of Directors. At such annual meeting, there shall be
---------------------
held an election of Directors.
Section 2-3. Special Meetings of Shareholders. Except as expressly
--------------------------------
required by law, the special meetings of shareholders may be called at any time
only by:
(a) the Chairman of the Board, if any, if the Chairman of the Board is
serving as the chief executive officer of the Corporation, and otherwise the
President of the Corporation;
<PAGE>
(b) any two Directors; or
(c) the holder or holders of at least 20% of the outstanding
securities of the Corporation (on a fully covered basis).
Upon the written request of any person who has a called or special
meeting, under these bylaws or applicable law, which request specifies the
general nature of the business to be transacted at such meeting, it shall be the
duty of the Secretary to fix the time and place of such meeting, which shall be
held not less than five nor more than 60 days after the receipt of such request,
and to give due notice thereof as is required by Section 2-4 hereof. If the
Secretary neglects or refuses to fix the time and place of such meeting, the
person or persons calling the meeting may do so."
Section 2-4. Notices of Meetings of Shareholders. Written notice,
-----------------------------------
complying with Article VI of these Bylaws, stating the place and time and, in
the case of special meetings, the general nature of the business to be
transacted at any meeting of the shareholders shall be given to each shareholder
of record entitled to vote at the meeting, except as provided in Section 1707 of
the Pennsylvania Business Corporation Law of 1988, as amended (the "Pennsylvania
BCL"), at least five days prior to the day named for the meeting, provided that
notice shall be given at least ten days prior to the day named for a meeting to
consider a fundamental change under Chapter 19 of the Pennsylvania BCL. Such
notices may be given by, or at the direction of, the Secretary or other
authorized person. If the Secretary or other authorized person neglects or
refuses to give notice of a meeting, the person or persons calling the meeting
may do so.
Section 2-5. Quorum of and Action by Shareholders.
------------------------------------
(a) General Rule. Except as provided in subsections (c), (d) and (e)
------------
of this Section 2-5, the presence, in person or by proxy, of shareholders
entitled to cast at least a majority of the votes that all shareholders are
entitled to cast on a particular matter to be acted upon at the meeting shall
constitute a quorum for the purpose of consideration and action on the matter.
Unless the Pennsylvania BCL permits otherwise, this Section 2-5(a) may be
modified only by a Bylaw amendment adopted by the shareholders.
(b) Action by Shareholders. Whenever any corporate action is to be
----------------------
taken by vote of the shareholders of the Corporation at a duly organized meeting
of shareholders, it shall be authorized by a majority of the votes cast at the
meeting by the holders of shares entitled to vote thereon. Unless the
Pennsylvania BCL permits otherwise, this Section 2-5(b) may be modified only by
a Bylaw amendment adopted by the shareholders.
(c) Withdrawal. The shareholders present at a duly organized meeting
----------
can continue to do business until adjournment, notwithstanding the withdrawal of
enough shareholders to leave less than a quorum.
2
<PAGE>
(d) Election of Directors at Adjourned Meetings. In the case of any
-------------------------------------------
meeting called for the election of Directors, those shareholders who attend a
meeting called for the election of Directors that has been previously adjourned
for lack of a quorum, although less than a quorum as fixed in subsection (a),
shall nevertheless constitute a quorum for the purpose of electing Directors.
(e) Conduct of Other Business at Adjourned Meetings. Those
-----------------------------------------------
shareholders entitled to vote who attend a meeting of shareholders that has been
previously adjourned for one or more periods aggregating at least 15 days
because of an absence of a quorum, although less than a quorum as fixed in
subsection (a), shall nevertheless constitute a quorum for the purpose of acting
upon any matter set forth in the notice of meeting if the notice states that
those shareholders who attend the adjourned meeting shall nevertheless
constitute a quorum for the purpose of acting upon the matter.
Section 2-6. Adjournments.
------------
(a) General Rule. Adjournments of any regular or special meeting of
------------
shareholders may be taken, but any meeting at which directors are to be elected
shall be adjourned only from day to day, or for such longer periods not
exceeding 15 days each As the shareholders present and entitled to vote shall
direct, until the directors have been elected.
(b) Lack of Quorum. If a meeting cannot be organized because a quorum
--------------
has not attended, those present may, except as otherwise provided in this
Section 2-6, adjourn the meeting to such time and place as they may determine.
(c) Notice of an Adjourned Meeting. When a meeting of shareholders is
------------------------------
adjourned, it shall not be necessary to give any notice of the adjourned meeting
or of the business to be transacted at an adjourned meeting, other than by
announcement at the meeting at which the adjournment is taken, unless the Board
fixes a new record date for the adjourned meeting.
Section 2-7. Voting List, Voting and Proxies.
-------------------------------
(a) Voting List. The officer or agent having charge of the transfer
-----------
books for shares of the Corporation shall make a complete list of the
shareholders entitled to vote at any meeting of shareholders, arranged in
alphabetical order, with the address of and the number of shares held by each.
The list shall be produced and kept open at the time and place of the meeting
and shall be subject to the inspection of any shareholder during the whole time
of the meeting for the purposes thereof except that, if the Corporation has
5,000 or more shareholders, in lieu of the making of the list the Corporation
may make the information therein available at the meeting by any other means.
3
<PAGE>
(b) Voting. Except as otherwise specifically provided by law, all
------
matters coming before the meeting shall be determined by a vote of shares. Such
vote shall be taken by voice unless a shareholder demands, before the vote
begins, that it be taken by ballot.
(c) Proxies. At all meetings of shareholders, shareholders entitled
-------
to vote may attend and vote either in person or by proxy. Every proxy shall be
executed in writing by the shareholder or by such shareholder's duly authorized
attorney-in-fact and filed with the Secretary of the Corporation. A proxy,
unless coupled with an interest (as defined in Section 1759(c) of the
Pennsylvania BCL), shall be revocable at will, notwithstanding any other
agreement or any provision in the proxy to the contrary, but the revocation of a
proxy shall not be effective until written notice thereof has been given to the
Secretary of the Corporation. An unrevoked proxy shall not be valid after three
years from the date of its execution unless a longer time is expressly provided
therein. A proxy shall not be revoked by the death or incapacity of the maker
unless, before the vote is counted or the authority is exercised, written notice
of the death or incapacity is given to the Secretary of the Corporation.
(d) Judges of Election. In advance of any meeting of shareholders of
------------------
the Corporation, the Board of Directors may appoint one or three Judges of
Election, who need not be shareholders and who will have such duties as provided
in Section 1765(3) of the Pennsylvania BCL, to act at the meeting or any
adjournment thereof. If one or three Judges of Election are not so appointed,
the presiding officer of the meeting may, and on the request of any shareholder
shall, appoint one or three Judges of Election at the meeting. In case any
person appointed as a Judge of Election fails to appear or refuses to act, the
vacancy may be filled by appointment made by the Board of Directors in advance
of the convening of the meeting or at the meeting by the presiding officer. A
person who is a candidate for office to be filled at the meeting shall not act
as a Judge of Election. Unless the Pennsylvania BCL permits otherwise, this
Section 2-7(d) may be modified only by a Bylaw amendment adopted by the
shareholders.
Section 2-8. Participation in Meetings by Conference Telephone. Unless
-------------------------------------------------
determined to the contrary by the Board of Directors in advance of a particular
meeting with respect to that meeting, any person who is otherwise entitled to
participate in any meeting of the shareholders may attend, be counted for the
purposes of determining a quorum and exercise all rights and privileges to which
such person might be entitled were such person personally in attendance,
including the right to vote, by means of conference telephone or similar
communications equipment by means of which all persons participating in the
meeting can hear each other, if such communications equipment is present in the
meeting room.
Section 2-9. Action by Unanimous Consent of Shareholders. Any action
-------------------------------------------
required or permitted to be taken at a meeting of the shareholders or a class of
shareholders may be taken without a meeting if, prior or subsequent to the
action, a consent or consents thereto in writing (executed personally or by
proxy), shall be signed by all of the shareholders who would be entitled to vote
at a meeting for such purpose and shall be filed with the Secretary of the
Corporation. In addition to other means of filing with the Secretary, insertion
in the minute book
4
<PAGE>
of the Corporation shall be deemed filing with the Secretary regardless of
whether the Secretary or some other authorized person has actual possession of
the minute book.
Section 2-10. Action by Less than Unanimous Consent of Shareholders. Any
-----------------------------------------------------
action required or permitted to be taken at a meeting of the shareholders or of
a class of shareholders may be taken without a meeting upon the written consent
of shareholders who would have been entitled to cast the minimum number of votes
that would be necessary to authorize the action at a meeting at which all
shareholders entitled to vote thereon were present and voting. The consents
shall be filed with the Secretary of the Corporation. In addition to other means
of filing with the secretary, insertion in the minute book of the Corporation
shall be deemed filing with the Secretary regardless of whether the secretary or
some other authorized person has actual possession of the minute book. The
action shall not become effective until after at least ten days written notice
of such action shall have been given to each shareholder entitled to vote
thereon who has not consented thereto.
Section 2-11. Annual Financial Statements. Unless otherwise agreed
---------------------------
between the Corporation and a shareholder, the Corporation shall furnish to its
shareholders annual financial statements, including at least a balance sheet as
of the end of each fiscal year and statement of income and expenses for the
fiscal year. The financial statements shall be prepared on the basis of
generally accepted accounting principles, if the Corporation prepares financial
statements for the fiscal year on that basis for any purpose, and may be
consolidated statements of the Corporation and one or more of its subsidiaries.
The financial statements shall be mailed by the Corporation to each of its
shareholders entitled thereto within 120 days after the close of each fiscal
year and, after the mailing and upon request, shall be mailed by the Corporation
to any shareholder or beneficial owner entitled thereto to whom a copy of the
most recent annual financial statements has not previously been mailed.
Statements that are audited or reviewed by a public accountant shall be
accompanied by the report of the accountant; in other cases, each copy shall be
accompanied by a statement of the person in charge of the financial records of
the Corporation (i) stating such person's reasonable belief as to whether or not
the financial statements were prepared in accordance with generally accepted
accounting principles and, if not, describing the basis of presentation, and
(ii) describing any material respects in which the financial statements were not
prepared on a basis consistent with those prepared for the previous year.
ARTICLE III-BOARD OF DIRECTORS
Section 3-1.
(a) General Rule. Unless otherwise provided by statute, all powers
------------
vested by law in the Corporation shall be exercised by or under the authority
of, and the business and affairs of the Corporation shall be managed under the
direction of, the Board of Directors.
5
<PAGE>
(b) Qualifications. Each Director of the Corporation shall be a
--------------
natural person of full age who need not be a resident of the Commonwealth of
Pennsylvania or a shareholder of the Corporation.
(c) Power to Select Directors. Except as otherwise provided in these
-------------------------
Bylaws, Directors of the Corporation shall be elected by the shareholders.
(d) Notice of Shareholder Business and Nominations. Nominations of
----------------------------------------------
persons for election to the Board of Directors of the Corporation and the
proposal of business to be considered by the shareholders may be made at an
annual meeting of shareholders (a) pursuant to the Corporation's notice of
meeting pursuant to the terms of these by-laws, (b) by or at the direction of
the Board of Directors, or (c) by any shareholder of the Corporation who was a
shareholder of record at the time of giving of notice provided for in this
Section 3-1(d), who is entitled to vote at the meeting and who complies with the
notice procedures set forth in this Section 3-1(d).
For nominations or other business to be properly brought before an annual
meeting of shareholders by a shareholder pursuant to this Section 3-1(d), the
shareholder must have given timely notice thereof in writing to the secretary of
the Corporation and such other business must otherwise be a proper matter for
shareholder action. To be timely, a shareholder's notice shall be delivered to
the secretary at the principal executive offices of the Corporation not later
than the close of business on the 90th calendar day nor earlier than the close
of business on the 120th calendar day prior to the first anniversary of the
preceding year's annual meeting of shareholders; provided, however, that in the
event that the date of the annual meeting of shareholders is more than 30
calendar days before or more that 60 calendar days after such anniversary date,
notice by the shareholder to be timely must be so delivered not earlier than the
close of business on the 120th calendar day prior to such annual meeting of
shareholders and not later than the close of business on the later of the 90th
calendar day prior to such annual meeting of shareholders or the 10th calendar
day following the calendar day on which public announcement of the date of such
meeting is first made by the Corporation. For purposes of determining whether a
shareholder's notice shall have been delivered in a timely manner for the annual
meeting of shareholders in 2000, the first anniversary of the previous year's
meeting shall be deemed to be May 1, 1999. In no event shall the public
announcement of an adjournment of an annual meeting of shareholders commence a
new time period for the giving of a shareholder's notice as described above.
Such shareholder's notice shall set forth, or be accompanied by, (a) in the
event the shareholder proposes to nominate one or more persons for election or
reelection as a director (1) the name and residence address of the shareholder
and of the person or persons to be nominated; (2) a representation that the
shareholder is a holder of record of voting stock of the Corporation and intends
to appear in person or by proxy at the meeting to nominate the person or persons
specified in the Notice; (3) such information regarding each nominee as would
have been required to be included in a proxy statement filed pursuant to
Regulation 14A promulgated by the Securities and Exchange Commission under the
Securities Exchange Act of 1934, as amended (or pursuant to any successor act or
regulation), including, without limitation, Rule
6
<PAGE>
14a-11 thereunder, had proxies been solicited with respect to such nominee by
the management or Board of Directors of the Corporation; (4) a description of
all arrangements or understandings among the shareholder and each nominee and
any other person or persons (naming such person or persons) pursuant to which
the nomination or nominations are to be made by the shareholder; and (5) the
written consent of each nominee to serve as a director of the Corporation if so
elected; and (b) in the event the shareholder proposes to bring any other
business before the meeting, (1) the name and residence address of the
shareholder proposing to bring business before the meeting and the beneficial
owner, if any, on whose behalf the proposal is made, (2) the class and number of
shares of the Corporation which are owned beneficially and of record by such
shareholder and such beneficial owner, (3) a representation that the shareholder
is a holder of record of the voting stock of the Corporation and intends to
appear in person or by proxy at the meeting to bring the business before the
meeting; and (4) a brief description of the business desired to be brought
before the meeting, the reasons for conducting such business of such shareholder
and beneficial owner, if any, on whose behalf the proposal is made.
Notwithstanding anything in the second sentence of the preceding paragraph
to the contrary, in the event that the number of directors to be elected to the
Board of Directors of the Corporation is increased and there is no public
announcement by the Corporation naming all of the nominees for director or
specifying the size of the increased Board of Directors at least 100 calendar
days prior to the first anniversary of the preceding year's annual meeting of
shareholders, a shareholder's notice required by this Section 3-1(d) shall also
be considered timely, but only with respect to nominees for any new positions
created by such increase, if it shall be delivered to the secretary at the
principal executive offices of the Corporation not later than the close of
business on the 10th calendar day following the day on which such public
announcement is first made by the Corporation.
Only such business shall be conducted at a special meeting of shareholders
as shall have been brought before the meeting pursuant to the Corporation's
notice of meeting under these by-laws. Nominations of persons for election to
the Board of Directors may be made at a special meeting of shareholders at which
Directors are to be elected pursuant to the Corporation's notice of meeting (a)
by or at the direction of the Board of Directors, or (b) provided that the Board
of Directors has determined that directors shall be elected at the meeting, by
any shareholder of the Corporation who is a shareholder of record at the time of
giving of notice provided for in this Section 3-1(d), who shall be entitled to
vote at the meeting and who complies with the notice procedures set forth in
this Section 3-1(d). In the event the Corporation calls a special meeting of
shareholders for the purpose of electing one or more directors to the Board of
Directors, any shareholder may nominate a person or persons (as the case may
be), for election to such position(s) as specified in the Corporation's notice
of meeting pursuant to such clause (b), if the shareholder's notice required by
the second preceding paragraph of this Section 3-1(d) shall be delivered to the
secretary at the principal executive offices of the Corporation not earlier than
the close of business on the 120th calendar day prior to such special meeting
and not later than the close of business on the later of the 90th calendar day
prior to such special meeting or the 10th calendar day following the day on
which public announcement is first made of the date of the
7
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special meeting and of the nominees proposed by the Board of Directors to be
elected at such meeting. In no event shall the public announcement of an
adjournment of a special meeting commence a new time period for the giving of a
shareholder's notice as described above.
Only such persons who are nominated in accordance with the procedures set
forth in this Section 3-1(d) shall be eligible to serve as Directors and only
such business shall be conducted at a meeting of shareholders as shall have been
brought before the meeting in accordance with the procedures set forth in this
Section 3-1(d). Except as otherwise provided by law, the articles of in
Corporation or these by-laws, the chairman of the meeting shall have the power
and duty to determine whether a nomination or any business proposed to be
brought before the meeting was made or proposed, as the case may be, in
accordance with the procedures set forth in this Section 3-1(d) and, if any
proposed nomination or business is not in compliance with this Section 3-1(d),
to declare that such defective proposal or nomination shall be disregarded.
For purposes of this Section 3-1(d), "public announcement" shall mean
disclosure in a press release reported by the Dow Jones News Service, Associated
Press or comparable national news service or in a document publicly filed by the
Corporation with the Securities and Exchange Commission pursuant to Section 13,
14 or 15(d) of the Securities Exchange Act of 1934, as amended.
Notwithstanding the foregoing provisions of this Section 3-1(d), a
shareholder shall also comply with all applicable requirements of the Securities
Exchange Act of 1934 and the rules and regulations thereunder with respect to
the matters set forth in this Section 3-1(d). Nothing in this Section 3-1(d)
shall be deemed to affect any rights of shareholders to request inclusion of
proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the
Exchange Act.
(e) Election of Directors. In elections for Directors, voting need
---------------------
not be by ballot, unless required by vote of the shareholders before the voting
for the election of Directors begins. The candidates receiving the highest
number of votes from each class or group of classes, if any, entitled to elect
Directors separately up to the number of Directors to be elected by the class or
group of classes shall be elected. If at any meeting of shareholders, Directors
of more than one class are to be elected, each class of Directors shall be
elected in a separate election.
(f) Number. The Board of Directors shall consist of one or more
------
members as may be determined from time to time by resolution of the Board of
Directors.
(g) Term of Office. Each Director shall hold office for one year and
--------------
until a successor has been selected and qualified or until his or her earlier
death, resignation or removal. A decrease in the number of directors shall not
have the effect of shortening the term of any incumbent director.
8
<PAGE>
(h) Resignation. Any Director may resign at any time upon written
-----------
notice to the Corporation. The resignation shall be effective upon receipt
thereof by the Corporation or at such subsequent time as shall be specified in
the notice of resignation.
(i) Vacancies. Vacancies in the Board of Directors, including
---------
vacancies resulting from an increase in the number of Directors, may be filled
by a majority vote of the remaining members of the Board though less than a
quorum, or by a sole remaining Director, and each person so selected shall be a
Director to serve until the next selection of the class for which such Director
has been chosen, and until a successor has been selected and qualified or until
his or her earlier death, resignation or removal.
(j) Removal of Directors.
--------------------
(i) Removal by the Shareholders. The entire Board of Directors
---------------------------
or any individual Director may be removed from office by vote of the
shareholders entitled to vote thereon without assigning any cause. In case the
Board or any one or more Directors are so removed, new Directors may be elected
at the same meeting.
(ii) Removal by the Board. The Board of Directors may declare
--------------------
vacant the office of a Director who has been judicially declared of unsound mind
or who has been convicted of an offense punishable by imprisonment for a term of
more than one year or if, within 60 days after notice of his or her selection,
the Director does not accept the office either in writing or by attending a
meeting of the Board of Directors.
Section 3-2. Place of Meetings. Meetings of the Board of Directors may
-----------------
be held at such place within or without the Commonwealth of Pennsylvania as a
majority of the Directors may appoint from time to time or as may be designated
in the notice of the meeting.
Section 3-3. Regular Meetings. A regular meeting of the Board of
----------------
Directors shall be held annually, immediately following the annual meeting of
the shareholders, at the place where such meeting of the shareholders is held or
at such other place and time as a majority of the Directors in office after the
annual meeting of shareholders may designate. At such meeting, the Board of
Directors shall elect officers of the Corporation. In addition to such regular
meeting, the Board of Directors shall have the power to fix by resolution the
place and time of other regular meetings of the Board.
Section 3-4. Special Meetings. Special meetings of the Board of
----------------
Directors shall be held whenever ordered by the Chairman of the Board, if any,
by the President, by a majority of the executive committee, if any, by any two
directors or by the holder or holders of at least 25% of the outstanding
securities of the Corporation (on a fully converted basis).
Section 3-5. Participation in Meetings by Conference Telephone.
-------------------------------------------------
Any Director may participate in any meeting of the Board of Directors or of any
committee (provided such Director
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<PAGE>
is otherwise entitled to participate), be counted for the purpose of determining
a quorum thereof and exercise all rights and privileges to which such Director
might be entitled were he or she personally in attendance, including the right
to vote, or any other rights attendant to presence in person at such meeting, by
means of conference telephone or similar communications equipment by means of
which all persons participating in the meeting can hear each other.
Section 3-6. Notices of Meetings of Board of Directors.
-----------------------------------------
(a) Regular Meetings. No notice shall be required to be given of any
----------------
regular meeting, unless the same is held at other than the place or time for
holding such meeting as fixed in accordance with Section 3-3 of these Bylaws, in
which event two days' notice shall be given of the place and time of such
meeting complying with Article VI of these Bylaws.
(b) Special Meetings. Written notice stating the place and time of
----------------
any special meeting of the Board of Directors shall be sufficient if given at
least one day, as provided in Article VI, in advance of the time fixed for the
meeting.
Section 3-7. Quorum and Action by Directors. A majority of the
------------------------------
Directors in office of the Corporation shall be necessary to constitute a quorum
for the transaction of business and the acts of a majority of the Directors
present and voting at a meeting at which a quorum is present shall be the acts
of the Board of Directors.
Section 3-8. Informal Action by the Board of Directors. Any action
-----------------------------------------
required or permitted to be taken at a meeting of the Directors, or of the
members of any committee of the Board of Directors, may be taken without a
meeting if, prior or subsequent to the action, a written consent or consents
thereto by all of the Directors in office (or members of the committee with
respect to committee action) is filed with the Secretary of the Corporation. In
addition to other means of filing with the Secretary, insertion in the minute
book of the Corporation shall be deemed filing with the Secretary regardless of
whether the Secretary or some other authorized person has actual possession of
the minute book.
Section 3-9. Committees.
----------
(a) Establishment and Powers. The Board of Directors of the
------------------------
Corporation may, by resolution adopted by a majority of the Directors in office,
establish one or more committees to consist of one or more Directors of the
Corporation. Any committee, to the extent provided in the resolution of the
Board of Directors or in the Bylaws, shall have and may exercise all of the
powers and authority of the Board of Directors, except that a committee shall
not have any power or authority as to the following:
(i) The submission to shareholders of any action requiring
approval of shareholders under Section 1731(a)(1) of the Pennsylvania BCL.
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<PAGE>
(ii) The creation or filling of vacancies in the Board of
Directors.
(iii) The adoption, amendment or repeal of the Bylaws.
(iv) The amendment or repeal of any resolution of the Board of
Directors that by its terms is amendable or repealable only by the Board of
Directors.
(v) Action on matters committed by the Bylaws or resolution of
the Board of Directors to another committee of the Board of Directors.
(b) Alternate Members. The Board of Directors may designate one or
-----------------
more Directors as alternate members of any committee who may replace any absent
or disqualified member at any meeting of the committee or for the purpose of any
written action by the committee. In the absence or disqualification of a member
and alternate member or members of a committee, the member or members thereof
present at any meeting and not disqualified from voting, whether or not he or
they constitute a quorum, may unanimously appoint another Director to act at the
meeting in the place of the absent or disqualified member.
(c) Term. Each committee of the Board of Directors shall serve at the
----
pleasure of the Board of Directors.
(d) Status of Committee Action. The term "Board of Directors" or
--------------------------
"Board", when used in any provision of these Bylaws relating to the organization
or procedures of or the manner of taking action by the Board of Directors, shall
be construed to include and refer to any executive or other committee of the
Board of Directors. Any provision of these Bylaws relating or referring to
action to be taken by the Board of Directors or the procedure required therefor
shall be satisfied by the taking of corresponding action by a committee of the
Board of Directors to the extent authority to take the action has been delegated
to the committee pursuant to this section.
ARTICLE IV-OFFICERS
Section 4-1. Election and Office. The Corporation shall have a
-------------------
President, a Secretary and a Treasurer who shall be elected by the Board of
Directors. The Board of Directors may elect as additional officers a Chairman of
the Board, a Chief Executive Officer, one or more Vice Chairmen of the Board,
one or more Vice Presidents, and one or more other officers or assistant
officers. Any number of offices may be held by the same person. All of the
officers shall be natural persons of the age of 18 years or older except that
the Treasurer may be a corporation.
Section 4-2. Term. The officers and assistant officers shall each
----
serve at the pleasure of the Board of Directors until the first meeting of the
Board of Directors following the next annual meeting of shareholders, unless
removed from office by the Board of Directors during their respective tenures.
Officers may, but need not, be Directors.
11
<PAGE>
Section 4-3. Powers and Duties of the Chief Executive Officer.
------------------------------------------------
Unless otherwise determined by the Board of Directors, the Chief Executive
Officer shall have general supervision over the business, finances, operations
and welfare of the Corporation, subject however, to the control of the Board of
Directors. The Chief Executive Officer shall sign, execute, and acknowledge, in
the name of the Corporation, deeds, mortgages, bonds, contracts or other
instruments, authorized by the Board of Directors, except in cases where the
signing and execution thereof shall be expressly delegated by the Board of
Directors, or by these bylaws or by the Chief Executive Officer, to some other
officer or agent of the Corporation; and, in general, shall have all powers and
perform all duties incident to the position of a chief executive officer and
such other powers and duties as from time to time may be assigned by the Board
of Directors. The Chief Executive Officer shall from time to time make such
reports of the affairs of the Corporation as the Board may require and shall
present to the annual meeting of the shareholders a report of the business of
the Corporation for the preceding fiscal year.
Section 4-4. Powers and Duties of the President. Unless otherwise
----------------------------------
determined by the Board of Directors, the President shall perform the duties of
the Chief Executive Officer in the absence of the Chief Executive Officer and
such other duties as may from time to time be assigned to the President by the
Chief Executive Officer.
Section 4-5. Powers and Duties of the Secretary. Unless otherwise
----------------------------------
determined by the Board of Directors, the Secretary shall be responsible for the
keeping of the minutes of all meetings of the Board of Directors and the
shareholders, in books provided for that purpose, and for the giving and serving
of all notices for the Corporation. The Secretary shall perform all other duties
ordinarily incident to the office of Secretary and shall have such other powers
and perform such other duties as may be assigned to the Secretary by the Board
of Directors. The minute books of the Corporation may be held by a person other
than the Secretary.
Section 4-6. Powers and Duties of the Treasurer. Unless otherwise
----------------------------------
determined by the Board of Directors, the Treasurer shall have charge of all the
funds and securities of the Corporation which may come into such officer's
hands. When necessary or proper, unless otherwise determined by the Board of
Directors, the Treasurer shall endorse for collection on behalf of the
Corporation checks, notes and other obligations, and shall deposit the same to
the credit of the Corporation to such banks or depositories as the Board of
Directors may designate and may sign all receipts and vouchers for payments made
to the Corporation. The Treasurer shall sign all checks made by the Corporation,
except when the Board of Directors shall otherwise direct. The Treasurer shall
be responsible for the regular entry in books of the Corporation to be kept for
such purpose of a full and accurate account of all funds and securities received
and paid by the Treasurer on account of the Corporation. Whenever required by
the Board of Directors, the Treasurer shall render a statement of the financial
condition of the Corporation. The Treasurer shall have such other powers and
shall perform the duties as may be assigned to such officer from time to time by
the Board of Directors. The Treasurer shall give such bond, if any, for the
faithful performance of the duties of such office as shall be required by the
Board of Directors.
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<PAGE>
Section 4-7. Powers and Duties of the Chairman of the Board.
----------------------------------------------
Unless otherwise determined by the Board of Directors, the Chairman of the
Board, if any, shall preside at all meetings of Directors. The Chairman of the
Board shall have such other powers and perform such further duties as may be
assigned to such officer by the Board of Directors, including, without
limitation, acting as chief executive officer of the Corporation. To be eligible
to serve, the Chairman of the Board must be a Director of the Corporation.
Section 4-8. Powers and Duties of Vice Chairmen of the Board, Vice
---------------------------------------------------------------
Presidents and Assistant Officers. Unless otherwise determined by the Board of
- ---------------------------------
Directors, each Vice Chairman, Vice President and each assistant officer shall
have the powers and perform the duties of his or her respective superior
officer. Vice Presidents and assistant officers shall have such rank as may be
designated by the Board of Directors. Vice Presidents may be designated as
having responsibility for a specific area of the Corporation's affairs, in which
event such Vice President shall be superior to the other Vice Presidents in
relation to matters within his or her area. The President shall be the superior
officer of the Vice Presidents. The Chairman of the Board shall be the superior
officer of the Vice Chairmen. The Treasurer and Secretary shall be the superior
officers of the Assistant Treasurers and Assistant Secretaries, respectively.
Section 4-9. Delegation of Office. The Board of Directors may delegate
--------------------
the powers or duties of any officer of the Corporation to any other person from
time to time.
Section 4-10. Vacancies. The Board of Directors shall have the power to
---------
fill any vacancies in any office occurring for any reason.
ARTICLE V-CAPITAL STOCK
Section 5-1. Share Certificates.
------------------
(a) Execution. Except as otherwise provided in Section 5-5, the shares
---------
of the Corporation shall be represented by certificates. Unless otherwise
provided by the Board of Directors, every share certificate shall be signed by
two officers and sealed with the corporate seal, which may be a facsimile,
engraved or printed, but where such certificate is signed by a transfer agent or
a registrar, the signature of any corporate officer upon such certificate may be
a facsimile, engraved or printed. In case any officer who has signed, or whose
facsimile signature has been placed upon, any share certificate shall have
ceased to be such officer because of death, resignation or otherwise, before the
certificate is issued, it may be issued with the same effect as if the officer
had not ceased to be such at the date of its issue. The provisions of this
Section 5-1 shall be subject to any inconsistent or contrary agreement at the
time between the Corporation and any transfer agent or registrar.
(b) Designations, etc. To the extent the Corporation is authorized to
-----------------
issue shares of more than one class or series, every certificate shall set forth
upon the face or back of the certificate (or shall state on the face or back of
the certificate that the Corporation will furnish
13
<PAGE>
to any shareholder upon request and without charge) a full or summary statement
of the designations, voting rights, preferences, limitations and special rights
of the shares of each class or series authorized to be issued so far as they
have been fixed and determined and the authority of the Board of Directors to
fix and determine the designations, voting rights, preferences, limitations and
special rights of the classes and series of shares of the Corporation.
(c) Fractional Shares. Except as otherwise determined by the Board of
-----------------
Directors, shares or certificates therefor may be issued as fractional shares
for shares held by any dividend reinvestment plan or employee benefit plan
created or approved by the Corporation's Board of Directors, but not by any
other person.
Section 5-2. Transfer of Shares. Transfer of shares shall be made on the
------------------
books of the Corporation only upon surrender of the share certificate, duly
endorsed or with duly executed stock powers attached and otherwise in proper
form for transfer, which certificate shall be canceled at the time of the
transfer.
Section 5-3. Determination of Shareholders of Record.
---------------------------------------
(a) Fixing Record Date. The Board of Directors of the Corporation may
------------------
fix a time prior to the date of any meeting of shareholders as a record date for
the determination of the shareholders entitled to notice of, or to vote at, the
meeting, which time, except in the case of an adjourned meeting, shall be not
more than 90 days prior to the date of the meeting of shareholders. Only
shareholders of record on the date fixed shall be so entitled notwithstanding
any transfer of shares on the books of the Corporation after any record date
fixed as provided in this subsection. The Board of Directors may similarly fix
a record date for the determination of shareholders of record for any other
purpose. When a determination of shareholders of record has been made as
provided in this section for purposes of a meeting, the determination shall
apply to any adjournment thereof unless the Board of Directors fixes a new
record date for the adjourned meeting.
(b) Determination when No Record Date Fixed. If a record date is not
---------------------------------------
fixed:
(i) The record date for determining shareholders entitled to
notice of or to vote at a meeting of shareholders shall be at the close of
business on the day fixed by the Board of Directors but in no event more than 90
days prior to the meeting or less than the day next preceding the day on which
notice is given or, if notice is waived, at the close of business on the day
immediately preceding the day on which the meeting is held.
(ii) The record date for determining shareholders entitled to
express consent or dissent to corporate action in writing without a meeting,
when prior action by the Board of Directors is not necessary, shall be the close
of business on the day on which the first written consent or dissent is filed
with the Secretary of the Corporation.
14
<PAGE>
(iii) The record date for determining shareholders for any other
purpose shall be at the close of business on the day on which the Board of
Directors adopts the resolution relating thereto.
(c) Certification by Nominee. The Board of Directors may adopt a
------------------------
procedure whereby a shareholder of the Corporation may certify in writing to the
Corporation that all or a portion of the shares registered in the name of the
shareholder are held for the account of a specified person or persons. The
resolution of the Board of Directors may set forth:
(i) the classification of shareholder who may certify;
(ii) the purpose or purposes for which the certification may be
made;
(iii) the form of certification and information to be contained
therein;
(iv) if the certification is with respect to a record date, the
time after the record date within which the certification must be received by
the Corporation; and
(v) such other provisions with respect to the procedure as are
deemed necessary or desirable.
Upon receipt by the Corporation of a certification complying with the
procedure, the persons specified in the certification shall be deemed, for the
purposes set forth in the certification, to be the holders of record of the
number of shares specified in place of the shareholder making the certification.
Section 5-4. Lost Share Certificates. Unless waived in whole or in
-----------------------
part by the Board of Directors, any person requesting the issuance of a new
certificate in-lieu of an alleged lost, destroyed, mislaid or wrongfully taken
certificate shall (a) give to the Corporation his or her bond of indemnity with
an acceptable surety, and (b) satisfy such other requirements as may be imposed
by the Corporation. Thereupon, a new share certificate shall be issued to the
registered owner or his or her assigns in lieu of the alleged lost, destroyed,
mislaid or wrongfully taken certificate, provided that the request therefor and
issuance thereof have been made before the Corporation has notice that such
shares have been acquired by a bona fide purchaser.
Section 5-5. Uncertificated Shares. Notwithstanding anything
---------------------
herein to the contrary, any or all classes and series of shares, or any part
thereof, may be represented by uncertificated shares to the extent determined by
the Board of Directors, except that shares represented by a certificate that is
issued and outstanding shall continue to be represented thereby until the
certificate is surrendered to the Corporation. Within a reasonable time after
the issuance or transfer of uncertificated shares, the Corporation shall send to
the registered owner thereof, a written notice containing the information
required to be set forth or stated on certificates. The rights and obligations
of the holders of shares represented by certificates and the rights and
obligations of
15
<PAGE>
the holders of uncertificated shares of the same class and series shall be
identical. Notwithstanding anything herein to the contrary, the provisions of
Section 5-2 shall be inapplicable to uncertificated shares and in lieu thereof
the Board of Directors shall adopt alternative procedures for registration of
transfers.
ARTICLE VI - NOTICES - COMPUTING TIME PERIODS
Section 6-1. Contents of Notice. Whenever any notice of a meeting is
------------------
required to be given pursuant to these Bylaws or the Articles of Incorporation
(the "Articles") or otherwise, the notice shall specify the place and time of
the meeting; in the case of a special meeting of shareholders or where otherwise
required by law or the Bylaws, the general nature of the business to be
transacted at such meeting; and any other information required by law.
Section 6-2. Modification of Proposal Contained in Notice. Whenever the
--------------------------------------------
language of a proposed resolution is included in a written notice of a meeting
required to be given under the provisions of the Pennsylvania BCL or the
articles or these bylaws, the meeting considering the resolution may without
further notice adopt it with such clarifying or other amendments as do not
enlarge its original purpose.
Section 6-3. Method of Notice. Whenever written notice is required
----------------
to be given to any person under the provisions of the Articles or these Bylaws,
it may be given to the person either personally or by sending a copy thereof by
first class or express mail, postage prepaid, or by telegram (with messenger
service specified), telex or TWX (with answerback received) or courier service,
charges prepaid, or by telecopier, to such person's address (or to such person's
telex, TWX, telecopier or telephone number) appearing on the books of the
Corporation or, in the case of Directors, supplied by such Director to the
Corporation for the purpose of notice. If the notice is sent by mail, telegraph
or courier service, it shall be deemed to have been given to the person entitled
thereto when deposited in the United States mail or with a telegraph office or
courier service for delivery to that person or, in the case of telex or TWX,
when dispatched. Except as otherwise provided herein, or as otherwise directed
by the Board of Directors, notices of meetings may be given by, or at the
direction of, the Secretary.
Section 6-4. Bulk Mail. If the Corporation has more than 30
---------
shareholders, notice of any regular or special meeting of the shareholders, or
any other notice required by the Business Corporation Law or by the articles or
these bylaws to be given to all shareholders or to all holders of a class or
series of shares, may be given by any class of postpaid mail if the notice is
deposited in the United States mail at least 20 days prior to the day named for
the meeting or any corporate or shareholder action specified in the notice.
Section 6-5. Computing Time Periods.
----------------------
(a) Days to be Counted. In computing the number of days for purposes
------------------
of these Bylaws, all days shall be counted, including Saturdays, Sundays or a
holiday on which
16
<PAGE>
national banks are or may elect to be closed ("Holiday"); provided, however,
that if the final day of any time period falls on a Saturday, Sunday or Holiday,
then the final day shall be deemed to be the next day which is not a Saturday,
Sunday or Holiday. In computing the number of days for the purpose of giving
notice of any meeting, the date upon which the notice is given shall be counted
but the day set for the meeting shall not be counted.
(b) One Day Notice. In any case where only one day's notice is being
--------------
given, notice must be given at least 24 hours in advance by delivery in person,
telephone, telex, TWX, telecopier or similar means of communication.
Section 6-6. Waiver of Notice. Whenever any notice is required to be
----------------
given by law or the Articles or these Bylaws, a waiver thereof in writing,
signed by the person or persons entitled to the notice, whether before or after
the time stated therein, shall be deemed equivalent to the giving of the notice.
Except as otherwise required by law or the next sentence, neither the business
to be transacted at, nor the purpose of, a meeting need be specified in the
waiver of notice of the meeting. In the case of a special meeting of
shareholders, the waiver of notice shall specify the general nature of the
business to be transacted. Attendance of a person at any meeting shall
constitute a waiver of notice of the meeting except where a person attends a
meeting for the express purpose of objecting, at the beginning of the meeting,
to the transaction of any business because the meeting was not lawfully called
or convened.
ARTICLE VII - LIMITATION OF DIRECTORS' LIABILITY AND
INDEMNIFICATION OF DIRECTORS, OFFICERS AND OTHER PERSONS
Section 7-1. Limitation of Directors' Liability. No Director of
----------------------------------
the Corporation shall be personally liable for monetary damages as such for any
action taken or any failure to take any action unless: (a) the Director has
breached or failed to perform the duties of his or her office under Section 1721
of the Pennsylvania BCL, and (b) the breach or failure to perform constitutes
self-dealing, wilful misconduct or recklessness; provided, however, that the
provisions of this Section shall not apply to the responsibility or liability of
a Director pursuant to any criminal statute, or to the liability of a Director
for the payment of taxes pursuant to local, Pennsylvania or Federal law.
Section 7-2. Indemnification and Insurance.
-----------------------------
(a) Indemnification of Directors and Officers.
-----------------------------------------
(i) Each Indemnitee (as defined below) shall be indemnified and
held harmless by the Corporation for all actions taken by him or her and for all
failures to take action (regardless of the date of any such action or failure to
take action) to the fullest extent permitted by Pennsylvania law against all
expense, liability and loss (including without limitation attorneys fees,
judgments, fines, taxes, penalties, and amounts paid or to be paid in
settlement) reasonably incurred or suffered by the Indemnitee in connection with
any Proceeding (as defined below).
17
<PAGE>
No indemnification pursuant to this Section shall be made, however, in any case
where the act or failure to act giving rise to the claim for indemnification is
determined by a court to have constituted wilful misconduct or recklessness.
(ii) The right to indemnification provided in this Section shall
include the right to have the expenses incurred by the Indemnitee in defending
any Proceeding paid by the Corporation in advance of the final disposition of
the Proceeding to the fullest extent permitted by Pennsylvania law; provided
that, if Pennsylvania law continues so to require, the payment of such expenses
incurred by the Indemnitee in advance of the final disposition of a Proceeding
shall be made only upon delivery to the Corporation of an undertaking, by or on
behalf of the Indemnitee, to repay all amounts so advanced without interest if
it shall ultimately be determined that the Indemnitee is not entitled to be
indemnified under this Section or otherwise.
(iii) Indemnification pursuant to this Section shall continue as
to an Indemnitee who has ceased to be a Director or officer and shall inure to
the benefit of his or her heirs, executors and administrators.
(iv) For purposes of this Article, (A) "Indemnitee" shall mean
each Director or officer of the Corporation who was or is a party to, or is
threatened to be made a party to, or is otherwise involved in, any Proceeding,
by reason of the fact that he or she is or was a Director or officer of the
Corporation or is or was serving in any capacity at the request or for the
benefit of the Corporation as a Director, officer, employee, agent, partner, or
fiduciary of, or in any other capacity for, another corporation or any
partnership, joint venture, trust, employee benefit plan, or other enterprise;
and (B) "Proceeding" shall mean any threatened, pending or completed action,
suit or proceeding (including without limitation an action, suit or proceeding
by or in the right of the Corporation), whether civil, criminal, administrative,
investigative or through arbitration.
(b) Indemnification of Employees and Other Persons. The Corporation
----------------------------------------------
may, by action of its Board of Directors and to the extent provided in such
action, indemnify employees and other persons as though they were Indemnitees.
To the extent that an employee or agent of the Corporation has been successful
on the merits or otherwise in defense of any Proceeding or in defense of any
claim, issue or matter therein, the Corporation shall indemnify such person
against expenses (including attorneys' fees) actually and reasonably incurred by
such person in connection therewith.
(c) Non-Exclusivity of Rights. The rights to indemnification and to
-------------------------
the advancement of expenses provided in this Article shall not be exclusive of
any other rights that any person may have or hereafter acquire under any
statute, provision of the Articles or Bylaws, agreement, vote of shareholders or
Directors, or otherwise.
18
<PAGE>
(d) Insurance. The Corporation may purchase and maintain insurance,
---------
at its expense, for the benefit of any person on behalf of whom insurance is
permitted to be purchased by Pennsylvania law against any expense, liability or
loss, whether or not the Corporation would have the power to indemnify such
person under Pennsylvania or other law. The Corporation may also purchase and
maintain insurance to insure its indemnification obligations whether arising
hereunder or otherwise.
(e) Fund For Payment of Expenses. The Corporation may create a fund
----------------------------
of any nature, which may, but need not be, under the control of a trustee, or
otherwise may secure in any manner its indemnification obligations, whether
arising hereunder, under the Articles, by agreement, vote of shareholders or
Directors, or otherwise.
Section 7-3. Amendment. The provisions of this Article VII relating
---------
to the limitation of Directors' liability, to indemnification and to the
advancement of expenses shall constitute a contract between the Corporation and
each of its Directors and officers which may be modified as to any Director or
officer only with that person's consent or as specifically provided in this
Section. Notwithstanding any other provision of these Bylaws relating to their
amendment generally, any repeal or amendment of this Article VII which is
adverse to any Director or officer shall apply to such Director or officer only
on a prospective basis, and shall not reduce any limitation on the personal
liability of a Director of the Corporation, or limit the rights of an Indemnitee
to indemnification or to the advancement of expenses with respect to any action
or failure to act occurring prior to the time of such repeal or amendment.
Notwithstanding any other provision of these Bylaws, no repeal or amendment of
these Bylaws shall affect any or all of this Article so as either to reduce the
limitation of Directors' liability or limit indemnification or the advancement
of expenses in any manner unless adopted by (a) the unanimous vote of the
Directors of the Corporation then serving, or (b) the affirmative vote of
shareholders entitled to cast not less than a majority of the votes that all
shareholders are entitled to cast in the election of Directors; provided that no
such amendment shall have retroactive effect inconsistent with the preceding
sentence.
Section 7-4. Changes in Pennsylvania Law. References in this Article VII
---------------------------
to Pennsylvania law or to any provision thereof shall be to such law as it
existed on the date this Article VII was adopted or as such law thereafter may
be changed; provided that (a) in the case of any change which expands the
liability of Directors or limits the indemnification rights or the rights to
advancement of expenses which the Corporation may provide, the rights to limited
liability, to indemnification and to the advancement of expenses provided in
this Article shall continue as theretofore to the extent permitted by law; and
(b) if such change permits the Corporation without the requirement of any
further action by shareholders or Directors to limit further the liability of
Directors (or limit the liability of officers) or to provide broader
indemnification rights or rights to the advancement of expenses than the
Corporation was permitted to provide prior to such change, then liability
thereupon shall be so limited and the rights to indemnification and the
advancement of expenses shall be so broadened to the extent permitted by law.
19
<PAGE>
ARTICLE VIII - FISCAL YEAR
Section 8-1. Determination of Fiscal Year. The Board of Directors
----------------------------
shall have the power by resolution to fix the fiscal year of the Corporation. If
the Board of Directors shall fail to do so, the President shall fix the fiscal
year.
ARTICLE IX - AMENDMENTS
Section 9-1. Except as otherwise expressly provided in Section 7-3:
(a) Shareholders. The shareholders entitled to vote thereon shall
------------
have the power to alter, amend, or repeal these Bylaws, by the vote of
shareholders entitled to cast at least a majority of the votes which all
shareholders are entitled to cast thereon, at any regular or special meeting,
duly convened after notice to the shareholders of such purpose. In the case of
a meeting of shareholders to amend or repeal these Bylaws, written notice shall
be given to each shareholder that the purpose, or one of the purposes, of the
meeting is to consider the adoption, amendment or repeal of the Bylaws.
(b) Board of Directors. The Board of Directors (but not a committee
------------------
thereof), by a vote of the majority of Directors then in office, shall have the
power to alter, amend, and repeal these Bylaws, regardless of whether the
shareholders have previously adopted the Bylaw being amended or repealed,
subject to the power of the shareholders to change such action, provided that
the Board of Directors shall not have the power to amend these Bylaws on any
subject that is expressly committed to the shareholders by the express terms
hereof by Section 1504 of the Pennsylvania BCL or otherwise.
ARTICLE X - INTERPRETATION OF BYLAWS -- SEPARABILITY
Section 10-1. Interpretation. All words, terms and provisions of these
--------------
Bylaws shall be interpreted and defined by and in accordance with the
Pennsylvania BCL.
Section 10-2. Separability. The provisions of these Bylaws are
------------
independent of and separable from each other, and no provision shall be affected
or rendered invalid or unenforceable by virtue of the fact that for any reason
any other or others of them may be invalid or unenforceable in whole or in part.
ARTICLE XI - DETERMINATIONS BY THE BOARD
Section 11-1. Effect of Board Determinations. Any determination involving
------------------------------
interpretation or application of these Bylaws made in good faith by the Board of
Directors shall be final, binding and conclusive on all parties in interest.
20
<PAGE>
ARTICLE XII - ADOPTION OF BYLAWS AND RECORD OF AMENDMENT
Section 12-1. Adoption. These Amended and Restated Bylaws have been
--------
adopted and filed with the undersigned on the ___ day of ______, 1999, and shall
be effective as of the closing of the Corporation's initial public offering.
-----------------------
Secretary
__________, 1999
21
<PAGE>
Exhibit 5
Morgan, Lewis & Bockius LLP
1701 Market Street
Philadelphia, Pennsylvania 19103
(215) 963-5000(telephone)
(215) 963-5299(facsimile)
May 11, 1999
Zany Brainy, Inc.
308 East Lancaster Avenue
Wynnewood, PA 19096
Re: Zany Brainy, Inc.
Registration Statement on Form S-1 (No. 333-74719)
--------------------------------------------------
Ladies and Gentlemen:
We have acted as counsel to Zany Brainy, Inc., a Pennsylvania corporation (the
"Company"), in connection with preparation of the above-referenced Registration
Statement on Form S-1 (the "Registration Statement"), relating to the offering
of up to 7,015,000 shares of the Company's common stock, par value $0.01 per
share (the "Common Stock"), of which 4,722,669 shares of Common Stock (the
"Company Shares") including 915,000 shares purchasable by the underwriters upon
exercise of their overallotment option, are to be newly issued and sold by the
Company, and 2,292,331 shares of Common Stock (the "Selling Shareholder Shares")
are to be sold by the selling shareholders (the "Selling Shareholders") listed
in the Registration Statement under "Principal and Selling Shareholders."
In rendering the opinion set forth below, we have reviewed (a) the Registration
Statement and the exhibits thereto; (b) the Company's Amended and Restated
Articles of Incorporation, as amended; (c) the Company's Amended and Restated
Bylaws; (d) certain records of the Company's corporate proceedings as reflected
in its minute and stock books; (e) a draft of the Underwriting Agreement
pertaining to the proposed offering subject to the Registration Statement; and
(f) such other documents as we have deemed relevant. In our examination, we have
assumed the genuineness of all signatures, the authenticity of all documents
submitted to us as originals and the conformity with the original of all
documents submitted to us as copies thereof.
Based upon the foregoing, we are of the opinion that, (i) when issued by the
Company in the manner contemplated in the Registration Statement, the Company
Shares will be validly issued, fully paid and nonassessable and (ii) the Selling
Shareholders Shares are validly issued, fully paid and nonassessable.
Our opinion set forth above is limited to the Pennsylvania Business Corporation
Law.
We hereby consent to the use of this opinion as Exhibit 5 to the Registration
Statement and to the reference to this firm under the caption "Legal Matters."
In giving such opinion, we do not thereby admit that we are acting within the
category of persons whose consent is required under Section 7 of the Act or the
rules or regulations of the Securities and Exchange Commission thereunder.
Very truly yours,
/s/ Morgan, Lewis & Bockius LLP
<PAGE>
Exhibit 10.8
Member NYSE, NASD, SIPC
PA4821
Retailing Industries Group
1345 Chestnut Street, 3 Widener
P.O. Box 7618
Philadelphia, Pennsylvania 19101-7618
215-786-4135
Fax 215-973-7820
[First Union logo appears here]
Zany Brainy, Inc. May 5, 1999
308 East Lancaster Avenue
Wynnewood, PA 19096
Attention: Howard Cates
Re: Commitment for Credit Facility
------------------------------
Dear Howard:
First Union National Bank ("First Union") is pleased to advise you of its
commitment to provide an aggregate $30,000,000 senior unsecured revolving credit
facility (the "Facility") to Zany Brainy, Inc. to be used to refinance certain
existing indebtedness, to issue letters of credit, and to provide for ongoing
working capital and other general corporate purposes, including permitted
acquisitions. The Facility will be based upon and subject to the terms and
conditions set forth herein and in the attached Summary of Terms and Conditions
(the "Term Sheet").
Our commitment is based upon the financial and other information regarding
Zany Brainy previously provided to First Union. Accordingly, the commitment
hereunder is subject to the conditions, among others, that: (i) no material
adverse change shall have occurred in the business, assets, liabilities (actual
or contingent), operations or condition of Zany Brainy; (ii) the execution by
First Union and Zany Brainy of definitive financing documentation and (iii) the
completion of the initial public offering of the stock of Zany Brainy. By
executing this letter agreement, you agree to reimburse First Union for all
reasonable out-of-pocket fees and other expenses (including, but not limited to,
those of legal counsel to First Union) incurred in connection with the Facility,
regardless of whether such definitive financing documentation has been executed
and delivered.
Very truly yours,
FIRST UNION NATIONAL BANK
By: /s/ Irene Rosen Marks
--------------------------
Name: Irene Rosen Marks
Title: Vice President
Accepted and Agreed:
ZANY BRAINY, INC.
By: /s/ Robert A. Helpert
----------------------------
Name: Robert A. Helpert
Title: Secretary
<PAGE>
Children's Concept, Inc. Confidential
- --------------------------------------------------------------------------------
April 6, 1999
Summary of Terms and Conditions
This is a Preliminary Term Sheet, not a commitment to lend. This term sheet does
not summarize all of the terms, conditions, covenants, representations,
warranties and other provisions which may be contained in legal documentation
for the transactions contemplated hereby. A commitment to lend is subject to
satisfactory completion of all due diligence, receipt of internal credit
approval and completion of final terms as needed.
Borrower: Zany Brainy, Inc. and Subsidiaries ("Zany Brainy" or
the "Borrower").
Lender: First Union National Bank ("Bank").
Amount: $30 million.
Facility: $30 million Senior Unsecured Revolving Credit Facility
(the "Facility").
Maturity: 3 years from closing.
Purpose: Refinance existing indebtedness, issue letters of
credit, fund working capital needs, permitted
acquisitions and general corporate purposes.
Collateral: None.
Availability: 50% of Eligible inventory plus 50% of outstanding
documentary letters of credit shall not exceed 100% of
loans and 100% of letters of credit.
Cleandown: No cash borrowings for a 20-day period between
December 1 and January 31 of each fiscal year.
Pricing:
Interest Rate: LIBOR + 1.75% or Prime.
Documentary Letters: 1.00% on average outstanding documentary letters of
credit.
Commitment Fee: 0.25% on unused portion of Facility.
Closing Fee: $25,000.
- --------------------------------------------------------------------------------
Summary of Terms and Conditions - Unsecured Page 1
<PAGE>
Children's Concept, Inc. Confidential
- --------------------------------------------------------------------------------
Legal Fees: Paid by Borrower; legal fees capped at $20,000 plus
expenses.
Conditions Precedent: Customary for facilities of this nature including but
not limited to documentation, opinions of counsel,
consents, no material adverse change, evidence of
insurance, delivery of a borrowing request, payment of
fees and completion of IPO.
Representations and
Warranties: Customary for facilities of this nature including but
not limited to corporate existence, financial
information, no material adverse change, compliance with
laws and agreements, ERISA compliance, no material
litigation, payment of taxes, and Y2K compliance.
Affirmative Covenants: Customary for facilities of this nature including but
not limited to financial reporting, conduct,
notification of material adverse changes and litigation,
payment and performance of obligations, maintenance of
records and accounts, inspection of books, compliance
with laws, payment of taxes, Y2K compliance.
Financial covenants: Tested quarterly:
Maximum Leverage Ratio: Maximum Debt (including L/C's)
to Total Capitalization (where Total Capitalization is
defined as Funded Debt plus L/C's plus Equity).
At all times not to exceed 0.40
Minimum Charge Coverage Fixed: EBITDAR/Interest + Rents
Closing - 3Q1999 1.10
4Q1999 - 3Q2000 1.25
Thereafter 1.50
Tested annually at fiscal year end:
Minimum Tangible Net Worth
$70 million at closing to increase by 75% of net income
with no deductions for losses.
Financial covenants will be measured for Zany Brainy,
Inc. and will not include consolidated financial
information for the contemplated internet subsidiary.
- --------------------------------------------------------------------------------
Summary of Terms and Conditions - Unsecured Page 2
<PAGE>
Children's Concept, Inc. Confidential
- --------------------------------------------------------------------------------
Negative Covenants: Customary for facilities of this nature including but
not limited to restrictions and limitations on
indebtedness, liens, guaranty obligations, loans,
investments, capital expenditures, changes in business,
mergers, sales of assets, transactions with affiliates
and restrictive agreements; subject to carve-outs and
exclusions to be agreed upon by the Borrower and Bank.
Events of Default: Customary for facilities of this nature and subject to
customary grace periods and cure rights, including
failure to pay any interest, principal or fees under the
Facility when due, failure to perform any covenant or
agreement, inaccurate or false representation or
warranties, cross defaults to other material debt
facilities, insolvency or bankruptcy, ERISA, judgement
defaults, and Change in Control.
Miscellaneous: This summary of terms and conditions does not purport to
summarize all of the covenants, representing warranties
and provisions which would be contained in definitive
credit documentation for the Facility.
- --------------------------------------------------------------------------------
Summary of Terms and Conditions - Unsecured Page 3
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
dated March 5, 1999 included herein and to all references to our Firm included
in this registration statement.
Philadelphia, Pa.,
/s/ Arthur Andersen LLP
May 11, 1999
