<PAGE>
As filed with the Securities and Exchange Commission on March 19, 1999
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
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ZANY BRAINY, INC.
(Exact name of registrant as specified in its charter)
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<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>
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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
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<TABLE>
<CAPTION>
Proposed
maximum aggregate
Title of each class of offering Amount of
securities to be registered price(1)(2) registration fee
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<S> <C> <C>
Common Stock, $.01 par value... $97,750,000 $27,174.50
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</TABLE>
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(1) Includes shares which the underwriters will have the option to purchase to
cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(o) under the Securities Act of 1933, as amended.
----------------
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--March 19, 1999
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Prospectus
, 1999
Logo
Zany Brainy, Inc.
Shares of Common Stock
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Zany Brainy: The Offering:
.We are a leading .We are offering
specialty retailer of of the
high quality toys, shares and existing
games, books and shareholders are
multimedia products offering of
for children. the shares.
.Zany Brainy, Inc. .The underwriters
308 East Lancaster Avenue have an option to
Wynnewood, PA 19096 purchase an
(610) 896-1500 additional
shares from Zany
Brainy and from
the selling
shareholders.
Proposed Symbol and .This is our initial
Market: public offering,
and no public
market currently
exists for our
shares.
.ZANY/Nasdaq National .We plan to use the
Market proceeds from this
offering to repay
bank debt, open new
stores, implement
new enterprise
software 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: $ $
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 in the inside front cover page are photographs of Zany Brainy stores
and grand opening events and a graphic of the mission statement]
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page Page
---- ----
<S> <C> <C> <C>
Prospectus Summary.................. 1 Our Business.............................. 26
Risk Factors........................ 5 Management................................ 35
Forward-Looking Statements.......... 13 Certain Transactions...................... 40
Use of Proceeds..................... 14 Principal and Selling Shareholders........ 42
Dividend Policy..................... 14 Description of Capital Stock.............. 44
Capitalization...................... 15 Shares Eligible for Future Sale........... 47
Dilution............................ 16 Underwriting.............................. 48
Selected Consolidated Historical Experts................................... 51
Financial and Operating Data...... 17 Legal Matters............................. 51
Management's Discussion and Analysis Additional Information.................... 51
of Financial Condition and Results Index to Our Financial Statements......... F-1
of Operations...................... 19
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
The following summarizes information in other sections of our prospectus,
including our consolidated financial statements and the notes to these
statements. This summary is not complete and does not contain all of the
information that you should consider before investing in our common stock. You
should read the entire prospectus carefully. Generally, references to "Zany
Brainy," "the Company," "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."
The Company
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 Pennsylvania in 1991 and, as of March 15,
1999, we operated 77 stores in 19 states. We opened 23 new stores last year and
plan to add approximately 25 stores in 1999, two of which we have already
opened, and 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 and 9.9% in
1998.
Our Unique Product Mission
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. 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. We believe that our
merchandising philosophy has enabled us to earn the confidence, loyalty and
trust of our customers. We purchase our selection of over 15,000 stock keeping
units from more than 400 suppliers in 20 different countries. Our extensive
selection of merchandise includes:
. Toys, games and puzzles . Infant development toys
. Books, audio cassettes and videotapes . Arts and crafts
. Building toys and trains
. Computer software and electronic learning aids
. 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. To further differentiate our
merchandise selection, we work closely with several specialty suppliers to
secure exclusive product or licensing arrangements.
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
1
<PAGE>
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 well-known
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................ shares
Selling shareholders....... shares
----------------
Total.................... shares
Common stock to be
outstanding
after this offering......... shares (a)
Use of proceeds.............. We plan to use the proceeds from this offering
to repay bank debt, open new stores, implement
new enterprise software 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>
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(a) Based on shares outstanding at March 15, 1999, excluding:
. 2,953,429 shares of common stock issuable upon the exercise of options
and warrants outstanding as of March 15, 1999 at a weighted average
exercise price of $3.89 per share; and
. 942,826 shares reserved for future grants under our 1993 stock incentive
plan and our 1998 equity compensation plan.
Generally, the information in this prospectus: (1) assumes there is no
exercise of the underwriters' over-allotment option; and (2) gives effect to
the conversion of all outstanding shares of preferred stock into 11,250,273
shares of common stock.
3
<PAGE>
Summary Consolidated Financial Data
The following table sets forth certain of our financial data. You should
read this information 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.
<TABLE>
<CAPTION>
Fiscal Year (a)
---------------------------------------------
1994 1995 1996 1997 1998
(in thousands, except per share,
number of stores and sales per square
foot data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales................... $23,471 $54,372 $92,563 $123,345 $168,471
Gross profit (b)............ 6,446 13,400 23,358 33,893 50,318
Selling, general and
administrative expenses.... 13,310 21,110 28,732 33,581 46,376
Operating income (loss)..... (6,864) (7,710) (5,374) 312 3,942
Net income (loss)........... (6,658) (7,828) (6,023) (153) 8,999(c)
Net income (loss) per common
share:
Basic...................... $ (1.35) $ (1.55) $ (1.19) $ (0.03) $ 1.67(c)
Diluted (d)................ (1.35) (1.55) (1.19) (0.03) 0.51(c)
Weighted average shares
outstanding:
Basic...................... 4,930 5,065 5,068 5,085 5,373
Diluted (d)................ 4,930 5,065 5,068 5,085 17,776
Store Data:
Number of stores at end of
fiscal year................ 16 31 43 52 75
Total square feet at end of
fiscal year................ 189 387 538 630 868
Comparable store sales
increase (e)............... 17.3% 0.3% 4.3% 9.1% 9.9%
Sales per square foot (f)... $ 245 $ 202 $ 183 $ 203 $ 227
Average sales per store
(f)........................ 2,502 2,382 2,286 2,523 2,746
Operating Data:
Gross profit margin......... 27.5% 24.6% 25.2% 27.5% 29.9%
Operating margin (loss)..... (29.2) (14.2) (5.8) 0.3 2.3
Capital expenditures........ $ 5,432 $ 7,377 $ 6,276 $ 6,420 $ 7,309
Depreciation and
amortization............... 730 2,115 3,713 5,017 6,859
</TABLE>
<TABLE>
<CAPTION>
As of January 30, 1999
-----------------------
Pro Forma,
Actual As Adjusted (g)
(dollars in thousands)
<S> <C> <C>
Balance Sheet Data:
Inventories.......................................... $43,252 $43,252
Working capital...................................... 25,542
Total assets......................................... 82,141
Short-term borrowings................................ 0 0
Capitalized lease obligations, including current
portion............................................. 4,542 4,542
Total shareholders' equity........................... 48,291
</TABLE>
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(a) 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.
(b) Gross profit represents net sales less cost of goods sold, which includes
buying, distribution and store occupancy costs.
(c) 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 the current year's income tax expense of $979.
(d) 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 as they were anti-dilutive due to the losses in each
of those years.
(e) A store becomes comparable in the 14th full month of store operations.
(f) Based on stores opened for the entire period.
(g) Represents actual data, as adjusted, to give effect to (1) the conversion
of all preferred stock into 11,250,273 shares of common stock and (2) the
sale of shares of common stock offered by us at an assumed initial
public offering price of $ after deducting underwriting discounts and
commissions and estimated offering expenses and the application of the
estimated net proceeds.
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.
We have a history of net losses and limited experience with the performance of
our prototype stores
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. At March 15,
1999, we operated 77 stores, nine of which were opened in 1997, 23 in 1998 and
two in 1999. The results achieved to date by our store base may not be
indicative of the results that may be achieved from a larger number of stores.
We have limited experience with the performance of our current 10,600 square
foot prototype store. Most of the stores we opened in 1997 and 1998, as well as
most of the 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 expectations, or if we report net losses
in future years, the price of our common stock will be adversely affected.
Our business is highly seasonal and our quarterly results may fluctuate which
may adversely affect our stock price
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:
. 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.
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. We believe that the seasonality of
our business is consistent with the seasonality experienced by other retailers
of toys and games.
Our quarterly results of operations may also fluctuate as a result of a
variety of other factors, including:
. the timing and number of new store openings;
. the amount of store pre-opening expenses;
. the impact of new store openings on the results of existing stores;
. the introduction of new products and changes in the mix of products sold
in our stores; and
5
<PAGE>
. the availability of and customer demand for particular products.
We may not succeed in implementing our store expansion program
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
25 stores during 1999, two of which we have already opened, and 25 stores in
2000. We may not be able to achieve our planned expansion. We will open
approximately 14 stores in 1999 in markets where we do not currently have a
presence. 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, we
will be adversely affected 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.
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. If our planned expansion is not
successful, our business will be adversely affected.
Changes in comparable store sales may affect our stock price
Changes in our comparable store sales results could cause the price of our
common stock to fluctuate substantially. 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 face intense competition from other retail companies
Our industry is highly competitive. Many of our competitors have much
greater brand recognition and greater financial, marketing and other resources
than ours. We could be at a disadvantage in responding to our competitors'
merchandising and pricing strategies, advertising campaigns and other
initiatives.
We believe that many mass market and traditional toy retailers, such as Toys
"R" Us, Wal-Mart and Target, are expanding the number of products that overlap
with our stores' products. An increased focus on the specialty retail market by
these retailers could materially adversely affect our business.
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. Non-toy specialty retailers, such as
Barnes & Noble and CompUSA, are competing with our children's book and software
businesses.
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.
Our business could be materially adversely affected 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.
We believe that some of our competitors have exclusivity restrictions in
their leases that restrict co-tenants from selling similar products. Such
restrictions could adversely affect our expansion strategy by preventing us
from opening stores in particular sites or limiting our ability to sell some
products or product categories at those sites.
The relocation of our distribution centers and corporate headquarters could
disrupt our operations
In 1999, we intend to close our two distribution centers in Delaware and
relocate to a larger facility in New Jersey. Approximately 80% of our products
are distributed through these facilities.
7
<PAGE>
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. 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 which could materially adversely affect our business.
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 materially adversely affect our
business.
We are dependent on our suppliers and distributors
We are dependent on our suppliers to provide us with sufficient quantities
of our products at competitive prices. 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, our business could be adversely
affected. 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 business.
Our business could also be adversely affected 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 have a
material adverse effect on our business.
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.
We may be unable to predict or react to changes in consumer demand and
preferences
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, our business
could be materially adversely affected. It is also common in the toy industry
for some popular products, such as Beanie Babies and yoyos, to achieve high
sales, but for unpredictable periods of time. In 1998, Beanie Babies
represented over 5% of our sales. 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 business could be
materially adversely affected. In addition, the introduction of new products
may depress sales of existing products. Moreover, because we sell only those
products that conform to our corporate mission, we may choose not to sell some
products that our customers desire and lose potential sales.
8
<PAGE>
We are increasingly dependent on imports
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 materially adversely affect our
business 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.
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.
We may not successfully develop our own private label products
We have been expanding our selection of 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 be adversely
affected.
9
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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.
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. If we do not appropriately upgrade our systems and infrastructure, our
business will be materially adversely affected.
The current provider of our enterprise software system, Systems for
Retailers (SFR), is no longer in business. Although we have the source code and
support of former SFR employees, we intend to replace SFR with a new software
system from JDA Software, Inc. (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 materially adversely affect 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. If we experience an information systems failure, our business may be
materially adversely affected.
We may be adversely affected by Year 2000 issues
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 may realize exposure and risk if the systems on which we depend to
conduct our operations are not Year 2000 compliant. We have assessed whether
our critical systems are Year 2000 compliant. We expect to resolve Year 2000
compliance issues primarily through upgrades of our software or by replacing
existing software with Year 2000 compliant applications at costs that we
currently do not expect to be material. However, such upgrades and replacements
may not be completed on schedule, may involve unanticipated material costs or
may not successfully address our Year 2000 compliance issues.
In addition, we are currently analyzing the extent to which our significant
suppliers have Year 2000 issues. If they are not yet Year 2000 compliant, we
are asking them to provide a description of their plan to become compliant. If
our efforts to address the Year 2000 compliance issues are not successful, or
if suppliers and other third parties with which we conduct business do not
successfully address such issues, our business could be materially adversely
affected.
10
<PAGE>
The magnitude of our Year 2000 problem, the costs to complete our Year 2000
plan and the dates on which we believe we will complete our plan are based on
our best estimates. We derived these estimates using numerous assumptions,
including continued availability of resources and third party compliance plans.
However, we cannot assure that these estimates will be achieved, and actual
results could differ materially from those anticipated. Specific factors that
might cause such material differences include our ability to identify and
correct all Year 2000 affected areas and the cost of Year 2000 remediation.
We are subject to inventory shrinkage
As is the case in our industry generally, we are subject to loss resulting
from theft of our products. Although we have implemented loss prevention
procedures, we remain susceptible to inventory shrinkage, which could
materially adversely affect our business.
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, our business may be adversely affected.
Future sales by our current shareholders may affect the market
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 shares of common stock outstanding immediately after
this offering. Of these shares, the shares sold in this offering and
additional shares will be freely transferable without restriction or further
registration under the Securities Act of 1933, except for any shares purchased
by our affiliates. The remaining shares will be restricted and may be
sold in the future only pursuant to an exemption under the Securities Act. The
holders of shares of common stock have agreed not to sell any such
securities for 180 days after this offering 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 shares of common stock, of which
are subject to the lock-up agreements described above, have demand and piggy-
back 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 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.
11
<PAGE>
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 materially
adversely affect the market price of our common stock, regardless of our
operating performance.
Benefits of this offering to current shareholders
This offering will benefit our existing shareholders. The selling
shareholders will receive $ in net proceeds, or $ if the
underwriters exercise the over-allotment option in full. 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 $ million, or $ million if the underwriters
exercise the over-allotment option in full.
12
<PAGE>
FORWARD-LOOKING STATEMENTS
We have made statements under the captions "Prospectus Summary," "Risk
Factors," "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 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."
13
<PAGE>
USE OF PROCEEDS
The net proceeds we will receive from the sale of shares in this
offering will be approximately $ million. This is based upon an assumed
initial public offering price of $ per share and after deducting
estimated underwriting discounts and commissions and expenses payable by us
estimated at $ . We will receive additional net proceeds of up to
$ 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 $ of the proceeds from this offering to repay bank
debt, $ to open new stores, $ to implement new enterprise software
and the balance for other working capital and general corporate purposes. Our
bank debt consists of a $35 million revolving credit facility. At March 15,
1999, the outstanding balance under our credit facility was $11.8 million.
Borrowings under the credit facility bear interest at variable rates, and the
weighted average interest rate at March 15, 1999 was 7.75%. The initial term of
the credit facility expires on October 8, 2000, but the loan agreement provides
for automatic annual renewals.
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 credit facility currently prohibits payment
of any dividends.
14
<PAGE>
CAPITALIZATION
The following table sets forth our actual cash position, short term debt and
total capitalization as of January 30, 1999 and our pro forma, as adjusted,
capitalization as of the same date. 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 shares of common stock offered by us
in this offering; and
. the application of the estimated net proceeds from the sale of our common
stock based on an assumed initial public offering price of $ per
share and after deducting underwriting discounts and commissions and
estimated offering expenses payable by us.
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>
As of January 30,
1999
--------------------
Pro Forma,
Actual As Adjusted
(in thousands)
<S> <C> <C>
Cash..................................................... $ 1,695 $
======= =======
Short term debt and current portion of capitalized lease
obligations (a)......................................... $ 1,682 $ 1,682
======= =======
Capitalized lease obligations, net of current portion.... $ 2,860 $ 2,860
------- -------
Shareholders' equity:
Preferred stock......................................... 24 --
Common stock (b)........................................ 54
Additional paid-in capital.............................. 60,826
Accumulated deficit..................................... (12,613) (12,613)
------- -------
Total shareholders' equity............................. 48,291
------- -------
Total capitalization................................. $51,151 $
======= =======
</TABLE>
- --------
(a) We had no outstanding borrowings under our credit facility at January 30,
1999. At March 15, 1999 the outstanding borrowings under our credit
facility were $11.8 million.
(b) The table above excludes an aggregate of 2,956,485 shares issuable upon
exercise of stock options and warrants outstanding at January 30, 1999,
plus an additional 939,820 shares reserved for issuance in connection with
future stock options and other awards under our 1993 stock incentive plan
and 1998 equity compensation plan.
15
<PAGE>
DILUTION
Our pro forma net tangible book value as of January 30, 1999 was
$ million or $ 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. The pro forma net
tangible book value per share after this offering will be $ less than the
price per share to the public in this offering, based on an assumed initial
public offering price of $ per share. Therefore, purchasers of shares of
common stock in this offering will realize immediate dilution of $ per
share. The following table illustrates this dilution.
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................... $
Pro forma net tangible book value per share as of January 30,
1999............................................................ $
Increase in net tangible book value per share attributable to new
investors.......................................................
-----
Pro forma net tangible book value per share after this offering....
-----
Dilution per share purchased in this offering...................... $
=====
</TABLE>
The following table presents, on a pro forma basis, as described above, as
of January 30, 1999 and assuming an initial public offering price of 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; and
. the average price per share paid before deducting estimated underwriting
discounts and commissions and our estimated offering expenses.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------- ---------------------- Price
Number Percent Amount Percent Per Share
-------- -------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders.. % $ % $
New investors..........
-------- -------- --------- ---------
Total................ 100% $ 100%
======== ======== ========= =========
</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 shares, or % of the
shares outstanding, and will increase the number of shares held by new
investors to shares, or % of the shares outstanding.
16
<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.
<TABLE>
<CAPTION>
Fiscal Year (a)
----------------------------------------------
1994 1995 1996 1997 1998
(in thousands, except per share,
number of stores and sales per square foot
data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net sales................. $23,471 $54,372 $ 92,563 $123,345 $168,471
Cost of goods sold,
including occupancy
costs.................... 17,025 40,972 69,205 89,452 118,153
------- ------- -------- -------- --------
Gross profit............. 6,446 13,400 23,358 33,893 50,318
Selling, general and
administrative expenses.. 13,310 21,110 28,732 33,581 46,376
------- ------- -------- -------- --------
Operating income (loss).. (6,864) (7,710) (5,374) 312 3,942
Interest income (expense),
net...................... 206 (118) (649) (465) (1,130)
------- ------- -------- -------- --------
Income (loss) before
income tax benefit...... (6,658) (7,828) (6,023) (153) 2,812
Income tax benefit........ -- -- -- -- (6,187)
------- ------- -------- -------- --------
Net income (loss)........ $(6,658) $(7,828) $ (6,023) $ (153) $ 8,999 (b)
======= ======= ======== ======== ========
Net income (loss) per
common share:
Basic.................... $ (1.35) $ (1.55) $ (1.19) $ (0.03) $ 1.67 (b)
Diluted (c).............. (1.35) (1.55) (1.19) (0.03) 0.51 (b)
Weighted average shares
outstanding:
Basic.................... 4,930 5,065 5,068 5,085 5,373
Diluted (c).............. 4,930 5,065 5,068 5,085 17,776
Store Data:
Number of stores at end of
fiscal year.............. 16 31 43 52 75
Total square feet at end
of fiscal year........... 189 387 538 630 868
Comparable store sales
increase (d)............. 17.3% 0.3% 4.3% 9.1% 9.9%
Sales per square foot
(e)...................... $ 245 $ 202 $ 183 $ 203 $ 227
Average sales per store
(e)...................... 2,502 2,382 2,286 2,523 2,746
Operating Data:
Gross profit margin....... 27.5% 24.6% 25.2% 27.5% 29.9%
Operating margin (loss)... (29.2) (14.2) (5.8) 0.3 2.3
Capital expenditures...... $ 5,432 $ 7,377 $ 6,276 $ 6,420 $ 7,309
Depreciation and
amortization............. 730 2,115 3,713 5,017 6,859
Balance Sheet Data:
Inventories............... $11,097 $20,538 $ 24,278 $ 29,822 $ 43,252
Working capital........... 9,509 15,220 21,599 20,085 25,542
Total assets.............. 25,238 41,393 56,376 59,552 82,141
Capitalized lease
obligations, less current
portion.................. 422 2,231 2,620 1,407 2,860
Total shareholders'
equity................... 16,535 28,372 38,547 39,219 48,291
</TABLE>
17
<PAGE>
- --------
(a) 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.
(b) 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 the current year's income tax expense of $979.
(c) 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 as they were anti-dilutive due to the losses in each of
those years.
(d) A store becomes comparable in the 14th full month of store operations.
(e) Based on stores opened for the entire period.
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 75 stores operating in
19 states as of January 30, 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.
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 25 new stores in 1999, two of which
we have already opened, and 25 new stores in 2000.
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.
19
<PAGE>
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. A store becomes comparable in its 14th full month of
operations in order to eliminate grand opening sales distortions.
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>
Fiscal Year
---------------------
1996 1997 1998
<S> <C> <C> <C>
Net sales................. 100.0 % 100.0 % 100.0 %
Cost of goods sold(a)..... 74.8 72.5 70.1
----- ----- -----
Gross profit............ 25.2 27.5 29.9
Selling, general and
administrative expenses.. 31.0 27.2 27.6
----- ----- -----
Operating income
(loss)................. (5.8) 0.3 2.3
Interest expense, net..... (0.7) (0.4) (0.6)
----- ----- -----
Income (loss) before
income taxes........... (6.5)% (0.1)% 1.7 %
===== ===== =====
Comparable store sales
increase (b)............. 4.3 % 9.1 % 9.9 %
===== ===== =====
</TABLE>
- --------
(a) Cost of goods sold includes buying, distribution and store occupancy costs.
(b) A store becomes comparable in the 14th full month of store operations.
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 leveraging store occupancy, buying and
distribution costs over a higher revenue base and improved product margins.
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 such expenses was primarily
attributable to store payroll and corporate expenses associated with the
expansion of our store base and infrastructure in 1998. 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 increase was
primarily due to an increase in marketing and promotion and incremental
preopening costs associated with opening 23 stores in 1998 versus nine stores
in 1997, and expenditures for training, loss prevention and internal computer
systems, partially offset by a decrease in store payroll and other selling
costs as a percentage of net sales.
20
<PAGE>
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 based on management's assessment that it is more likely
than not that our net deferred tax assets will be realized through future
taxable earnings.
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 increases achieved in product margins, as well as a reduction in store
occupancy and buying costs as a percentage of net sales.
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 such expenses was primarily
attributable to 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 lower store
payroll and corporate expenses as a percentage of sales.
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.
Quarterly Results of Operation and Seasonality
The following table presents certain unaudited results of operations for our
eight fiscal quarters ending January 30, 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.
21
<PAGE>
<TABLE>
<CAPTION>
1997 1998
------------------------------------- -------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(dollars in thousands)
<S> <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
As a % of full year.... 18.1 % 17.8 % 19.0 % 45.1% 16.3 % 17.6 % 18.2 % 47.9%
Gross profit............ $ 5,252 $ 4,992 $ 6,331 $17,318 $ 7,315 $ 7,544 $ 8,590 $26,869
As a % of full year.... 15.5 % 14.7 % 18.7 % 51.1% 14.5 % 15.0 % 17.1 % 53.4%
As a % of net sales.... 23.5 22.8 27.0 31.2 26.6 25.4 28.0 33.3
Operating income
(loss)................. $(2,420) $(2,677) $(1,916) $ 7,325 $(2,344) $(4,048) $(3,485) $13,819
As a % of net sales.... (10.8)% (12.2)% (8.2)% 13.2% (8.5)% (13.7)% (11.4)% 17.1%
Number of stores:
Opened during period... 2 1 5 1 1 4 8 10
Open at end of period.. 45 46 51 52 53 57 65 75
Comparable store sales
increase............... 9.5 % 8.2 % 7.0 % 10.4% 6.8 % 13.4 % 9.1 % 10.0%
</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 and 23 stores in 1998.
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 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 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 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.
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Our primary long-term capital requirement is for the opening of new stores.
We lease all of our stores. We currently expect to open 25 stores in 1999, two
of which we have already opened, and an additional 25 stores in 2000. The
average net cost of opening a store in 1998 was approximately $780,000. This
amount included approximately $310,000 of inventory, net of accounts payable,
$360,000 for leasehold improvements and fixtures, net of landlord allowances,
and $110,000 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
million. We intend to use these funds primarily to develop new stores, enhance
our management information systems and purchase fixtures and equipment for our
new distribution facility.
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 January 30, 1999, the total borrowing limit, including letters
of credit, was $22.1 million. At March 15, 1999, $11.8 million of borrowings
and $830,000 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 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.
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 January 30, 1999, we were in
compliance with the terms of the credit facility.
At January 30, 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.
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Our Year 2000 Readiness
Information Technology Systems. Our core business is run on an enterprise
software system, Software For Retailers (SFR). The functions supported by SFR
include buying, replenishment, physical distribution, general ledger and
payables. SFR is a product from Creative Data Systems (CDS), a subsidiary of
Sterling Software. CDS has recently discontinued operations. We currently run
our systems on version 6.5, which is not Year 2000 compliant, but we anticipate
completing our upgrade to version 7.0, which is Year 2000 compliant, by the end
of the first quarter of 1999. We have completed the plans for testing and
implementing version 7.0 and have engaged consultants who are former employees
of CDS and experienced in version 7.0 upgrades, to assist with our upgrade. We
are currently testing version 7.0.
Late in 1998, we agreed to purchase new enterprise software from JDA
Software. 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 by the
third quarter of 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., and provide point-of-sale (POS) and store
inventory systems (SIS) support for store management functions. The POS and SIS
software are not Year 2000 compliant. We are engaged in a project with ICL that
is designed to achieve Year 2000 compliance by the third quarter of 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. Our store register hardware is not Year
2000 compliant. We are engaged in a project with ICL that is designed to
achieve Year 2000 compliance by the third quarter of 1999.
We have developed a project plan and resources to fully assess the ICL
application suites, register, server, SIS workstation hardware, our email
applications, our software demonstration stations and certain Microsoft tools
used with some of the applications. We plan to have our store systems achieve
Year 2000 compliance for both software 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.
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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, our store operations would be materially
adversely affected.
In addition, the failure to successfully upgrade to SFR version 7.0 or to
implement the new JDA system could disrupt the movement of inventory into and
out of our distribution center and our ability to transfer inventory to our
stores. This could adversely affect our ability to supply merchandise on a
timely basis, and therefore our revenues.
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 $15,000 in costs associated with Year 2000
issues. The total cost associated with 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 $215,000 relating to Year 2000 compliance.
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.
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<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 March 15, 1999,
Zany Brainy operated 77 stores in 19 states. We plan to add 25 stores in 1999,
two of which we have already opened, and 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 and 9.9% in 1998.
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 25
stores in 1999, two of which we have already opened, and 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 14 stores in new markets and to
open 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.
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
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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.
Industry and Competition
We believe that the market for our product categories was approximately $14
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;
. 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.
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<PAGE>
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.
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
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<PAGE>
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.
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
29
<PAGE>
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.
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.
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The map and store list below present the stores we operate as of March 15,
1999:
[Map of United States showing store locations]
Pre-1995 Openings
- --------------------------
Sq.
City, State 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
1996 Openings
- ---------------------------
Sq.
City, State 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*
1998 Openings
- ---------------------------
Sq.
City, State 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
- ---------------------------
Sq.
City, State 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
- --------------------------
Sq.
City, State Footage
- ------------------- -------
Alpharetta, GA 13,582
Marietta, GA 11,100*
Norcross, GA 15,001
Northbrook, IL 15,058
Schaumburg, IL 15,000
Wheaton, IL 12,499
Eatontown, NJ 13,044
Princeton, NJ 11,372
Warrington, PA 12,500
Huntingdon Valley,
PA 12,500
Bailey's
Crossroads, VA 13,329
Woodbridge, VA 12,593
Fairfax, VA 12,814
Reston, VA 12,716
Springfield, VA 12,000
- -----------------------------------------
Average Sq.
Footage.......... 10,631
- -----------------------------------------
Average Sq.
Footage........... 13,007
Average Sq.
Footage.......... 10,447
1999 Openings
---------------------------
Sq.
City, State Footage
------------------ -------
Dublin, CA 10,500
Huntington Beach,
CA 10,625
- --------
*Excludes square footage licensed to a third party.
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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 nationally
known 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.
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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 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 two distribution centers in Delaware that contain in
the aggregate approximately 180,000 square feet. Approximately 80% of our
products are distributed through these facilities 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 existing distribution centers
and consolidate distribution center operations in a new 250,000 square foot
facility in Swedesboro, New Jersey. This transition is scheduled to occur in
the summer of 1999. The new distribution center will be automated to reduce
labor expenses. We also plan to implement a new warehouse management system as
part of the JDA software installation that we anticipate completing in early
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,
Systems for Retailers (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 Software, Inc. (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 second 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
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<PAGE>
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 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 January 30, 1999, we employed over 2,000 employees, 729 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 two distribution centers: one in New Castle,
Delaware consisting of approximately 120,000 square feet, and one in Newark,
Delaware consisting of approximately 60,000 square feet. These leases will
expire in April 1999 and March 2000. We plan on closing our two distribution
centers and consolidating into one facility in Swedesboro, New Jersey in June
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 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 6-18 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 March 15, 1999, we had 21 signed leases for planned stores in
1999, two of which we have already opened, and two signed leases for planned
stores 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.
34
<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
Phillip Cohen............. 56 Director
C. Donald Dorsey.......... 57 Director
Robert A. Fox............. 69 Director
Gerald R. Gallagher....... 57 Director
Henry Nasella............. 52 Director
Yves B. Sisteron.......... 43 Director
David V. Wachs............ 72 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.
Phillip Cohen has served as one of our directors since January 1993. Mr.
Cohen is currently the Chairman of Chelsea House Publishing Company and The
Main Line Book Company, positions he has held for more than five years.
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.
35
<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.
Messrs. Cohen and Nasella were elected to our board pursuant to the
provisions of our shareholders agreement that entitle 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 the
provisions of our shareholders agreement that entitle Mr. Fox to designate one
director, in addition to himself, to our board. Messrs. Gallagher and Sisteron
were elected to our board pursuant to the provisions of our shareholders
agreement that entitle 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.
36
<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 $2,335
Thomas G. Vellios, President........... 1998 275,000 110,000 2,466
Robert A. Helpert, Chief Financial
Officer, Secretary and Treasurer...... 1998 262,500 91,875 6,666
</TABLE>
- --------
(a) Represents premiums paid by us with respect to term life insurance for the
benefit of the named executive officer.
Stock Option Information
There were no stock option grants to any of the executive officers named in
the Summary Compensation Table during fiscal year 1998.
The following table sets forth information with respect to the number and
value of outstanding options held by executive officers named in the Summary
Compensation Table at the end of 1998.
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Year End(#) at Year End ($)(a)
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Keith C. Spurgeon........... 237,500 462,500 -- --
Thomas G. Vellios........... 175,000 275,000 -- --
Robert A. Helpert........... 113,750 161,250 -- --
</TABLE>
- --------
(a) Based on an assumed initial public offering price of $ 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 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
37
<PAGE>
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 March 15, 1999, 2,494,106 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, as of March 17, 1998,
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 outstanding 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 March 15, 1999, 225,700 options were outstanding under the 1998 plan.
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
38
<PAGE>
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, directors,
consultants and advisors non-qualified stock options under individual
agreements with the grantees. As of March 15, 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. During 1998, the base salaries for Messrs. Spurgeon, Vellios and Helpert
were $300,000, $275,000 and $262,500, 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.
39
<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; and
. 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
40
<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; and
. 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.;
. 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.
41
<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 of the date of this prospectus.
As of March 15, 1999, there were 16,633,894 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.
<TABLE>
<CAPTION>
Shares Shares
Beneficially Number of Beneficially
Owned Prior to Shares of Owned After
Offering Common Stock Offering
----------------- to be Sold --------------
Name of Beneficial Owner Number Percent in Offering Number Percent
------------------------ ------ ------- ------------ ------ -------
<S> <C> <C> <C> <C> <C>
Executive Officers and Directors
Keith C. Spurgeon (a)........... 237,500 1.4%
Thomas G. Vellios (b)........... 175,000 1.0
Robert A. Helpert (c)........... 113,750 *
Phillip Cohen (d)............... 72,088 *
C. Donald Dorsey (e)............ 53,512 *
Robert A. Fox (f)............... 1,844,912 11.1
Gerald R. Gallagher (g)......... 1,400,047 8.4
Henry Nasella (h)............... 88,417 *
Yves B. Sisteron (i)............ 3,224,836 19.4
David V. Wachs (j).............. 251,558 1.5
All executive officers and
directors as a group
(10 persons) (k)............... 7,461,600 42.9
Five Percent Holders
Frontenac VI Limited Partnership
(l)............................ 843,831 5.1
Fourcar, B.V. (m)............... 2,442,154 14.7
Nassau Capital Partners II L.P.
(n)............................ 1,220,788 7.3
David Schlessinger (o).......... 2,054,550 12.4
Vulcan Ventures (p)............. 2,141,757 12.9
Selling Shareholders
</TABLE>
- --------
* Percentage of shares of common stock beneficially owned does not exceed one
percent.
(a) Represents 237,500 shares of common stock underlying presently exercisable
options.
42
<PAGE>
(b) Represents 175,000 shares of common stock underlying presently exercisable
options.
(c) Represents 113,750 shares of common stock underlying presently exercisable
options.
(d) Includes (i) 34,000 shares of common stock underlying presently exercisable
options and (ii) 38,088 shares of common stock held by Mr. Cohen's
children.
(e) Represents (i) 34,000 shares of common stock underlying presently
exercisable options and (ii) 19,512 shares of common stock held by the C.
Donald Dorsey and Lydia Dorsey Family Trust Dated August 5, 1993.
(f) Includes (i) 4,000 shares of common stock underlying presently exercisable
options and (ii) 594,416 shares held by Robert A. Fox, as Voting Trustee
pursuant to a Voting Trust Agreement Dated January 20, 1993. Mr. Fox's
address is One Pitcairn Place, Suite 2100, 165 Township Line Road,
Jenkintown, PA 19046.
(g) Includes (i) 1,287,099 shares owned by Oak Investment Partners V, Limited
Partnership, (ii) 82,152 shares of common stock underlying presently
exercisable options held by Oak Investment Partners V, Limited Partnership,
(iii) 28,948 shares owned by Oak V Affiliates Fund, Limited Partnership and
(iv) 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.
(h) Represents (i) 39,000 shares of common stock underlying presently
exercisable options and (ii) 49,417 shares of common stock held jointly
with his wife.
(i) Includes (i) 4,000 shares of common stock underlying presently exercisable
options, (ii) 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 (iii) 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
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.
(j) Includes (i) 34,000 shares of common stock underlying presently exercisable
options and (ii) 142,558 shares of common stock held by Wachs Partners. Mr.
Wachs is the general partner of Wachs Partners.
(k) Includes 759,250 shares of common stock underlying presently exercisable
options.
(l) Frontenac's address is 135 S. LaSalle Street, Suite 3800, Chicago, Illinois
60603.
(m) Includes (i) 414,119 shares of common stock held by Lacomble Retailing and
(ii) 4,000 shares of common stock underlying presently exercisable options
and 950 shares of common stock held by Yves Sisteron. The address for
Fourcar B.V. is Gebouw Autumn, Overschiestraate No. 184P, 1062XK Amsterdam
Netherlands.
(n) Includes 6,076 shares of common stock held by NAS Partners I L.L.C. The
address of Nassau Capital Partners II L.P. is 22 Chamber Street, Princeton,
NJ 08542.
(o) Mr. Schlessinger resigned as one of our directors in August 1998. His
address is 125 Lincoln Avenue, Suite 400, Santa Fe, NM 87501.
(p) Vulcan Ventures' address is 110--110th Avenue, N.E., Suite 550, Bellevue,
WA 98004.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of shares of common stock, par
value $.01 per share, and shares of preferred stock, par value $.01 per
share.
Common Stock
As of March 15, 1999, our outstanding common stock consisted of 16,633,894
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
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 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 (the
"BCL"), provides us with the power to indemnify any officer or director acting
in his or her capacity as a representative
44
<PAGE>
of 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);
45
<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 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. In accordance
with the terms of such piggyback registration rights, included in this offering
are certain securities requested to be included by the holders of piggyback
registration rights. Registration of shares of common stock pursuant to the
exercise of demand registration rights or piggyback 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 .
46
<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 shares to be outstanding after the offering, the
shares of common stock offered hereby and an additional 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 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 March 15, 1999, there were outstanding warrants to
purchase 103,623 shares of common stock and options to purchase 2,849,806
shares of common stock. An additional 942,826 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 as soon as
practicable following the date of this prospectus.
Certain holders of shares of common stock and holders of warrants
to purchase 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 180 days after the date of this prospectus without the prior
written consent of DLJ. See "Underwriting."
47
<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............................................................
=====
</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.
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.
48
<PAGE>
<TABLE>
<CAPTION>
No Full
Exercise Exercise
-------- --------
<S> <C> <C>
Zany Brainy:
Per share............................................. $ $
Total................................................. $ $
Selling shareholders:
Per share............................................. $ $
Total................................................. $ $
</TABLE>
The selling shareholders and Zany Brainy have granted to the underwriters an
option, exercisable for 30 days after the date of the underwriting agreement,
to purchase up to 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 our expenses relating to this offering will be
$ .
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
of 180 days from the date of this prospectus 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.
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 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 intend to apply to list our common stock for quotation on the Nasdaq
National Market under the symbol "ZANY."
49
<PAGE>
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.
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:
50
<PAGE>
. 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. Certain legal
matters in connection with this offering will be passed upon for the
underwriters by Latham & Watkins, Los Angeles, California.
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. Statements contained in this prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in
each instance reference is made to the copy of such contract or other document
filed as an exhibit to the registration statement, each such statement being
qualified in all respects by such reference.
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.
51
<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.
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,
ASSETS 1998 1999
------ ----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............................ $ 5,030 $ 1,695
Receivables, net..................................... 1,631 3,390
Inventories, net..................................... 29,822 43,252
Deferred tax asset................................... -- 4,313
Prepaid expenses..................................... 672 940
-------- --------
Total current assets............................... 37,155 53,590
PROPERTY AND EQUIPMENT, net............................ 21,996 25,905
DEFERRED TAX ASSET..................................... -- 2,024
OTHER ASSETS, net...................................... 401 622
-------- --------
$ 59,552 $ 82,141
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of capitalized lease obligations..... $ 1,199 $ 1,682
Accounts payable..................................... 8,596 16,161
Income taxes payable................................. -- 150
Accrued liabilities.................................. 7,275 10,055
-------- --------
Total current liabilities.......................... 17,070 28,048
-------- --------
DEFERRED RENT.......................................... 1,856 2,942
-------- --------
CAPITALIZED LEASE OBLIGATIONS, net of current portion.. 1,407 2,860
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 10)
SHAREHOLDERS' EQUITY
Convertible Preferred stock, $.01 par value,
4,000,000 shares authorized, 2,402,955 shares issued
and outstanding, liquidation value of $56,546 at
January 30, 1999.................................... 24 24
Common stock, $.01 par value, 25,000,000 shares
authorized, 5,361,523 and 5,383,571 shares issued
and outstanding..................................... 54 54
Additional paid-in capital........................... 60,753 60,826
Accumulated deficit.................................. (21,612) (12,613)
-------- --------
Total shareholders' equity......................... 39,219 48,291
-------- --------
$ 59,552 $ 82,141
======== ========
</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>
For the Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
NET SALES................................. $92,563 $123,345 $168,471
COST OF GOODS SOLD, including occupancy
costs.................................... 69,205 89,452 118,153
------- -------- --------
Gross profit........................... 23,358 33,893 50,318
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 28,732 33,581 46,376
------- -------- --------
Operating income (loss)................ (5,374) 312 3,942
INTEREST INCOME........................... 153 253 81
INTEREST EXPENSE.......................... (802) (718) (1,211)
------- -------- --------
Income (loss) before income tax
benefit............................... (6,023) (153) 2,812
INCOME TAX BENEFIT........................ -- -- (6,187)
------- -------- --------
NET INCOME (LOSS)......................... $(6,023) $ (153) $ 8,999
======= ======== ========
NET INCOME (LOSS) PER COMMON SHARE:
Basic................................... $ (1.19) $ (0.03) $ 1.67
Diluted................................. $ (1.19) $ (0.03) $ 0.51
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic................................... 5,068 5,085 5,373
Diluted................................. 5,068 5,085 17,776
</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
=== === === === === ======= ======== =======
</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>
For the Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................... $(6,023) $ (153) $ 8,999
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities--
Depreciation and amortization............. 3,713 5,017 6,859
Provision for deferred rent............... 294 700 1,086
Issuance of warrants to consultants....... 20 40 --
Deferred income tax benefit............... -- -- (6,337)
Changes in assets and liabilities--
(Increase) decrease in--
Receivables............................. (625) (457) (1,759)
Inventories............................. (3,740) (5,544) (13,430)
Prepaid expenses........................ 107 840 (268)
Other assets............................ (6) 33 (270)
Increase in--
Accounts payable........................ 473 1,680 7,565
Accrued liabilities..................... 3,132 1,388 2,780
Income tax payable...................... -- -- 150
------- ------- --------
Net cash provided by (used in)
operating activities.................. (2,655) 3,544 5,375
------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net... (6,276) (6,420) (7,309)
------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments on line of credit, net.......... -- -- --
Net proceeds from sale of convertible
preferred stock........................... 16,160 -- --
Payments on capitalized lease obligations.. (1,002) (1,309) (1,379)
Debt issuance costs........................ -- (258) (95)
Proceeds from exercise of stock options.... 18 35 73
Proceeds from exercise of warrants......... -- 750 --
------- ------- --------
Net cash provided by (used in)
financing activities.................. 15,176 (782) (1,401)
------- ------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS................................ 6,245 (3,658) (3,335)
CASH CASH EQUIVALENTS, BEGINNING OF YEAR.... 2,443 8,688 5,030
------- ------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR...... $ 8,688 $ 5,030 $ 1,695
======= ======= ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 30, 1999
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.
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.
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 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.
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
F-7
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
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, cash and cash equivalents include $196,000 of funds held
by a bank as collateral for outstanding standby letters of credit.
Inventories
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 and $6,833,000 during fiscal 1996, 1997 and 1998,
respectively. Buying and distribution costs remaining in inventories at January
31, 1998 and January 30, 1999 were $1,423,000 and $2,093,000, respectively.
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." 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 assets used in the Company's distribution center was recorded in
fiscal 1998 due to the anticipated facility move in fiscal 1999. Management
believes that there has been no other impairment of the Company's long-lived
assets as of January 30, 1999.
F-8
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 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. These
costs are included in other assets on the accompanying consolidated balance
sheets, net of accumulated amortization of $42,000 and $186,000 at January 31,
1998 and January 30, 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 when the advertising is run.
Advertising expense, including grand opening advertising, was $2,082,000,
$2,301,000 and $5,036,000, net of certain vendor reimbursements, in fiscal
1996, 1997 and 1998, respectively.
Supplemental Cash Flows Information
For fiscal 1996, 1997 and 1998, the Company paid $802,000, $718,000 and
$1,211,000, respectively, for interest expense. For fiscal 1998, the Company
paid $57,000 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.
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.
F-9
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
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.
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>
Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Basic weighted average number of shares
outstanding............................... 5,068,223 5,085,153 5,373,365
Incremental shares from assumed exercise
or conversion of:
Stock options.......................... -- -- 1,124,941
Warrants............................... -- -- 27,496
Preferred stock........................ -- -- 11,250,273
--------- --------- ----------
Diluted weighted average number of shares
outstanding............................... 5,068,223 5,085,153 17,776,075
========= ========= ==========
</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 calculation as they were anti-dilutive.
4. PROPERTY AND EQUIPMENT (in thousands):
<TABLE>
<CAPTION>
January 31, January 30,
1998 1999
----------- -----------
<S> <C> <C>
Furniture and fixtures.. $ 13,796 $ 18,739
Computers and
equipment.............. 9,625 12,596
Leasehold improvements.. 10,459 13,158
-------- --------
33,880 44,493
Less--Accumulated
depreciation and
amortization........... (11,884) (18,588)
-------- --------
$ 21,996 $ 25,905
======== ========
</TABLE>
F-10
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
5. ACCRUED LIABILITIES (in thousands):
<TABLE>
<CAPTION>
January 31, January 30,
1998 1999
----------- -----------
<S> <C> <C>
Payroll and related expenses...................... $2,079 $ 3,163
Other............................................. 5,196 6,892
------ -------
$7,275 $10,055
====== =======
</TABLE>
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 on the line and the total amount available under the
line was $22,077,000, less outstanding letters of credit.
Under these lines, the highest amount outstanding was $8,039,000,
$12,207,000 and $22,872,000 in fiscal 1996, 1997 and 1998, respectively. The
average amount outstanding was $2,400,000, $1,527,000 and $6,388,000, and the
weighted average interest rate was 8.25%, 8.92% and 9.04% in fiscal 1996, 1997
and 1998, respectively. At January 31, 1998 and January 30, 1999, there were
$388,000 and $914,000, 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 expires in March 1999.
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-11
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
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-12
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
The reconciliation of the Federal statutory rate to the Company's effective
income tax rate is as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------
February 1, January 31, January 30,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Tax provision (benefit) at Federal
statutory rate.................... (34.0)% (34.0)% 34.0%
State taxes, net of Federal
benefit........................... (3.5) (2.7) 0.3
Other.............................. 0.2 8.1 0.5
Increase (decrease) in valuation
allowance......................... 37.3 28.6 (254.8)
----- ----- ------
-- % -- % (220.0)%
===== ===== ======
</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 and January 30,
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-13
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
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 has reserved 3,700,000 shares of its Common stock for awards
under the Plans. 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>
F-14
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 1999
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 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
========== ========== =====
</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 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.
F-15
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JANUARY 30, 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 and 1998 was approximately $9,654,000, $11,468,000 and
$13,927,000, 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 as of January 30, 1999 is as follows (in
thousands):
<TABLE>
<S> <C>
Total minimum lease payments...................................... $5,100
Less-- Amount representing interest............................... (558)
------
Present value of minimum lease payments........................... $4,542
======
</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 January 30, 1999, are as
follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Operating Capital
------ --------- -------
<S> <C> <C>
1999.................................................... $ 19,168 $2,075
2000.................................................... 21,288 1,598
2001.................................................... 21,688 1,022
2002.................................................... 22,021 405
2003.................................................... 22,400 --
2004 and thereafter..................................... 58,904 --
-------- ------
$165,469 $5,100
======== ======
</TABLE>
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 or 1998.
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-16
<PAGE>
[Depicted on the inside back cover page are photographs of Zany Brainy stores
and grand opening events]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
, 1999
[LOGO]
Zany Brainy, Inc.
Shares of Common Stock
----------------
PROSPECTUS
----------------
Donaldson, Lufkin & Jenrette
BT Alex. Brown
William Blair & Company
U.S. Bancorp Piper Jaffray
----------------
DLJdirect Inc.
- --------------------------------------------------------------------------------
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 shall create an
implication that the information contained herein or the affairs of Zany Brainy
have not changed since the date hereof.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Until , 1999 (25 days after the date of this prospectus), all dealers,
whether or not participating in this offering, that effect 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............................... *
Printing and engraving expenses.................................. *
Legal fees and expenses.......................................... *
Blue sky fees and expenses....................................... $ 7,500.00
Nasdaq National Market listing fee...............................
Accountants' fees and expenses................................... *
Miscellaneous.................................................... *
----------
Total Expenses................................................... $
==========
</TABLE>
- --------
* To be provided by amendment.
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
</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
</TABLE>
Zany Brainy believes that the issuance of shares and grants of options
described above did not involve a public offering and were exempt from
registration under Section 4(2) of the Securities Act because such issuances
and grants 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. In addition,
shares issued upon exercise of options were exempt from registration under Rule
3(b) of the Securities Act and Rule 702 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* Underwriting Agreement
3.1* Form of Amended and Restated Articles of Incorporation
3.2* 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
Form of Stock Purchase Agreement providing registration rights to
10.3 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* Loan Agreement dated October 9, 1997, as amended, between Zany Brainy,
Inc. and First Union Corporation.
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>
- --------
* To be filed by amendment.
(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 Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in Wynnewood,
Pennsylvania on March 19, 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
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
EACH PERSON IN SO SIGNING ALSO MAKES, CONSTITUTES AND APPOINTS KEITH C.
SPURGEON AND ROBERT A. HELPERT, AND EACH OF THEM ACTING ALONE, HIS OR HER TRUE
AND LAWFUL ATTORNEY-IN-FACT, WITH FULL POWER OF SUBSTITUTION, TO EXECUTE AND
CAUSE TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO THE
REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED, ANY AND ALL AMENDMENTS
AND POST-EFFECTIVE AMENDMENTS TO THIS REGISTRATION STATEMENT, AND INCLUDING ANY
REGISTRATION STATEMENT FOR THE SAME OFFERING THAT IS TO BE EFFECTIVE UPON
FILING PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT, WITH EXHIBITS THERETO
AND OTHER DOCUMENTS IN CONNECTION THEREWITH, AND HEREBY RATIFIES AND CONFIRMS
ALL THAT SAID ATTORNEY-IN-FACT OR HIS OR HER SUBSTITUTE OR SUBSTITUTES MAY DO
OR CAUSE TO BE DONE BY VIRTUE HEREOF.
<TABLE>
<S> <C> <C>
Signature Capacity Date
/s/ Keith C. Spurgeon Chairman of the March 19, 1999
- ----------------------------------- Board and Chief
Keith C. Spurgeon Executive Officer
(principal executive officer)
/s/ Robert A. Helpert Chief Financial March 19, 1999
- ----------------------------------- Officer (principal
Robert A. Helpert financial and
accounting officer)
/s/ Phillip Cohen Director March 19, 1999
- -----------------------------------
Phillip Cohen
/s/ C. Donald Dorsey
- ----------------------------------- Director March 19, 1999
C. Donald Dorsey
/s/ Robert A. Fox Director March 19, 1999
- -----------------------------------
Robert A. Fox
</TABLE>
II-5
<PAGE>
<TABLE>
<S> <C> <C>
/s/ Gerald R. Gallagher Director March 19, 1999
- -----------------------------------
Gerald R. Gallagher
/s/ Henry Nasella Director March 19, 1999
- -----------------------------------
Henry Nasella
/s/ Yves B. Sisteron
- ----------------------------------- Director March 19, 1999
Yves B. Sisteron
/s/ David V. Wachs Director March 19, 1999
- -----------------------------------
David V. Wachs
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- ----------------------------------------------------------------------
<C> <S>
1* Underwriting Agreement
3.1* Form of Amended and Restated Articles of Incorporation
3.2* 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
Form of Stock Purchase Agreement providing registration rights to
10.3 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* Loan Agreement dated October 9, 1997, as amended, between Zany Brainy,
Inc. and First Union Corporation.
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>
- --------
* To be filed by amendment.
<PAGE>
Exhibit 10.3
PURCHASE AGREEMENT
This PURCHASE AGREEMENT (this "Purchase Agreement") dated as of
September 24, 1996 is entered into by Children's Concept, Inc., a Pennsylvania
corporation (the "Company"), Fourcar, B.V. and its affiliates set forth on the
signature page hereto (collectively "Fourcar"), Vulcan Ventures, Inc. ("Vulcan")
and the other entities and individuals who have executed counterpart signature
pages hereto as of the respective dates set forth on such signature pages
(Fourcar, Vulcan and the other entities and individuals who have executed
counterpart signature pages hereto are hereafter referred to as the
"Purchasers").
In consideration of the respective representations, warranties,
covenants and agreements set forth herein, the parties hereto, intending to be
legally bound hereby, agree as follows:
ARTICLE I
AUTHORIZATION AND ISSUANCE
OF SECURITIES
1.1 AUTHORIZATION OF ISSUE.
(a) Series C Convertible Preferred Stock. The Company has duly
------------------------------------
authorized the issuance and sale to the Purchasers of an aggregate of up to
750,000 shares of Series C Convertible Preferred Stock, par value $.01 per share
(the "Series C Preferred Stock"), of the Company. The designations, rights,
preferences and other terms and conditions relating to the Series C Preferred
Stock shall be as set forth on Exhibit A.
(b) Series BB Convertible Preferred Stock. The Company has duly
authorized the issuance to certain of the Purchasers, pursuant to Paragraph
1.2(b), of an aggregate of up to 846,412 shares of Series BB Convertible
Preferred Stock, par value $.01 per share (the "Series BB Preferred Stock"), of
the Company. The designations, rights, preferences and other terms and
conditions relating to the Series BB Preferred Stock shall be as set forth on
Exhibit B.
1.2 ISSUANCE OF SECURITIES. Subject to the terms and conditions set
forth herein, at the Closing (as defined in Paragraph 4.1) and the issuance and
delivery conditions set forth in Paragraph 4.2:
(a) The Company shall sell, and the Purchasers, except for
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"), shall purchase from
the Company for $22.50 per share (the "Purchase Price"), that number of shares
of Series C
<PAGE>
Preferred Stock representing the total number of shares committed by each such
Purchaser as set forth on Exhibit C.
(b) Certain Purchasers shall exchange the number of shares of
Series B Convertible Preferred Stock, par value $.01 per share (the "Series B
Preferred Stock") held by such Purchasers, as set forth in Exhibit C, for an
equal number of shares of Series BB Preferred Stock. Except as expressly
provided herein to the contrary, Purchasers who exchange shares of Series B
Preferred Stock for shares of Series BB Preferred Stock shall remain bound by
the surviving provisions of that certain Purchase Agreement among the Company,
Schlessinger and the Purchasers (as defined therein), as amended (the "Series B
Purchase Agreement"). Upon receipt of certificates representing shares of Series
B Preferred Stock surrendered for exchange hereunder and the issuance of
corresponding shares of Series BB Preferred Stock, the Company shall cancel the
surrendered shares of Series B Preferred Stock.
(c) The Company shall sell, and DLJ shall purchase from the
Company, that number of shares of Series C Preferred Stock as shall be mutually
agreed to by the Company and DLJ, calculated in accordance with the terms of the
letter agreement (the "Letter Agreement") dated June 10, 1996 between the
Company and DLJ which shall represent full and complete payment of DLJ's
financing fee in connection to the sale of shares of Series C Preferred Stock at
the Closing.
1.3 THE CONVERTED SHARES. The Company has authorized and has reserved
and covenants to continue to reserve a sufficient number of its previously
authorized but unissued shares of Common Stock, par value $.01 per share
("Common Stock"), to satisfy the rights of conversion of the holders of the
Series C Preferred Stock and the Series BB Preferred Stock.
1.4 THE SECURITIES. The Series C Preferred Stock and the Series BB
Preferred Stock and any shares of Common Stock issuable upon conversion of the
Series C Preferred Stock and the Series BB Preferred Stock and such shares when
issued are sometimes collectively referred to herein as the "Shares."
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to the Purchasers the matters set forth
in this Article II:
2
<PAGE>
2.1 ORGANIZATION, STANDING AND QUALIFICATION. The Company and each of
its subsidiaries is a corporation duly organized, validly existing and in good
standing under the laws of the jurisdiction in which it is organized and has all
requisite corporate power and authority to own, lease and operate its
properties, to carry on its business as currently conducted and as now proposed
to be conducted, and to carry out the transactions contemplated hereby. The
Company and each of its subsidiaries is duly qualified to do business as a
foreign corporation and is in good standing in every jurisdiction, if any, in
which the conduct of its business or its ownership, leasing or operation of
property requires such qualification, except where the failure to so qualify
would not have a material adverse effect on the Company's business, financial
condition or results of operations. The Company has made available to Purchasers
true, correct and complete copies of its Articles of Incorporation and its
bylaws, in each case as amended and as in effect on the date hereof (the
"Articles of Incorporation" and the "Bylaws," respectively), and has previously
made available to Purchasers the Company's complete corporate minute and stock
books which include all actions of the Company's Board of Directors and
shareholders, whether by meeting or by written consent in lieu of a meeting.
2.2 CAPITALIZATION. The authorized capital stock of the Company
consists of 25,000,000 shares of Common Stock of which 5,065,003 shares are
currently issued and outstanding, fully paid and non-assessable. The Company is
authorized to issue up to 4,000,000 shares of preferred stock, $.01 par value,
(a) 1,000,000 shares of which have been designated as Series A Convertible
Preferred Stock, par value $.01 per share, of which 806,559 shares are currently
issued and outstanding, fully paid and non-assessable and (b) 1,000,000 shares
of which have been designated as Series B Convertible Preferred Stock, par value
$.01 per share of which 846,412 shares are currently issued and outstanding,
fully paid and non-assessable. Except as set forth in the disclosure schedule,
there are no options, warrants, rights, shareholders agreements or other
instruments or agreements outstanding giving any person or entity the right to
acquire any shares of capital stock of the Company.
2.3 AGREEMENTS. Except as set forth in the disclosure schedule and
except as entered into in the ordinary course of business, the Company is not a
party to or bound by any material written, oral or implied contract, agreement,
lease or other commitment. All of the Company's material agreements are valid,
binding and enforceable against the respective parties thereto in accordance
with their respective terms and the Company has no knowledge of any breach or
anticipated breach of any material agreements.
2.4 NO DEFAULTS. The Company is not in default and the transactions
contemplated hereby will not result in the Company being in default (a) under
(i) the Articles of Incorporation or Bylaws, or (ii) any material written, oral
or implied, contract, agreement, lease or other commitment to which the Company
is a party and, to the best knowledge of the Company, the other party to such
contract agreement, lease or other commitment is not in default thereunder, or
(b) with respect to any order, writ, injunction or decree of any court or any
federal, state, municipal or other domestic or foreign governmental department,
3
<PAGE>
commission, board, bureau, agency or instrumentality which, in the aggregate,
would have a material adverse effect on the Company's business, financial
condition or results of operations.
2.5 INTELLECTUAL PROPERTY RIGHTS. The Company owns, has the right to
use and, where necessary, has made proper application for the use of the name
"Zany Brainy" in all jurisdictions in which the Company currently transacts
business. The Company has federally registered service marks with the United
States Patent and Trademark Office for the "Zany Brainy" name, the "Zany Brainy"
design and the words "A Zillion Neat Things For Kids". No claim is pending or
threatened to the effect that any such intellectual property owned by the
Company is invalid or unenforceable by the Company.
2.6 LITIGATION. There is no litigation or governmental proceeding or
investigation pending, or to the knowledge of the Company, threatened against
the Company (nor to the knowledge of the Company, any basis therefor) affecting
any of its respective properties or assets. The Company is not in default with
respect to any order, writ, injunction, decree, ruling or decision of any court,
commission, board or government agency. There are no actions or proceedings
pending or, to the Company's knowledge, threatened (or any basis therefor known
to the Company), which might result, either in any case or in the aggregate, in
any material adverse effect on the business, operations, affairs or condition of
the Company or in any of its properties or assets, or which might call into
question the validity of this Purchase Agreement, any of the Shares, or any
action taken or to be taken pursuant hereto or thereto.
2.7 TAX MATTERS. All federal, state, local and foreign tax returns and
tax reports required to be filed by the Company and its subsidiaries have been
filed in accordance with applicable laws with the appropriate governmental
agencies in all jurisdictions in which such returns and reports are required to
be filed except for any such returns or reports as to which the consequences of
any failure to file are not material for the Company and its business. All
federal, state, local and foreign income, profits, franchise, sales, use,
occupation, property, excise, payroll, withholding and other taxes (including
interest and penalties) required to have been paid by the Company and its
subsidiaries have been fully paid or adequately provided for on the balance
sheet, except for tax and liabilities arising in the ordinary course of business
since February 3, 1996. There are no pending audits and the Company has not been
notified by any tax authority that any such audits are contemplated.
2.8 OFFERING MEMORANDUM. The Company has delivered to the Purchasers
its Private Placement Memorandum dated July 1996 (the "Offering Memorandum"),
which Offering Memorandum has been material to the Purchasers in their decision
to enter into this Purchase Agreement. The description of the business,
operations, products, properties and assets of the Company contained in the
Offering Memorandum, the identity of all persons material to the ongoing
operation of the Company's business and product development, as well as all
other factual statements contained therein, are true and correct in all material
respects. The financial projections attached as Exhibit 6 to the Offering
4
<PAGE>
Memorandum (the "Projections") and any other estimate contained in the Offering
Memorandum are derived in good faith by the Company from assumptions that are
believed to be reasonable, but no representation or warranty is made regarding
the accuracy of the Projections or that any other projections of future
performance or results contained in the Offering Memorandum will be achieved. If
the Company achieves the results contained in the Projections, the Company will
not have "earnings and profits" for the 1996 fiscal year, as that phrase is
defined for purposes of Section 305 of the Internal Revenue Code of 1986, as
amended, and the regulations promulgated thereunder.
2.9 COMPLIANCE. The Company (a) has in all material respects complied
with all federal, state, local and foreign laws, ordinances, regulations and
orders applicable to it, the Company's business or the ownership of the
Company's assets, and (b) has all federal, state, local and foreign governmental
licenses and permits material to and necessary in the conduct of the Company's
business as currently being conducted. Such licenses and permits are in full
force and effect, and (i) no violations have been recorded in respect of any
such licenses or permits, (ii) no proceeding is pending or threatened to revoke
or limit any thereof, and (iii) no notice of non-compliance, assessment or
material change has been received by the Company.
2.10 POWER AND AUTHORITY. The Company has the power and authority to
make, deliver and perform this Purchase Agreement and the transactions
contemplated hereby. The execution, delivery and performance of this Purchase
Agreement have been duly authorized by all necessary corporate actions. In
addition, the issuance, sale and delivery of the Series C Preferred Stock and
the issuance, exchange and delivery of the Series BB Preferred Stock in
accordance with the terms of this Purchase Agreement have been duly authorized
by all requisite corporate action of the Company. When issued, sold and
delivered in accordance with this Purchase Agreement, the Series C Preferred
Stock and the Series BB Preferred Stock issued hereunder, will be validly issued
and outstanding and not subject to preemptive or any other similar rights of the
shareholders of the Company or others.
2.11 OFFERING EXEMPTION. Subject to the accuracy of the
representations and warranties of Purchasers set forth under Article III of this
Purchase Agreement, the offering and sale of the Series C Preferred Stock and
the exchange of the Series B Preferred Stock for shares of Series BB Preferred
Stock is exempt from registration under the Securities Act of 1933, as amended
(the "Securities Act"), pursuant to Section 4(2) thereof, and under applicable
state securities and "blue sky" laws.
2.12 FINANCIAL STATEMENTS. The Company has furnished to the Purchasers
the audited balance sheets and statements of operations and cash flows for the
fiscal year ended February 3, 1996 (the "Financial Statements"). The Financial
Statements were prepared in accordance with generally accepted accounting
principles consistently applied throughout the periods reported upon. The
Financial Statements present fairly the financial condition, results of
operations and cash flows of the Company as of the dates and for the
5
<PAGE>
period indicated and are consistent with the books and records of the Company.
The Company has no material liabilities except as set forth on the Financial
Statements.
2.13 NO MATERIAL ADVERSE CHANGE. Except as set forth in the Disclosure
Schedule, since February 3, 1996, there has not been and, to the knowledge of
the Company, there is not threatened, any material adverse change in the
financial condition, business, prospects or affairs of the Company or any
material physical damage or loss to any of its properties or assets or to the
premises occupied by it (whether or not such damage or loss is covered by
insurance) and the Company has not taken any action outside of the ordinary
course of business, including but not limited to incurring any debt, liability
or obligation, purchasing or redeeming any shares of Common Stock of the Company
or paying any dividends on the Common Stock of the Company. The business,
condition, operations or prospects of the Company or any of its properties or
assets have not been adversely affected as the result of any legislative or
regulatory change, any revocation or change in any franchise, permit, license or
right to do business, or any other event or occurrence, whether or not insured
against.
2.14 TITLE TO ASSETS, PROPERTIES. The Company owns, or has a valid
leasehold interest in, or valid license for, all assets necessary for the
conduct of its business as currently conducted. All material tangible assets of
the Company are in a good state of maintenance and repair and are adequate for
use in the Company's business to the extent of its current operations. The
Company owns no real property. The Company enjoys peaceful and undisturbed
possession under all leases under which it is operating, and all said leases are
valid and subsisting in full force and effect. The Company's inventory is of
merchantable quality, in all material respects, except to the extent that it is
returnable to the vendor. Inventory returns to vendors, either as a result of
lack of merchantable quality or pursuant to the terms of purchase orders, do not
exceed 25% of the Company's inventory.
2.15 COMPLIANCE WITH ALL ERISA; BENEFIT PLANS; EMPLOYEES. Except as
set forth in the disclosure schedule, (i) the Company is not a party to any
collective bargaining agreement or employment agreement and is not a party to
any pending or threatened labor dispute, (ii) the Company does not maintain and
has never maintained any employee benefit plan subject to the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), and (iii) the
Company does not have any pension or profit sharing plan for the benefit of
employees. There is no employee of the Company whose employment is not
terminable at will.
2.16 CONFLICTING INTERESTS. Except as set forth in the Disclosure
Schedule, no director, officer or any relative or an affiliate of the foregoing
has a pecuniary interest in, or loan, lease, royalty agreement or other
continuing transaction with, any supplier or customer of the Company or in any
other business enterprise with which the Company conducts business.
6
<PAGE>
2.17 CUSTOMERS, DEALERS AND SUPPLIERS. The Company has good working
relationships with its material customers, dealers and suppliers. None of such
customers, dealers or suppliers has terminated, or to the best knowledge of the
Company, has threatened or given notice to terminate, its relationship with the
Company.
2.18 DISCLOSURE. To the best knowledge of the Company, this Purchase
Agreement, including the Exhibits and Schedules thereto, does not contain any
untrue statement of a material fact or omit to state a material fact necessary
in order to make the statements contained herein not misleading. The Company has
no information and knows of no fact which has or would have a material adverse
effect on the Company's business which has not been disclosed to the Purchasers
in the Purchase Agreement, including Exhibits and Schedules thereto.
2.19 INSURANCE. The Company carries insurance covering its (and its
subsidiaries) properties and businesses customary for the type and scope of its
properties and businesses, but in any event in amounts sufficient to prevent the
Company from becoming a co-insurer.
2.20 BOOKS AND RECORDS. The books of account, ledgers, order books,
records and documents of the Company accurately and completely reflect all
material information relating to the consolidated business of the Company, the
location and collection of its assets, and the nature of all transactions giving
rise to the obligations or accounts receivable of the Company.
ARTICLE III
REPRESENTATION AND WARRANTIES OF THE PURCHASERS
Each Purchaser severally represents and warrants to the Company and
acknowledges, that, on the date such Purchaser purchases shares of Series C
Preferred Stock:
3.1 Such Purchaser is an "accredited investor" within the meaning of
Rule 501(1) of the General Rules and Regulations under the Securities Act; and
either alone or with such Purchaser's financial advisor, has such knowledge and
experience in financial and business matters that such Purchaser is capable of
evaluating the merits and risks of the investment to be made hereunder; and is
acquiring the Series C Preferred Stock for such Purchaser's own account for
investment and not with a view to the distribution thereof within the meaning of
the Securities Act or resale.
3.2 Such Purchaser (together with such Purchaser's adviser(s), if any)
has been afforded the opportunity to ask questions and receive answers
concerning the terms and conditions of the offering of Series C Preferred Stock
and to obtain any additional information, to the extent the Company was able to
acquire such information without unreasonable effort or
7
<PAGE>
expense, necessary to (i) verify the accuracy of the information set forth in
the Offering Memorandum and (ii) to evaluate the merits and risks of purchasing
the shares of Series C Preferred Stock.
3.3 Such Purchaser acknowledges that it is obligated to the Company
for the entire amount committed by such Purchaser on the signature page hereto
or on such Purchaser's counterpart signature page hereto, as the case may be.
3.4 Such Purchaser understands that none of the Shares which are being
purchased or otherwise issued pursuant to this Purchase Agreement have been
registered under the Securities Act or the securities laws of certain states and
are being offered and sold in reliance on exemptions from the registration
requirements of such act and such laws. The Shares are subject to restrictions
on transferability and resale and may not be transferred or resold except as
permitted under such act and such laws pursuant to registration or exemption
therefrom. The Shares have not been approved or disapproved by the Securities
and Exchange Commission, any state securities commission or other regulatory
authority, nor have any of the foregoing authorities passed upon or endorsed the
merits of this offering or the accuracy or adequacy of the Offering Memorandum.
3.5 Such Purchaser has not employed any broker or finder in connection
with the transactions contemplated by this Purchase Agreement.
3.6 Such Purchaser is not in default and the transactions contemplated
hereby will not result in such Purchaser being in default under any material
written, oral or implied contract, agreement, lease or other commitment that
would have a materially adverse effect on the transactions contemplated hereby
to which such Purchaser is a party.
3.7 Such Purchaser agrees that this Purchase Agreement is enforceable
against such Purchaser in accordance with its terms.
3.8 IF A PURCHASER IS A RESIDENT OF THE COMMONWEALTH OF PENNSYLVANIA,
THE PURCHASER ACKNOWLEDGES AND AGREES THAT (a) THE SECURITIES PURCHASED BY SUCH
PURCHASER CANNOT BE SOLD FOR A PERIOD OF TWELVE (12) MONTHS FROM THE DATE OF
PURCHASE, EXCEPT AS PERMITTED UNDER SECTION 204.011 OF THE PENNSYLVANIA
SECURITIES REGULATIONS, AND (b) PURSUANT TO SECTION 207(M) OF THE PENNSYLVANIA
SECURITIES ACT, EACH PENNSYLVANIA RESIDENT WHO ACCEPTS AN OFFER TO PURCHASE
SECURITIES EXEMPTED FROM REGISTRATION UNDER SECTION 203(D) OF THE PENNSYLVANIA
SECURITIES ACT DIRECTLY FROM AN ISSUER OR AN AFFILIATE OF AN ISSUER HAS THE
RIGHT TO WITHDRAW HIS ACCEPTANCE WITHOUT INCURRING ANY LIABILITY TO THE SELLER,
UNDERWRITER, IF ANY, OR ANY OTHER PERSON WITHIN TWO (2) BUSINESS DAYS FROM THE
DATE OF RECEIPT BY THE ISSUER OF HIS WRITTEN BINDING CONTRACT OF PURCHASE
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OR, IN THE CASE OF A TRANSACTION IN WHICH THERE IS NO WRITTEN BINDING CONTRACT
OF PURCHASE, WITHIN TWO (2) BUSINESS DAYS AFTER HE MAKES THE INITIAL PAYMENT FOR
THE SECURITIES BEING OFFERED. TO ACCOMPLISH THE WITHDRAWAL, THE PURCHASER NEED
ONLY SEND A LETTER OR TELEGRAM TO THE ISSUER (OR THE PLACEMENT AGENT IF ONE IS
LISTED ON THE FRONT PAGE OF THE OFFERING DOCUMENT) INDICATING THE PURCHASER'S
INTENTION TO WITHDRAW. SUCH LETTER OR TELEGRAM SHOULD BE SENT AND POSTMARKED
PRIOR TO THE END OF THE AFOREMENTIONED SECOND BUSINESS DAY. IF THE PURCHASER IS
SENDING A LETTER, IT IS PRUDENT TO SEND IT BY CERTIFIED MAIL, RETURN RECEIPT
REQUESTED, TO ENSURE THAT IT IS RECEIVED AND ALSO TO EVIDENCE THE TIME WHEN IT
WAS MAILED. SHOULD THE PURCHASER MAKE THE REQUEST ORALLY, THE PURCHASER SHOULD
ASK FOR WRITTEN CONFIRMATION THAT THE PURCHASER'S REQUEST HAS BEEN RECEIVED.
3.9 If the Purchaser is a resident of the Commonwealth of
Massachusetts, such Purchaser represents that its investment will not exceed 25%
of its net worth (excluding for such purposes the value of such Purchaser's
principal residence and its furnishings.
3.10 Such Purchaser, if it is an entity, is duly formed and validly
existing under the laws of the jurisdiction in which such Purchaser was
organized or came into existence and the execution, delivery and performance of
this Purchase Agreement and the Shareholders' Agreement (as defined in Paragraph
4.1) has been duly authorized by such Purchaser and such Purchaser has not been
organized for the specific purpose of acquiring the Shares being offered.
ARTICLE IV
CLOSING
4.1 CLOSING.
(a) The closing (the "Closing") shall take place simultaneously
with the execution hereof at the offices of Morgan, Lewis & Bockius LLP or such
other place as shall be agreed to between the Company and Fourcar and Vulcan on
behalf of the Purchasers.
(b) From time to time prior to and following the Closing, the
Company may, but shall not be obligated to, offer and sell shares of Series C
Preferred Stock up to an aggregate, including shares of Series C Preferred Stock
sold to Purchasers, of $16,875,000 to such other purchasers as the Company may
determine in its sole discretion (collectively, the "Other Purchasers"), at a
price per share no less than the price per share paid by the Purchasers
hereunder, at one or more subsequent closings to occur not more than 60 days
after the Closing. By executing the counterpart signature page to this Purchase
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Agreement, the Purchasers hereunder agree to the inclusion of such Other
Purchasers as parties to this Purchase Agreement and the Amended and Restated
Shareholders' Agreement dated May 18, 1994, as amended (the "Shareholders'
Agreement"), and it shall be a condition to each subsequent closing that the
Other Purchasers shall become parties to this Purchase Agreement and the
Shareholders' Agreement and subject to the terms hereof and thereof. If such a
subsequent closing is held, the term "Closing", as used herein, shall be deemed
to apply to the initial closing and each such subsequent closing.
4.2 THE COMPANY'S DELIVERIES.
(a) At the Closing, the Company shall deliver to the Purchasers
the legal opinion of Morgan, Lewis & Bockius LLP, counsel for the Company, with
respect to the shares of Services C Preferred Stock and Series BB Preferred
Stock being issued by the Company at such Closing, in a form reasonably
acceptable to counsel for the Purchasers.
(b) As soon as practicable after the Closing, but in no event
more than ten business days after the Company has filed its amended and restated
Articles of Incorporation with the Secretary of the Commonwealth of the
Commonwealth of Pennsylvania, as provided in Paragraph 6.7, the Company shall
deliver to the Purchasers each of the following:
(i) A duly executed Series C Preferred Stock Certificate issued
to each Purchaser for that number of shares of Series C Preferred Stock set
forth opposite such Purchaser's name on Exhibit C; and
(ii) A duly executed Series BB Preferred Stock Certificate issued
to each Purchaser who, pursuant to Exhibit C, is exchanging its shares of
Series B Preferred Stock for an equal number of shares of Series BB
Preferred Stock, representing the number of shares of Series BB Preferred
Stock to be delivered hereunder.
4.3 PURCHASER DELIVERIES.
(a) Each Purchaser that, prior to the Closing, was not a
shareholder of the Company, shall deliver to the Company a counterpart signature
page to the Shareholders' Agreement, a copy of which is attached hereto as
Exhibit D; the failure to so deliver such signature page shall relieve the
Company of any and all obligations to such Purchaser under this Purchase
Agreement.
(b) Each Purchaser identified on Exhibit C as exchanging shares of
Series B Preferred Stock for Series BB Preferred Stock shall deliver to the
Company a certificate representing the number of shares of Series B Preferred
Stock to be exchanged.
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ARTICLE V
REGISTRATION RIGHTS
5.1 DEFINITIONS. As used in this Purchase Agreement, the following
terms shall have the following respective meanings:
"Commission" means the United States Securities and Exchange
----------
Commission, or any other federal agency at the time administering the Securities
Act.
"Exchange Act" means the Securities Exchange Act of 1934 or any
------------
similar Federal statute, and the rules and regulations of the Commission
thereunder, all as the same shall be in effect at the time.
"IPO" means the Company's initial public offering under the Securities
---
Act pursuant to Form S-1 or a comparable successor form.
"Qualified Public Offering" means a fully underwritten, firm
-------------------------
commitment public offering pursuant to an effective registration under the
Securities Act covering the offer and sale by the Company of its Common Stock in
which the aggregate net proceeds to the Company exceed $15,000,000, and in which
the price per share of such Common Stock equals or exceeds $12.00 (such price
subject to equitable adjustment in the event of any stock split, stock dividend,
combination, reorganization, reclassification or other similar event).
"Registration Expenses" means the expenses so described in Paragraph
---------------------
5.6.
"Restricted Stock" means the Series C Preferred Stock and Series BB
----------------
Preferred Stock being issued to the Purchasers on the date hereof, and any
additional shares of Common Stock issued with respect to the foregoing (by stock
dividend, stock split or otherwise), excluding such shares of Common Stock which
may at the time be sold pursuant to Rule 144(k) under the Securities Act (or
which may be otherwise sold without restriction under the Securities Act.)
"Securities Act" means the Securities Act of 1933 or any similar
--------------
Federal statute, and the rules and regulations of the Commission thereunder, all
as the same shall be in effect at the time.
"Selling Expenses" means the expenses so described in Paragraph 5.6.
----------------
5.2 NOTICE OF PROPOSED TRANSFER. Subject to the limitations set
forth in the Shareholders' Agreement, prior to any proposed transfer of any
Restricted Stock (other than under the circumstances described in Paragraph
5.3), the shareholder wanting to make such a transfer shall give written notice
("Notice") to the Company of its intention to
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effect such transfer. Each Notice: (a) shall describe the manner and
circumstances of the proposed transfer and shall contain an undertaking by such
shareholder to furnish such other information as may be required to render the
opinion referred to below; and (b) shall designate counsel for the Company, or
other counsel, reasonably satisfactory to the Company, for the purpose of giving
the opinion referred to below. If such shareholder shall so designate counsel
other than counsel for the Company, such shareholder shall submit a copy of the
Notice to the counsel designated in the Notice. If, in the opinion of the
designated counsel, which, at the Company's option, need not be reduced to
writing, the proposed transfer of the Restricted Stock may be effected without
registration under the Securities Act and applicable state securities or blue-
sky laws, the Company, as promptly as practicable, but in any event no later
than ten business days after the Company's receipt of the Notice, shall notify
such shareholder and, such shareholder shall thereupon be entitled to transfer
such Restricted Stock in accordance with the terms of the Notice; provided,
however that no such transfer shall be allowed if otherwise prohibited by the
Shareholders' Agreement. Such shareholder shall not be entitled to transfer
Restricted Stock until receipt of notice from the Company under this Paragraph
5.2. Each certificate transferred as above provided shall bear a legend in
substantially the following form:
"THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933
(THE "1933 ACT") OR UNDER ANY APPLICABLE STATE SECURITIES LAWS. THE
SECURITIES HAVE BEEN TAKEN BY THE REGISTERED OWNER FOR INVESTMENT, AND
WITHOUT A VIEW TO RESALE OR DISTRIBUTION THEREOF, AND MAY NOT BE
TRANSFERRED OR DISPOSED OF WITHOUT AN OPINION OF COUNSEL REASONABLY
SATISFACTORY TO THE ISSUER THAT SUCH TRANSFER OR DISPOSITION DOES NOT
VIOLATE THE 1933 ACT AND THE RULES AND REGULATIONS THEREUNDER."
except that such certificate shall not be required to bear such legend if (i)
such transfer is in accordance with the provisions of Rule 144 (or any other
rule permitting public sale without registration under the Securities Act) or
(ii) the opinion of counsel referred to above is to the further effect that the
transferee and any subsequent transferee (other than an affiliate of the
Company) would be entitled to transfer such securities in a public sale without
registration under the Securities Act.
5.3 REQUIRED REGISTRATION.
(a) The holders of at least two-thirds of the Restricted Stock
held by the Purchasers may request, in writing, at any time after June 2, 1998,
that the Company register under the Securities Act all or any portion of the
shares of Restricted Stock held by it for sale in the manner specified in such
notice.
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(b) In addition to the rights granted in subsection (a), the
holders of at least two-thirds of the Restricted Stock may request in writing at
any time between the second and third anniversary of the closing of an IPO that
the Company register under the Securities Act all or any portion of the shares
of Restricted Stock held by such Purchasers for sale in the manner specified in
such notice; provided that (i) the Company shall only be obligated to honor such
demand if the Company is eligible to file a registration statement on Form S-3
and (ii) in no event shall the Company be obligated to file two registration
statements on behalf of the holders of Restricted Stock within any one year
period. The Company shall use best efforts to timely file all reports or other
material as it may be required to file pursuant to the Exchange Act. In the
event that the Company ceases or fails to be eligible to file a registration
statement on Form S-3 at any time between the second and third anniversary of
the closing of an IPO, the rights granted to the Purchasers pursuant to this
subsection (b) shall be extended from the date the Company again becomes
eligible to file a registration statement on Form S-3 for a period equal to one
year less the period between the second and third anniversary of an IPO during
which the Company was ineligible to file a registration statement on Form S-3.
(c) Notwithstanding anything to the contrary contained in
subparagraphs (a) or (b), no request may be made under this Paragraph 5.3 within
90 days after the effective date of a registration statement filed by the
Company covering an underwritten public offering.
(d) Promptly following receipt of any notice under this Paragraph
5.3, the Company immediately shall notify all holders of Restricted Stock from
whom notice has not been received that a request for registration pursuant to
subparagraph 5.3(a) has been received (such notice from the Company is called a
"Registration Notice") and shall use its best efforts to register under the
Securities Act, for public sale in accordance with the method of disposition
specified in such notice (which method shall be in accordance with the following
sentence) from the requesting holders, the number of shares of Restricted Stock
specified in such notice (and in all notices received from other holders of
Restricted Stock within 20 days after the giving of a Registration Notice from
the Company). Any sale or distribution shall be conducted through a broker-
dealer or managing underwriter acceptable to the Company, which acceptance shall
not be unreasonably withheld, or in such other manner as is reasonably
acceptable to the Company.
(e) The Company will be entitled to include in any registration
statement referred to in this Paragraph 5.3, for sale in accordance with the
method of disposition specified above, shares of Common Stock to be sold by the
Company for its own account, and shares of any other person having registration
rights with respect to Common Stock, provided that (i) the number of shares of
Common Stock to be sold by the Company for its own account shall not exceed 20%
of the number of shares of Restricted Stock requested to be registered by the
Purchasers and (ii) to the extent that, in the opinion of the managing
underwriter (if such method of disposition shall be an underwritten public
offering), such
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inclusion would adversely affect the marketing of the Restricted Stock to be
sold, the number of shares of Common Stock to be registered and sold shall be
reduced as follows: First, the shares of Common Stock requested to be registered
by shareholders with "piggyback" or other registration rights (other than the
holders of the Restricted Stock) shall be reduced at the direction of the
Company in accordance with the underwriters opinions. In the event that the
elimination of all of such shares is not sufficient to reduce the number of
shares of Common Stock to be registered to the number recommended by the
underwriters, then the number of shares to be registered by the Company shall
then be reduced (to zero, if necessary). In the event that the holders of
Restricted Stock have requested more shares to be registered than recommended by
the underwriters, the number of shares of Restricted Stock shall be reduced pro
rata according to the number of shares requested by each such holder to be
registered; provided, however, that if the number of shares of Restricted Stock
requested to be registered by the Purchasers is reduced by more than 20%, then
the Purchasers shall have the option to terminate the registration of the
Restricted Stock pursuant to this Paragraph 5.3; provided, however, that if the
Purchasers elects to so terminate, it will not be deemed to have exercised its
demand right pursuant to this Paragraph 5.3. Except as provided in this
subparagraph 5.3(c) and except for registration statements on Form S-8, S-4 or
any successor thereto, the Company shall not file, or make any public
announcement that it intends to file, with the Commission any other registration
statement with respect to its equity securities, whether for its own account or
that of other shareholders, from the date of receipt of a notice from requesting
holders pursuant to this Paragraph 5.3 until the earlier of (x) completion of
the period of distribution of the registration contemplated thereby and (y) 90
days after the effectiveness of the registration statement relating thereto.
5.4 PIGGYBACK REGISTRATION. If the Company at any time (other than
pursuant to Paragraph 5.3) proposes to register any of its Common Stock under
the Securities Act for sale to the public, whether for its own account or for
the account of other security holders or both (except with respect to
registration statements on Forms S-8, S-4 or another form not available for
registering the Restricted Stock for sale to the public), each such time it will
give written notice to all holders of outstanding Restricted Stock of its
intention so to do. Upon the written request of any such holder, given within 20
days after receipt of any such notice, to register any of its Restricted Stock,
the Company will use its best efforts to cause the Restricted Stock as to which
registration shall have been so requested to be included in the securities to be
covered by the registration statement proposed to be filed by the Company. In
the event that any registration pursuant to this Paragraph 5.4 shall be the
Company's underwritten public offering of Common Stock, the number of shares of
Restricted Stock to be included in such an underwriting may be reduced if and to
the extent that the managing underwriter shall be of the opinion that such
inclusion would adversely affect the marketing of the securities to be sold by
the Company therein as follows: First, all persons (other than the Company) who
have requested shares to be registered and who are not holders of registration
rights shall be reduced (to zero, if necessary) in the manner provided by the
Company. In the event that the number of shares of stock requested to registered
after such reduction shall still be in excess of the number of shares
recommended to be registered by the
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underwriters, then the number of shares shall be further reduced pro rata
according to the number of shares requested by each holder of registration
rights to be registered. Notwithstanding the foregoing provisions, the Company
may withdraw any registration statement referred to in this Paragraph 5.4
without thereby incurring any liability to the holders of Restricted Stock.
5.5. REGISTRATION PROCEDURES. If and whenever the Company is required
by the provisions of Paragraphs 5.3 and 5.4 to effect the registration of any
shares of Restricted Stock under the Securities Act, the Company will, as
expeditiously as possible:
(a) prepare and file with the Commission a registration
statement, which, in the case of an underwritten public offering pursuant to
Paragraph 5.3(a) or (b), shall be on Form S-3 (provided, that in the case of
Paragraph 5.3(a), if the Company does not qualify for use of Form S-3 in such
registration, such registration statement shall be a Form S-1 or other available
form satisfactory to the managing underwriter, if any, selected as therein
provided) with respect to such securities and use best efforts to cause such
registration statement to become and remain effective until the completion of
the distribution. The Company will provide the Purchasers with the opportunity
to review and comment on such registration statement;
(b) prepare and file with the Commission such amendments and
supplements to such registration statement and the prospectus used in connection
therewith as may be necessary to keep such registration statement effective for
the period specified in subparagraph 5.5(a) and as to comply with the provisions
of the Securities Act with respect to the disposition of all Restricted Stock
covered by such registration statement in accordance with the intended method of
disposition set forth in such registration statement for such period;
(c) furnish to each seller and to each underwriter such number of
copies of the registration statement and the prospectus included therein
(including each preliminary prospectus) as such persons reasonably may request
in order to facilitate the public sale or other disposition of the Restricted
Stock covered by such registration statement;
(d) use its best efforts to register or qualify the Restricted
Stock covered by such registration statement under the securities or blue sky
laws of such jurisdictions as the sellers of Restricted Stock or, in the case of
an underwritten public offering, the managing underwriter reasonably shall
request;
(e) use its best efforts to list or include the Restricted Stock
on the principal securities exchanges, or the Nasdaq National Market, if any, on
which the Common Stock is then being traded.
(f) make available for inspection by each seller, any underwriter
participating in any distribution pursuant to such registration statement, and
any attorney,
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accountant or other agent retained by such seller or underwriter, all financial
and other records, pertinent corporate documents and properties of the Company,
and cause the Company's officers, directors and employees to supply all
information reasonably requested by any such seller, underwriter, attorney,
accountant or agent in connection with such registration statement. All such
individuals exercising his right under this subparagraph 5.5(f) shall execute a
confidentiality agreement in a form reasonably acceptable to the Company.
In connection with each registration hereunder, the selling holders of
Restricted Stock shall furnish to the Company in writing such information with
respect to themselves and the proposed distribution by them as reasonably shall
be necessary in order to assure compliance with federal and applicable state
securities laws.
In connection with each registration pursuant to Paragraphs 5.3 and
5.4 covering an underwritten public offering, the Company and each seller of
Restricted Stock agree to enter into a written agreement with the managing
underwriter selected in the manner herein provided and any other participating
underwriters in such form and containing such provisions as is reasonably
satisfactory to the Company and as are customary in the securities business for
such an arrangement between such underwriters and companies of the Company's
size and investment stature.
5.6 EXPENSES. All expenses incurred by the Company in complying with
Paragraphs 5.3 and 5.4, including without limitation all registration and filing
fees, printing expense, fees and disbursements of counsel and independent public
accountants for the Company, fees and expenses incurred in connection with
complying with state securities or "blue sky" laws (other than those which by
law must be paid by the selling security holders), fees of the National
Association of Securities Dealers, Inc., transfer taxes, fees of transfer agents
and registrars, but excluding fees and expenses of any counsel or accountants
retained by holders of Restricted Stock, are called "Registration Expenses."
All underwriting discounts and selling commissions applicable to the sale of
Restricted Stock and fees and expenses of any counsel or accountants retained by
holders of Restricted Stock are called "Selling Expenses."
The Company shall pay all Registration Expenses in connection with two
registration statements pursuant to Paragraph 5.3, and the Company shall pay all
Registration Expenses in connection with any registration statement pursuant to
Paragraph 5.4. All Selling Expenses in connection with any registration
statement filed pursuant to Paragraphs 5.3 and 5.4 shall be borne by the
participating sellers.
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ARTICLE VI
CERTAIN COVENANTS OF THE COMPANY
The Company covenants and agrees that, unless the Purchasers otherwise
agree in writing, for so long as the Purchasers hold at least twenty-five
percent (25%) of the shares of Series C Preferred Stock being issued to the
Purchasers pursuant to the terms of the Purchase Agreement:
6.1 PRESERVATION OF FRANCHISES AND EXISTENCE. The Company shall
maintain its corporate existence, rights, licenses and franchises in full force
and effect; provided, however, that the Company shall not be required to
preserve any right or franchise if the Board of Directors of the Company, as the
case may be, shall in good faith determine that the preservation thereof is no
longer desirable in the conduct of the business of the Company and that the loss
thereof is not materially disadvantageous to the Company.
6.2 USE OF PROCEEDS. Except as agreed to in advance in writing by the
Company and the Purchasers, the net proceeds received by the Company from the
sale of the Series C Preferred Stock shall be used by the Company in a manner
consistent with the description set forth in the Offering Memorandum.
6.3 FINANCIAL STATEMENTS. The Company shall maintain proper books of
accounts and records and shall deliver to the Purchasers:
(a) Quarterly Reports: As soon as available and in any event
-----------------
within 30 days after the end of each of the first three quarters of each fiscal
year of the Company. Consolidated balance sheets of the Company and its
subsidiaries as of the end of such quarter and consolidated statements of income
and retained earnings and of changes in financial position of the Company and
its subsidiaries for such quarter and for the period commencing at the end of
the previous fiscal year ending with the end of such quarter, setting forth in
each case in comparative form the corresponding figures for the corresponding
period of the preceding fiscal year.
(b) Annual Reports: As soon as available and in any event within
--------------
90 days after the end of each fiscal year of the Company, a copy of the annual
audit report for such year for the Company and its subsidiaries including
therein consolidated balance sheets of the Company and its subsidiaries as of
the end of such fiscal year and consolidated balance sheets of the Company and
its subsidiaries as of the end of such fiscal year and consolidated statements
of income and retained earnings and of changes in financial position of the
Company and its subsidiaries for such fiscal year, setting forth in each case in
comparative form the corresponding figures for the preceding fiscal year,
reported on by, and accompanied by an opinion of the Company's independent
certified public accounting firm.
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6.4 MONTHLY REPORTS. The Company shall deliver, as soon as available
and in any event within 30 days after the end of each calendar month, to each
director and to each attendee at Board of Directors, meetings consolidated
balance sheets of the Company and its subsidiaries, if any, as of the end of
such month and consolidated statements of income and retained earnings of the
Company and its subsidiaries, if any, for such month and for the period
commencing at the end of the previous fiscal year and ending with the end of
such month, setting forth in each case in comparative form the corresponding
figures for the corresponding period of the preceding fiscal year, and including
comparisons to monthly budgets, all in reasonable detail and duly certified
(subject to year-end audit adjustments) by the chief financial officer of the
Company as having been prepared in accordance with generally accepted accounting
principles consistently applied.
6.5 INSPECTION. The Purchasers may visit and inspect any of the
properties of the Company, examine its books of account, take copies and
extracts therefrom and discuss the affairs, finances and accounts of the Company
with the Company's officers, employees and public accountants during reasonable
business hours, with a representative of the Company present, but subject to
such security and safety regulations as the Company, as the case may be, have in
effect generally and provided that any such inspection shall be conducted in
such a manner as not to interfere unreasonably with the conduct of the business
by the Company and provided that the Purchasers shall sign appropriate
undertakings of nondisclosure if the Company so requests.
6.6 ADDITIONAL SERIES C PREFERRED STOCK. Except as expressly permitted
or as required pursuant to the terms of this Agreement, the Company shall not
issue any shares of Series C Preferred Stock without the prior written consent
of Fourcar and Vulcan.
6.7 CERTAIN AMENDMENTS. The Company and the Purchasers acknowledge
that, prior to the Closing, the Company and certain shareholders of the Company
shall have executed consents in lieu of a meeting of the Company's shareholders
to duly amend the Company's Articles of Incorporation in order to, among other
things, amend certain provisions relating to the preferences of the Company's
Series A Preferred Stock and Series B Preferred Stock. The Company covenants
that, as soon as practicable after the Closing, the Company shall provide notice
of such amendment to non-consenting shareholders of the Company, and, as soon as
practicable after the waiting period required under Pennsylvania law, file
amended and restated Articles of Incorporation with the Secretary of the
Commonwealth of the Commonwealth of Pennsylvania.
ARTICLE VII
CERTAIN COVENANTS AND RIGHTS OF PURCHASERS
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7.1 COVENANT NOT TO COMPETE: CONFIDENTIALITY
(a) Each Purchaser agrees that, unless the President or the Chief
Executive Officer of the Company otherwise consents, so long as he is bound by
this Purchase Agreement and for a two year period thereafter, he will not,
directly or indirectly, engage in (as a principal, partner, director, officer,
agent, employee, consultant, owner, independent contractor or otherwise, with or
without compensation) or hold a financial interest in (i) any retailing business
that primarily engages in, or plans to primarily engage in, the sale of any
combination of the following children's merchandise: multimedia/educational
----------
merchandise, books, educationally-oriented or specialty-market games and toys,
audiotapes, videotapes, computer software products and arts and crafts supplies
(the "Company's Merchandise Assortment") and has more than 3,000 square feet of
retail selling space in any one store or (ii) any retailing business that
dedicates more than 15% of its retail selling space to any combination of the
Company's Merchandise Assortment and has more than 7,500 square feet of retail
selling space dedicated to such merchandise. The preceding sentence shall not
apply to (A) the ownership of five percent (5%) or less of the shares of any
class of equity securities of a company whose securities are traded on a
national securities exchange or the Nasdaq National Market, (B) any investment
in Kid Source, Inc. or (C) as shall be mutually agreed upon by the parties in a
separate agreement. Each Purchaser acknowledges that the restrictions contained
in this subparagraph, in view of the nature of the business in which the Company
is engaged, are reasonable and necessary in order to protect the legitimate
interests of the Company, and that any violation thereof would result in
irreparable injuries to the Company, entitling the Company to obtain from any
court of competent jurisdiction preliminary and permanent injunctive relief as
well as damages and an equitable accounting of all earnings, profits and other
benefits arising from such violation, which rights shall be cumulative and in
addition to any other rights or remedies to which Company may be entitled. If
any of the provisions in this subparagraph shall for any reason be held to be
excessively broad as to duration, area or scope, it shall be construed by
limiting and reducing it, so as to be valid and enforceable to the fullest
extent compatible with the applicable law or the determination by a court of
competent jurisdiction.
(b) From and after the date hereof, each Purchaser agrees to
maintain the confidentiality of, and not use for any purpose unrelated to the
business of the Company, all information that it receives from or about the
Company, other than information which (i) is or becomes generally available to
the public other than as a result of a disclosure by such Purchaser, (ii) is
already in such Purchaser's possession, provided that such information is not
subject to another confidentiality agreement with, or other legal or fiduciary
obligations of secrecy or confidentiality to the Company, or (iii) becomes
available to such Purchaser on a nonconfidential basis from a person unrelated
to the Company who is under no obligation of confidentiality to the Company.
7.2 PREEMPTIVE RIGHTS. Each time the Company proposes to issue any
shares of its Common Stock or securities convertible into Common Stock
(hereafter the "New
19
<PAGE>
Issue Securities"), the Company shall first offer the New Issue Securities to
the Purchasers in accordance with the following provisions:
(a) The Company shall give a notice to its Purchasers (the "First
Notice"), stating (i) its intention to issue the New Issue Securities, (ii) the
number of such shares or amount of New Issue Securities to be issued and (iii)
the consideration for which it proposes to issue the New Issue Securities.
(b) By notice given to the Company within twenty (20) days after
the First Notice, any Purchaser may elect to purchase, for the consideration and
on the terms specified in such notice, up to that proportion of the New Issue
Securities which equals the proportion that the number of Shares (as that term
is defined in the Shareholders' Agreement) held by such Purchaser bears to the
total number of Shares on a fully converted and fully diluted basis.
(c) The preemptive right contained in this Paragraph shall not
include the issuance or sale of securities of the Company, as duly approved by
the Board of Directors, (i) to employees in connection with their employment,
(ii) to Directors of the Company or (iii) to any independent contractor in
connection with the performance by such independent contractor of services on
behalf of the Company.
ARTICLE VII
MISCELLANEOUS
8.1 AMENDMENTS, CONSENTS AND WAIVERS. This Purchase Agreement may
not be changed, modified or discharged orally, nor may any waiver or consent be
given orally hereunder, and every such change, modification, discharge, waiver
or consent shall be in writing and, except as provided in the following
sentence, signed by the person against which enforcement thereof is sought.
This Purchase Agreement may be amended and any of its restrictions or provisions
may be waived only with the consent of the Company and holders of a majority of
the shares of Series C Preferred Stock held by Purchasers. Written consent of
the holders of a majority of shares of Series C Preferred Stock held by
Purchasers, or by the holder of a valid proxy to vote a majority of shares of
Series C Preferred Stock held by Purchasers, shall constitute the agreement,
consent and approval of Purchasers for all purposes of this Purchase Agreement.
8.2 SURVIVAL OF REPRESENTATIONS AND WARRANTIES. All representations
and warranties made herein shall survive the execution and delivery of this
Purchase Agreement until the earlier of a Qualified Public Offering or the end
of the Company's fiscal year ending January 31, 1998.
20
<PAGE>
8.3 TERM OF AGREEMENT. Unless terminated sooner by unanimous
agreement in writing of the Company and the Purchasers, this Agreement shall
terminate upon receipt by the Company of the proceeds from a distribution of
equity securities of the Company in a Qualified Public Offering; provided,
--------
however, that Article V and Paragraph 7.1 of Article VII shall survive the
- -------
termination of this Agreement.
8.4 COPY OF AGREEMENT TO BE KEPT ON FILE. The Company shall keep on
file at its principal executive offices, and will exhibit to any Purchaser or
its duly authorized representative at any and all reasonable times, an executed
copy of this Agreement and all amendments thereto.
8.5 STOCK CERTIFICATES TO BE MARKED WITH LEGEND. All certificates
representing shares purchased hereunder shall be marked with the following
legend:
"This certificate and the securities represented hereby are held
subject to the terms, covenants and conditions of an agreement
dated as of September 24, 1996 between the Company and the
holder hereof, as it may be amended from time to time, and may
not be transferred or disposed of except in accordance with the
terms and provisions thereof. A copy of said agreement and all
amendments thereto is on file and may be inspected at the
principal executive offices of the Company."
8.6 INTEGRATION AND SEVERABILITY. This Purchase Agreement and the
Shareholders' Agreement shall embody the entire agreement and understanding
among Purchasers and the Company and shall supersede all prior agreements and
understandings relating to the subject matter hereof or thereof, except for (a)
the Purchase Agreement dated as of June 3, 1994 by the Company, Schlessinger and
the Purchasers (as defined therein), as amended, and (b) the Purchase Agreement
dated as of June 28, 1995 by the Company, Schlessinger and the Purchasers (as
defined therein).
8.7 SUCCESSORS AND ASSIGNS. All representations and warranties in
this Purchase Agreement or any certificate delivered pursuant hereto by or on
behalf of Purchasers and the Company shall bind and inure to the benefit of the
respective personal representatives, successors and assigns of such party
hereto, except where the context otherwise requires.
21
<PAGE>
8.8 NOTICES AND OTHER COMMUNICATIONS. All notices, requests, demands
and other communications hereunder shall be in writing and shall be deemed to
have been duly given, made and received only when delivered (personally, by
courier service such as Federal Express or by other messenger, or when deposited
in the United States mails, certified or registered mail, return receipt
requested, postage prepaid and addressed as set forth below:
(a) If to Purchasers:
To the address currently listed for such Purchaser in the
Company's records or such address as is set forth on the
counterpart signature pages hereto.
With a copy to:
Sokolow, Dunaud, Mercadier & Carreras
1211 Avenue of the Americas, 43rd Floor
New York, New York 10036-8701
Attn: Jean-Francois Carreras, Esquire
(b) If to the Company:
Children's Concept, Inc.
308 East Lancaster Avenue
Wynnewood, Pennsylvania 19096
Attention: Keith Spurgeon
with a copy, given in the manner
prescribed above, to:
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103-6993
Attention: Stephen M. Goodman, Esquire
Any party may alter the address to which communications or copies are
to be sent by giving notice of such change of address in conformity with the
provisions of this Paragraph for the giving of notice.
8.9 GOVERNING LAW. This Purchase Agreement shall be construed in
accordance with and governed by the laws of the Commonwealth of Pennsylvania.
EACH PARTY HERETO IRREVOCABLY SUBMITS TO THE EXCLUSIVE JURISDICTION OF ANY COURT
OF COMPETENT JURISDICTION IN THE COMMONWEALTH OF
22
<PAGE>
PENNSYLVANIA AND THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF
PENNSYLVANIA AND ANY OTHER COURT OF THE COMMONWEALTH OF PENNSYLVANIA AND THE
UNITED STATES WITH JURISDICTION TO HEAR APPEALS FROM ANY SUCH COURT, FOR THE
PURPOSES OF ANY SUIT, ACTION OR OTHER PROCEEDING OF ANY TYPE WHATSOEVER ARISING
OUT OF THIS AGREEMENT OR THE SUBJECT MATTER HEREOF OR ANY OF THE TRANSACTIONS
CONTEMPLATED HEREBY BROUGHT BY ANY PARTY, AND TO THE EXTENT PERMITTED BY
APPLICABLE LAW, HEREBY WAIVES, AND AGREES NOT TO ASSERT, BY WAY OF MOTION, AS A
DEFENSE, OR OTHERWISE, IN ANY SUCH SUIT, ACTION OR PROCEEDING ANY CLAIM THAT
SUCH PARTY IS NOT PERSONALLY SUBJECT TO THE JURISDICTION OF THE ABOVE-NAMED
COURTS, THAT THE SUIT, ACTION OR PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM,
THAT THE VENUE OF THE SUIT, ACTION OR PROCEEDING IS IMPROPER OR THAT THIS
AGREEMENT, OR THE SUBJECT MATTER HEREOF MAY NOT BE ENFORCED IN OR BY SUCH COURT.
EACH PARTY HERETO FURTHER AGREES NOT TO BRING OR PURSUE ANY SUCH SUIT, ACTION OF
OTHER PROCEEDING IN ANY OTHER COURTS OR JURISDICTION.
8.1 HEADINGS. The headings of the various subdivisions hereof are
for convenience of reference only and shall in no way modify any of the terms or
provisions hereof.
8.1 EXECUTION IN COUNTERPARTS. This Purchase Agreement may be
executed in any number of counterparts, each of which shall be deemed to be an
original as against any party whose signature appears thereon, and all of which
shall together constitute one and the same instrument. This Purchase Agreement
shall become binding when one (1) or more counterparts hereof, individually or
taken together, shall bear the signatures of all of the parties reflected hereon
as signatories.
8.1 GENDER, ETC. Words used herein, regardless of the number and
gender specifically used, shall be deemed and construed to include any other
number, singular or plural, and any other gender, masculine, feminine or neuter,
as the context indicates is appropriate.
8.1 COSTS, EXPENSES AND TAXES. The Company agrees to pay (i) the
reasonable fees and out-of-pocket expenses of McDermott, Will & Emery, special
counsel for the Purchasers, with respect to the preparation, execution and
delivery of this Agreement; and (ii) the reasonable out-of-pocket expenses, if
any, with respect to certain due diligence matters incurred by Fourcar in
connection with its investment hereto; provided, however that the fees and
expenses provided in (i) and (ii) above shall not exceed $10,000. In addition,
the Company shall pay any and all stamp and other taxes payable or determined to
be payable in connection with the execution and delivery of this Agreement, the
issuance of the Series C Preferred Stock and the Series BB Preferred Stock and
other instruments and documents to be
23
<PAGE>
delivered hereunder or thereunder, and agrees to save the Purchasers harmless
from and against any and all liabilities with respect to or resulting from any
delay in paying or omission to pay such taxes.
8.14 TREATMENT OF FOURCAR, B.V. AND AFFILIATES. Notwithstanding
anything contained in this Purchase Agreement or the Amended and Restated
Shareholders' Agreement, Fourcar, B.V., together with any entity that would be a
permitted transferee of Fourcar, B.V. for purposes of Paragraph 1(b) of the
Amended and Restated Shareholders' Agreement (each, a "Fourcar Affiiated
Entity"), whether a party hereto or a holder of any other equity securities
issued by the Company, shall be treated as one shareholder for the purposes of
(a) calculating any pro rata purchase commitment for any preemptive rights
contained herein and (b) receiving any benefit due the holders of the Series C
Preferred Stock. Fourcar may assign any such benefit to any Fourcar Affiliated
Entity.
24
<PAGE>
IN WITNESS WHEREOF, the parties hereto intending to be legally bound, have
caused this Purchase Agreement to be executed and delivered as instrument under
seal as of the date set forth above.
CHILDREN'S CONCEPT, INC.
By:
__________________________
Keith C. Spurgeon
President and Chief Executive Officer
PURCHASERS:
FOURCAR, B.V.
By: _______________________________
Yves Sisteron,
Attorney-in-Fact
SOCIETE DE NOYANGE
By: _______________________________
Yves Sisteron,
Attorney-in-Fact
ASCHLOTEN BEHEER, B.V.
By: _______________________________
Yves Sisteron,
Attorney-in-Fact
BREUGELEM STIFTUNG
By: _______________________________
Yves Sisteron,
Attorney-in-Fact
25
<PAGE>
FUNDACION JUAN MARCH LUXEMBURGO SA
By: ________________________________
Yves Sisteron,
Attorney-in-Fact
ARABELLA
By: ________________________________
Kevin McCarthy,
Attorney-in-Fact
DULVERTON HOLDINGS LTD.
By: ____________________________
Yves Sisteron,
Attorney-in-Fact
DEANMORE HOLDINGS LTD.
By: ____________________________
Yves Sisteron,
Attorney-in-Fact
FONDATION APPOMATOX
By: ________________________________
Yves Sisteron,
Attorney-in-Fact
FONDATION CONSUELO
By: ________________________________
Yves Sisteron,
Attorney-in-Fact
26
<PAGE>
DANIEL BERNARD
By: _______________________________
Yves Sisteron,
Attorney-in-Fact
OAK INVESTMENT PARTNERS V,
LIMITED PARTNERSHIP
By: ________________________________
Gerald R. Gallagher,
General Partner of Oak Associates V,
Limited Partnership, the General Partner
of Oak Investment Partners V, Limited Partnership
OAK V AFFILIATES FUND
By: _______________________________
Gerald R. Gallagher,
General Partner of Oak V Affiliates,
the General Partner of Oak V Affiliates
Fund, Limited Partnership
VULCAN VENTURES, INC.
By: _____________________________
William D. Savoy
Vice President
27
<PAGE>
Exhibit 21
Subsidiaries
Name State of Organization
---- ---------------------
Children's Products, Inc. Delaware
Children's Development Inc. Delaware
Children's Distribution, L.L.C. New Jersey
<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.,
March 19, 1999
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<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JAN-30-1999 JAN-31-1998
<PERIOD-START> FEB-01-1998 FEB-02-1997
<PERIOD-END> JAN-30-1999 JAN-31-1998
<CASH> 1,695 5,030
<SECURITIES> 0 0
<RECEIVABLES> 3,390 1,631
<ALLOWANCES> 0 0
<INVENTORY> 43,252 29,822
<CURRENT-ASSETS> 53,590 37,155
<PP&E> 44,493 33,880
<DEPRECIATION> 18,588 11,884
<TOTAL-ASSETS> 82,141 59,552
<CURRENT-LIABILITIES> 28,048 17,070
<BONDS> 2,860 1,407
0 0
24 24
<COMMON> 54 54
<OTHER-SE> 48,213 39,141
<TOTAL-LIABILITY-AND-EQUITY> 82,141 59,552
<SALES> 168,471 123,345
<TOTAL-REVENUES> 168,471 123,345
<CGS> 118,153 89,452
<TOTAL-COSTS> 118,153 89,452
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,130 465
<INCOME-PRETAX> 2,812 (153)
<INCOME-TAX> (6,187) 0
<INCOME-CONTINUING> 8,999 (153)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 8,999 (153)
<EPS-PRIMARY> 1.67 (.03)
<EPS-DILUTED> .51 (.03)
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