<PAGE>
SECURITIES AND EXCHANGE COMISSION
Form 10-Q
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15 (d) of the Securities and Exchange
Act of 1934.
For Period ended July 29, 2000 Commission File Number
------------- 0-26185
---------------
Zany Brainy, Inc.
--------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2663337
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
2520 Renaissance Boulevard, King of Prussia, PA 19406
-------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610) 278-7800
--------------
Indicate by check whether the registrant (1) has filed all reports to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No _____
-----
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.
Class Outstanding at July 29, 2000
--------------------------- ----------------------------
Common Stock, par value $.01 31,079,430
<PAGE>
ZANY BRAINY, INC.
FORM 10-Q
QUARTER ENDED JULY 29, 2000
INDEX
<TABLE>
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited):
Condensed Consolidated Statements of Operations for the thirteen and
twenty-six weeks ended July 29, 2000 and July 31, 1999.......................................... Page 1
Condensed Consolidated Balance Sheets as of July 29, 2000 and January 29, 2000.................... Page 2
Condensed Consolidated Statements of Cash Flows for the thirteen and
twenty-six weeks ended July 29, 2000 and July 31, 1999.......................................... Page 3
Notes to Condensed Consolidated Financial Statements.............................................. Page 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................. Page 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK......................................................................... Page 11
PART II - OTHER INFORMATION............................................................................ Page 13
ITEM 2. EXHIBITS AND REPORTS ON FORM 8-K.......................................................... Page 13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................... Page 13
</TABLE>
<PAGE>
ITEM #1: FINANCIAL STATEMENTS
ZANY BRAINY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------------------------- ---------------------------------------
July 29, 2000 July 31, 1999 July 29, 2000 July 31, 1999
----------------- ----------------- ------------------ -----------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
NET SALES $ 71,724 $ 64,937 $ 135,159 $ 128,404
COST OF GOODS SOLD, including
occupancy costs 65,206 48,572 115,965 94,939
----------------- ----------------- ------------------ -----------------
Gross profit 6,518 16,365 19,194 33,465
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES 26,169 23,037 50,731 43,122
MERGER AND INTEGRATION COSTS 9,830 - 9,830 -
----------------- ----------------- ------------------ -----------------
Operating loss (29,481) (6,672) (41,367) (9,657)
INTEREST EXPENSE, net 841 88 1,114 456
EQUITY LOSS IN JOINT VENTURE 5,789 - 5,789 -
----------------- ----------------- ------------------ -----------------
Loss before income tax benefit (36,111) (6,760) (48,270) (10,113)
INCOME TAX BENEFIT 13,917 1,300 18,578 2,054
----------------- ----------------- ------------------ -----------------
NET LOSS $ (22,194) $ (5,460) $ (29,692) $ (8,059)
================= ================= ================== =================
NET LOSS PER COMMON
SHARE:
Basic and Diluted $ (0.71) $ (0.23) $ (0.96) $ (0.41)
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic and Diluted 31,065 24,124 31,061 19,439
</TABLE>
The accompanying notes are an integral part of these statements
1
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands except share data)
<TABLE>
<CAPTION>
July 29, January 29,
2000 2000
---------- -------------
(unaudited)
ASSETS
------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,058 $ 25,041
Receivables, net 3,666 4,880
Inventories, net 106,215 106,303
Deferred tax asset 9,656 2,308
Prepaid expenses 3,394 3,942
----------- -------------
Total current assets 125,989 142,474
PROPERTY AND EQUIPMENT, net 66,802 63,533
DEFERRED TAX ASSET 17,931 6,251
OTHER ASSETS, net 653 389
INVESTMENT IN JOINT VENTURE 5,739 5,000
----------- -------------
$ 217,114 $ 217,647
=========== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Line of credit $ 36,908 $ 4,019
Accounts payable 26,823 29,396
Accrued liabilities 19,755 21,341
Current portion of long term debt and capitalized lease obligations 2,695 2,578
----------- -------------
Total current liabilities 86,181 57,334
----------- -------------
DEFERRED RENT 8,021 7,333
----------- -------------
LONG TERM DEBT AND CAPITALIZED LEASE
OBLIGATIONS, net of current portion 4,086 4,544
----------- -------------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
SHAREHOLDERS' EQUITY (NOTE 1):
Convertible Preferred stock, $.01 par value, 5,000,000
shares authorized at July 29, 2000; 0 shares issued
and outstanding at July 29, 2000 and
January 29, 2000 respectively - -
Common stock, $.01 par value, 100,000,000
shares authorized at July 29, 2000; 31,079,430
and 31,052,116 shares issued and outstanding at
July 29, 2000 and January 29, 2000 respectively 311 311
Additional paid-in capital 143,588 143,504
Accumulated deficit (25,073) 4,621
----------- -------------
Total shareholders' equity 118,826 148,436
----------- -------------
$ 217,114 $ 217,647
=========== =============
</TABLE>
The accompanying notes are an integral part of these statements
2
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Twenty-Six Weeks Ended
------------------ -----------------
July 29, 2000 July 31, 1999
------------------ -----------------
(unaudited)
<S> <C> <C>
CONTINUING OPERATIONS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (29,692) $ (8,059)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 7,434 5,503
Provision for deferred rent 688 1,107
Inventory write-downs 8,650 -
Equity loss in joint venture 5,789 -
Deferred income tax benefit (19,028) (2,054)
Changes in assets and liabilities
(Increase) decrease in
Receivables 1,214 (1,556)
Inventories (8,562) (24,130)
Prepaid expenses 548 (1,304)
Other assets 316 221
Increase (decrease) in
Accounts payable (2,573) 7,320
Accrued liabilities (1,586) (257)
------------------ -----------------
Net cash used in continuing operations (36,802) (23,209)
DISCONTINUED OPERATIONS
Change In net liabilities of discontinued operations - 34
------------------ -----------------
Net cash used in operating activities (36,802) (23,175)
------------------ -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (9,602) (10,902)
Investment in joint venture (6,870) -
------------------ -----------------
Net cash used in investing activities (16,472) (10,902)
------------------ -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on line of credit, net 32,889 4,841
Net proceeds from sale of common stock - 42,313
Payments on capitalized lease obligations (1,360) (1,988)
Debt issuance costs (320) -
Proceeds from exercise of stock options 82 285
Proceeds from exercise of warrants - 130
------------------ -----------------
Net cash provided by financing activities 31,291 45,581
------------------ -----------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (21,983) 11,504
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 25,041 11,883
------------------ -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,058 $ 23,387
================== =================
</TABLE>
The accompanying notes are an integral part of these statements
3
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. BASIS OF PRESENTATION
Effective July 26, 2000, Night Owl Acquisition, Inc., our wholly owned
subsidiary, and Noodle Kidoodle, Inc. were merged in a tax-free, stock-for-stock
transaction that was accounted for as a pooling of interests (the "Merger") (see
note 10). Our accompanying historical financial statements have been
retroactively restated to include the combined accounts and operations of Zany
Brainy, Inc. and Noodle Kidoodle, Inc. as if the Merger had occurred at the
beginning of the periods presented. The combined results include certain
reclassifications and adjustments to conform the accounting and financial
reporting policies of the companies. The financial statements for the thirteen
and twenty-six weeks ended July 29, 2000 include the results of Noodle Kidoodle,
Inc. from February 1, 2000 through the date of the merger.
Our accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial reporting and the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for fair presentation have been included. Certain reclassifications
have been made to the prior period financial statements to conform to current
year financial statement presentation.
Operating results for the thirteen and twenty-six week periods ended July
29, 2000 are not necessarily indicative of the results that may be expected for
the year ending February 3, 2001. For further information, refer to the
consolidated financial statements and notes thereto included in our registration
statement on Form S-4 (registration #333-37612) dated June 21, 2000 for the year
ended January 29, 2000, which includes Supplemental Financial Data to reflect
the retroactive restatement of the financial statements of Zany Brainy, Inc. and
Noodle Kidoodle, Inc. on a combined basis.
2. INITIAL PUBLIC OFFERING
In June 1999, we sold 4,722,669 shares of Common stock at $10.00 per share
($9.30 after an underwriting discount of $.70 per share) in an initial public
offering (the "Offering"). All shares of Preferred stock outstanding prior to
the Offering were converted into 11,250,273 shares of Common stock. The
Offering generated proceeds of $43.9 million ($42.3 million after deducting
transaction expenses of $1.6 million). We used $18.4 million to pay down our
line of credit balance plus accrued interest and $22.2 million for 18 new store
openings, the relocation of the distribution center, new enterprise software and
the Internet investment. The remainder of the net proceeds was used for general
corporate purposes.
3. SUPPLEMENTAL CASH FLOWS INFORMATION
For the twenty-six weeks ended July 29, 2000 and July 31, 1999, we made
payments of $688,071 and $604,000, respectively, in interest. For the twenty-six
weeks ended July 29, 2000 and July 31, 1999, we made payments of $690,650 and
$276,977, respectively, for income taxes. Capitalized lease obligations of $1.0
million and $1.1 million were incurred on equipment leases entered into during
the twenty-six weeks ended July 29, 2000 and July 31, 1999, respectively.
4. MERCHANDISE INVENTORIES
Merchandise inventories are valued at the lower of cost (first-in, first-
out) or market. Costs associated with certain buying and distribution activities
are included in inventories.
5. NET LOSS PER SHARE
Net loss per share is calculated utilizing the principles of Statement of
Financial Accounting Standards No. 128, "Earnings per Share". The weighted
average impact of stock options, warrants and Preferred stock was excluded from
the calculation of diluted loss per share for all periods presented as they were
anti-dilutive due to our net loss.
4
<PAGE>
6. LINE OF CREDIT
In May 2000, Noodle Kidoodle, Inc. entered into a three-year credit
facility covering a maximum principal amount of $50.0 million.
On July 12, 2000 we signed a commitment letter entering into a three-year
credit facility covering a maximum principal amount of $115.0 million, secured
by our inventories and other assets, subject to a borrowing base. The borrowing
base is defined as a seasonal percentage of eligible inventories. This secured
line of credit bears interest at prime rate, or, if we elect, at an annual rate
of LIBOR plus 2.0%-2.5% (depending on availability). The line will be completed
in two parts. An initial $65.0 million portion was completed on July 26, 2000
and replaced our existing $30.0 million bank line. The remaining $50.0 million
portion is expected to be completed early in the third quarter and will replace
Noodle Kidoodle, Inc.'s existing $50.0 million facility.
As of July 29, 2000, we had $20.3 million outstanding on our line of credit
and an additional $8.0 million in outstanding letters of credit. As of July 29,
2000, there was $16.6 million outstanding on Noodle Kidoodle, Inc.'s existing
line of credit and an additional $2.2 million in outstanding letters of credit.
As of July 29, 2000, $49.9 million was available under these credit facilities.
7. COMMON STOCK OPTIONS AND WARRANTS
As of July 29, 2000, there were options to purchase 3,996,325 shares of
Common stock outstanding of which options to purchase 2,634,183 shares are
currently exercisable at a weighted average price of $5.04. In addition,
warrants to purchase 15,000 shares of Common stock are outstanding. These
warrants have an exercise price of $4.00 per share and expire in January 2003.
Information with respect to all options outstanding is as follows:
<TABLE>
<CAPTION>
Weighted
Option Price Average Price
Shares Per Share Per Share
-------------- ---------------- -----------------
<S> <C> <C> <C>
Options Outstanding, January 29, 2000 4,347,487 $2.43 - 11.75 $ 5.24
Granted 190,913 2.50 - 5.375 3.38
Exercised (27,314) 2.43 - 5.25 2.94
Canceled (514,761) 2.48 - 11.75 6.23
-------------- ---------------- -----------------
Options Outstanding, July 29, 2000 3,996,325 $2.43 - 11.75 $ 5.04
============== ================ -----------------
</TABLE>
8. COMMITMENTS AND CONTINGENCIES
From time to time, we are named as a defendant in legal actions arising
from our normal business activities. Although the amount of any liability that
could arise with respect to currently pending actions cannot be estimated, in
our opinion, any such liability will not have a material adverse effect on our
financial position, operating results or liquidity.
9. RELATED PARTY TRANSACTIONS
In October 1999, we formed ZB Holdings LLC, a joint venture with Online
Retail Partners, Inc. ZB Holdings LLC was formed for the purpose of developing
and operating www.zanybrainy.com, an Internet shopping website, offering its
customers comprehensive content, extensive product assortment and related value-
added online services. ZB Holdings LLC formed ZanyBrainy.com LLC
("ZanyBrainy.com"), a wholly owned subsidiary, for the purpose of developing and
operating such a site. We contributed $5.0 million for the purchase of 100% of
the outstanding Preferred interests of ZB Holdings LLC and Online Retail
Partners contributed a total of $15.0 million for the purchase of 100% of the
Common interests of ZB Holdings LLC. In March 2000, the joint venture partners
agreed to contribute another $12.0 million to the joint venture, of which our
pro rata contribution was $6.9 million. Both partners hold 50% of the voting
stock of the joint venture and we have an ownership interest in the joint
venture of approximately 49%, on a fully diluted basis. There could be future
dilution of our interests if further investments, or stock grants, in the joint
venture are made.
5
<PAGE>
As of July 29, 2000, our total investment in ZanyBrainy.com was $11.9
million. While Online Retail Partners agreed to first take all losses of
ZanyBrainy.com up to the extent of their capital account, any losses beyond that
point require us to recognize losses up to the amount of our investment. As of
July 29, 2000 ZanyBrainy.com's cumulative losses exceeded Online Retail
Partners' investment. As a result, in the thirteen and twenty-six weeks ended
July 29, 2000, we recognized a pre-tax loss from our investment in the joint
venture of $5.8 million. We expect that ZanyBrainy.com will continue to incur
losses for the foreseeable future and that we will have to recognize all or a
portion of those losses.
10. THE MERGER
Effective July 26, 2000, Night Owl Acquisition, Inc., our wholly owned
subsidiary, and Noodle Kidoodle, Inc. were merged in a tax-free, stock-for-stock
transaction that was accounted for as a pooling of interests. Under the terms
of the Merger agreement, we issued 1.233 shares of Zany Brainy, Inc. common
stock for each outstanding share of Noodle Kidoodle, Inc. common stock for an
aggregate issuance of approximately 9.4 million shares of our common stock to
the former Noodle Kidoodle, Inc. stockholders.
Net revenue and net loss for the periods preceding the Merger were as
follows (in thousands):
<TABLE>
<CAPTION>
Thirteen weeks ended Twenty-six weeks ended
July 29, 2000 July 29, 2000
---------------------- ------------------------
<S> <C> <C>
Revenue:
--------
Zany Brainy, Inc. $ 44,793 $ 84,156
Noodle Kidoodle, Inc. 23,686 47,758
---------------------- ------------------------
Total $ 68,479 $ 131,914
====================== ========================
Net loss:
---------
Zany Brainy, Inc. ($7,961) ($13,011)
Noodle Kidoodle, Inc. (2,507) (4,955)
---------------------- ------------------------
Total ($10,468) ($17,966)
====================== ========================
</TABLE>
During the second quarter of 2000, we recorded expenses totaling $18.5
million (pre-tax) related to the Merger and management's restructuring and
integration plan associated with the Merger, as follows (in thousands):
As Part of Cost of Sales:
-------------------------
Inventory write-downs $ 8,650
As Part of SG&A Expense:
------------------------
Professional fees 5,025
Severence and change in control costs 3,000
Other integration costs 1,805
----------
Total $18,480
==========
Management's restructuring and integration plan relates primarily to the
discontinuance and liquidation of product SKU's, which resulted in inventory
write-downs of $8.7 million which are included in cost of goods sold on the
accompanying statements of operations. Additionally, management's plan includes
consolidating Noodle Kidoodle, Inc.'s administrative functions into our
headquarters in King of Prussia, PA. Employee termination charges resulting from
this consolidation, coupled with change in control payments, totaled $3.0
million. We expect to complete management's plan during the second half of 2000.
During the second half of 2000, we expect to incur additional merger and
integration charges for store closures and other costs of approximately $10.7
million.
The major components of the charges booked as of July 29, 2000, including
an accrual balance, are as follows (in thousands):
6
<PAGE>
<TABLE>
<CAPTION>
Expenses Paid Accrued
-------- ---- -------
<S> <C> <C> <C>
As Part of Cost of Sales:
-------------------------
Inventory write-downs $ 8,650 $ - $ 8,650
As Part of SG&A Expenses:
-------------------------
Professional fees 5,025 3,680 1,345
Severence and change in control costs 3,000 2,616 384
Other integration costs 1,805 225 1,580
------------------------------------
Total $ 18,480 $ 6,521 $ 11,959
====================================
</TABLE>
7
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
We are a rapidly growing specialty retailer of high quality toys, games,
books and multimedia products for children, with 171 stores operating in 34
states as of July 29, 2000.
Recent Developments
Effective July 26, 2000, our wholly owned subsidiary and Noodle Kidoodle,
Inc. were merged in a tax-free, stock-for-stock transaction that was accounted
for as a pooling of interests. All data presented includes the results of Noodle
Kidoodle, Inc. Under the terms of the Merger agreement, we issued 1.233 shares
of Zany Brainy, Inc. common stock for each outstanding share of Noodle Kidoodle,
Inc. common stock for an aggregate issuance of approximately 9.4 million shares
of our common stock to the former Noodle Kidoodle, Inc. stockholders.
Results of Operations
The following table sets forth our financial data expressed as a percentage
of net sales, and operating data for the periods indicated.
<TABLE>
<CAPTION>
Thirteen Weeks Ended Twenty-Six Weeks Ended
---------------------------------------- -----------------------------------------
July 29, 2000 July 31, 1999 July 29, 2000 July 31, 1999
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold /1/ 90.9 74.8 85.8 73.9
------------------ ------------------ ------------------ ------------------
Gross profit 9.1 25.2 14.2 26.1
Selling, general and administrative
expenses 36.5 35.5 37.5 33.6
Merger and integration costs 13.7 0.0 7.3 0.0
------------------ ------------------ ------------------ ------------------
Operating loss (41.1) (10.3) (30.6) (7.5)
Interest expense, net 1.1 0.1 0.8 0.4
Equity loss in joint venture 8.1 0.0 4.3 0.0
------------------ ------------------ ------------------ ------------------
Loss before income tax benefit (50.3) (10.4) (35.7) (7.9)
Income tax benefit 19.4 2.0 13.7 1.6
------------------ ------------------ ------------------ ------------------
Net loss (30.9%) (8.4%) (22.0%) (6.3%)
================== ================== ================== ==================
Comparable store net sales /2/ (9%) 2% (14%) 5%
================== ================== ================== ==================
Total number of stores at
end of period 171 139 171 139
================== ================== ================== ==================
Stores opened during period 5 13 10 22
================== ================== ================== ==================
</TABLE>
/1/ Cost of goods sold includes buying distribution and occupancy costs
/2/ A store becomes comparable in the 14th full month of store operations
Thirteen Weeks Ended July 29, 2000 Compared to Thirteen Weeks Ended July 31,
1999
NET SALES. Net sales increased $6.8 million, or 10.5%, to $71.7 million in
the thirteen weeks ended July 29, 2000 from $64.9 million in the comparable 1999
period. This increase resulted primarily from sales from 27 additional stores
opened since the first quarter of last year, and sales from those stores opened
in fiscal 1999 which are not yet included in our comparable store sales base,
partially offset by a comparable store sales decrease of 9%. The decrease in
comparable store sales is primarily attributable to the decline in sales of
popular products such as Beanie Babies and Crazy Bones, and the resulting
decline in store traffic and ancillary purchases.
8
<PAGE>
We expect these difficult sales comparisons to continue into the third quarter
of 2000. Additionally, we expect sales of popular products to remain
significantly below last year's levels for the remainder of the fiscal year.
This could lead to negative comparable store sales results.
GROSS PROFIT. Gross profit includes all buying, distribution and occupancy
costs. Gross profit decreased to 9.1% of net sales for the period, from 25.2%
in the comparable 1999 period. The decrease of 16.1% was due primarily to
merger and integration costs of $8.7 million (or 12.1% of net sales for the
period), which was related to inventory markdowns on merchandise that will not
be included in the continuing assortment of the combined company going forward
with the balance due to our inability to leverage occupancy, distribution and
buying costs from negative comparable store sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include all direct store level expenses and all
corporate level costs not directly associated with or allocable to cost of goods
sold. Selling, general and administrative expenses increased $3.1 million, or
13.6%, to $26.2 million during the second quarter, from $23.0 million in the
same period last year. The dollar increase in selling, general and
administrative expenses was primarily attributable to $2.9 million in
incremental store payroll and other selling expenses incurred in the second
quarter associated with the opening and operation of 27 additional stores
following the first quarter of 1999. Corporate expenses increased approximately
$251,000 during this period to support this additional store growth. Selling,
general and administrative expenses increased to 36.5% of net sales from 35.5%
of net sales due to our inability to leverage corporate, store and other
expenses from negative comparable store sales.
MERGER AND INTEGRATION COSTS. During the quarter, we recognized pre-tax
merger-related costs totaling $18.5 million of which $8.7 million was included
in cost of goods sold and $9.8 million was related to professional fees,
severance and change in control costs, and other expenses.
INTEREST EXPENSE, NET. Net interest expense was approximately $841,000 for
the period, an increase of $753,000 from the comparable period in 1999. This
increase was due to increased borrowings under our line of credit and decreased
cash balances.
EQUITY LOSS IN JOINT VENTURE. During the quarter, we recognized losses
from ZanyBrainy.com totaling $5.8 million. We expect to continue to recognize
operating losses from ZanyBrainy.com for the remainder of the fiscal year.
INCOME TAX BENEFIT. For the thirteen weeks ended July 29, 2000, we
recorded an income tax benefit of $13.9 million primarily related to the Federal
tax benefit of the net loss, compared to an income tax benefit of approximately
$1.3 million for the comparable period in 1999. For the thirteen weeks ended
July 31, 1999, no benefit was recorded for Noodle Kidoodle, Inc. with respect to
the net operating loss carryforward because they established a valuation
allowance. The effective tax rate for the second quarter of fiscal 2000 was
38.5%.
Twenty-Six Weeks Ended July 29, 2000 Compared to Twenty-Six Weeks Ended July 31,
1999
NET SALES. Net sales increased $6.8 million, or 5.3%, to $135.2 million in
the twenty-six weeks ended July 29, 2000 from $128.4 million in the comparable
1999 period. This increase resulted primarily from sales from 27 additional
stores opened since the first quarter of last year, and sales from those stores
opened in fiscal 1999 which are not yet included in our comparable store sales
base, partially offset by a comparable store sales decrease of 14%. The decrease
in comparable store sales is primarily attributable to the decline in sales of
popular products such as Beanie Babies and Crazy Bones, and the resulting
decline in store traffic and ancillary purchases. We expect these difficult
sales comparisons to continue into the third quarter of 2000. We also expect
sales of popular products to remain significantly below last year's levels for
the remainder of the fiscal year, which could lead to negative comparable store
sales results.
GROSS PROFIT. Gross profit includes all buying, distribution and occupancy
costs. Gross profit decreased to 14.2% of net sales for the period, from 26.1%
in the comparable 1999 period. The decrease of 11.9% was due primarily to
merger-related costs of $8.7 million (or 6.4% of net sales for the period),
which was related to inventory markdowns on merchandise that will not be
included in the continuing assortment of the combined company going forward with
the balance due to our inability to leverage occupancy, distribution and buying
costs from negative comparable store sales.
9
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include all direct store level expenses, and all
corporate level costs not directly associated with or allocable to cost of goods
sold. Selling, general and administrative expenses increased $7.6 million, or
17.6%, to $50.8 million during the second quarter, from $43.1 million in the
same period last year. The dollar increase in selling, general and
administrative expenses was primarily attributable to $6.1 million in
incremental store payroll and other selling expenses associated with the opening
and operation of 27 additional stores following the first quarter of 1999.
Corporate expenses increased approximately $1.5 million during this period to
support this additional store growth. Selling, general and administrative
expenses increased to 37.5% of net sales from 33.6% of net sales due to our
inability to leverage corporate, store and other expenses.
MERGER AND INTEGRATION COSTS. During the twenty-six weeks ended July 29,
2000 we recognized pre-tax merger-related costs totaling $18.5 million of which
$8.7 million was included in cost of goods sold and $9.8 million was related to
professional fees, severance costs and other expenses.
INTEREST EXPENSE, NET. Net interest expense was approximately $1.1
million for the period, an increase of $658,000 from the comparable period in
1999. This increase was due to increased borrowings under our line of credit
and decreased cash balances.
EQUITY LOSS IN JOINT VENTURE. During the twenty-six weeks ended July 29,
2000, we recognized losses from ZanyBrainy.com totaling $5.8 million. We expect
to continue to recognize operating losses from ZanyBrainy.com for the remainder
of the fiscal year.
INCOME TAX BENEFIT. For the twenty-six weeks ended July 29, 2000, we
recorded an income tax benefit of $18.6 million primarily related to the Federal
tax benefit of the net loss, compared to an income tax benefit of approximately
$2.1 million for the comparable period in 1999. For the twenty-six weeks ended
July 31, 1999, no benefit was recorded for Noodle Kidoodle, Inc. with respect to
the net operating loss carryforward because they established a valuation
allowance. The effective tax rate for the twenty-six weeks ended July 29, 2000
was 38.5%.
LIQUIDITY AND CAPITAL RESOURCES
We require cash principally to finance capital investment in new stores,
new store inventories, seasonal working capital and losses during non-
profitable quarters. We opened ten stores through the twenty-six weeks ended
July 29, 2000.
Cash flows used in operating activities were $36.8 million for the twenty-
six weeks ended July 29, 2000, an increase of $13.6 million over the same period
for the previous year. The increase was primarily a result of an increase in the
net loss before deferred income tax benefit, partially offset by a lower
increase in inventory, net of payables.
Cash flows used in investing activities were $16.5 million for the twenty-
six weeks ended July 29, 2000, an increase of approximately $5.6 million over
the same period for the previous year.
Cash flows provided by financing activities during the twenty-six weeks
ended July 29, 2000 were principally provided through net borrowings on our
credit facilities of $33.0 million. For the comparable period last year, cash
was principally provided by the proceeds of the initial public offering of $42.5
million and borrowings on the former Noodle Kidoodle, Inc. credit line of $4.8
million.
In May 2000, Noodle Kidoodle, Inc. entered into a three-year credit
facility covering a maximum principal amount of $50.0 million.
On July 12, 2000 we signed a commitment letter entering into a three-year
credit facility covering a maximum principal amount of $115.0 million, secured
by our inventories and other assets, subject to a borrowing base. The borrowing
base is defined as a seasonal percentage of eligible inventories. This secured
line of credit bears interest at prime rate, or, if we elect, at an annual rate
of LIBOR plus 2.0%-2.5% (depending on availability). The line will be completed
in two parts. An initial $65.0 million portion was completed on July 26, 2000
and replaced our existing $30.0 million bank line. The remaining $50.0 million
portion is expected to be completed early in the third quarter and will replace
Noodle Kidoodle, Inc.'s existing $50.0 million facility. As of July 29, 2000, we
had $20.3 million outstanding on
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our line of credit and an additional $8.0 million in outstanding letters of
credit. As of July 29, 2000, there was $16.6 million outstanding on Noodle
Kidoodle, Inc.'s existing line of credit and an additional $2.2 million in
outstanding letters of credit.
We believe that our operating cash flow together with the unused portion of
our credit facility and other financing arrangements will be sufficient to
finance current operating requirements including capital expenditures and new
store openings for at least the next twelve months.
Seasonality of Business
Seasonal shopping patterns affect our business. A significant portion of
our sales occurs in the fourth quarter, coinciding with the Christmas holiday
shopping season. Therefore, results of operations for the entire year depend
heavily on fourth quarter results and the success of the Christmas selling
season. Based upon previous experience, we do not expect to earn a profit in the
first three quarters of a fiscal year in the foreseeable future.
Internet Sales Channel
During the third quarter of 1999 we implemented an Internet shopping site
(www.zanybrainy.com) through a joint venture with Online Retail Partners, Inc.
We each initially contributed $5.0 million to this joint venture. Online Retail
Partners contributed an additional $10.0 million to the joint venture in
November 1999. In March 2000, the joint venture partners agreed to contribute
another $12.0 million to the joint venture of which our pro rata contribution
was $6.9 million. As of July 29, 2000 we owned approximately 49%, on a fully
diluted basis, of the joint venture.
As of July 29, 2000, our total amount invested to date in ZanyBrainy.com
was $11.9 million. While Online Retail Partners agreed to take all losses of
ZanyBrainy.com up to the extent of their capital account, any losses beyond that
point require us to recognize losses up to the amount of our investment. As of
July 29, 2000, ZanyBrainy.com's cumulative losses exceeded Online Retail
Partners' investment. As a result, in the twenty-six weeks ended July 29, 2000
we recognized a pre-tax loss from our investment in the joint venture of $5.8
million, reducing our investment in the joint venture to $5.7 million. We will
have to recognize additional losses up to the amount of our investment if
ZanyBrainy.com incurs additional losses or if our investment were to become
materially impaired.
We expect that ZanyBrainy.com will continue to require cash investment or
financing prior to its profitability. We also expect that ZanyBrainy.com will
continue to incur losses for the foreseeable future.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION ACT OF 1995
This report and the documents incorporated by reference herein contain
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. When used in this report and the documents incorporated herein by
reference, the words "anticipate," "believe," "estimate," and similar
expressions are generally intended to identify forward-looking statements.
Forward-looking statements include, among others, the statements about the
following: the sufficiency of our operating cash flow over the next 12 months;
the dollar amount of the merger-related charges; our ability to finalize the
remaining portion of our new line of credit; our expectations with respect to
our inability to earn a profit in the first three quarters of a fiscal year; the
impact that future investments in the Internet joint venture would have on our
equity ownership of the Internet business and our financial statements; our
expectations with respect to future sales of popular products and negative
comparable store sales; the potential negative effects selling our products on
the Internet could have on our existing store sales and our customer base; our
expectations with respect to the ability to raise capital for the Internet
shopping site; and the timing and impact of any losses associated with the
Internet business.
There are important factors that could cause actual results to differ
materially from those expressed or implied by such forward-looking statements
including, but not limited to, the following: a decline in the level of demand
for our products, including popular products; actions by our competitors; a
decline in general economic and business conditions and in the specialty retail
or toy industry in particular; our inability to manage our growth, open new
stores on a timely basis and expand in new and existing markets; our ability to
integrate the operations of Noodle Kidoodle, Inc. and Zany Brainy, Inc.; our
ability to successfully market and expand the Internet shopping site and
successfully work with Online Retail Partners; the availability of product and
our ability to replenish product on a timely basis; our ability to successfully
manage our inventory; unanticipated cash requirements to support current
operations or expansion of our business; the availability and cost of additional
capital to fund our operations or that of ZanyBrainy.com; and our ability to
attract, train and retain highly qualified associates. These and other risks and
uncertainties affecting Zany Brainy, Inc. are discussed in greater detail in
this report and in other filings by Zany Brainy, Inc. with the Securities and
Exchange Commission.
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PART II - OTHER INFORMATION
ITEM 2: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 - Employment Agreement dated as of June 6, 2000 between Zany
Brainy, Inc. and Keith C. Spurgeon (1)
10.2 - Employment Agreement dated as of June 6, 2000 between Zany
Brainy, Inc. and Thomas G. Vellios (1)
10.3 - Employment Agreement dated as of June 6, 2000 between Zany
Brainy, Inc. and Robert A. Helpert (1)
10.4 - Loan and Security Agreement dated July 25, 2000 by and among
First Union National Bank, Congress Financial Corporation and
Zany Brainy, Inc.
27.1 - Financial Data Schedule
(1) Previously filed as exhibits to the Company's quarterly report
on Form 10-Q for the fiscal quarter ended April 29, 2000 and
incorporated herein by reference.
(b) Reports on Form 8-K:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Shareholders on July 26, 2000. At the annual
meeting, our shareholders (i) elected each of the persons below to serve as our
directors until the next annual meeting of shareholders or until his or her
successor is elected; and (ii) approved the proposal to approve the amended and
restated agreement and plan of merger, dated as of April 21, 2000, among Zany
Brainy, Inc., Noodle Kidoodle, Inc. and Night Owl Acquisition, Inc.
ELECTION OF DIRECTORS
Director
--------
Keith C. Spurgeon
C. Donald Dorsey
Robert A. Fox
Henry Nasella
Yves B. Sisteron
Mary Ann Tocio
David V. Wachs
PROPOSAL - RATIFICATION THE PROPOSAL TO APPROVE THE AMENDED AND RESTATED
AGREEMENT AND PLAN OF MERGER, DATED AS OF APRIL 21, 2000, AMONG ZANY BRAINY,
INC., NOODLE KIDOODLE, INC. AND NIGHT OWL ACQUISITION, INC.
Votes in Favor 10,062,033
Votes Against 91,433
Abstentions 12,415
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Zany Brainy, Inc.
Date: September 12, 2000 By: /s/ Keith C. Spurgeon
------------------ -----------------
Keith C. Spurgeon
Chairman & Chief
Executive Officer
Date: September 12, 2000 By: /s/ Robert A. Helpert
------------------ -----------------
Robert A. Helpert
Chief Financial Officer,
Secretary and Treasurer
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EXHIBIT INDEX
Exhibit Description
Number
10.1 Employment Agreement dated June 6, 2000 between
Zany Brainy, Inc. and Keith C. Spurgeon (1)
10.2 Employment Agreement dated June 6, 2000 between
Zany Brainy, Inc. and Thomas G. Vellios (1)
10.3 Employment Agreement dated June 6, 2000 between
Zany Brainy, Inc. and Robert A. Helpert (1)
10.4 Loan and Security Agreement dated July 25, 2000 by
and among First Union National Bank, Congress
Financial Corporation and Zany Brainy, Inc.
27.1 Financial Data Schedule
(1) Previously filed as exhibits to the Company's quarterly report on Form 10-Q
for the fiscal quarter ended April 29, 2000 and incorporated herein by
reference.
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