<PAGE>
SECURITIES AND EXCHANGE COMMISSION
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 October 28, 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 October 28, 2000
----- -------------------------------
Common Stock, par value $.01 31,079,430
<PAGE>
ZANY BRAINY, INC.
FORM 10-Q
QUARTER ENDED OCTOBER 28, 2000
INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
<S> <C>
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Condensed Consolidated Statements of Operations for the thirteen and
thirty-nine weeks ended October 28, 2000 and October 30, 1999................................ Page 1
Condensed Consolidated Balance Sheets as of October 28, 2000 , October 30,
1999 and January 29, 2000..................................................................... Page 2
Condensed Consolidated Statements of Cash Flows for the thirteen and
thirty-nine weeks ended October 28, 2000 and October 30, 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
</TABLE>
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-Nine Weeks Ended
---------------------------------- ----------------------------------
October 28, 2000 October 30, 1999 October 28, 2000 October 30, 1999
---------------- ---------------- ---------------- ----------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
NET SALES $ 76,408 $ 73,902 $ 211,566 $ 202,306
COST OF GOODS SOLD, including
occupancy costs 59,406 52,738 173,733 146,232
---------------- ---------------- ---------------- ----------------
Gross profit 17,002 21,164 37,833 56,074
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES 28,572 25,825 80,961 70,494
MERGER AND INTEGRATION COSTS 5,069 - 14,899 -
---------------- ---------------- ---------------- ----------------
Operating loss (16,639) (4,661) (58,027) (14,420)
INTEREST EXPENSE, net 1,448 337 2,562 804
EQUITY LOSS IN JOINT VENTURE 3,514 - 9,304 -
---------------- ---------------- ---------------- ----------------
Loss before income tax benefit (21,601) (4,998) (69,893) (15,224)
INCOME TAX BENEFIT 8,317 757 26,914 2,925
---------------- ---------------- ---------------- ----------------
NET LOSS FROM CONTINUING OPERATIONS (13,284) (4,241) (42,979) (12,299)
---------------- ---------------- ---------------- ----------------
GAIN FROM DISPOSAL OF DISCONTINUED
OPERATIONS - 2,500 - 2,500
---------------- ---------------- ---------------- ----------------
NET LOSS $ (13,284) $ (1,741) $ (42,979) $ (9,799)
================ ================ ================ ================
NET LOSS PER COMMON
SHARE:
Basic and Diluted $ (0.43) $ (0.06) $ (1.38) $ (0.42)
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic and Diluted 31,079 30,904 31,067 23,274
</TABLE>
The accompanying notes are an integral part of these statements
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands except share data)
<TABLE>
<CAPTION>
October 28, October 30, January 29,
2000 1999 2000
------------- ------------- ------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C>
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 3,427 $ 696 $ 25,041
Receivables, net 8,441 8,719 4,880
Inventories, net 173,618 163,815 106,303
Deferred tax asset 9,656 6,711 2,308
Prepaid expenses 3,840 4,949 3,942
------------- ------------- ------------
Total current assets 198,982 184,890 142,474
PROPERTY AND EQUIPMENT, net 68,350 62,625 63,533
DEFERRED TAX ASSET 26,248 2,024 6,251
OTHER ASSETS, net 1,081 306 389
INVESTMENT IN JOINT VENTURE 2,225 5,000 5,000
------------- ------------- ------------
$ 296,886 $ 254,845 $ 217,647
============= ============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Line of credit $ 86,346 $ 31,578 $ 4,019
Accounts payable 70,660 69,577 29,396
Accrued liabilities 19,862 22,650 21,341
Current portion of long term debt and capitalized lease
obligations 2,652 1,525 2,578
------------- ------------- ------------
Total current liabilities 179,520 125,330 57,334
------------- ------------- ------------
DEFERRED RENT 8,345 7,224 7,333
------------- ------------- ------------
LONG TERM DEBT AND CAPITALIZED LEASE
OBLIGATIONS, net of current portion 3,475 2,476 4,544
------------- ------------- ------------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
SHAREHOLDERS' EQUITY:
Convertible Preferred stock, $.01 par value, 5,000,000
shares authorized at October 28, 2000; 0 shares issued
and outstanding at October 28, 2000, October 30, 1999
and January 29, 2000, respectively - - -
Common stock, $.01 par value, 100,000,000
shares authorized at October 28, 2000; 31,079,430,
30,957,827 and 31,052,116 shares issued and
outstanding at October 28, 2000, October 30, 1999 and
January 29, 2000, respectively 311 310 311
Additional paid-in capital 143,593 142,980 143,504
Accumulated (deficit) earnings (38,358) (23,475) 4,621
------------- ------------- ------------
Total shareholders' equity 105,546 119,815 148,436
------------- ------------- ------------
$ 296,886 $ 254,845 $ 217,647
============= ============= ============
</TABLE>
The accompanying notes are an integral part of these statements
<PAGE>
ZANY BRAINY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Thirty-Nine Weeks Ended
-----------------------------------------
October 28, 2000 October 30, 1999
------------------- -----------------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
CONTINUING OPERATIONS
Net loss from continuing operations $ (42,979) $ (12,299)
Adjustments to reconcile net loss to net cash
used in operating activities--------
Depreciation and amortization 11,133 8,854
Provision for deferred rent 1,012 2,293
Merger-related inventory write-down 8,802 -
Equity loss in joint venture 9,304 -
Deferred income tax benefit (27,345) (2,818)
Noncash compensation expense 340 -
Loss on disposal of assets 1,272 -
Changes in assets and liabilities--------
(Increase) decrease in
Receivables (3,561) (4,013)
Inventories (76,117) (98,387)
Prepaid expenses 102 (1,544)
Other assets (30) 336
Increase (decrease) in
Accounts payable 41,264 44,841
Accrued liabilities (1,479) 4,696
------------------- -----------------
Net cash used in continuing operations (78,282) (58,041)
DISCONTINUED OPERATIONS
Gain from disposal of discontinued operating activities - 2,500
Change In net liabilities of discontinued operations - (1,303)
------------------- -----------------
Net cash used in operating activities (78,282) (56,844)
------------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (16,046) (22,674)
Investment in joint venture (6,862) (5,000)
------------------- -----------------
Net cash used in investing activities (22,908) (27,674)
------------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on line of credit, net 82,327 31,578
Net proceeds from sale of common stock - 42,313
Payments on capitalized lease obligations (2,045) (1,274)
Debt issuance costs (788) -
Proceeds from exercise of stock options 82 584
Proceeds from exercise of warrants - 130
------------------- -----------------
Net cash provided by financing activities 79,576 73,331
------------------- -----------------
NET (DECREASE) IN CASH AND
CASH EQUIVALENTS (21,614) (11,187)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 25,041 11,883
------------------- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,427 $ 696
=================== =================
</TABLE>
The accompanying notes are an integral part of these statements
<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 all periods
presented include the results of Noodle Kidoodle, Inc. from the beginning of the
periods 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 thirty-nine week periods ended
October 28, 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
a joint venture investment. The remainder of the net proceeds was used for
general corporate purposes.
3. SUPPLEMENTAL CASH FLOWS INFORMATION
For the thirty-nine weeks ended October 28, 2000 and October 30, 1999,
we made payments of $1.9 million and $1.1 million, respectively, in interest and
payments of $0.9 million and $0.3 million, respectively, for income taxes.
Capitalized lease obligations of $1.0 million and $0 were incurred on equipment
leases entered into during the thirty-nine weeks ended October 28, 2000 and
October 30, 1999, respectively.
4. INVENTORIES
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 all 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 (see Note 7).
4
<PAGE>
6. LINE OF CREDIT
In July, 2000 we entered 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 was 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 was completed on
October 12, 2000 and replaced Noodle Kidoodle's existing $50.0 million facility.
As of October 28, 2000, we had $86.3 million outstanding on our line of
credit and an additional $3.2 million in outstanding letters of credit. As of
October 28, 2000, $20.8 million was available under this credit facility.
7. COMMON STOCK OPTIONS AND WARRANTS
As of October 28, 2000, there were options to purchase 3,814,318 shares
of common stock outstanding of which options to purchase 2,656,031 shares are
currently exercisable at a weighted average price of $4.00. 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 298,810 2.00 - 5.38 3.09
Exercised (27,314) 2.43 - 5.25 2.94
Canceled (804,665) 2.00 - 11.75 6.46
----------- ------------- --------------
Options Outstanding, October 28, 2000 3,814,318 $2.00 - 11.75 $ 4.83
=========== ============= ==============
</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. As of October 28, 2000, both partners
held 50% of the voting stock of the joint venture and we had an ownership
interest in the joint venture of approximately 52%, on a fully diluted basis.
5
<PAGE>
As of October 28, 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
October 28, 2000, ZanyBrainy.com's cumulative losses exceeded Online Retail
Partners' investment. As a result, in the thirteen and thirty-nine weeks ended
October 28, 2000, we recognized pre-tax losses from our investment in the joint
venture of $3.5 million and $9.3 million, respectively.
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 from January 30, 2000 through July
26, 2000 were as follows (in thousands):
Revenue:
-------
Zany Brainy, Inc. $84,156
Noodle Kidoodle, Inc. 47,758
-----------------------
Total $131,914
=======================
Net loss:
--------
Zany Brainy, Inc. ($13,011)
Noodle Kidoodle, Inc. (4,955)
-----------------------
Total ($17,966)
=======================
Effective July 26, 2000, the date of the merger, we recorded an $18.5
million expense for merger, integration and restructuring. During the thirteen
weeks ended October 28, 2000, we recorded $5.2 million for similar costs. The
breakdown of those costs is as follows (in thousands):
<TABLE>
<CAPTION>
Twenty-six weeks Thirteen weeks ended Thirty-nine weeks ended
ended July 29, 2000 October 28, 2000 October 28, 2000
--------------------- ---------------------- -------------------------
<S> <C> <C> <C>
As Part of Cost of Sales:
-------------------------
Inventory write-downs $ 8,650 $ 152 $ 8,802
As Part of SG&A Expense:
------------------------
Professional fees 5,025 684 5,709
Severance and change in control costs 3,000 213 3,213
Training and other related costs - 559 559
Grand reopening and related costs - 1,921 1,921
Systems conversion and related costs - 691 691
Other integration costs 1,805 1,001 2,806
--------------------- ---------------------- -------------------------
Total $ 18,480 $ 5,221 $ 23,701
===================== ====================== =========================
</TABLE>
Management's restructuring and integration plan relates primarily to the
discontinuance and liquidation of product SKU's, and resulted in inventory
write-downs of $0.1 million and $8.8 million for the thirteen and thirty-nine
weeks ended October 28, 2000, respectively. These costs have been included in
cost of goods sold on the accompanying statements of operations. On October 28,
2000, we had $8.2 million accrued for these costs as an inventory reserve on the
accompanying balance sheet. Additionally, management's plan includes
consolidating Noodle Kidoodle, Inc.'s administrative functions into our
headquarters in King of Prussia, PA. We expect to complete
6
<PAGE>
management's plan during the next fiscal year. During the fourth quarter of
2000, we expect to incur additional merger and integration costs for the
distribution centers, store closures and other costs of approximately $5.4
million.
The merger and integration charge during the thirteen weeks was expensed
as incurred. The utilization of the initial accruals as of the date of the
merger is as follows (in thousands):
<TABLE>
<CAPTION>
Accrual
Initial as of
Accrual Utilized October 28, 2000
------- -------- ----------------
<S> <C> <C> <C>
Merger and Integration Costs
----------------------------
Inventory write-downs $ 8,650 $ 468 $ 8,182
Professional fees 5,025 4,955 70
Other integration costs 905 285 620
Restructuring Costs
-------------------
Severence and change in control costs 3,000 2,608 392
Disposal of property 900 872 28
------------------------------------------
Total $ 18,480 $ 9,188 $ 9,292
==========================================
</TABLE>
11. SUBSEQUENT EVENT
In December, 2000, we entered into an agreement with Online Retail
Partners, Inc. ("ORP") to dissolve and liquidate our Internet joint venture, ZB
Holdings LLC and its wholly owned subsidiary, ZanyBrainy.com LLC. As a result,
we have assumed full ownership and control of www.ZanyBrainy.com, our
------------------
internet shopping website, through our wholly-owned subsidiary, Zany Brainy
Direct LLC, and have assumed all of the joint venture liabilities. Pursuant to
the terms of the transaction, in satisfaction of approximately $3 million of
ZanyBrainy.com payables to ORP and to pay for ORP's web site services through
fiscal year end, we issued to ORP 1.25 million new shares of our common stock
and a five-year warrant to purchase an additional one million shares of common
stock at an exercise price of $6.00 per share and agreed to pay ORP $1 million.
The income statement effect of the dissolution and liquidation of the joint
venture is not anticipated to be material. We expect that our Internet
operations will continue to incur losses for the foreseeable future.
7
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
We are a specialty retailer of high quality toys, games, books and
multimedia products for children, with 188 stores operating in 34 states as of
October 28, 2000.
Recent Developments
On September 15, 2000, Thomas G. Vellios was named President and Acting
Chief Executive Officer of Zany Brainy, Inc. and was also elected to the Board
of Directors. Mr. Vellios, who had been President of Zany Brainy since January,
1998 and has been with the Company in an executive capacity since November,
1995, succeeded Keith C. Spurgeon, who resigned as Chairman and Chief Executive
Officer.
In December, 2000, we entered into an agreement with Online Retail
Partners, Inc. ("ORP") to dissolve and liquidate our Internet joint venture, ZB
Holdings LLC and its wholly owned subsidiary, ZanyBrainy.com LLC. As a result,
we have assumed full ownership and control of www.ZanyBrainy.com, the
------------------
internet shopping website, through our wholly-owned subsidiary, Zany Brainy
Direct LLC, and have assumed all of the joint venture liabilities. Pursuant to
the terms of the transaction, in satisfaction of approximately $3 million of
ZanyBrainy.com payables to ORP and to pay for ORP's web site services through
fiscal year end, we issued to ORP 1.25 million new shares of our common stock
and a five-year warrant to purchase an additional one million shares of common
stock at an exercise price of $6.00 per share and agreed to pay ORP $1 million.
We expect that our Internet operations will continue to incur losses for the
foreseeable future.
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 Thirty-Nine Weeks Ended
--------------------------------------- --------------------------------------
October 28, 2000 October 30, 1999 October 28, 2000 October 30, 1999
------------------ ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold/1/ 77.8 71.4 82.1 72.3
----------------- ----------------- ----------------- -----------------
Gross profit 22.2 28.6 17.9 27.7
Selling, general and administrative
expenses 37.4 34.9 38.3 34.9
Merger and integration costs 6.6 0.0 7.0 0.0
----------------- ----------------- ----------------- -----------------
Operating loss (21.8) (6.3) (27.4) (7.2)
Interest expense, net 1.9 0.4 1.2 0.4
Equity loss in joint venture 4.6 0.0 4.4 0.0
----------------- ----------------- ----------------- -----------------
Loss before income tax benefit (28.3) (6.7) (33.0) (7.6)
Income tax benefit 10.9 1.0 12.7 1.5
----------------- ----------------- ----------------- -----------------
Net loss from continuing operations (17.4) (5.7) (20.3) (6.1)
Gain from disposal of discontinued
operations 0.0 3.4 0.0 1.2
----------------- ----------------- ----------------- -----------------
Net loss (17.4%) (2.3%) (20.3%) (4.9%)
================= ================= ================= =================
Comparable store net sales/2/ (9.7%) 0.1% (12.6%) 2.9%
================= ================= ================= =================
Total number of stores at
end of period 188 159 188 159
================= ================= ================= =================
Stores opened during period 17 20 27 42
================= ================= ================= =================
</TABLE>
/1/ Cost of goods sold includes buying, distribution and occupancy costs
/2/ A store becomes comparable in the 14/th/ full month of store operations
8
<PAGE>
Thirteen Weeks Ended October 28, 2000 Compared to Thirteen Weeks Ended October
30, 1999
NET SALES. Net sales increased $2.5 million, or 3.4%, to $76.4 million
in the thirteen weeks ended October 28, 2000 from $73.9 million in the
comparable 1999 period. This increase resulted primarily from sales from 29
additional stores opened since the third quarter of last year, and sales from
those stores opened in fiscal 1999 which are not yet included in our comparable
store sales base, offset by a comparable store sales decrease of 9.7%. The
decrease in comparable store sales is primarily attributable to the decline in
sales of popular products such as Beanie Babies, Pokemon and Crazy Bones,
aggregating 3.9% and 15.5% of sales in 2000 and 1999, respectively, and the
resulting decline in store traffic and ancillary purchases.
We expect these difficult sales comparisons to continue into the fourth
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,
which could lead to negative comparable store sales results.
GROSS PROFIT. Gross profit includes all buying, distribution and
occupancy costs. Gross profit decreased to 22.2% of net sales for the period,
from 28.6% in the comparable 1999 period. The decrease of 6.4% was due to higher
distribution costs associated with operating four distribution centers in 2000
and also 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 $2.7 million, or
10.6% to $28.6 million during the
9
<PAGE>
third quarter, from $25.8 million in the same period last year. The dollar
increase in selling, general and administrative expenses was primarily
attributable to $1.7 million in incremental store payroll and other selling
expenses associated with the opening and operation of 29 additional stores
following the third quarter of 1999. Corporate expenses remained relatively flat
during this period as the company began to realize synergies from the merger.
These cost synergies were offset by increased severance costs and higher
depreciation. Selling, general and administrative expenses increased to 37.4% of
net sales from 34.9% 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 $5.2 million related to professional fees,
severance and change in control costs, and other expenses.
INTEREST EXPENSE, NET. Net interest expense was approximately $1.4
million for the period, an increase of $1.1 million from the comparable period
in 1999. This increase was due to increased borrowings under our line of credit.
EQUITY LOSS IN JOINT VENTURE. During the quarter, we recognized losses
from ZanyBrainy.com totaling $3.5 million. We expect to continue to recognize
operating losses from our Internet operations for the remainder of this fiscal
year and next year.
INCOME TAX BENEFIT. For the thirteen weeks ended October 28, 2000, we
recorded an income tax benefit of $8.3 million primarily related to the Federal
tax benefit of the net loss, compared to an income tax benefit of approximately
$0.8 million for the comparable period in 1999. For the thirteen weeks ended
October 30, 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 third quarter of fiscal 2000 was
38.5%.
Thirty-Nine Weeks Ended October 28, 2000 Compared to Thirty-Nine Weeks Ended
October 30, 1999
NET SALES. Net sales increased $9.3 million, or 4.6%, to $211.6 million
in the thirty-nine weeks ended October 28, 2000 from $202.3 million in the
comparable 1999 period. This increase resulted primarily from sales from 29
additional stores opened since the third 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
12.6%. The decrease in comparable store sales is primarily attributable to the
decline in sales of popular products such as Beanie Babies, Pokemon and Crazy
Bones, aggregating 5.5% and 14.3% of sales in 2000 and 1999, respectively, and
the resulting decline in store traffic and ancillary purchases. 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. Starting in the first quarter of 2001, we expect this trend to
ameliorate.
GROSS PROFIT. Gross profit includes all buying, distribution and
occupancy costs. Gross profit decreased to 17.9% of net sales for the period,
from 27.7% in the comparable 1999 period. This 9.8% decrease was partially due
to merger-related costs of $8.8 million (or 4.2% 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. The
balance of the decrease was primarily 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 $10.5 million, or
14.9%, to $81.0 million during the period, from $70.5 million in the same period
last year. The dollar increase in selling, general and administrative expenses
was primarily attributable to $5.9 million in incremental store payroll and
other selling expenses associated with the opening and operation of 29
additional stores following the third quarter of 1999. Corporate expenses
increased approximately $2.1 million during this period to support this
additional store growth. Additionally, during the first half of 2000, pre-merger
corporate expenses do not reflect any synergies. Selling, general and
administrative expenses increased to 38.3% of net sales from 34.9% of net sales
due to our inability to leverage corporate, store and other expenses from
negative comparable store sales.
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MERGER AND INTEGRATION COSTS. During the thirty-nine weeks ended October
28, 2000, we recognized pre-tax merger-related costs totaling $23.7 million of
which $8.8 million was included in cost of goods sold and $14.9 million was
related to professional fees, severance costs and other expenses.
INTEREST EXPENSE, NET. Net interest expense was approximately $2.6
million for the period, an increase of $1.8 million from the comparable period
in 1999. This increase was due to increased borrowings under our line of credit.
EQUITY LOSS IN JOINT VENTURE. During the thirty-nine weeks ended October
28, 2000, we recognized losses from ZanyBrainy.com totaling $9.3 million. We
expect to continue to recognize operating losses from our Internet operations
for the remainder of the fiscal year.
INCOME TAX BENEFIT. For the thirty-nine weeks ended October 28, 2000, we
recorded an income tax benefit of $26.9 million primarily related to the Federal
tax benefit of the net loss, compared to an income tax benefit of approximately
$2.9 million for the comparable period in 1999. For the thirty-nine weeks ended
October 30, 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 thirty-nine weeks ended October 28,
2000 was 38.5%.
LIQUIDITY AND CAPITAL RESOURCES
We require cash principally to finance capital investment in new stores,
new store inventories, our Internet operations, seasonal working capital and
losses during non-profitable quarters. We opened 27 stores through the
thirty-nine weeks ended October 28, 2000.
Cash flows used in operating activities were $78.3 million for the
thirty-nine weeks ended October 28, 2000, an increase of $21.4 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 $22.9 million for the
thirty-nine weeks ended October 28, 2000, a decrease of approximately $4.8
million over the same period for the previous year.
Cash flows provided by financing activities during the thirty-nine weeks
ended October 28, 2000 were principally provided through net borrowings on our
credit facilities of $82.3 million. For the comparable period last year, cash
was principally provided by the proceeds of the initial public offering of $42.3
million and by net borrowings on the credit line of $31.6 million. We were in
compliance with all debt covenants as of October 28, 2000 and expect to continue
to be in compliance next year.
In July, 2000 we entered 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 was 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 was completed on
October 12, 2000 and replaced Noodle Kidoodle's existing $50.0 million facility.
As of October 28, 2000, we had $86.3 million outstanding on our line of credit
and an additional $3.2 million in outstanding letters of credit. As of October
28, 2000, $25.0 million of the outstanding line was at an interest rate of
8.69%, $48.0 million was at a rate of 8.619%, and $13.3 million was at a rate of
9.5%.
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.
Internet Sales Channel
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. As of October 28, 2000, both partners
held 50% o the voting stock of the joint venture and we had an ownership
interest in the joint venture of approximately 52%, on a fully diluted basis.
As of October 28, 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
October 28, 2000, ZanyBrainy.com's cumulative losses exceeded Online Retail
Partners' investment. As a result, in the thirteen and thirty-nine weeks ended
October 28, 2000, we recognized pre-tax losses from our investment in the joint
venture of $3.5 million and $9.3 million, respectively.
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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 effect of pending legal actions; the expectation of continuing
losses from our Internet operations; our continuing compliance with all debt
covenants of our credit facility; the sufficiency of our operating cash flow and
financing arrangements over the next 12 months; the dollar amount of the merger-
related charges; our expectations with respect to future sales of popular
products and comparable store sales; 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; unexpected costs and difficulties associated with
the integration of the operations of Noodle Kidoodle, Inc. and Zany Brainy,
Inc.; our ability to successfully operate the Internet shopping site and
continue to work with Online Retail Partners and Submitorder.com; 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; unanticipated liabilities and obligations arising from the end
of the Internet joint venture and the integration of the Internet operations
into Zany Brainy Direct LLC; 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 - Amended and Restated Employment Agreement dated September
15, 2000 between Zany Brainy, Inc. and Thomas G. Vellios
10.2 - Amendment to Incentive Stock Option Grants dated September
15, 2000 between Zany Brainy, Inc. and Thomas G. Vellios
10.3 - Plan of Dissolution dated as of December 4, 2000 by and
among ZanyBrainy.com LLC, ZB Holdings LLC, Children's
Equity LLC, Zany Brainy Direct LLC, Zany Brainy, Inc., and
Online Retail Partners Inc.
10.4 - Stock Purchase Agreement dated as of December 4, 2000 by
and between Zany Brainy, Inc. and Online Retail Partners
Inc.
27.1 - Financial Data Schedule
(b) Reports on Form 8-K:
None filed.
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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: December 12, 2000 By: /s/ /Thomas G. Vellios
------------------ ------------------------
Thomas G. Vellios
President & Acting Chief
Executive Officer
Date: December 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 Amended and Restated Employment Agreement dated September
15, 2000 between Zany Brainy, Inc. and Thomas G. Vellios
10.2 Amendment to Incentive Stock Option Grants dated September
15, 2000 between Zany Brainy, Inc. and Thomas G. Vellios
10.3 Plan of Dissolution dated as of December 4, 2000 by and
among ZanyBrainy.com LLC, ZB Holdings LLC, Children's Equity
LLC, Zany Brainy Direct LLC, Zany Brainy, Inc., and Online
Retail Partners Inc.
10.4 Stock Purchase Agreement dated as of December 4, 2000 by and
between Zany Brainy, Inc. and Online Retail Partners Inc.
27.1 Financial Data Schedule
16
