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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL QUARTER ENDED JUNE 30, 2000
COMMISSION FILE NUMBER 0-27717
SMARTERKIDS.COM, INC.
DELAWARE 04-3226127
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
15 CRAWFORD STREET, NEEDHAM, MA 02494
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 449-7567
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $.01 par value
Indicate by check mark whether the registrant: (1) has filed all reports
required 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 report(s), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [_] No
The number of shares outstanding of the registrant's $.01 par value common
stock as of August 9, 2000 was 20,592,918.
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SMARTERKIDS.COM, INC.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED JUNE 30, 2000
CONTENTS
<TABLE>
<CAPTION>
Item Number Page
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<S> <C>
PART I: FINANCIAL INFORMATION.............................................. 3
ITEM 1. FINANCIAL STATEMENTS............................................. 3
BALANCE SHEET (UNAUDITED)........................................ 3
STATEMENT OF OPERATIONS (UNAUDITED).............................. 4
STATEMENT OF CASH FLOWS (UNAUDITED).............................. 5
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)........................ 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................ 8
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS................... 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....... 20
PART II: OTHER INFORMATION................................................ 21
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................ 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 22
SIGNATURES................................................................ 23
EXHIBIT INDEX............................................................. 24
</TABLE>
2
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SMARTERKIDS.COM, INC.
BALANCE SHEET
-------------
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
-------- ------------
2000 1999
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................................ $ 13,100 $ 55,621
Short-term investments.................................................................. 28,400 11,735
Accounts receivable, net of allowance for doubtful accounts of $27 at
June 30, 2000 and December 31, 1999................................................ 148 132
Inventories............................................................................. 6,624 8,902
Other current assets.................................................................... 2,206 2,403
-------- --------
Total current assets.......................................................... 50,478 78,793
Property and equipment, net.................................................................. 5,310 2,421
Intangible assets, net....................................................................... 447 621
Restricted cash.............................................................................. 1,000 500
-------- --------
Total assets.................................................................. $ 57,235 $ 82,335
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations............................................ $ 524 $ 74
Accounts payable........................................................................ 3,722 10,996
Accrued expenses........................................................................ 3,382 6,699
Deferred revenue........................................................................ 812 811
Other current liabilities............................................................... 72 87
-------- --------
Total current liabilities..................................................... 8,512 18,667
Capital lease obligations and borrowings under line of credit................................ 946 34
-------- --------
Total liabilities............................................................. 9,458 18,701
-------- --------
Commitments and contingencies (Note 4) -- --
Stockholders' equity:
Common stock, $0.01 par value; 90,000,000 shares authorized; 20,586,450
and 20,301,770 shares issued and outstanding at June 30, 2000 and
December 31, 1999, respectively.................................................... 205 203
Additional paid-in capital.............................................................. 111,879 112,907
Deferred stock compensation............................................................. (4,974) (6,286)
Accumulated deficit..................................................................... (59,333) (43,190)
-------- --------
Total stockholders' equity.................................................... 47,777 63,634
-------- --------
Total liabilities and stockholders' equity.................................... $ 57,235 $ 82,335
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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SMARTERKIDS.COM, INC.
STATEMENT OF OPERATIONS
-----------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------------------------------------------
2000 1999 2000 1999
------- ------- -------- -------
<S> <C> <C> <C> <C>
Net revenues.............................. $ 1,528 $ 293 $ 2,997 $ 387
Cost of revenues.......................... 1,149 210 2,250 279
------- ------- -------- -------
Gross profit.............................. 379 83 747 108
------- ------- -------- -------
Operating expenses:
Marketing and sales..................... 7,144 3,690 14,444 5,713
Development............................. 821 396 1,764 763
General and administrative.............. 816 244 1,722 399
Stock compensation...................... 336 196 514 580
------- ------- -------- -------
Total operating expenses.............. 9,117 4,526 18,444 7,455
------- ------- -------- -------
Loss from operations...................... (8,738) (4,443) (17,697) (7,347)
Interest and other income (expense), net.. 654 28 1,482 52
------- ------- -------- -------
Net loss.................................. $(8,084) $(4,415) $(16,215) $(7,295)
======= ======= ======== =======
Basic and diluted net loss per common
share.................................... $(.39) $(2.66) $(.79) $(4.43)
Weighted average shares outstanding-basic
and diluted............................. 20,504 1,661 20,406 1,646
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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SMARTERKIDS.COM, INC.
STATEMENT OF CASH FLOWS
-----------------------
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE
SIX MONTHS ENDED
JUNE 30,
-------------------------------------
2000 1999
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss.............................................. $(16,215) $(7,295)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization....................... 759 14
Stock compensation expense.......................... 514 580
Changes in assets and liabilities:
Accounts receivable........................... (16) 604
Inventories................................... 2,278 (137)
Other assets.................................. 197 (282)
Accounts payable.............................. (7,274) 2,808
Accrued expenses.............................. (3,317) 290
Other current liabilities..................... (14) (211)
-------- -------
Net cash used in operating activities................... (23,088) (3,629)
-------- -------
Cash flows from investing activities:
Purchase of short-term investments............... (16,665) --
Purchases of property and equipment.............. (3,474) (40)
Deposit of restricted cash (500)
-------- -------
Net cash used in investing activities................... (20,639) (40)
-------- -------
Cash flows from financing activities:
Proceeds from long-term borrowings............... 1,601 --
Repayments of long-term borrowings............... (229) (24)
Proceeds from exercise of common stock options... 23 107
Proceeds from exercise of common stock warrants.. 15 --
Increase from estimated IPO costs................ (204) --
-------- -------
Net cash provided by financing activities............... 1,206 83
-------- -------
Net decrease in cash and cash equivalents............... (42,521) (3,586)
Cash and cash equivalents at beginning of period........ 55,621 4,273
-------- -------
Cash and cash equivalents at end of period.............. $ 13,100 $ 687
======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
(UNAUDITED)
1. BASIS OF PRESENTATION:
The interim financial statements as of and for the six months ended June 30,
2000 and 1999 have been prepared by SmarterKids.com, Inc. ("SmarterKids.com" or
the "Company") pursuant to the rules and regulations of the Securities and
Exchange Commission (the "SEC") for interim financial reporting. These
statements are unaudited and, in the opinion of management, include all
adjustments (consisting only of normal recurring adjustments and accruals)
necessary to present fairly the balance sheet and the statement of operations
and cash flows for the periods presented. Operating results for the six months
ended June 30, 2000 may not be indicative of the results for the year ending
December 31, 2000. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been omitted in accordance with the rules and
regulations of the SEC. These financial statements should be read in conjunction
with the audited financial statements, and accompanying notes, included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingencies at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from the estimates.
Marketing and Sales Expenses
Marketing and sales expenses consist primarily of the cost of advertising and
promotional activities, fulfillment costs including service fees to J.L. Hammett
Co., commissions to online marketing companies, and expenses for personnel
engaged in marketing and merchandising. Fulfillment costs include the cost of
operating and staffing a distribution center including customer service.
Advertising costs are charged to operations as incurred. Advertising expenses
were $3,535,000 and $2,530,000 for the quarters ended June 30, 2000 and 1999,
respectively, and $7,384,000 and $3,891,000 for the six months ended June 30,
2000 and 1999, respectively.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standard Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of Accounting Policy Bulletin ("APB") Opinion No.
25 and among other issues clarifies the following: the definition of an employee
for purposes of applying APB Opinion No. 25, the criteria for determining
whether a plan qualifies as a noncompensatory plan, the accounting consequence
of various modifications to the terms of previously issued fixed stock options
or awards, and the accounting for an exchange of stock compensation awards in a
business combination. FIN 44 is effective July 1, 2000, but certain conclusions
in FIN 44 cover specific events that occurred after either December 15, 1998 or
January 12, 2000. The Company does not believe that FIN 44 will have a material
impact on the Company's financial position or results of operations.
In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB")
101, "Revenue Recognition in Financial Statements", which provides guidance on
the recognition, presentation and disclosure of revenue in financial statements.
Subsequently, SAB 101 A and B have been released which direct the application of
the guidance in SAB 101 to be required in the Company's fourth quarter of 2000.
The effects of applying this guidance, if any, will be reported as a cumulative
effect adjustment resulting from a change in accounting principle. The Company
does not expect the adoption of SAB 101 to have a material effect on its
financial statements, however, the final evaluation of SAB 101 with respect to
the Company is not yet complete.
6
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SMARTERKIDS.COM, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
---------------- ---------------
2000 1999
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<S> <C> <C>
Software........................................ $1,392 $ 377
Furniture and fixtures.......................... 226 207
Computer and office equipment................... 3,762 1,774
Leasehold improvements.......................... 959 507
------ ------
6,339 2,865
Less--Accumulated depreciation and amortization. 1,029 444
------ ------
$5,310 $2,421
====== ======
</TABLE>
During April 2000, the Company entered into a lease agreement for a new
distribution facility. Capital costs incurred during the quarter ended June 30,
2000 relate primarily to software and equipment to be used in this facility. As
of June 30, 2000, there was $2,824,000 of such costs held in fixed assets. The
five-year lease requires minimum annual payments of approximately $900,000.
3. EQUIPMENT LINE OF CREDIT:
During the quarter ended March 31, 2000, the Company secured a $1.5 million,
three-year equipment line of credit facility. Equipment collateralized under
this agreement approximates $1.3 million at March 30, 2000. During the quarter
ended June 30, 2000, the Company drew down an additional amount of $184,000.
The interest on the agreement is the three-year U.S. Treasury rate plus 3.5%.
In accordance with the agreement, the balance under the line of credit was
converted to a 36-month term loan at the time of funding. Accordingly, the
Company is making payments of approximately $45,000 per month over the term of
the loan. At June 30, 2000 a total balance of $1.3 million remains outstanding.
During the quarter ended June 30, 2000, the Company secured an additional $1.0
million under another three-year equipment line of credit facility. Equipment
collateralized under this agreement approximates $149,000 at June 30, 2000. The
interest on the borrowings is 9% per annum. The Company issued warrants for the
purchase of 16,667 shares of common stock with an exercise price of $3.00 per
share in connection with the facility. The warrants have been valued and a
discount of $8,645 has been recorded on the lease obligation. The discount is
being amortized to interest expense over the life of the line of credit. At
June 30, 2000 a balance of $141,660 remains outstanding.
4. COMMITMENTS AND CONTINGENCIES:
Restricted Time Deposit
In connection with a facility lease entered into in 1999, the Company is
required to maintain, on behalf of the landlord, a certificate of deposit in the
amount of $500,000, which is restricted as to its use. In connection with the
warehouse facility lease entered into in the second quarter of 2000, the Company
was required to maintain, on behalf of the landlord, $500,000 in an interest-
bearing account, which will be restricted as to its use.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the accompanying financial
statements for the periods specified and the associated notes. Further reference
should be made to the Company's Annual Report on Form 10-K for the period ending
December 31, 1999.
The following discussion contains forward-looking statements which involve risks
and uncertainties. SmarterKids.com makes such forward-looking statements under
the provision of the "Safe Harbor" section of the Private Securities Litigation
Reform Act of 1995. Any forward-looking statements should be considered in
light of the factors described below in this Item 2 under "Certain Factors That
May Affect Future Results." Actual results may vary materially from those
projected, anticipated or indicated in any forward-looking statements. In this
Item 2, the words "anticipates," "believes," "expects," "intends," "future,"
"could," and similar words or expressions (as well as other words or expressions
referencing future events, conditions, or circumstances) identify forward-
looking statements. The following discussion and analysis should be read in
conjunction with the accompanying financial statements and related notes
included elsewhere in this Quarterly Report on Form 10-Q.
OVERVIEW
SmarterKids.com is a leading online educational store dedicated to helping
parents help their children learn, develop, and grow. The site offers the
Internet's most personalized shopping experience, linking teacher-reviewed toys,
games, books, software, and hands-on activities through SmarterKids.com's
patent-pending evaluation and recommendation process. The Company serves as a
resource for parents, offering specialty centers, the Grade Expectations! guide
to education standards and thousands of educational products, including both
well-known brands and hard-to-find quality offerings, for children aged infant
through 15.
RECENT EVENTS
The Company's recent initiatives include:
. SmarterKids.Com launched its next-generation site design.
. SmarterKids.Com introduced the Web's first "Early Development Checklists,"
comprehensive online tools for new parents who wish to gauge their infant's
and toddler's early development and find educational products uniquely suited
for their child. Checklists cover five developmental areas for children
through age 6 years.
. SmarterKids.com launched an Infant Store offering hundreds of developmental
toys, games and books for children aged 0-18 months. All of these items are
evaluated, selected, and reviewed by the Company's early childhood experts to
ensure they are developmentally appropriate, stimulating and fun.
. SmarterKids.com launched two new product categories: music/video and
construction toys. Offerings in these categories include popular brands such
as Barney, Disney, Madeline, BRIO, K'Nex, LEGO Dacta, and Lincoln Logs.
. SmarterKids.com partnered with ChildU to offer the latter's "Learning
Odyssey" distance-learning curriculum to hundreds of thousands of customers,
creating a new source of revenue for both partners. Through this partnership,
SmarterKids.com will also recommend products to complement the ChildU
learning program.
. SmarterKids.com opened its own 140,000 sq. ft. fulfillment center in
Mansfield, Massachusetts which will enable the Company to fulfill orders
faster and more economically.
8
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RESULTS OF OPERATIONS
Revenues. Revenues in fiscal 2000 and 1999 consist of online sales of third-
party educational products and charges to customers for shipping. In the
quarters ended June 30, 2000 and 1999, we continued to derive substantially all
of our revenues from sales within the United States. Revenues are recognized
upon shipment to the customer and are net of promotional discounts, coupons and
return allowances, which are determined by historical trends of actual returns.
Revenues were $1.5 million and $293,000 in the quarters ended June 30, 2000
and 1999, respectively, and $3.0 million and $387,000 in the six months ended
June 30, 2000 and 1999, respectively. The increase in revenue in the quarter
ended June 30, 2000 from the quarter ended June 30, 1999 and in the six months
ended June 30, 2000 from the six months ended June 30, 1999, resulted from
increased marketing efforts and brand-building during the more recent periods.
Cost of revenues. Cost of revenues consists primarily of the cost of products
sold to customers and our shipping costs. We anticipate that our gross margins
will fluctuate from quarter to quarter depending on consumer preferences for our
mix of products. The cost of revenues was $1.1 million and $210,000 in the
quarters ended June 30, 2000 and 1999, respectively, and $2.3 million and
$279,000 in the six months ended June 30, 2000 and 1999, respectively. The
increase in cost of revenues in the quarter ended June 30, 2000 from the quarter
ended June 30, 1999 and in the six months ended June 30, 2000 from the six
months ended June 30, 1999 was attributable to growth in online sales. Our
gross margin decreased to 25% in each of the 2000 periods from 28% in each of
the 1999 periods due to a change in product mix and increased freight costs.
Marketing and sales. Marketing and sales expenses consist primarily of the
cost of advertising and promotional activities, fulfillment costs, commissions
to online marketing companies, and expenses for personnel engaged in marketing,
merchandising and customer service activities. Fulfillment costs include the
cost of operating and staffing the distribution center, as well as fees paid to
J.L. Hammett Co., a fulfillment partner. As of June 1, 2000, the Company
discontinued using J.L. Hammett Co. as a third party fulfillment partner due to
the opening of its own distribution facility.
Marketing and sales expenses were $7.1 million and $3.7 million in the
quarters ended June 30, 2000 and 1999, respectively, and $14.4 million and $5.7
million in the six months ended June 30, 2000 and 1999, respectively. The
increase in the quarter ended June 30, 2000 from the quarter ended June 30, 1999
and in the six months ended June 30, 2000 from the six months ended June 30,
1999 was primarily attributable to increased advertising and promotional
activities, fees to our previous fulfillment partner, J.L. Hammett Co., as well
as the hiring of 56 additional employees.
The SEC and other accounting standard setters are currently reviewing the
financial statement classification of distribution and fulfillment costs and
other items by a number of e-commerce companies, including SmarterKids.com. We
consider distribution and fulfillment costs as recurring costs incurred for the
operation of our distribution centers and customer service centers and have
classified such costs in marketing and sales expenses. These costs are primarily
composed of distribution facility expenses, including equipment and supplies,
payroll and travel expenses for personnel engaged in distribution activities,
and third-party fulfillment fees. These costs represent the facility costs
necessary for warehousing inventory, as well as costs incurred to pick and pack
a customer order and the related packaging supplies. The SEC and other
accounting standard setters may decide to require that certain distribution
center costs be classified as cost of sales. Should this occur, we will
reclassify any distribution and fulfillment costs as required and our gross
profit will be correspondingly affected. However, such reclassification will not
impact our sales, operating profit or loss, net income or loss, or cash flows.
Development. Development expenses consist primarily of payroll and related
costs for personnel performing website design, development and testing.
Development expenses were $821,000 and $396,000 in the quarters ended June 30,
2000 and 1999, respectively, and $1.8 million and $763,000 in the six months
ended June 30, 2000 and 1999, respectively. The increase in the quarter ended
June 30, 2000 from the quarter ended June 30, 1999 and in the
9
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six months ended June 30, 2000 from the six months ended June 30, 1999 was
attributable primarily to costs related to enhancing the features, content and
functionality of our website, as well as the hiring of ten additional employees.
General and administrative. General and administrative expenses consist
primarily of payroll and related costs for executive and administrative
personnel, professional service expenses and other general corporate expenses.
General and administrative expenses were $816,000 and $244,000 in the quarters
ended June 30, 2000 and 1999, respectively, and $1.7 million and $399,000 in the
six months ended June 30, 2000 and 1999, respectively. The increase in the
quarter ended June 30, 2000 from the quarter ended June 30, 1999 and in the six
months ended June 30, 2000 from the six months ended June 30, 1999 was
attributable primarily to the costs related to the expansion of our operations
and infrastructure, as well as the hiring of 15 additional employees.
Stock compensation. We recorded stock compensation expense of $336,000 and
$196,000 in the quarters ended June 30, 2000 and 1999, respectively, and
$514,000 and $580,000 in the six months ended June 30, 2000 and 1999,
respectively, related to amortization of deferred stock compensation for options
and warrants granted to employees and non-employees.
Interest and other income (expense), net. Interest and other income
(expense), net consists primarily of interest income earned on our short-term
investments offset by interest expense related to short-term lease obligations
and borrowings under our equipment line of credit. Interest and other income
(expense), net increased to $654,000 in the quarter ended June 30, 2000 from
$28,000 in the quarter ended June 30, 1999 and to $1.5 million in the six months
ended June 30, 2000 from $52,000 in the six months ended June 30, 1999. The
increase was primarily attributable to an increase in interest income from
higher balances of invested capital generated from our initial public offering.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have incurred significant losses. We have met our
cash requirements primarily through the sale of capital stock and the use of
capital leases. We received capital from investors in three private venture
capital financings totaling $37.0 million through July 1999. On November 23,
1999, we completed an initial public offering of 4,500,000 shares of common
stock resulting in net proceeds of $65.9 million. The primary purposes of the
initial public offering were to increase our capitalization and financial
flexibility, create a public market for SmarterKids.com's common stock, and
facilitate future access to public markets. As of June 30, 2000, we have used
$24.4 million of the offering proceeds for working capital.
Net cash used in operating activities was $23.1 million and $3.6 million in
the six months ended June 30, 2000 and 1999, respectively. The increase in net
cash used in operating activities from the six months ended June 30, 1999 to the
six months ended June 30, 2000 was primarily attributable to a larger net loss
and payments to vendors for inventory and advertising expenses. We expect that
operating cash requirements will increase and that a significant portion of our
cash used in operating activities will be attributable to investments in
inventory and advertising.
Net cash used in investing activities has been primarily for purchases of
fixed assets and short-term investments. Cash used in investing activities was
$20.6 million and $40,000 in the six months ended June 30, 2000 and 1999,
respectively. The increase in cash used in investing activities was primarily
attributable to increased purchases of equipment for the build-out of our new
distribution facility and the purchase of short-term investments of $16.7
million.
Net cash provided by financing activities was $1.2 million and $83,000 in the
six months ended June 30, 2000 and 1999, respectively. Net cash provided by
financing activities in the six months ended June 30, 2000 primarily reflects
the net proceeds of $1.6 million from an equipment line of credit. Net cash
provided by financing activities in the six months ended June 30, 1999 consisted
of proceeds from the exercise of stock options.
During the first quarter of 2000, we entered into a $1.5 million three-year
equipment line of credit facility. Equipment collateralized under this agreement
approximates $1.5 million at June 30, 2000. The interest on the agreement is
equal to the three-year U.S. Treasury rate plus 3.5%. We are currently making
payments on this credit facility of $45,000 per month.
10
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During the second quarter of 2000, we entered into a lease agreement for a
140,000 square foot distribution center in Mansfield, Massachusetts. The
distribution center allows us to better manage our fulfillment process. As a
result, we discontinued using J.L. Hammett Co. as its fulfillment partner during
the second quarter of 2000. The five-year operating lease for the warehouse will
require minimum payments of approximately $900,000 per year.
As of June 30, 2000, we had $13.1 million of cash and cash equivalents and
$28.4 million of short-term investments. As of that date, our principal
commitments consisted of obligations outstanding under an equipment line of
credit and capital leases in the amount of $1.5 million, commitments for annual
facility lease obligations of $2 million, and accounts payable of $3.7 million.
We anticipate that our business model will require us to commit significant
resources to aggressively promote our brand, expand our product and service
offerings and enhance our infrastructure.
We currently anticipate that current cash, cash equivalents and short-term
investments will be sufficient to meet our anticipated needs for working capital
and capital expenditures through the next 12 months. We anticipate that we are
likely to need additional financing to execute our business model after such 12
months, or sooner if we need to respond to business contingencies such as lower-
than-anticipated revenues, funding additional advertising expenditures,
developing new or enhancing existing content, features or services, enhancing
our operating infrastructure, responding to competitive pressures, or acquiring
complementary businesses or technologies. We have transitioned customer order
fulfillment to our own distribution facility during the second quarter in 2000.
In conjunction with this transaction, we invested capital for the infrastructure
to support these fulfillment activities at the new distribution facility. If we
raise additional funds through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders may be reduced, and
these newly issued securities may have rights, preferences or privileges senior
to those of existing stockholders. We cannot be certain that additional
financing will be available to us on favorable terms when required, or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standard Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of Accounting Policy Bulletin ("APB") Opinion No. 25
and among other issues clarifies the following: the definition of an employee
for purposes of applying APB Opinion No. 25, the criteria for determining
whether a plan qualifies as a noncompensatory plan, the accounting consequence
of various modifications to the terms of previously issued fixed stock options
or awards, and the accounting for an exchange of stock compensation awards in a
business combination. FIN 44 is effective July 1, 2000, but certain conclusions
in FIN 44 cover specific events that occurred after either December 15, 1998 or
January 12, 2000. The Company does not believe that FIN 44 will have a material
impact on the Company's financial position or results of operations.
In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB")
101, "Revenue Recognition in Financial Statements", which provides guidance on
the recognition, presentation and disclosure of revenue in financial statements.
Subsequently, SAB 101 A and B have been released which direct the application of
the guidance in SAB 101 to be required in our fourth quarter of 2000. The
effects of applying this guidance, if any, will be reported as a cumulative
effect adjustment resulting from a change in accounting principle. We do not
expect the adoption of SAB 101 to have a material effect on our financial
statements, however, the final evaluation of SAB 101 with respect to the Company
is not yet complete.
11
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CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE BEEN OPERATING UNDER OUR
NEW BUSINESS MODEL FOR LESS THAN TWO YEARS. OUR MARKET MAY NOT DEVELOP AS
ANTICIPATED, AND WE MAY NOT SUCCESSFULLY EXECUTE OUR BUSINESS STRATEGY.
We have a limited operating history upon which you can evaluate our business.
We did not launch the SmarterKids.com website and begin selling children's
educational products online until November 1998. In addition, most of our
management team was hired within the last two years. From inception through
March 1998, our activities consisted primarily of the conception, development,
publishing, marketing and sales of proprietary educational and entertainment CD-
ROM software. In March 1998, we began transitioning our business model to online
sales of third-party educational products. In November 1998, we launched our
website, ceased the sale of our proprietary CD-ROM products through traditional
retail channels and now offer our proprietary CD-ROM products on a limited basis
through our online channel.
We cannot be certain that our business strategy will be successful or that we
will successfully address these and other challenges, risks and uncertainties.
OUR LIMITED OPERATING HISTORY MAKES FORECASTING DIFFICULT. WE MAY BE UNABLE TO
ADJUST OUR SPENDING IN A TIMELY MANNER TO COMPENSATE FOR ANY UNEXPECTED REVENUE
SHORTFALL.
As a result of our limited operating history with our current business model
introduced in November 1998, it is difficult to accurately forecast future
revenues. Also, we have limited meaningful historical financial data upon which
to base planned operating expenses. We base our current and future expense
levels on our operating plans and estimates of future revenue. Revenue and
operating results are difficult to forecast because they generally depend on the
volume and timing of the orders we receive. As a result, we may be unable to
adjust our spending in a timely manner to compensate for any unexpected revenue
shortfall, which would result in further substantial losses. We may also be
unable to expand our operations in a timely manner to adequately meet customer
demand to the extent it exceeds our expectations.
WE HAVE A HISTORY OF LOSSES, AND WE EXPECT TO INCUR SUBSTANTIAL NET LOSSES IN
THE FUTURE. IF WE DO NOT ACHIEVE PROFITABILITY, OUR FINANCIAL CONDITION AND OUR
STOCK PRICE COULD SUFFER.
Since inception, we have incurred significant losses. As of June 30, 2000, we
had an accumulated deficit of $59.3 million. We incurred a net loss of $16.2
million for the six months ended June 30, 2000. We expect operating losses and
negative cash flow to continue for the foreseeable future.
Our ability to become profitable depends on our ability to generate and
sustain higher revenue while maintaining reasonable expense levels. We
anticipate sales growth will moderate during the remainder of the year as we
reduce our marketing investment and focus on those programs that bring us the
most loyal customers. Our focus is on cost-effective top line growth,
attracting the most profitable traffic, new customer acquisition, and reaching
profitability. These efforts may not be effective in converting a large number
of customers from traditional shopping methods to online shopping for
educational products and services or attracting online customers to our website.
In addition, we are obligated to pay commissions based on a percentage of
revenue to companies with which we have online marketing relationships. Through
May 2000, we paid our fulfillment services provider, J.L. Hammett Co., a fee
based on a fixed percentage of the costs of our products to us and will incur
operating expenses related to fulfillment activities in our new distribution
center that opened in June 2000. Some of these costs will increase as our
revenues and orders increase. If we do achieve profitability, we cannot be
certain that we will be able to sustain or increase profitability on a quarterly
or annual basis in the future.
WE EXPECT OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE. IF WE FAIL TO MEET THE
EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS, THE MARKET PRICE OF OUR
COMMON STOCK WILL DECLINE.
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If our quarterly revenue or operating results fall below investor or
securities analyst expectations, our stock price could fall substantially. The
Company's operating results may fall below investor or analyst expectations
irregardless of the Company's success or profitability. Factors that may cause
our operating results to fluctuate include:
. decreases in the number of visitors to our website or our inability to
convert visitors on our website to customers
. the mix of children's educational books, toys and games, and software sold by
us
. seasonality due to the academic year and holiday season
. our inability to manage supplier or distributor relationships
. price competition
. an increase in the level of product returns
. increases in the cost of advertising
. the amount and timing of operating costs and capital expenditures relating to
expansion of our operations
. unexpected increases in shipping costs and delivery times, particularly
during the holiday season
. technical difficulties or system interruptions
In addition, general economic conditions and fluctuations in the demand for
children's educational product, over which we have no control, may also cause
our operating results to fluctuate.
Many of the other risk factors listed in this Quarterly Report on Form 10-Q
may negatively affect our quarterly operating results and contribute to
fluctuations. Our limited operating history makes it difficult to assess the
impact of these factors on our operating results. Because of this difficulty in
predicting future performance, our operating results will likely fall below the
expectations of securities analysts or investors in some future quarter or
quarters, which would likely adversely affect the market price of our common
stock.
OUR MARKET IS HIGHLY SEASONAL AND MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE
FROM QUARTER TO QUARTER. OUR ANNUAL RESULTS ARE HIGHLY DEPENDENT ON THE SUCCESS
OF OUR HOLIDAY SELLING SEASON.
The market for children's educational books, toys and games, and software is
highly seasonal and increases significantly during the holiday season. In
addition, Internet usage generally declines in the summer. Accordingly, we
expect to experience seasonal fluctuations in our revenue. In particular, we
expect a disproportionate amount of our revenue to be realized during any
quarter of each calendar year. If for any reason our revenue is below
expectations during the fourth quarter, our annual operating results would be
adversely affected. In the future, our seasonal sales patterns may become more
pronounced, may strain our personnel and fulfillment relationships and may cause
a shortfall in revenue as compared to expenses in a given period. These seasonal
patterns will cause quarterly fluctuations in our operating results and could
adversely affect our financial performance.
WE PAY COMMISSIONS TO COMPANIES WITH WHICH WE HAVE ONLINE MARKETING
RELATIONSHIPS. OUR PROFITS AS A PERCENTAGE OF REVENUES WILL DECREASE AS THE
PROPORTION OF OUR REVENUES FROM THESE ARRANGEMENTS INCREASES.
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Our relationships with online companies are intended to drive traffic to our
website. Approximately 6% of our revenues in the quarter ended June 30, 2000 was
derived from these relationships. We pay commissions to these companies based on
a percentage of the revenues we derive from these relationships. Although these
relationships are intended to increase the number of our customers and,
therefore, our revenues, as revenues derived from these relationships increases,
our profit as a percentage of revenues will decrease.
WE FACE SIGNIFICANT INVENTORY RISKS BECAUSE CONSUMER DEMAND CAN CHANGE FOR
PRODUCTS THAT WE HAVE IN INVENTORY OR ON ORDER.
The demand for certain products can change what we have in inventory or on
order. As a result, we may own inventory that may become obsolete if customer
orders do not materialize. This risk may be greatest in the first calendar
quarter of each year, after we have significantly increased our inventory levels
for the prior holiday season. This risk will increase as we enter into new
product categories due to our lack of experience in purchasing products for
these categories. In addition, to the extent that demand for our products
increases over time, we may be forced to increase inventory levels. Any such
increase would subject us to additional inventory risks.
THE INABILITY TO PERFORM OUR OWN DISTRIBUTION SERVICES COULD LEAD TO
INTERRUPTIONS IN OUR OPERATIONS, LOST REVENUES AND INCREASED EXPENSE.
During the second quarter, we moved our order fulfillment from a third party
partner, J.L. Hammett Co., to our own distribution facility in Mansfield,
Massachusetts. Our inability to manage our distribution center could lead to
interruptions in our operations, lost revenues and increased expense.
OUR BUSINESS RELIES ON OUR ABILITY TO OBTAIN SUFFICIENT QUANTITIES OF QUALITY
MERCHANDISE ON ACCEPTABLE COMMERCIAL TERMS.
Vendors may stop selling merchandise to us and we may not be able to secure
identical or comparable merchandise from alternative vendors in a timely manner
or on acceptable terms. From time to time, we expect to experience difficulty in
obtaining sufficient quantities of certain products. If we cannot supply our
products to consumers at acceptable prices, we may lose sales and market share
as consumers make purchases elsewhere. Further, an increase in supply costs
could increase operating losses beyond current expectations.
INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND RESULT IN THE LOSS OF
SIGNIFICANT RIGHTS.
We regard trademarks, copyrights, service marks, trade secrets, patents and
similar intellectual property as important to our success. We rely on trademark
and copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers and others to protect our proprietary
rights.
Other parties may assert infringement or unfair competition claims against us.
In the past, other parties have sent us notice of claims of infringement of
proprietary rights, including trademarks, copyrights and patents related to our
business, and we may receive other notices in the future. If we are forced to
defend against any such claims, whether they are with merit or are determined in
our favor, then we may face costly litigation, diversion of technical and
management personnel and product shipment delays. If there is a successful claim
of infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology on a timely basis, or
if we are required to cease using one or more of our business or product names
due to a successful trademark infringement claim against us, it could adversely
affect our business.
In addition, effective trademark, service mark, copyright, trade secret and
patent protection may not be available in every country in which we sell our
products and services online. Therefore, the steps we take to protect our
proprietary rights may be inadequate and our business could be adversely
affected.
IF WE ARE UNABLE TO RETAIN OR ACQUIRE THE NECESSARY DOMAIN NAMES, OUR BRAND AND
REPUTATION COULD BE DAMAGED AND WE COULD LOSE CUSTOMERS.
We currently hold the web domain name SmarterKids.com as well as several other
variations of this domain name. The acquisition and maintenance of domain names
generally is regulated by governmental agencies and their designees. In the
United States, the National Science Foundation has appointed Network Solutions,
Inc., and recently several others, as the current registrars for the ".com",
".net" and ".org" generic top-level domains. The regulation of domain names
in the United States and in foreign countries is subject to change in the near
future. As a result, we may be unable to acquire or maintain relevant domain
names in all countries in which we conduct
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business. Furthermore, the relationship between regulations governing domain
names and laws protecting trademarks and similar proprietary rights is unclear.
Therefore, we may be unable to prevent third parties from acquiring domain names
that are similar to, infringe upon or otherwise decrease the value of our
trademarks and other proprietary rights. In addition, other parties hold domain
names that are similar to ours. Any confusion of our website with another
party's could diminish our brand.
WE MAY FAIL TO COMPETE EFFECTIVELY IN OUR MARKET.
The market for children's educational products online is new, rapidly evolving
and intensely competitive. We expect competition to intensify in the future.
Barriers to entry are minimal and current and new competitors can launch new
websites at a relatively low cost. In addition, the markets for children's
books, toys and games, and software in general, including those for children's
educational products, are very competitive and highly fragmented, with no clear
dominant leader and increasing public and commercial attention.
Our competitors can be divided into several groups, including:
. mass market retail chains, such as Kmart, Target and Wal-Mart
. mass market book sellers, toy stores and computer hardware and software
stores, such as Barnes & Noble, Toys "R" Us and CompUSA
. traditional regional or local bookstores, toy stores and computer and
software stores
. traditional specialty educational retailers, such as Learning Express and
Zany Brainy
. online book sellers, toy sellers and computer software sellers, such as
Amazon.com, eToys,KBkids.com and Beyond.com
. educational catalog distributors, such as Scholastic
Many of our current and potential competitors have longer operating histories,
larger customer or user bases, greater brand recognition and significantly
greater financial, marketing and other resources than we do. Our competitors
may be able to secure products from vendors on more favorable terms, fulfill
customer orders more efficiently and adopt more aggressive pricing or inventory
availability policies than we can. Traditional store-based retailers also
enable customers to see and feel products in a manner that is not possible over
the Internet. Some of our competitors have significantly greater experience in
selling children's educational products. Many of these current and potential
competitors can devote substantially greater resources to marketing and
promotional campaigns and website and systems development than we can. Their
financial strength could prevent us from increasing market share. In addition,
larger, more well-established and better financed entities are acquiring,
investing in and forming joint ventures with online competitors and publishers
or suppliers of children's educational books, toys and games and software as the
use of the Internet increases. Increased competition may result in reduced
operating margins, loss of market share and diminished brand awareness.
IF WE ENTER NEW BUSINESS CATEGORIES AND PURSUE NEW PRODUCT OFFERINGS AND
SERVICES THAT DO NOT ACHIEVE MARKET ACCEPTANCE, OUR BRAND AND REPUTATION COULD
BE DAMAGED AND WE COULD INCUR ADDITIONAL FINANCIAL LOSSES.
We may choose to expand our operations by expanding the breadth and depth of
products and services offered or expanding our market presence through
relationships with third parties. In addition, we may pursue the acquisition of
new or complementary businesses, products, services or technologies, although we
have no present understandings, commitments or agreements with respect to any
material acquisitions or investments. We may not be successful in our efforts to
expand our operations, and potential customers may not react favorably to these
efforts. Furthermore, any new product or service category that is launched by us
but not favorably received by consumers could damage our brand or reputation. An
expansion of our business would also require significant additional expenses,
expose us to additional supplier/distributor inventory risk and strain our
management, financial
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and operational resources. Given our lack of capital resources, any expansion
program or new business category that is not successful could strain our
financial resources and detract capital from otherwise successful operations.
IF WE ARE UNABLE TO MANAGE OUR GROWTH AND THE RELATED EXPANSION IN OUR
OPERATIONS EFFECTIVELY, OUR BUSINESS MAY BE HARMED.
Our ability to successfully offer products and services and implement our
business model in a rapidly evolving market requires an effective planning and
management process. We continue to increase the scope of our operations and have
grown our headcount substantially. Excluding part-time employees, we have grown
from 15 employees at December 31, 1997 to 142 employees at June 30, 2000. We
will need additional personnel in the future. We may be unable to hire qualified
employees as needed. Our growth has placed, and our anticipated future
operations will continue to place, a significant strain on our management,
information systems, network and other resources.
WE DEPEND UPON UNITED PARCEL SERVICE AND THE UNITED STATES POSTAL SERVICE TO
DELIVER OUR PRODUCTS ON A TIMELY AND CONSISTENT BASIS. A DETERIORATION IN OUR
RELATIONSHIP WITH EITHER CARRIER COULD DECREASE OUR ABILITY TO TRACK SHIPMENTS,
CAUSE SHIPMENT DELAYS AND INCREASE OUR SHIPPING COSTS AND THE NUMBER OF DAMAGED
PRODUCTS.
Our supply and distribution system is dependent upon our relationship with
United Parcel Service and the United States Postal Service. If either
relationship is terminated or impaired or if either carrier is unable to deliver
product for us, whether through labor shortage, slow down or stoppage,
deteriorating financial or business condition or for any other reason, we would
be required to use alternative carriers for the shipment of products to our
customers. We may be unable to engage an alternative carrier on a timely basis
or upon terms favorable to us. Potential adverse consequences of changing
carriers include:
. reduced visibility into order status and package tracking
. delays in order processing and product delivery
. increased cost of delivery, resulting in reduced gross margins
. reduced shipment quality which may result in damaged products and customer
dissatisfaction
IF WE DO NOT SUCCESSFULLY MAINTAIN AND EXPAND OUR WEBSITE AND THE SYSTEMS THAT
PROCESS CUSTOMERS' ORDERS, WE COULD LOSE CUSTOMERS AND OUR REVENUES COULD BE
REDUCED.
Our success, in particular our ability to successfully receive and fulfill
orders and provide high quality customer service, largely depends on the
efficient and uninterrupted operation of our computer and communications
systems. As of June 2000, all orders are fulfilled at our own distribution
center.
Our success also depends on our ability to rapidly expand our website,
transaction-processing systems and network infrastructure without systems
interruptions in order to accommodate significant increases in customer traffic
and demand. Many of our software systems are custom-developed, and we rely on
our employees and third-party contractors to develop and maintain these systems.
If any of these employees or contractors become unavailable to us, we may
experience difficulty in improving and maintaining such systems.
In addition, we rely on a third party, Exodus Communications, to host our
website and are thus subject to its ability to provide service when and as we
require.
IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR SERVICES COULD BECOME
OBSOLETE AND WE COULD LOSE CUSTOMERS.
To remain competitive, we must continue to enhance and improve the
functionality and features of our online store. The Internet and the online
commerce industry are rapidly changing. If competitors introduce new products
and services embodying new technologies or if new industry standards and
practices emerge, our existing website
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and proprietary technology and systems may become obsolete. Our future success
will depend on our ability to do the following:
. both license and internally develop leading technologies useful in our
business
. enhance our existing services
. develop new services and technologies that address the increasingly
sophisticated and varied needs of our prospective customers
. respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis
Ongoing development of our website and other proprietary technology entails
significant expense and technical risks. We may use new technologies
ineffectively or we may fail to adapt our website, transaction-processing
systems and network infrastructure to customer requirements or emerging industry
standards. If we face material delays in introducing new services, products and
enhancements, our customers may forego the use of our services and use those of
our competitors.
OUR FACILITIES AND SYSTEMS ARE VULNERABLE TO UNEXPECTED PROBLEMS INCLUDING
PROBLEMS RELATING TO SYSTEM EXPANSION ACTIVITIES OR LACK OF SYSTEM CAPACITY. THE
OCCURRENCE OF A NATURAL DISASTER OR OTHER UNEXPECTED PROBLEM COULD DAMAGE OUR
REPUTATION AND BRAND AND REDUCE OUR REVENUES.
Although we expect to periodically enhance and expand our website,
transaction-processing systems and network infrastructure, we may experience
interruptions in our systems. We may be unable to project the rate or timing of
increases, if any, in the use of our website. This would make it difficult for
us to effectively upgrade and expand our transaction-processing systems and to
smoothly integrate any newly developed or purchased modules with our existing
systems. To the extent we are required to outsource any technological
enhancements or become dependent on third party proprietary technology,
expanding and upgrading our systems could become more difficult. Due to the
seasonal nature of our business, it is particularly important that we are able
to expand our website, transaction-processing systems and network infrastructure
as necessary in preparation for the holiday season and that we operate during
that period without systems interruptions. Our failure to achieve or maintain
high capacity data transmission without system downtime, particularly during
this period, would adversely affect our business.
Substantially all of our computer and communications hardware systems related
to transaction processing and network infrastructure are hosted at a third-party
facility owned and operated by Exodus Communications in Waltham, Massachusetts.
Our systems and operations, including our fulfillment operation, at our new
distribution center in Mansfield, Massachusetts, are vulnerable to damage or
interruption from fire, flood, power loss, telecommunications failure, break-
ins, earthquake and similar events. Furthermore, our servers may be vulnerable
to computer viruses, physical or electronic break-ins and similar disruptions.
We have no formal disaster recovery plan, and our business interruption
insurance may not adequately compensate us for losses that may occur. The
occurrence of a natural disaster or unanticipated problems our new distribution
center or at the Exodus Communications facility could cause interruptions or
delays in our business, loss of data or render us unable to accept and fulfill
customer orders. The occurrence of any or all of these events could adversely
affect our reputation, brand and business.
THE SUCCESS OF OUR BUSINESS DEPENDS ON THE CONTINUING CONTRIBUTION OF OUR KEY
PERSONNEL, INCLUDING MR. DAVID A. BLOHM, OUR PRESIDENT AND CHIEF EXECUTIVE
OFFICER.
Our future success is dependent on key members of our management team and in
particular David A. Blohm, our President and Chief Executive Officer. The
competition for qualified personnel in the electronic commerce market is
extremely intense, especially in the Northeastern part of the United States. The
loss of service of Mr. Blohm or a significant number of our employees could have
a material adverse effect on our business. In particular, the loss of several
key programmers could inhibit the development and enhancement of our website and
could damage customer relations and our brand. Similarly, the loss of several
marketing and sales personnel could inhibit our ability to effectively promote
our website.
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WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS.
We face an inherent risk of exposure to product liability claims in the event
that the use of the products we sell results in injury. We may not have adequate
resources in the event of a successful claim against us. Our general liability
insurance may not cover these claims or we may not be indemnified for any or all
of the liabilities that may be imposed. We cannot predict whether product
liability claims will be brought against us in the future or if the resulting
adverse publicity would harm our business.
WE DEPEND ON THE INTERNET AND THE DEVELOPMENT OF THE INTERNET INFRASTRUCTURE.
Our success will depend in large part on continued growth in, and the use of,
the Internet for commerce. The electronic commerce market is new and rapidly
evolving, and the extent of consumer acceptance is uncertain. The issues
concerning the commercial use of the Internet that we expect to affect the
development of the market for our services include security, reliability, cost
of access, ease of access, ease of use, speed and quality of service.
In addition, popular companies that provide access to Internet transactions
through network access or web browsers, such as America Online, Yahoo, Lycos and
Microsoft, could promote our competitors or charge us a substantial fee for
connection to our website. Either of these developments could adversely affect
our business.
OUR BUSINESS IS SUBJECT TO GOVERNMENT REGULATION OF THE INTERNET AND OTHER LEGAL
UNCERTAINTIES WHICH COULD NEGATIVELY IMPACT OUR OPERATIONS.
Law and regulations directly applicable to communications or commerce over the
Internet are becoming more prevalent. The U.S. Congress recently enacted
Internet laws, including laws relating to children's privacy, the transmission
of sexually explicit material and taxation of Internet-based enterprises. As
directed by Congress in the Children's Online Privacy Protection Act, the
Federal Trade Commission (the "FTC") recently adopted regulations that became
effective on April 21, 2000, prohibiting unfair and deceptive acts and practices
in connection with the collection and use of personal information from children
under 13 years old on the Internet.
There can be no assurance that we will adopt policies that conform to
regulations adopted or policies advocated by the FTC or any other governmental
entity. In addition, the FTC has already begun investigations into the privacy
practices of companies that collect information on the Internet. One
investigation resulted in a consent decree pursuant to which an Internet company
agreed to establish programs to implement the principles noted above. We may
become subject to a similar investigation, or the FTC's regulatory and
enforcement efforts may adversely affect our ability to collect demographic and
personal information from users, which could adversely affect our marketing
efforts.
In addition, the European Union recently enacted its own privacy regulations.
The European Union Directive on the Protection of Personal Data (the "EU
Directive"), which became effective in October 1998, fosters electronic commerce
by establishing a stable framework to ensure both a high level of protection for
private individuals and the free movement of personal data within the European
Union. The European Union and the U.S. Department of Commerce are currently
negotiating an agreement under which the privacy policies of U.S. businesses may
be deemed to be adequate under the EU Directive. Until such time as an agreement
is reached, the European Union has voluntarily agreed to a moratorium on
enforcement of the EU Directive against U.S. businesses. Although the Company
has received less than 2% of revenues from outside of the United States in the
six months ended June 30, 2000, the European legislation and its adoption via
any agreement could adversely affect our ability to expand our sales efforts to
Europe by limiting how information about us can be sent over the Internet in the
European Union and limiting our efforts to collect information from European
users.
The U.S. Omnibus Appropriations Act of 1998 places a moratorium on taxes
levied on Internet access from October 1, 1998 to October 21, 2001. However,
states may place taxes on Internet access if taxes had already been generally
imposed and actually enforced prior to October 1, 1998. States which can show
they enforced Internet access taxes prior to October 1, 1998 and states after
October 21, 2001 may be able to levy taxes on Internet access resulting in
increased cost to access to the Internet, resulting in a material adverse effect
on our business.
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The laws governing the use of the Internet, in general, remain largely
unsettled, even in areas where there has been some legislative action. It may
take years to determine whether and how existing laws such as those governing
intellectual property, privacy, libel and taxation apply to the Internet. In
addition, the growth and development of the market for online commerce may
prompt calls for more stringent consumer protection laws, both in the United
States and abroad. This occurrence may impose additional burdens on companies
conducting business online by limiting how information can flow over the
Internet and the type of information that can flow over the Internet. The
adoption or modification of laws or regulations relating to the Internet could
adversely affect our business. Because we receive a significant amount of orders
as a result of e-mail advertising, new regulations affecting the use of
unsolicited e-mail advertising would impair our marketing efforts.
WE MAY BE LIABLE FOR THE CONTENT WE PROVIDE ON OUR WEBSITE OR WHICH IS ACCESSED
FROM OUR WEBSITE.
We believe that our future success will depend in part upon our ability to
deliver original and compelling descriptive content about the children's
educational books, toys and games, and software that we sell on the Internet. As
a publisher of online content, we face potential liability for defamation,
negligence, copyright, patent or trademark infringement, or other claims based
on the nature and content of materials that we publish or distribute. In the
past, plaintiffs have brought such claims and sometimes successfully litigated
them against online services. Although we carry general liability insurance, our
insurance may not cover claims of these types or may be inadequate to indemnify
us for all liability that may be imposed on us. If we face liability,
particularly liability that is not covered by our insurance or is in excess of
our insurance coverage, then our reputation and our business may suffer.
OUR REVENUES AND REPUTATION WOULD BE ADVERSELY AFFECTED IF OUR SECURITY MEASURES
FAIL.
Consumer concerns regarding the security of transactions conducted on the
Internet and users' privacy may inhibit the growth of use of the Internet and
electronic commerce. To securely transmit confidential information, such as
customer credit card numbers, we rely on encryption and authentication
technology that we license from third parties. We cannot predict whether we will
experience compromises of, or breaches in, the technologies we use to protect
customer transaction data.
We may need to expend significant additional capital and other resources to
protect against security breaches or alleviate problems caused by any such
breaches. We cannot guarantee that security breaches will not occur, and if our
security measures fail, our business could be harmed. Any penetration of our
network security or misappropriation of our users' personal or credit card
information could subject us to liability. Claims could also be based on other
misuses of personal information, including the use of this information for
unauthorized marketing purposes. These claims could result in litigation.
OUR REVENUES AND REPUTATION WOULD BE ADVERSELY AFFECTED IF WE EXPERIENCE
SIGNIFICANT CREDIT CARD FRAUD.
Under current credit card practices, merchants are liable for fraudulent
credit card transactions where, as is the case with the transactions we process,
the merchant does not obtain a cardholder's signature. We may be liable for
claims based on unauthorized purchases with credit card information,
impersonation or other similar fraud claims. A failure to adequately control
fraudulent credit card transactions would harm our business.
PRIVACY CONCERNS AND LEGISLATION MAY LIMIT THE INFORMATION WE CAN GATHER.
When a visitor first arrives at our website, our software creates a profile
for that visitor. If the visitor registers or logs in, the visitor's identity is
added to the profile, preserving any profile information that was gathered up to
that point. We track both explicit user profile data supplied by the user, as
well as implicit profile attributes derived from the user's behavior on the
website. We also suggest that parents provide us with an educational profile on
their children, an important feature of our website. Privacy concerns relating
to children are particularly acute. Privacy concerns may cause visitors to
resist providing the personal data or avoid websites that track the behavioral
information necessary to support this profiling capability. More importantly,
even the perception of security and privacy concerns, whether or not valid, may
indirectly inhibit market acceptance of our products. For example, the European
Union recently adopted a directive addressing data privacy that may limit the
collection and use of certain information regarding Internet users. This
directive may limit our ability to target advertising or collect and use
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information in certain European countries. In addition, legislative or
regulatory requirements may heighten these concerns if businesses must notify
website users that the data captured after visiting websites may be used to
direct product promotion and advertising to that user. Other countries and
political entities, such as the European Union, have adopted such legislation or
regulatory requirements. The United States may adopt similar legislation or
regulatory requirements. If privacy legislation is enacted or consumer privacy
concerns are not adequately addressed, our business, financial condition and
operating results could be harmed.
Websites typically place "cookies" on a user's hard drive without the user's
knowledge or consent. We use cookies for a variety of reasons, including the
collection of data derived from the user's Internet activity. Most currently
available web browsers allow users to remove cookies at any time or to prevent
cookies from being stored on their hard drives. In addition, some commentators,
privacy advocates and governmental bodies have suggested limiting or eliminating
the use of cookies. Any reduction or limitation in the use of cookies could
limit the effectiveness of our sales and marketing efforts. The FTC and several
states have investigated the use by certain Internet companies of personal
information. We could incur significant additional expenses if new regulations
regarding the use of personal information are introduced or if our privacy
practices are investigated.
OUR REVENUES COULD DECREASE IF WE BECAME SUBJECT TO SALES AND OTHER TAXES.
We do not currently collect sales or other similar taxes for physical
shipments of goods into states other than Massachusetts. However, one or more
local, state, federal or foreign jurisdictions may seek to impose sales tax
collection obligations on us. In addition, any new operation in states outside
Massachusetts could subject our shipments in such states to state sales taxes
under current or future laws. A number of legislative proposals have been made
at the federal, state and local level and by foreign governments that would
impose additional taxes on the sale of goods and services over the Internet and
certain states have taken measures to tax Internet-related activities. Although
Congress recently placed a three-year moratorium on new state and local taxes on
Internet access or on discriminatory taxes on electronic commerce, existing
state or local laws were expressly excepted from this moratorium. Further, once
this moratorium expires, some type of federal and/or state taxes may be imposed
upon Internet commerce. The moratorium is presently scheduled to expire on
October 20, 2001. Such legislation or other attempts at regulating commerce over
the Internet may substantially impair the growth of commerce on the Internet
and, as a result, adversely affect our opportunity to derive financial benefit
from such activities. If one or more states or any foreign country successfully
asserts that we should collect sales or other taxes on the sale of our products,
it could adversely affect our business and results of operations.
SMARTERKIDS.COM'S STOCK PRICE, LIKE THAT OF OTHER RETAIL E-COMMERCE COMPANIES,
IS SUBJECT TO SIGNIFICANT VOLATILITY.
Our stock price may be volatile because of factors such as:
. speculation in the press or investment community
. changes in revenue or earnings estimates by the investment community
. announcement of new competitors in a highly competitive marketplace
In addition, Smarterkids.com's stock price may be affected by general market
conditions and economic factors unrelated to Smarterkids.com's performance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about the Company's market risk includes "forward-
looking statements" that involve risks and uncertainties. Actual results could
differ materially from those projected in the forward-looking statements. The
Company does not use derivative financial instruments for speculative or trading
purposes.
Interest Rate Risk. SmarterKids.com is exposed to market risk from changes in
interest rates primarily through its investing activities. In addition, our
ability to finance future acquisition transactions may be impacted if we are
unable to obtain appropriate financing at acceptable rates. Our investment
portfolio consists solely of investments in high-grade, commercial bank money
market accounts and certificates of deposit.
20
<PAGE>
Credit Risk. Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash, cash equivalents,
short-term investments and accounts receivable. The Company does not believe
that it is subject to any unusual credit risk beyond the normal credit risk
associated with commercial banking relationships.
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Recent Sales of Unregistered Securities
In connection with the equipment line credit facility entered into in April 13,
2000, the Company issued to TLP Leasing Programs, Inc. 16,667 warrants for
Company common stock at an exercise price of $3.00 per share and an aggregate
exercise price of $50,001. Upon the exercise of the warrants, which may take
place at any time before the expiration of warrants of April 13, 2006, each
warrant shall convert into one share of the Company's common stock, par value
$.01 per share. The Company claims that the offer and sale of the Shares were
exempt from registration under the Securities Act of 1933, as amended, pursuant
to Rule 506 of Regulation D. The warrants were offered only to TLP Leasing
Programs, Inc., an "Accredited Investor" as such term is defined in Rule 501 of
Regulation D.
(d) Use of Proceeds from Registered Securities
We received capital from investors in three private venture capital financings
totaling $37.0 million through July 1999. On November 23, 1999, the Company
completed an initial public offering of 4,500,000 shares of common stock $0.01
par value per share (5,175,000 shares including 658,500 over-allotment shares
and 16,500 shares offered by selling stockholders), resulting in net proceeds to
the Company of $65.9 million. The primary purposes of the initial public
offering were to increase our capitalization and financial flexibility, create a
public market for SmarterKids.com's common stock, and facilitate future access
to public markets. As of June 30, 2000, SmarterKids.com used $24.4 million of
the offering proceeds for working capital and approximately $41.5 million of the
offering proceeds remain in cash and short-term investments.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of stockholders was held on June 16, 2000.
Holders of an aggregate of 20,473,012 shares at the close of business on April
21, 2000 were entitled to vote at the meeting. A total of 16,881,325 shares of
common stock voted at the annual meeting. At the meeting, the Company's
stockholders voted as follows:
PROPOSAL I. To re-elect Messrs. Brian Hickey and Michael Kolowich as Class I
Directors, each to serve for a three-year term.
<TABLE>
<CAPTION>
Total Votes for Total Votes Abstentions from Broker
Director Name Proposal I Withheld for Proposal I Proposal I Non-votes
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Brian Hickey 16,830,918 50,407 - -
Michael Kolowich 16,824,448 56,877 - -
</TABLE>
Messrs. Jeff A. Pucci, and Michael T. Fitzgerald will continue to hold office
until the 2001 annual meeting of stockholders or until their successors have
been duly elected or until their earlier resignation or removal. Messrs. David
Blohm and Richard A. D'Amore will continue to hold office until the 2002 annual
meeting of stockholders or until their successors have been duly elected or
until their earlier resignation or removal
PROPOSAL II. To approve an amendment to the Company's 1999 Stock Option and
Incentive Plan to increase the number of shares of common stock authorized
thereunder from 2,000,000 to 3,500,000.
<TABLE>
<CAPTION>
Total Votes for Total Votes Against Abstentions from Broker Non-votes
Proposal I Proposal II Proposal II
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
12,265,916 723,724 16,535 3,875,150
</TABLE>
21
<PAGE>
PROPOSAL III. To ratify the selection of the firm of PricewaterhouseCoopers
LLP, independent public accountants, as the Company's auditors for the fiscal
year ending December 31, 2000.
<TABLE>
<CAPTION>
Total Votes for Total Votes Against Abstentions from Broker Non-votes
Proposal III Proposal III Proposal II
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
16,775,263 103,055 3,007 -
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. Exhibit
------------- ----------------------------------------------------------------------------------------------------------
<S> <C>
10.10 Lease Agreement dated April 7, 2000 between Smarterkids.com, Inc. and Keep Your Day Job, LLC
27.1 Financial Data Schedule
</TABLE>
(b) REPORTS ON FORM 8-K.
Not applicable.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
SMARTERKIDS.COM, INC.
(Registrant)
Date: August 11, 2000 By: /s/ Robert J. Cahill
-------------------------
Robert J. Cahill
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial and Accounting Officer)
23
<PAGE>
Exhibit Index
10.10 Lease Agreement dated April 7, 2000 between SmarterKids.com, Inc. and
Keep Your Day Job, LLC
27.1 Financial Data Schedule
