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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
Form 10-Q
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Quarter Ended March 31, 2000
Commission File Number 0-27717
SMARTERKIDS.COM, INC.
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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)
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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. Yes [X] No [_]
The number of shares outstanding of the registrant's $.01 par value Common
Stock as of May 12, 2000 was 20,473,012.
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SMARTERKIDS.COM, INC.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED MARCH 31, 2000
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PART I: FINANCIAL INFORMATION......................................................... 3
ITEM 1. BALANCE SHEET-March 31, 2000 and December 31, 1999........................... 3
STATEMENT OF OPERATIONS-Three months ended March 31, 2000 and
March 31, 1999............................................................... 4
STATEMENT OF CASH FLOWS-Three months ended March 31, 2000 and
March 31, 1999............................................................... 5
NOTES TO FINANCIAL STATEMENTS................................................ 6-7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................8-11
CAUTIONARY STATEMENTS........................................................ 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................... 21
PART II: OTHER INFORMATION............................................................
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.................................... 21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................. 21
Exhibit 10.1 Loan and Security Agreement by and between SmarterKids.com and
Silicon Valley Bank
Exhibit 27.1 Financial Data Schedule
SIGNATURES........................................................................... 23
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PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SMARTERKIDS.COM, INC.
BALANCE SHEET
(In thousands, except share data)
(Unaudited)
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<CAPTION>
March 31, December 31,
2000 1999
---- ----
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ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 16,984 $ 55,621
Short-term investments............................................................... 33,437 11,735
Accounts receivable, net of allowance for doubtful accounts of $27 at
March 31, 2000 and December 31, 1999............................................... 40 132
Inventories.......................................................................... 7,237 8,902
Other current assets................................................................. 2,727 2,403
---------- -----------
Total current assets.............................................................. 60,425 78,793
---------- -----------
Property and equipment, net............................................................. 3,887 2,421
Intangible assets, net.................................................................. 534 621
Restricted cash......................................................................... 500 500
---------- -----------
Total assets...................................................................... $ 65,346 $ 82,335
========== ===========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations.......................................... $ 108 $ 74
Accounts payable...................................................................... 3,599 10,996
Accrued expenses...................................................................... 4,128 6,699
Deferred revenue...................................................................... 780 811
Other current liabilities............................................................. 402 87
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Total current liabilities......................................................... 9,017 18,667
---------- -----------
Capital lease obligations and borrowings under line of credit........................... 837 34
---------- -----------
Total liabilities................................................................. 9,854 18,701
---------- -----------
Commitments and contingencies (Note 4) -- --
Stockholders' equity:
Common stock, $0.01 par value; 90,000,000 shares authorized;
20,473,012 and 20,301,770 shares issued and outstanding at March 31, 2000 and
December 31, 1999, respectively....................................................... 204 203
Additional paid-in capital.............................................................. 112,218 112,907
Deferred stock compensation............................................................. (5,609) (6,286)
Accumulated deficit..................................................................... (51,321) (43,190)
---------- -----------
Total stockholders' equity.......................................................... 55,492 63,634
---------- -----------
Total liabilities and stockholders' equity.......................................... $ 65,346 $ 82,335
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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)
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<CAPTION>
Three Months Ended
March 31,
--------------------------------
2000 1999
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Net revenues................................... $ 1,469 $ 94
Cost of revenues............................... 1,101 69
----------- ----------
Gross profit................................... 368 25
----------- ----------
Operating expenses:
Marketing and sales.......................... 7,300 2,023
Development.................................. 943 367
General and administrative................... 906 155
Stock compensation........................... 178 384
----------- ----------
Total operating expenses.................. 9,327 2,929
----------- ----------
Loss from operations........................... (8,959) (2,904)
Other income, net.............................. 828 24
----------- ----------
Net loss....................................... $ (8,131) $ (2,880)
=========== ==========
Basic and diluted net loss per common
share......................................... $ (.40) $ (1.77)
Weighted average shares outstanding-basic
and diluted................................... 20,308 1,631
</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)
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<CAPTION>
Three Months Ended
March 31,
-------------------------------
2000 1999
------------ ------------
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Cash flows from operating activities:
Net loss............................................................. $ (8,131) $ (2,880)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization...................................... 365 7
Stock compensation expense......................................... 178 384
Changes in assets and liabilities:
Accounts receivable............................................ 92 176
Inventories.................................................... 1,665 8
Other assets................................................... (324) (72)
Accounts payable............................................... (7,397) 379
Accrued expenses............................................... (2,571) 471
Deferred revenue............................................... (31) --
Sales return allowances........................................ (15) 10
------------ ------------
Net cash used in operating activities.................................. (16,169) (1,517)
------------ ------------
Cash flows from investing activities:
Purchase of short-term investments.............................. (21,702) --
Purchases of property and equipment............................. (1,742) (15)
------------ ------------
Net cash used in investing activities.................................. (23,444) (15)
------------ ------------
Cash flows from financing activities:
Proceeds from long-term borrowings.............................. 1,267 --
Repayments of long-term borrowings.............................. (100) --
Proceeds from exercise of common stock options.................. 13 --
Increase from estimated IPO Costs............................... (204) --
Costs of issuance of Series B redeemable preferred stock........ -- (11)
------------ ------------
Net cash provided by (used in) financing activities.................... 976 (11)
------------ ------------
Net (decrease) in cash and cash equivalents............................ (38,637) (1,543)
Cash and cash equivalents at beginning of period....................... 55,621 4,273
------------ ------------
Cash and cash equivalents at end of period............................. $ 16,984 $ 2,730
============ ============
</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 three months ended March
31, 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 three months
ended March 31, 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 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 service fees to J.L. Hammett Co.,
commissions to online marketing companies, and expenses for personnel engaged in
marketing, merchandising and customer service activities. Fulfillment costs
related to online retail products, including the outsourced cost of operating
and staffing warehousing and distribution centers, as well as customer service,
are also included in marketing and sales expenses. Advertising costs are charged
to operations as incurred. Advertising expenses were $3,849,000 and $1,361,000
for the three-month periods ended March 31, 2000 and 1999, respectively.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board 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 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 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
is currently assessing the impact of FIN 44 on the Company's financial position
or results of operations.
In December 1999, the SEC staff released SAB No. 101, Revenue Recognition
in Financial Statements, which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements. Subsequently,
SAB101A has been released which directs the application of the guidance in SAB
101 to be required in the Company's second quarter of 2000. The effects of
applying this guidance, if any, will be reported as a cumulative effect
adjustment resulting in a change in accounting principle. The Company does not
expect the adoption of SAB 101 to have a material effect on our financial
statements; however, the final evaluation of SAB 101 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):
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<CAPTION>
March 31, December 31,
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2000 1999
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Software............................................... $ 449 $ 377
Furniture and fixtures................................. 221 207
Computer and office equipment.......................... 2,191 1,774
Leasehold improvements................................. 525 507
Construction in progress............................... 1,221 0
------------ ------------
4,607 2,865
Less--Accumulated depreciation and amortization........ 720 444
------------ ------------
$ 3,887 $ 2,421
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During April 2000, the Company entered into a lease agreement for a new
distribution facility. Capital costs incurred during the quarter ended March 31,
2000 relate primarily to equipment to be used in this facility. As of March 31,
2000, there was $1,221,000 of such costs held in construction in progress.
Accordingly, these assets will be depreciated once the warehouse begins
operations. 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 first utilized its
$1.5 million three-year equipment line of credit facility. Equipment
collateralized under this agreement approximates $1,267,000 at March 31, 2000.
The interest on the credit facility is equal to the rate on the three-year U.S.
Treasury Note plus 3.5%. In accordance with the agreement, the balance under the
line of credit was converted to a 36 month term loan in February 2000.
Accordingly, the Company is making payments of principal and interest of
approximately $39,000 per month over the term of the loan.
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
will be required to maintain, on behalf of the landlord, a certificate of
deposit in the amount of $850,000, which will be restricted as to its use. This
certificate of deposit will be reduced to $500,000 on June 30, 2000.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS'
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
proprietary 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 ages toddler
through 15.
Recent Events
The Company's recent initiatives include:
Grade Expectations: The first online academic standards tool. This innovative
feature explains the grade and subject specific milestones and objectives that
guide school curriculum design. This tool helps parents match educational
products with their child's classroom curriculum based on national academic
standards. For the first time ever, parents can use the Internet to find
detailed, grade-specific information about their child's academic challenges, as
well as hundreds of educational product recommendations to enrich the academic
experience.
Special Needs Center: The Company launched an on-site Special Needs Center to
help parents of the nation's 5.8 million school-aged children who have special
challenges. It contains helpful content and recommendations for the best
products for each child. Currently, SmarterKids.com recommends items for the
following special needs: Attention Deficit Disorder (ADD), Attention Deficit
Hyperactivity Disorder (ADHD), autism, blind/visually impaired, deaf/hearing
impaired, developmental delay, and other learning and physical disabilities.
Parents can also click on the "Ask the Special Needs Teacher" button to receive
one-on-one guidance from the special-needs teachers on-staff at SmarterKids.com.
In addition, SmarterKids.com provides enhanced information on more than 500
products to illustrate how children with special needs and their parents can use
these educational products to help advance the child's development.
Gifted and Talented Center: SmarterKids.com was the first company online to
launch a Gifted and Talented specialty center. This feature helps parents
challenge children gifted in the areas of creative/productive thinking, language
arts, mathematics, science, and visual/performing arts. It contains terms,
content, activities, product recommendations, and links to on-staff educators.
New Distribution Facility: During the second quarter of 2000, the Company
entered into a lease agreement for a distribution center, which is expected to
open during the latter part of the second quarter of 2000. See "-Liquidity and
Capital Resources" for additional information on this distribution center.
8
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Results of Operations
Revenues. Revenues in 2000 and 1999 consist of online sales of third-party
educational products and charges to customers for shipping and handling. In the
quarters ended March 31, 2000 and 1999, we derived less than 2% of our revenues
from outside of the United States. Revenues are recognized upon shipment to the
customer and are net of promotional discounts and coupons and return
allowances, which are determined by historical trends with actual returns.
Revenues were $1.5 million and $94,000 in the quarters ended March 31, 2000
and 1999, respectively. The increase in revenue in the first quarter of 2000
from the first quarter of 1999 was primarily attributable to the transition of
our business model to online sales of third-party educational products and
reflected the results of our significant marketing efforts. Repeat customers
accounted for approximately 43% of the sales during the first quarter of 2000.
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 $69,000 in the
quarters ended March 31, 2000 and 1999, respectively. The increase in the first
quarter of 2000 from the first quarter of 1999 was attributable to growth in
online sales of third-party educational products. Our gross margin decreased to
25.1% in 2000 from 26.6% in 1999.
Marketing and sales. Marketing and sales expenses consist primarily of the
cost of advertising and promotional activities, fulfillment service fees to J.L.
Hammett Co., commissions to online marketing companies, and expenses for
personnel engaged in marketing, merchandising and customer service activities.
Marketing and sales expenses were $7.3 million and $2.0 million in the quarters
ended March 31, 2000 and 1999, respectively. The increase in the first quarter
of 2000 from the first quarter of 1999 was primarily attributable to increased
advertising and promotional activities, fees to our fulfillment partner, J.L.
Hammett Co., as well as the hiring of 34 additional employees.
The SEC is 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 define 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 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 $943,000 and $367,000 in the quarters ended March 31,
2000 and 1999, respectively. The increase in the first quarter of 2000 from
the first quarter of 1999 was attributable primarily to the hiring of 28
additional employees and costs related to enhancing the features, content and
functionality of our website.
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 $906,000 and $155,000 in the quarters
ended March 31, 2000 and 1999, respectively. The increase in the first quarter
of 2000 from the first quarter of 1999 was attributable primarily to the hiring
of 14 additional employees and costs related to the expansion of our operations
and infrastructure.
Stock compensation. We recorded stock compensation expense of $178,000 and
$384,000 in the quarters ended March 31, 2000 and 1999, respectively, related to
amortization of deferred stock compensation options and warrants granted to
employees and non-employees.
Other income, net. Other income, net consists primarily of interest expense
related to short-term lease obligations and borrowings under our equipment line
of credit as well as interest income earned on our short-term investments. Other
income, net increased to $828,000 in the first quarter of 2000 from $24,000 in
the first quarter of 1999. The increase was primarily attributable to an
increase in interest income from higher balances of invested capital.
Liquidity and Capital Resources
Since inception, the Company has incurred significant losses. The Company has
met its 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, the Company
9
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completed an initial public offering of 4,500,000 shares of common stock
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 March 31, 2000,
SmarterKids.com had used $21.2 million of the offering proceeds for working
capital and approximately $44.7 million of the offering proceeds remain in cash
and short-term investments or were used for the purchase of temporary
investments consisting of cash equivalents and short-term investments.
Net cash used in operating activities was $16.2 million and $1.5 million in
the quarters ended March 31, 2000 and 1999, respectively. The increase in cash
used in operating activities from the first quarter of 1999 to the first quarter
of 2000 was primarily attributable to increased expenses associated with the
continued promotion of our website and retail Internet business. 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
$23.4 million and $15,000 in the quarters ended March 31, 2000 and 1999,
respectively. The increase in cash used in investing activities was primarily
attributable to increased purchases of equipment and the purchase of short-term
investments of $21.7 million.
Net cash provided by (used in) financing activities was $976,000 and ($11,000)
in the quarters ended March 31, 2000 and 1999, respectively. Net cash provided
by financing activities in the quarter ended March 31, 2000 primarily reflects
the net proceeds of $1.3 million from an equipment line of credit. Net cash
used in financing activities in the quarter ended March 31, 1999 consisted of
issuance costs for the Series B redeemable preferred stock offering.
During the quarter ended March 31, 2000, the Company first utilized its $1.5
million three-year equipment line of credit facility. Equipment collateralized
under this agreement approximates $1,267,000 at March 31, 2000. The interest on
the credit facility is equal to the rate on the three-year U.S. Treasury Note
plus 3.5%. The Company is making payments of principal and interest of
approximately $39,000 per month over the term of the loan.
During the second quarter of 2000, the Company entered into a lease agreement
for an approximately 140,000 square foot distribution center in Mansfield,
Massachusetts, which is expected to open in the second quarter of 2000. The
distribution center will allow the Company to better manage its fulfillment
process. As a result, the Company plans to discontinue using J.L. Hammett as a
fulfillment partner during the second quarter of 2000. The five-year operating
lease will require minimum leasehold payments of approximately $900,000
per year.
As of March 31, 2000, we had $17.0 million of cash and cash equivalents and
$33.4 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 aggregating $1.3 million, and accounts payable of
$3.6 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 are planning to transition
customer order fulfillment to our own distribution facility by the end of the
second quarter in 2000. In conjunction with this transaction, we anticipate
investing capital and 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.
10
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Recent Accounting Pronouncements
In December 1999, the SEC staff released SAB No. 101, Revenue Recognition in
Financial Statements, which provides guidance on the recognition, presentation
and disclosure of revenue in financial statements. Subsequently, SAB101A has
been released which directs the application of the guidance in SAB 101 to be
required in our second quarter of 2000. The effects of applying this guidance,
if any, will be reported as a cumulative effect adjustment resulting in 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 is not yet complete.
In March 2000, the Financial Accounting Standard Board 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 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 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 is
currently assessing the impact of FIN 44 on the Company's financial position or
results of operations.
Cautionary Statements
This Quarterly Report on Form 10-Q contains forward-looking statements
including, without limitation, statements concerning the future of the industry,
product development, business strategy (including the possibility of future
acquisitions), anticipated operational and capital expenditure levels, continued
acceptance and growth of our products, and dependence on significant customers
and suppliers. This Quarterly Report on Form 10-Q contains forward-looking
statements that we have made based on our current expectations, estimates and
projections about our industry, operations, and prospects, not historical facts.
We have made these forward-looking statements pursuant to the provisions of the
Private Securities Litigation Reform Act of 1995. These statements can be
identified by the use of forward-looking terminology such as "may," "will,"
"believe," "expect," "anticipate," "estimate," "intend," "continue" or other
similar expressions. These statements discuss future expectations, and may
contain projections of results of operations or of financial condition or state
other forward-looking information. These forward-looking statements are subject
to business and economic risks and uncertainties, and our actual results of
operations may differ materially from those contained in the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed in "Factors that May Affect Future
Results" in our Annual Report filed on Form 10-K dated March 30, 2000, as well
as other risks and uncertainties referenced in this Quarterly Report. These
risks include, but are not limited to, the following:
. our past dependence on J.L. Hammett & Co., our sole provider of
distribution services, increases our susceptibility to interruptions
in order fulfillment.
. our transition to our own distribution facility could lead to
interruptions in order fulfillment.
. we derive a disproportionate amount of our revenue during the holiday
season, which can cause our operating results to fluctuate from quarter
to quarter.
11
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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 March 31, 2000, we
had an accumulated deficit of $51.3 million. We incurred a net loss of $8.1
million for the quarter ended March 31, 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, and we
pay our fulfillment services provider, J.L. Hammett Co., a fee based on a fixed
percentage of the costs of our products to us. 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.
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
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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 products, over which we have no control, may also cause
our operating results to fluctuate.
Many of the other risk factors listed in this 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 due to 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.
Our relationships with online companies are intended to drive traffic to our
website. Approximately 6% of our revenues in the quarter ended March 31, 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.
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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.
We are dependent on J.L. Hammett Co., our sole provider of distribution
services. The inability of J.L. Hammett Co., for any reason, to perform these
functions could lead to interruptions in our operations, lost revenues and
increased expense.
We are highly dependent upon our relationship with J.L. Hammett Co., a
national distributor of educational products, which serves as our exclusive
provider of products and distribution services. J.L. Hammett Co. works closely
with us to determine our projected inventory needs and then orders and maintains
the physical inventory of children's educational books, toys and games and
software necessary to satisfy customer orders. J.L. Hammett Co. orders and
stocks inventory on our behalf, fulfills our customer orders as they are
received, and then packs and ships the orders using our packaging materials.
J.L. Hammett Co. also handles promotional mailings and product returns as
necessary on our behalf. J.L. Hammett Co. is, to a limited extent, a competitor.
The termination of our relationship with J.L. Hammett Co. could lead to
interruptions in our operations, lost revenues and increased expense necessary
to quickly implement an alternative distribution and order fulfillment
infrastructure.
Our transition to our own distribution center could lead to interruptions in our
operations, lost revenues and increased expense.
During the second quarter, we will be moving our order procurement from a
third party, J.L. Hammett, to our own facility. The postponement of or change
in this transition could lead to interruptions in our operations, lost revenues,
increased expense necessary to continue distribution with J.L. Hammett or
quickly implement an alternative distribution center.
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.
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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",
".ne" 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 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, Noodle Kidoodle and Zany Brainy
. online book sellers, toy sellers and computer software sellers,
such as Amazon.com, eToys, KBkids.com, toysmart.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 more well-financed entities are acquiring,
investing in and forming joint ventures with online competitors and publishers
or suppliers of children's educational
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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 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 123 employees at March 31, 2000. We
will need to add 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 to deliver our products on a timely and
consistent basis. A deterioration in our relationship with United Parcel Service
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. If our relationship with United Parcel Service is
terminated or impaired or if United Parcel Service 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
and those systems of J.L. Hammett Co. While we select and own our own inventory,
take all orders and manage our customer service, all our inventory resides at a
warehouse owned and maintained by J.L. Hammett Co. J.L. Hammett Co. picks, packs
and ships all orders, and J.L. Hammett Co. maintains our warehouse management
system. As of
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June 2000, the Company will no longer use the services of J.L. Hammett to pick,
pack and ship all orders. All orders will be procured 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 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
integrate smoothly 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, part of which
is located at a facility owned and operated by J.L. Hammett Co., and part of
which in under construction at our new distribution
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center, 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 at the J.L. Hammett Co. facility, our new distribution
center, or at the Exodus 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.
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.
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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 European Union Directive against U.S.
businesses. Although the Company has received less than 2% of revenues from
outside of the United States in the three months ended March 31, 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.
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.
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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 of
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
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
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. 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.
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
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 March 31, 2000, SmarterKids.com used $21.2 million of the offering
proceeds for working capital and approximately $44.7 million of the offering
proceeds remain in cash and short-term investments or were used for the purchase
of temporary investments consisting of cash equivalents and short-term
investments.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Form 10-Q, required by
Item 601 of Regulation S-K.
(1) Exhibits.
See Exhibit Index. The Exhibits listed in the accompanying Exhibit Index
are filed or incorporated by reference as part of this report.
21
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(b) Reports on Form 8-K.
None.
(c) Exhibits.
SmarterKids.com hereby files as part of this Quarterly Report on Form 10-Q
the exhibits listed in Item 6(a)(1) above. Exhibits which are incorporated
herein by reference can be inspected and copied at the public reference
rooms maintained by the Securities and Exchange Commission in Washington,
D.C., New York, New York, and Chicago, Illinois. Please call the Securities
and Exchange Commission at 1-800-SEC-0330 for further information on the
public reference rooms. Securities and Exchange Commission filings are also
available to the public from commercial document retrieval services and at
the web site maintained by the Securities and Exchange Commission at
http://www.sec.gov.
------------------
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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)
Dated: May 15, 2000 By: /s/ Robert J. Cahill
----------------------------------
Robert J. Cahill
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
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Exhibit Index to Report on Form 10-Q
for Quarter Ended March 31, 2000
<TABLE>
<CAPTION>
Exhibit No. Exhibit
----------- -------
<S> <C>
10.1* Loan and Security Agreement dated November 24, 1999 between Smarterkids.com, Inc. and Silicon Valley Bank
27.1* Financial Data Schedule
</TABLE>
________________
* Filed herewith.
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LOAN AND SECURITY AGREEMENT
THIS LOAN AND SECURITY AGREEMENT (this "Agreement") dated as of November
24, 1999, between SILICON VALLEY BANK, a California-chartered bank, with its
principal place of business at 3003 Tasman Drive, Santa Clara, California 95054
and with a loan production office located at Wellesley Office Park, 40 William
Street, Suite 350, Wellesley, Massachusetts 02481, doing business under the name
"Silicon Valley East" ("Bank") and SMARTERKIDS.COM, INC. ("Borrower"), provides
the terms on which Bank shall lend to Borrower and Borrower shall repay Bank.
The parties agree as follows:
1 ACCOUNTING AND OTHER TERMS
Accounting terms not defined in this Agreement shall be construed following
GAAP. Calculations and determinations must be made following GAAP. The term
"financial statements" includes the notes and schedules. The terms "including"
and "includes" always mean "including (or includes) without limitation" in this
or any Loan Document. Capitalized terms in this Agreement shall have the
meanings set forth in Section 13. This Agreement shall be construed to impart
upon Bank a duty to act reasonably at all times.
2 LOAN AND TERMS OF PAYMENT
2.1 CREDIT EXTENSIONS. Borrower shall pay Bank the unpaid principal
amount of all Credit Extensions and interest on the unpaid principal amount of
the Credit Extensions as and when due in accordance with this Agreement.
2.1.1 EQUIPMENT FACILITY.
(a) Subject to the terms and conditions of this Agreement, Bank agrees
to lend to Borrower, from time to time prior to the Commitment Termination Date,
equipment advances (each an "Equipment Advance" and collectively the "Equipment
Advances") in an aggregate amount not to exceed the Committed Equipment Line.
When repaid, the Equipment Advances may not be re-borrowed. The proceeds of the
Equipment Advances shall be used solely to reimburse Borrower for the purchase
of Eligible Equipment purchased within ninety (90) days (determined based upon
the applicable invoice date of such Eligible Equipment) of the Equipment Advance
and to purchase new Eligible Equipment. Not withstanding the foregoing, the
proceeds of the first Equipment Advance shall be used to reimburse the Borrower
for the purchase of Eligible Equipment purchased within one hundred twenty (120)
days (determined based upon the applicable invoice date of such Eligible
Equipment) of the Equipment Advance. Bank's obligation to lend hereunder shall
terminate on the earlier of (i) the occurrence and continuance of an Event of
Default, or (ii) the Commitment Termination Date. For purposes of this
Section, the minimum amount of each Equipment Advance is One Hundred Thousand
Dollars ($100,000.00). The Borrower may only request a total of ten (10)
Equipment Advances.
(b) To obtain an Equipment Advance, Borrower shall deliver to Bank a
completed loan supplement in substantially the form attached as Exhibit B ("Loan
Supplement"), together with a UCC Financing Statement covering the Financed
Equipment described on Annex A to the applicable Loan Supplement and such
additional information as Bank may reasonably request at least five (5)
<PAGE>
Business Days before the proposed funding date (the "Funding Date"). On each
Funding Date, Bank shall specify in the Loan Supplement for each Equipment
Advance, the Basic Rate, the Loan Factor, and the Payment Dates. If Borrower
satisfies the conditions of each Equipment Advance, Bank shall disburse such
Equipment Advance by internal transfer to Borrower's deposit account with Bank.
Each Equipment Advance may not exceed 100% of the Original Stated Cost of the
Financed Equipment.
(c) Bank's obligation to lend the undisbursed portion of the Committed
Equipment Line shall terminate if there has been a material adverse change in
the general affairs, management, results of operation, condition (financial or
otherwise) of Borrower, whether or not arising from transactions in the ordinary
course of business, or there has been any material adverse deviation by Borrower
from the most recent business plan of Borrower presented to and accepted by Bank
prior to the execution of this Agreement.
2.2 INTEREST RATE; PAYMENTS.
(1) Principal and Interest Payments On Payment Dates. Borrower shall
repay each Equipment Advance pursuant to the terms set forth in the
corresponding Loan Supplement. For each Equipment Advance, Borrower shall make
equal monthly payments of principal and interest, in advance, calculated by the
Bank based upon: (1) the amount of the Equipment Advance, (2) the Basic Rate,
and (3) an amortization schedule equal to the Repayment Period (individually,
the "Scheduled Payment", and collectively, "Scheduled Payments"), on the first
Business Day of the month following the month in which the Funding Date occurs
(or commencing on the Funding Date if the Funding Date is the first Business Day
of the month) with respect to such Equipment Advance and continuing thereafter
during the Repayment Period on the first Business Day of each successive
calendar month (each a "Payment Date"). All unpaid principal and accrued
interest is due and payable in full on the last Payment Date with respect to
such Equipment Advance. Payments received after 12:00 noon Eastern time are
considered received at the opening of business on the next Business Day. An
Equipment Advance may only be prepaid in accordance with Sections 2.2(e) and
2.2(g).
(b) Interest Rate. Borrower shall pay interest on the unpaid
principal amount of each Equipment Advance from the first Payment Date after the
Funding Date of such Equipment Advance until the Equipment Advance has been paid
in full, at the per annum rate of interest equal to the Basic Rate determined by
Bank as of the Funding Date for each Equipment Advance in accordance with the
definition of the Basic Rate. Any amounts outstanding during the continuance of
an Event of Default shall bear interest at a per annum rate equal to the Basic
Rate plus five percent (5%)(the "Default Rate"). If any change in the law
increases Bank's expenses or decreases its return from the Equipment Advances,
Borrower shall pay Bank upon request the amount of such increase or decrease.
(c) Interim Payment. In addition to the Scheduled Payments, on the
Funding Date for each
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<PAGE>
Equipment Advance (unless the Funding Date is the first Business Day of the
month, in which event no Interim Payment shall be due or owing), Borrower shall
pay to Bank, on behalf of Bank, an amount (the "Interim Payment") equal to the
initial Equipment Advance multiplied by the product of (i) the quotient derived
from dividing the initial Loan Factor with respect to such Equipment Advance by
30, and (ii) the number of days from the Funding Date of the Equipment Advance
until the first Payment Date with respect to such Equipment Advance.
(d) Final Payment. On the Maturity Date with respect to each
Equipment Advance, Borrower
shall pay, in addition to the unpaid principal and accrued interest and all
other amounts due on such date with respect to such Equipment Advance, an amount
equal to the Final Payment.
(e) Prepayment Upon an Event of Loss. If any Financed Equipment is
subject to an Event of
Loss and Borrower is required to or elects to prepay the Equipment Advance with
respect to such Financed Equipment pursuant to Section 6.7 then such Equipment
Advance shall be prepaid to the extent and in the manner provided in such
section.
(f) Mandatory Prepayment Upon an Acceleration. If the Equipment
Advances are accelerated
following the occurrence of an Event of Default or otherwise (other than
following an Event of Loss), then Borrower shall immediately pay to Bank (i) all
unpaid Scheduled Payments with respect to each Equipment Advance due prior to
the date of prepayment, (ii) all accrued unpaid interest, including interest at
the Default Rate, to the date of the prepayment, (iii) the Final Payment, and
(iv) all other sums, if any, that shall have become due and payable with respect
to any Equipment Advance.
(g) Permitted Prepayment of Loans. With Bank's prior written
consent, which shall not be
unreasonably withheld, delayed or conditioned, Borrower shall have the option to
prepay all, but not less than all, of the Equipment Advances advanced by Bank
under this Agreement, provided Borrower (i) provides written notice to Bank of
its election to prepay the Equipment Advances at least thirty (30) days prior to
such prepayment, and (ii) pays, on the date of such prepayment (A) all
outstanding principal; (B) all unpaid accrued interest to the date of the
prepayment; (C) the Final Payment in respect of each Equipment Advance ; and (D)
all other sums, if any, that shall have become due and payable hereunder with
respect to this Agreement.
2.3 FEES. Borrower shall pay to Bank all Bank Expenses (including
reasonable attorneys' fees and expenses incurred through and after the Closing
Date when due.
2.4 REQUEST TO DEBIT. Bank may debit any of Borrower's deposit accounts
including Account Number ______________________ for principal and interest
payments or any amounts Borrower owes Bank when due. Bank shall notify Borrower
when it debits Borrower's accounts. These debits are not a set-off.
3
<PAGE>
3 CONDITIONS OF LOANS
3.1 CONDITIONS PRECEDENT TO INITIAL CREDIT EXTENSION. The obligation of
Bank to make the initial Credit Extension is subject to the condition precedent
that Bank shall have received, in form and substance satisfactory to Bank, the
following:
(1) this Agreement;
(2) a certificate of the Secretary of Borrower with respect to
articles, bylaws, incumbency and resolutions authorizing the execution and
delivery of this Agreement;
(3) an opinion of Borrower's counsel;
(4) financing statements (Forms UCC-1);
(5) insurance certificate;
(6) payment of the fees and Bank Expenses then due specified in
Section 2.3 hereof;
(7) Certificate of Good Standing/Legal Existence;
(8) Certificate of Foreign Qualification (if applicable); and
(9) such other documents, and completion of such other matters, as
Bank may reasonably deem necessary or appropriate.
3.2 CONDITIONS PRECEDENT TO ALL CREDIT EXTENSIONS. Bank's obligations to
make each Credit Extension, including the initial Credit Extension, is subject
to the following:
(1) timely receipt of a completed Loan Supplement and UCC financing
statement covering the Financed Equipment described on Annex A to the Loan
Supplement; and
(2) the representations and warranties in Section 5 must be materially
true on the date of the Loan Supplement and on the effective date of each Credit
Extension and no Event of Default may have occurred and be continuing, or result
from the Credit Extension. Each Credit Extension is Borrower's representation
and warranty on that date that the representations and warranties in Section 5
remain true.
(3) the Bank shall have the opportunity to confirm that upon filing
the UCC-1 financing statement covering the Equipment described on the Loan
Supplement, that the Bank shall have a first perfected security interest in such
Equipment.
4
<PAGE>
4 CREATION OF SECURITY INTEREST
4.1 GRANT OF SECURITY INTEREST. Borrower grants Bank a continuing
security interest in all presently existing and later acquired Collateral to
secure all Obligations and performance of each of Borrower's duties under the
Loan Documents. Any security interest shall be a first priority security
interest in the Collateral. If the Agreement is terminated, Bank's lien and
security interest in the Collateral shall continue until Borrower fully
satisfies its Obligations. Upon termination of this Agreement and satisfaction
of the Obligations, Bank shall release its security interest in all Collateral,
and shall execute all documents and take all actions reasonably requested by
Borrower in connection therewith.
5 REPRESENTATIONS AND WARRANTIES
Borrower represents and warrants as follows:
5.1 DUE ORGANIZATION AND AUTHORIZATION. Borrower and each Subsidiary is
duly existing and in good standing in its state of formation and qualified and
licensed to do business in, and in good standing in, any state in which the
conduct of its business or its ownership of property requires that it be
qualified.
The execution, delivery and performance of the Loan Documents have been
duly authorized, and do not conflict with Borrower's organizational documents,
nor constitute an event of default under any material agreement by which
Borrower is bound. Borrower is not in default under any agreement to which or
by which it is bound in which the default could reasonably be expected to cause
a Material Adverse Change.
5.2 COLLATERAL. Borrower has good title to the Collateral, free of Liens.
5.3 LITIGATION. Except as shown in the Schedule, there are no actions or
proceedings pending or, to Borrower's knowledge, threatened by or against
Borrower or any Subsidiary in which an adverse decision could could reasonably
be expected to cause a Material Adverse Change.
5.4 NO MATERIAL ADVERSE CHANGE IN FINANCIAL STATEMENTS. All consolidated
financial statements for Borrower and any Subsidiary delivered to Bank fairly
present in all material respects Borrower's consolidated financial condition and
Borrower's consolidated results of operations. There has not been any material
deterioration in Borrower's consolidated financial condition since the date of
the most recent financial statements submitted to Bank.
5.5 SOLVENCY. Borrower is able to pay its debts (including trade debts)
as they mature.
5.6 REGULATORY COMPLIANCE. Borrower is not an "investment company" or a
company "controlled" by an "investment company" under the Investment Company
Act. Borrower is not engaged as one of its important activities in extending
credit for margin stock (under Regulations T and U of the Federal Reserve Board
of Governors). Borrower has complied with the Federal Fair
5
<PAGE>
Labor Standards Act. Borrower has not violated any laws, ordinances or rules,
the violation of which could reasonably be expected to cause a Material Adverse
Change. None of Borrower's or any Subsidiary's properties or assets has been
used by Borrower or any Subsidiary or, to the best of Borrower's knowledge, by
previous Persons, in disposing, producing, storing, treating, or transporting
any hazardous substance other than legally. Borrower and each Subsidiary has
timely filed all required tax returns and paid, or made adequate provision to
pay, all material taxes. Borrower and each Subsidiary has obtained all consents,
approvals and authorizations of, made all declarations or filings with, and
given all notices to, all government authorities that are necessary to continue
its business as currently conducted.
5.7 SUBSIDIARIES. Borrower does not own any stock, partnership interest
or other equity securities.
5.8 FULL DISCLOSURE. No representation, warranty or other statement of
Borrower in any certificate or written statement given to Bank contains any
untrue statement of a material fact or omits to state a material fact necessary
to make the statements contained in the certificates or statements, in light of
the circumstances in which they were made, not misleading.
6 AFFIRMATIVE COVENANTS
Borrower shall do all of the following:
6.1 GOVERNMENT COMPLIANCE. Borrower shall maintain its and all
Subsidiaries' corporate existence and good standing in its jurisdiction of
incorporation and maintain qualification in each jurisdiction in which the
failure to so qualify could have a material adverse effect on Borrower's
business or operations. Borrower shall comply, and have each Subsidiary comply,
with all laws, ordinances and regulations to which it is subject, noncompliance
with which could have a material adverse effect on Borrower's business or
operations or cause a Material Adverse Change.
6.2 FINANCIAL STATEMENTS, REPORTS, CERTIFICATES.
(1) Borrower shall deliver to Bank: (i) a company prepared
consolidated balance sheet and income statement covering Borrower's consolidated
operations during the period, in a form acceptable to Bank and certified by a
Responsible Officer (a) prior to the occurrence of the Capitalization Event, as
soon as available, but no later than thirty (30) days after the last day of each
month, and (b) upon and after the occurrence of the Capitalization Event, as
soon as available, but no later than forty five (45) days after the last day of
each quarter; (ii) as soon as available, but no later than ninety (90) days
after the end of Borrower's fiscal year, audited consolidated financial
statements prepared under GAAP, consistently applied, together with an
unqualified opinion on the financial statements from an independent certified
public accounting firm acceptable to Bank; (iii) within five (5) days of filing,
copies of all statements, reports and notices made available to Borrower's
security holders or to any holders of Subordinated Debt and all reports on Form
10-K, 10-Q and 8-K filed with the Securities and Exchange Commission; (iv) a
prompt report of any legal actions pending or threatened against Borrower or any
Subsidiary that could result in damages or
6
<PAGE>
costs to Borrower or any Subsidiary of Two Hundred Thousand Dollars
($200,000.00) or more; and (v) other financial information Bank reasonably
requests.
(2) Borrower shall deliver to Bank with the financial statements, a
Compliance Certificate signed by a Responsible Officer in the form of Exhibit C
as follows: (i) if prior to the occurrence of the Capitalization Event, within
thirty (30) days after the last day of each month, and (ii) upon and after the
occurrence of the Capitalization Event, within forty five (45) days after the
last day of each quarter.
6.3 TAXES. Borrower shall make, and cause each Subsidiary to make, timely
payment of all material federal, state, and local taxes or assessments owing by
Borrower and shall deliver to Bank, on demand, appropriate certificates
attesting to such payments.
6.4 INSURANCE. Borrower shall keep its business and the Collateral
insured for risks and in amounts, as Bank requests. Insurance policies shall be
in a form, with companies, and in amounts that are reasonably satisfactory to
Bank. All property policies shall have a lender's loss payable endorsement
showing Bank as an additional loss payee and all liability policies shall show
the Bank as an additional insured and all policies shall provide that the
insurer must give Bank at least twenty (20) days notice before canceling its
policy. At Bank's request, Borrower shall deliver certified copies of policies
and evidence of all premium payments. Proceeds payable under any policy shall,
at Bank's option, be payable to Bank on account of the Obligations.
Notwithstanding the foregoing and subject to Section 6.7 below, so long as no
Event of Default has occurred and is continuing, Borrower shall have the option
of applying the proceeds of any casualty policy up to Five Thousand Dollars
($5,000.00) toward the replacement or repair of destroyed or damaged property;
provided that (i) any such replaced or repaired property (a) shall be of equal
or like value as the replaced or repaired Collateral and (b) shall be deemed
Collateral in which Bank has been granted a first priority security interest and
(ii) after the occurrence and during the continuation of an Event of Default all
proceeds payable under such casualty policy shall, at the option of the Bank, be
payable to Bank on account of the Obligations.
6.5 PRIMARY ACCOUNTS. Borrower shall maintain an operating account with
Bank. On the Closing Date, Borrower shall deposit at least Two Million Five
Hundred Thousand Dollars ($2,500,000.00) with the Bank. Upon the occurrence of
the Capitalization Event, Borrower shall deposit with Bank an additional Five
Million Dollars ($5,000,000.00).
6.6 FURTHER ASSURANCES. Borrower shall execute any further instruments
and take further action as Bank requests to perfect or continue Bank's security
interest in the Collateral or to effect the purposes of this Agreement.
6.7 LOSS; DESTRUCTION; OR DAMAGE. Borrower shall bear the risk of the
Financed Equipment being lost, stolen, destroyed, or damaged. If during the
term of this Agreement any item of Financed Equipment becomes obsolete or is
lost, stolen, destroyed, damaged beyond repair, rendered permanently unfit for
use, or seized by a governmental authority for any reason for a period
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<PAGE>
equal to at least the remainder of the term of this Agreement (an "Event of
Loss"), then in each case, Borrower:
(1) prior to the occurrence of an Event of Default, at Borrower's
option, shall (i) pay to Bank on account of the Obligations all accrued interest
to the date of the prepayment, plus all outstanding principal, plus the Final
Payment; or (ii) repair or replace any Financed Equipment subject to an Event of
Loss provided the repaired or replaced Financed Equipment is of equal or like
value to the Financed Equipment subject to an Event of Loss and provided further
that Bank has a first priority perfected security interest in such repaired or
replaced Financed Equipment.
(2) during the continuance of an Event of Default, on or before the
next Payment Date following such Event of Loss, for each such item of Financed
Equipment subject to such Event of Loss, Borrower shall, at Bank's option, pay
to Bank an amount equal to the sum of: (i) all accrued and unpaid Scheduled
Payments (with respect to such Equipment Advance related to the Event of Loss)
due prior to the next such Payment Date, (ii) all outstanding principal plus
unpaid accrued interest), (iii) the Final Payment plus (iv) all other sums, if
any, that shall have become due and payable, including interest at the Default
Rate with respect to any past due amounts.
(3) On the date of receipt by Bank of the amount specified above with
respect to each such item of Financed Equipment subject to an Event of Loss,
this Agreement shall terminate as to such Financed Equipment. If any proceeds of
insurance or awards received from governmental authorities are in excess of the
amount owed under this Section, Bank shall promptly remit to Borrower the amount
in excess of the amount owed to Bank.
7 NEGATIVE COVENANTS
Borrower shall not do any of the following without the Bank's written
consent, which shall not be unreasonably withheld:
7.1 DISPOSITIONS. Convey, sell, lease, transfer or otherwise dispose of
(collectively a "Transfer"), or permit any of its Subsidiaries to Transfer, all
or any material part of the Collateral, other than a Transfer (i) of inventory
in the ordinary course of business; (ii) of non-exclusive licenses and similar
arrangements for the use of the property of Borrower or its Subsidiaries in the
ordinary course of business; or (iii) of worn-out or obsolete Equipment.
7.2 CHANGES IN BUSINESS, OWNERSHIP, MANAGEMENT OR BUSINESS LOCATIONS.
Engage in or permit any of its Subsidiaries to engage in any business other than
the businesses currently engaged in by Borrower or if either the Chief
Financial Officer or the Chief Executive Officer leaves office and a replacement
acceptable to the Bank is not made within thirty (30) days. Borrower shall not,
without at least thirty (30) days prior written notice to Bank, relocate its
principal executive office or add any new offices or business locations.
7.3 COMPLIANCE. Undertake as one of its important activities extending
credit to purchase or carry margin stock, or use the proceeds of any Equipment
Advance for that purpose; fail to meet
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<PAGE>
the minimum funding requirements of ERISA, permit a Reportable Event or
Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the
Federal Fair Labor Standards Act or violate any other law or regulation, if the
violation could reasonably be expected to have a material adverse effect on
Borrower's business or operations or cause a Material Adverse Change, or permit
any of its Subsidiaries to do so.
8 EVENTS OF DEFAULT
Any one of the following is an Event of Default:
8.1 PAYMENT DEFAULT. Borrower fails to pay any of the Obligations within
three (3) days after their due date. During the additional period the failure to
cure the default is not an Event of Default (but no Credit Extensions shall be
made during the cure period);
8.2 COVENANT DEFAULT. Borrower does not perform any obligation in
Section 6 or violates any covenant in Section 7 or does not perform or observe
any other material term, condition or covenant in this Agreement, any Loan
Documents, or in any agreement between Borrower and Bank and as to any default
under a term, condition or covenant that can be cured, has not cured the default
within ten (10) days after it occurs, or if the default cannot be cured within
ten (10) days or cannot be cured after Borrower's attempts in the ten (10) day
period, and the default may be cured within a reasonable time, then Borrower
shall have additional time, (of not more than thirty (30) days) to attempt to
cure the default. During the additional period the failure to cure the default
is not an Event of Default (but no Credit Extensions shall be made during the
cure period);
8.3 MATERIAL ADVERSE CHANGE. (i) A material impairment in the perfection
or priority of Bank's security interest in the Collateral or in the value of
such Collateral which is not covered by adequate insurance occurs; or (ii) Bank
determines, based upon information available to it and in its reasonable
judgment, that there is a reasonable likelihood that Borrower shall fail to
comply with one or more of the financial covenants in Section 6 during the next
succeeding financial reporting period;
8.4 ATTACHMENT. (i) Any material portion of Borrower's assets is
attached, seized, levied on, or comes into possession of a trustee or receiver
and the attachment, seizure or levy is not removed in thirty (30) days; (ii)
Borrower is enjoined, restrained, or prevented by court order from conducting a
material part of its business; (iii) a judgment or other claim becomes a Lien on
a material portion of Borrower's assets; or (iv) a notice of lien, levy, or
assessment is filed against any of Borrower's assets by any government agency
and not paid within ten (10) days after Borrower receives notice. These are not
Events of Default if stayed or if a bond is posted pending contest by Borrower
(but no Credit Extensions shall be made during the cure period);
8.5 INSOLVENCY. (i) Borrower becomes insolvent; (ii) Borrower begins an
Insolvency Proceeding; or (iii) an Insolvency Proceeding is begun against
Borrower and not dismissed or stayed within forty-five (45) days (but no Credit
Extensions shall be made before any Insolvency Proceeding is dismissed);
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<PAGE>
8.6 OTHER AGREEMENTS. If there is a default in any agreement to which
Borrower is a party with a third party or parties resulting in a right by such
third party or parties, whether or not exercised, to accelerate the maturity of
any Indebtedness in an amount in excess of Two Hundred Fifty Thousand Dollars
($250,000) or that could have a Material Adverse Effect;
8.7 JUDGMENTS. If a judgment or judgments for the payment of money in an
amount, individually or in the aggregate, of at least Two Hundred Fifty Thousand
Dollars ($250,000) shall be rendered against Borrower and shall remain
unsatisfied and unstayed for a period of thirty (30) days (provided that no
Credit Extensions will be made prior to the satisfaction or stay of such
judgment);
8.8 MISREPRESENTATIONS. If Borrower or any Person acting for Borrower
makes any material misrepresentation or material misstatement now or later in
any warranty or representation in this Agreement or in any communication
delivered to Bank or to induce Bank to enter this Agreement or any Loan
Document.
9 BANK'S RIGHTS AND REMEDIES
9.1 RIGHTS AND REMEDIES. When an Event of Default occurs and continues
Bank may, without notice or demand, do any or all of the following in accordance
with applicable law:
(1) Declare all Obligations immediately due and payable (but if an
Event of Default described in Section 8.5 occurs all Obligations are
immediately due and payable without any action by Bank);
(2) Stop advancing money or extending credit for Borrower's benefit
under this Agreement or under any other agreement between Borrower and
Bank;
(3) Make any payments and do any acts it considers necessary or
reasonable to protect its security interest in the Collateral. Borrower
shall assemble the Collateral if Bank requests and make it available as
Bank designates. Bank may enter premises where the Collateral is located,
take and maintain possession of any part of the Collateral, and pay,
purchase, contest, or compromise any Lien which appears to be prior or
superior to its security interest and pay all expenses incurred. Borrower
grants Bank a license to enter and occupy any of its premises, without
charge, to exercise any of Bank's rights or remedies;
(4) Apply to the Obligations any (i) balances and deposits of Borrower
it holds, or (ii) any amount held by Bank owing to or for the credit or the
account of Borrower;
(5) Ship, reclaim, recover, store, finish, maintain, repair, prepare
for sale, advertise for sale, and sell the Collateral; and
(6) Dispose of the Collateral according to the Code.
10
<PAGE>
9.2 POWER OF ATTORNEY. Borrower hereby irrevocably appoints Bank as its
lawful attorney-in-fact, to be effective upon the occurrence and during the
continuance of an Event of Default, to: (i) endorse Borrower's name on any
checks or other forms of payment or security; (ii) make, settle, and adjust all
claims under Borrower's insurance policies; and (iii) transfer the Collateral
into the name of Bank or a third party as the Code permits. Borrower hereby
appoints Bank its power of attorney to sign Borrower's name on any documents
necessary to perfect or continue the perfection of any security interest
regardless of whether an Event of Default has occurred until all Obligations
have been satisfied in full and Bank is under no further obligation to make
Credit Extensions hereunder. Bank's foregoing appointment as Borrower's
attorney in fact, and all of Bank's rights and powers, coupled with an interest,
are irrevocable until all Obligations have been fully repaid and performed and
Bank's obligation to provide Credit Extensions terminates.
9.3 BANK EXPENSES. If Borrower fails to obtain insurance as required
under Section 6.4 or to pay any amount or furnish any required proof of payment
to third persons and the Bank, Bank may make all or part of the payment or
obtain such insurance policies required in Section 6.4, and take any action
under the policies Bank deems prudent. Any amounts paid by Bank as provided
herein are Bank Expenses and are immediately due and payable, bearing interest
at the then applicable rate and secured by the Collateral. No payments by Bank
are deemed an agreement to make similar payments in the future or Bank's waiver
of any Event of Default.
9.4 BANK'S LIABILITY FOR COLLATERAL. So long as the Bank complies with
reasonable banking practices and applicable law regarding the safekeeping of
collateral, the Bank shall not be liable or responsible for: (a) the safekeeping
of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution
in the value of the Collateral; or (d) any act or default of any carrier,
warehouseman, bailee, or other person. Borrower bears all risk of loss, damage
or destruction of the Collateral.
9.5 REMEDIES CUMULATIVE. Bank's rights and remedies under this Agreement,
the Loan Documents, and all other agreements are cumulative. Bank has all
rights and remedies provided under the Code, by law, or in equity. Bank's
exercise of one right or remedy is not an election, and Bank's waiver of any
Event of Default is not a continuing waiver. Bank's delay is not a waiver,
election, or acquiescence. No waiver is effective unless signed by Bank and then
is only effective for the specific instance and purpose for which it was given.
9.6 DEMAND WAIVER. Borrower waives demand, notice of default or dishonor,
notice of payment and nonpayment, notice of any default, nonpayment at maturity,
release, compromise, settlement, extension, or renewal of accounts, documents,
instruments, chattel paper, and guaranties held by Bank on which Borrower is
liable.
10 NOTICES
All notices or demands by any party to this Agreement or any other related
agreement must be in writing and be personally delivered or sent by an overnight
delivery service, by certified mail,
11
<PAGE>
postage prepaid, return receipt requested, or by telefacsimile at the addresses
listed at the beginning of this Agreement. Either Bank or Borrower may change
its notice address by giving the other written notice.
If to Borrower: Smarterkids.com, Inc.
15 Crawford Street
Needham, Massachusetts 02494
Attn: Robert Cahill
FAX: (781) 449-4887
with a copy to: Testa, Hurwitz & Thibeault, LLP
High Street Tower
125 High Street
Boston, Massachusetts 02110
Attn: Gordon H. Hayes, Esq.
If to Bank: Silicon Valley Bank
40 William Street
Wellesley, Massachusetts 02481
Attn: Douglas W. Marshall
FAX: (781) 431-9906
with a copy to: Riemer & Braunstein LLP
Three Center Plaza
Boston, Massachusetts 02108
Attn: David A. Ephraim, Esquire
FAX: (617) 880-3456
11 CHOICE OF LAW, VENUE AND JURY TRIAL WAIVER
Massachusetts law governs the Loan Documents without regard to principles
of conflicts of law. Borrower and Bank each submit to the exclusive
jurisdiction of the State and Federal courts in Suffolk County, Massachusetts;
provided, however, that if for any reason Bank cannot avail itself of such
courts in the Commonwealth of Massachusetts, Borrower accepts jurisdiction of
the courts and venue in Santa Clara County, California.
BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE
OF ACTION ARISING OUT OF OR BASED UPON THIS AGREEMENT, THE LOAN DOCUMENTS OR ANY
CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER
CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS
AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.
12 GENERAL PROVISIONS
12.1 SUCCESSORS AND ASSIGNS. This Agreement binds and is for the benefit
of the successors and permitted assigns of each party. Borrower may not assign
this Agreement or any
12
<PAGE>
rights or Obligations under it without Bank's prior written consent which may be
granted or withheld in Bank's discretion. Bank has the right, without the
consent of or notice to Borrower, to sell, transfer, negotiate, or grant
participation in all or any part of, or any interest in, Bank's obligations,
rights and benefits under this Agreement, the Loan Documents or any related
agreement.
12.2 INDEMNIFICATION. Borrower hereby indemnifies, defends and holds the
Bank and its officers, employees and agents harmless against: (a) all
obligations, demands, claims, and liabilities asserted by any other party in
connection with the transactions contemplated by the Loan Documents; and (b) all
losses or Bank Expenses incurred, or paid by Bank from, following, or
consequential to transactions between Bank and Borrower (including reasonable
attorneys' fees and expenses), except for losses caused by Bank's gross
negligence or willful misconduct.
12.3 TIME OF ESSENCE. Time is of the essence for the performance of all
Obligations in this Agreement.
12.4 SEVERABILITY OF PROVISION. Each provision of this Agreement is
severable from every other provision in determining the enforceability of any
provision.
12.5 AMENDMENTS IN WRITING, INTEGRATION. All amendments to this Agreement
must be in writing signed by both Bank and Borrower. This Agreement and the
Loan Documents represent the entire agreement about this subject matter, and
supersedes prior or contemporaneous negotiations or agreements. All prior or
contemporaneous agreements, understandings, representations, warranties, and
negotiations between the parties about the subject matter of this Agreement and
the Loan Documents merge into this Agreement and the Loan Documents.
12.6 COUNTERPARTS. This Agreement may be executed in any number of
counterparts and by different parties on separate counterparts, each of which,
when executed and delivered, are an original, and all taken together, are one
Agreement.
12.7 SURVIVAL. All covenants, representations and warranties made in this
Agreement continue in full force while any Obligations remain outstanding. The
obligations of Borrower in Section 12.2 to indemnify Bank shall survive until
all statutes of limitations for actions that may be brought against Bank have
run.
12.8 CONFIDENTIALITY. In handling any confidential information, Bank shall
exercise the same degree of care that it exercises for its own proprietary
information, but disclosure of information may be made: (i) to Bank's
subsidiaries or affiliates in connection with their present or prospective
business relations with Borrower; (ii) to prospective transferees or purchasers
of any interest in the Loans; (iii) as required by law, regulation, subpoena, or
other order, (iv) as required in connection with Bank's examination or audit;
and (v) as Bank considers appropriate in exercising remedies under this
Agreement. Confidential information does not include information that either:
(a) is in the public domain or in Bank's possession when disclosed to Bank, or
becomes part of the public domain after disclosure to Bank; or (b) is disclosed
to Bank by a third party, if Bank does not know that the third party is
prohibited from disclosing the information.
13
<PAGE>
12.9 ATTORNEYS' FEES, COSTS AND EXPENSES. In any action or proceeding
between Borrower and Bank arising out of the Loan Documents, the prevailing
party shall be entitled to recover its reasonable attorneys' fees and other
costs and expenses incurred, in addition to any other relief to which it may be
entitled, whether or not a lawsuit is filed.
13 DEFINITIONS
13.1 DEFINITIONS.
"AFFILIATE" of a Person is a Person that owns or controls directly or
indirectly the Person, any Person that controls or is controlled by or is under
common control with the Person, and each of that Person's senior executive
officers, directors, partners and, for any Person that is a limited liability
company, that Person's managers and members.
"BANK EXPENSES" are all audit fees and expenses and reasonable costs or
expenses (including reasonable attorneys' fees and expenses) for preparing,
negotiating, administering, defending and enforcing the Loan Documents
(including appeals or Insolvency Proceedings).
"BASIC RATE" is, as of the Funding Date the per annum rate of interest
(based on a year of 360 days) equal to the sum of (a) U.S. Treasury note yield
to maturity for a term equal to the Treasury Note Maturity as quoted in the Wall
Street Journal on the day the Loan Supplement is prepared, plus (b) the Loan
Margin.
"BUSINESS DAY" is any day that is not a Saturday, Sunday or a day on which
the Bank is closed.
"CAPITALIZATION EVENT" is the making and completion by the Borrower of an
initial public offering.
"CHIEF EXECUTIVE OFFICER" is David Blohm.
"CHIEF FINANCIAL OFFICER" is Robert Cahill.
"CLOSING DATE" is the date of this Agreement.
"CODE" is the Massachusetts Uniform Commercial Code.
"COLLATERAL" is the property described on Exhibit A.
---------
"COMMITTED EQUIPMENT LINE" is an Equipment Advance or Equipment Advances
of up to One Million Five Hundred Thousand Dollars ($1,500,000.00).
14
<PAGE>
"COMMITMENT TERMINATION DATE" shall be the date which is the one year
anniversary of the Closing Date.
"CONTINGENT OBLIGATION" is, for any Person, any direct or indirect
liability, contingent or not, of that Person for (i) any indebtedness, lease,
dividend, letter of credit or other obligation of another such as an obligation
directly or indirectly guaranteed, endorsed, co-made, discounted or sold with
recourse by that Person, or for which that Person is directly or indirectly
liable; (ii) any obligations for undrawn letters of credit for the account of
that Person; and (iii) all obligations from any interest rate, currency or
commodity swap agreement, interest rate cap or collar agreement, or other
agreement or arrangement designated to protect a Person against fluctuation in
interest rates, currency exchange rates or commodity prices; but "Contingent
Obligation" does not include endorsements in the ordinary course of business.
The amount of a Contingent Obligation is the stated or determined amount of the
primary obligation for which the Contingent Obligation is made or, if not
determinable, the maximum reasonably anticipated liability for it determined by
the Person in good faith; but the amount may not exceed the maximum of the
obligations under the guarantee or other support arrangement.
"CREDIT EXTENSION" is each Equipment Advance or any other extension of
credit by Bank for Borrower's benefit.
"ELIGIBLE EQUIPMENT" is (a) general purpose computer equipment, office
equipment, test and laboratory equipment, furnishings, and (b) Other Equipment
that complies with all of Borrower's representations and warranties to Bank and
which is reasonably acceptable to Bank in all respects.
"EQUIPMENT" is all present and future machinery, equipment, tenant
improvements, furniture, fixtures, vehicles, tools, parts and attachments in
which Borrower has any interest.
"EQUIPMENT ADVANCE" is defined in Section 2.1.1.
"ERISA" is the Employment Retirement Income Security Act of 1974, and its
regulations.
"EVENT OF LOSS" is defined in Section 6.7.
"FINAL PAYMENT" is a payment (in addition to and not a substitution for the
regular monthly payments of principal plus accrued interest) due on the Maturity
Date for such Equipment Advance equal to the Loan Amount for such Equipment
Advance at such time multiplied by the Final Payment Percentage.
"FINAL PAYMENT PERCENTAGE" is, for each Equipment Advance, five percent
(5.0%).
"FINANCED EQUIPMENT" is all present and future Eligible Equipment in which
Borrower has any interest, the
purchase of which is financed by an Equipment Advance.
15
<PAGE>
"FUNDING DATE" is any date on which an Equipment Advance is made to or on
account of Borrower.
"GAAP" is generally accepted accounting principles.
"INDEBTEDNESS" is (a) indebtedness for borrowed money or the deferred price
of property or services, such as reimbursement and other obligations for surety
bonds and letters of credit, (b) obligations evidenced by notes, bonds,
debentures or similar instruments, (c) capital lease obligations and (d)
Contingent Obligations.
"INSOLVENCY PROCEEDING" is any proceeding by or against any Person under
the United States Bankruptcy Code, or any other bankruptcy or insolvency law,
including assignments for the benefit of creditors, compositions, extensions
generally with its creditors, or proceedings seeking reorganization,
arrangement, or other relief.
"LIEN" is a mortgage, lien, deed of trust, charge, pledge, security
interest or other encumbrance.
"LOAN AMOUNT" in respect of each Equipment Advance is the aggregate amount
of such Equipment Advance.
"LOAN DOCUMENTS" are, collectively, this Agreement, any note executed by
Borrower, and any other present or future agreement between Borrower and/or for
the benefit of Bank in connection with this Agreement, all as amended, extended
or restated.
"LOAN FACTOR" is the percentage which results from dividing (i) the monthly
Scheduled Payment with respect to the applicable Equipment Advance by (ii) the
original principal amount of such Equipment Advance.
"LOAN MARGIN" is three hundred fifty (350) basis points.
"LOAN SUPPLEMENT" is defined in Section 2.1.1(b) and attached as Exhibit B.
---------
"MATERIAL ADVERSE CHANGE " is defined in Section 8.3.
"MATURITY DATE" is, with respect to each Equipment Advance, the last day of
the Repayment Period for such Equipment Advance, or if earlier, the date of
acceleration of such Equipment Advance by Bank following an Event of Default.
"OBLIGATIONS" are debts, principal, interest, Bank Expenses and other
amounts Borrower owes Bank now or later, including letters of credit and foreign
exchange contracts, if any, and including interest accruing after Insolvency
Proceedings begin and debts, liabilities, or obligations of Borrower assigned to
Bank.
16
<PAGE>
"ORIGINAL STATED COST" is: (i) the original cost to the Borrower of the
item of new Equipment net of any and all freight, installation, tax, or (ii)
the fair market value assigned to such item of used Equipment by mutual
agreement of Borrower and Bank at the time of making of the Equipment Advance.
"OTHER EQUIPMENT" is leasehold improvements, intangible property such as
computer software and software licenses, equipment specifically designed or
manufactured for Borrower, other intangible property, limited use property and
other similar property and soft costs approved by the Bank, including sales tax,
freight and installation expenses. Unless otherwise agreed to by Bank, not more
than 25% of the aggregate Equipment Advances shall consist of Other Equipment.
"PAYMENT DATE" is defined in Section 2.2(a).
"PERSON" is any individual, sole proprietorship, partnership, limited
liability company, joint venture, company, trust, unincorporated organization,
association, corporation, institution, public benefit corporation, firm, joint
stock company, estate, entity or government agency.
"REPAYMENT PERIOD," as to each Equipment Advance, is thirty six (36) months
from the Funding Date of such Equipment Advance.
"RESPONSIBLE OFFICER" is each of the Chief Executive Officer, President,
Chief Financial Officer and Controller of Borrower.
"SCHEDULE" is any attached schedule of exceptions.
"SCHEDULED PAYMENT" is defined in Section 2.2(a).
"SUBORDINATED DEBT" is debt incurred by Borrower subordinated to Borrower's
debt to Bank (pursuant to a subordination agreement entered into between the
Bank, the Borrower and the subordinated creditor).
"SUBSIDIARY" is for any Person, joint venture, or any other business entity
of which more than 50% of the voting stock or other equity interests is owned or
controlled, directly or indirectly, by the Person or one or more Affiliates of
the Person.
"TREASURY NOTE MATURITY" is thirty six (36) months.
17
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as a sealed instrument under the laws of the Commonwealth of
Massachusetts as of the date first above written.
BORROWER:
SMARTERKIDS.COM, INC.
By_________________________________________
Name:______________________________________
Title:_____________________________________
BANK:
SILICON VALLEY BANK, d/b/a
SILICON VALLEY EAST
By_________________________________________
Name:______________________________________
Title:_____________________________________
SILICON VALLEY BANK
By_________________________________________
Name:______________________________________
Title:_____________________________________
(Signed in Santa Clara County, California)
525425.4 (56120/232)
18
<PAGE>
EXHIBIT A
---------
The Collateral consists of all of Borrower's right, title and interest in
and to the following:
Each item of equipment, or personal property financed with a "Equipment
Advance" pursuant to that certain Loan and Security Agreement, dated as of
_______________________________, 1999 (the "Loan Agreement"), by and between
Borrower and Bank, including, without limitation, the property described in
Annex A hereto, whether now owned or hereafter acquired, together with all
substitutions, renewals or replacements of and additions, improvements, and
accessions to any and all of the foregoing, and all proceeds from sales,
renewals, releases or other dispositions thereof.
19
<PAGE>
ANNEX A TO EXHIBIT A
--------------------
The Financed Equipment being financed with the Equipment Advance is listed
below. Upon the funding of such Equipment Advance, this schedule automatically
shall be deemed to be a part of the Collateral.
Description of Equipment Make Model Serial # Invoice#
20
<PAGE>
EXHIBIT B
---------
FORM OF LOAN AGREEMENT SUPPLEMENT
LOAN AGREEMENT SUPPLEMENT No. [ ]
LOAN AGREEMENT SUPPLEMENT No. [ ], dated ______________, ______
("Supplement"), to the Loan and Security Agreement dated as of ______________,
1999 (the "Loan Agreement) by and between the undersigned Smarterkids.com, Inc.
("Borrower"), and Silicon Valley Bank ("Bank").
Capitalized terms used herein but not otherwise defined herein are used
with the respective meanings given to such terms in the Loan Agreement.
To secure the prompt payment by Borrower of all amounts from time to time
outstanding under the Loan Agreement, and the performance by Borrower of all the
terms contained in the Loan Agreement, Borrower grants Bank, a first priority
security interest in each item of equipment and other property described in
Annex A hereto, which equipment and other property shall be deemed to be
additional Financed Equipment and Collateral. The Loan Agreement is hereby
incorporated by reference herein and is hereby ratified, approved and confirmed.
Annex A (Equipment Schedule) and Annex B (Loan Terms Schedule) are attached
hereto. The proceeds of the Loan should be transferred to Borrower's account
with Bank set forth below:
Bank Name: Silicon Valley Bank
Account No.: ____________________________
Borrower hereby certifies that (a) the foregoing information is true and correct
and authorizes Bank to endorse in its respective books and records, the Basic
Rate applicable to the Funding Date of the Loan contemplated in this Loan
Agreement Supplement and the principal amount set forth in the Loan Terms
Schedule; (b) the representations and warranties made by Borrower in the Loan
Agreement are true and correct on the date hereof and shall be true and correct
on such Funding Date. No Event of Default has occurred and is continuing under
the Loan Agreement. This Supplement may be executed by Borrower and Bank in
separate counterparts, each of which when so executed and delivered shall be an
original, but all such counterparts shall together constitute but one and the
same instrument.
This Supplement is delivered as of this day and year first above written.
SILICON VALLEY BANK SMARTERKIDS.COM, INC.
By: By:
------------------------------ ------------------------------
Name: Name:
---------------------------- ----------------------------
Title: Title:
--------------------------- ---------------------------
Annex A - Description of Financed Equipment
Annex B - Loan Terms Schedule
21
<PAGE>
ANNEX A TO EXHIBIT B
--------------------
The Financed Equipment being financed with the Equipment Advance which this
Loan Agreement Supplement is being executed is listed below. Upon the funding
of such Equipment Advance, this schedule automatically shall be deemed to be a
part of the Collateral.
Description of Equipment Make Model Serial # Invoice#
22
<PAGE>
ANNEX B TO EXHIBIT B
LOAN TERMS SCHEDULE #______
Loan Funding Date: _____________, ____
Original Loan Amount: $____________
Basic Rate: ______%
Loan Factor: ______%
Scheduled Payment Dates and Amounts*:
One (1) payment of $_______ due ______________
______ payment of $_______ due monthly in advance from _____ through_____.
One (1) payment of $_______ due ______________
Maturity Date: ____________
Final Payment: An additional amount equal to the Final Payment Percentage
multiplied by the Loan Amount then in effect, shall be paid on
the Maturity Date with respect to such Loan.
Payment No. Payment Date
1
2
3
4
. . .
35
[36]
. . .
*/ The amount of each Scheduled Payment shall change as the Loan Amount changes.
23
<PAGE>
EXHIBIT C
COMPLIANCE CERTIFICATE
TO: SILICON VALLEY BANK
FROM: SMARTERKIDS.COM, INC.
The undersigned authorized officer of SMARTERKIDS.COM, INC. certifies that
under the terms and conditions of the Loan and Security Agreement between
Borrower and Bank (the "Agreement"), (i) Borrower is in complete compliance for
the period ending _______________ with all required covenants except as noted
below and (ii) all representations and warranties in the Agreement are true and
correct in all material respects on this date. Attached are the required
documents supporting the certification. The Officer certifies that these are
prepared in accordance with Generally Accepted Accounting Principles (GAAP)
consistently applied from one period to the next except as explained in an
accompanying letter or footnotes. The Officer acknowledges that no borrowings
may be requested at any time or date of determination that Borrower is not in
compliance with any of the terms of the Agreement, and that compliance is
determined not just at the date this certificate is delivered.
PLEASE INDICATE COMPLIANCE STATUS BY CIRCLING YES/NO UNDER "COMPLIES"
COLUMN.
<TABLE>
<CAPTION>
REPORTING COVENANT REQUIRED COMPLIES
- ------------------ -------- --------
<S> <C> <C>
Financial statements with Compliance Certificate (a) Prior to Capitalization Event: Monthly within 30 days Yes No
(b) After Capitalization Event: Quarterly within 45 days Yes No
Annual (CPA Audited) FYE within 90 days Yes No
10-Q, 10-K and 8-K Within 5 days after filing with SEC Yes No
COVENANTS REQUIRED ACTUAL COMPLIES
- --------- -------- ------ --------
Deposit at Closing $2,500,000.00 $_______ Yes No
Deposit at Occurrence of Capitalization Event $5,000,000.00 $_______ Yes No
</TABLE>
COMMENTS REGARDING EXCEPTIONS: See Attached.
---------------------------------------
Sincerely, BANK USE ONLY
_____________________________ Received by: _____________________
Signature AUTHORIZED SIGNER
_____________________________ Date: _________________________
Title
Verified: ________________________
_____________________________ AUTHORIZED SIGNER
Date
Date: ______________________
525425.4 (56120/232)
Compliance Status: Yes No
3
---------------------------------------
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-2000 DEC-31-1999
<PERIOD-START> JAN-01-2000 JAN-01-1999
<PERIOD-END> MAR-31-2000 MAR-31-1999
<CASH> 16,984 2,730
<SECURITIES> 33,437 0
<RECEIVABLES> 40 739
<ALLOWANCES> 27 27
<INVENTORY> 7,237 95
<CURRENT-ASSETS> 2,727 241
<PP&E> 3,887 51
<DEPRECIATION> 279 7
<TOTAL-ASSETS> 65,346 3,857
<CURRENT-LIABILITIES> 9,017 3,239
<BONDS> 0 0
0 0
0 10,287
<COMMON> 204 16
<OTHER-SE> 55,288 (9,684)
<TOTAL-LIABILITY-AND-EQUITY> 65,346 3,857
<SALES> 1,469 94
<TOTAL-REVENUES> 1,469 94
<CGS> 1,101 69
<TOTAL-COSTS> 1,101 69
<OTHER-EXPENSES> 9,327 2,929
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 4 1
<INCOME-PRETAX> (8,131) (2,880)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (8,131) (2,880)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (8,131) (2,880)
<EPS-BASIC> (.40) (1.77)
<EPS-DILUTED> (.40) (1.77)
</TABLE>
