<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended OCTOBER 31, 1998
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-20035
NATURAL WONDERS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0141610
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
4209 TECHNOLOGY DRIVE, FREMONT, CALIFORNIA 94538
(Address of principal executive offices)
(Zip code)
510-252-9600
(Registrant's telephone number, including area code)
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 reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
---
Common stock outstanding as of November 28, 1998: 7,943,489 shares of common
stock.
1 of 12
<PAGE>
NATURAL WONDERS, INC.
INDEX
<TABLE>
<CAPTION>
Page
Number
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Condensed Statement of Operations 3
Quarters ended October 31, 1998 and November 1, 1997
Condensed Balance Sheets 4
October 31, 1998, January 31, 1998 and November 1, 1997
Condensed Statements of Cash Flows 5
Nine months ended October 31, 1998 and November 1, 1997
Notes to Condensed Financial Statements for the 6
period ended October 31, 1998
ITEM 2. Management's Discussion and Analysis of 7-10
Financial Condition and Results of Operations
PART II. OTHER INFORMATION 11
ITEM 1. Legal Proceedings -- None
ITEM 2. Changes in Securities -- None
ITEM 3. Defaults Upon Senior Securities -- None
ITEM 4. Submission of Matters to a Vote of Security Holders -- None
ITEM 5. Other Information -- None
ITEM 6. Exhibits and Reports on Form 8-K -- None
SIGNATURE 12
</TABLE>
2 of 12
<PAGE>
NATURAL WONDERS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
-------------------------- -------------------------
OCTOBER 31, NOVEMBER 1, OCTOBER 31, NOVEMBER 1,
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales $ 24,464 $ 25,199 $ 75,173 $ 74,285
Cost of goods sold and
store occupancy expenses 18,786 17,688 58,184 54,266
---------- ---------- ---------- ----------
Gross margin 5,678 7,511 16,989 20,019
Selling, general & administrative expenses 10,426 10,828 31,417 30,486
---------- ---------- ---------- ----------
Operating loss (4,748) (3,317) (14,428) (10,467)
Interest expense 158 153 285 445
Interest income and other, net 150 (118) 202 66
---------- ---------- ---------- ----------
Loss before taxes (4,756) (3,588) (14,511) (10,846)
Income tax benefit (1,760) (1,399) (5,369) (4,231)
---------- ---------- ---------- ----------
Net loss $ (2,996) $ (2,189) $ (9,142) $ (6,615)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net loss per common share:
Basic $ (0.38) $ (0.27) $ (1.14) $ (0.83)
Diluted $ (0.38) $ (0.27) $ (1.14) $ (0.83)
Weighted average common shares outstanding
Basic 7,978 8,005 8,037 7,995
Diluted 7,978 8,005 8,037 7,995
</TABLE>
See notes to financial statements
3 of 12
<PAGE>
NATURAL WONDERS, INC.
CONDENSED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31, NOVEMBER 1,
1998 1998 1997
----------- ----------- -----------
ASSETS
<S> <C> <C> <C>
Current Assets:
Cash and cash equivalents $ 14 $ 6,351 $ 1,887
Short-term investments 0 13,400 0
Merchandise inventories 38,693 23,184 46,519
Prepaid expenses and other current assets 11,471 5,332 9,260
-------- -------- --------
Total current assets 50,178 48,267 57,666
Property and Equipment:
Leasehold improvements 30,173 28,818 27,628
Property and equipment under capital lease 4,189 4,993 7,963
Furniture, fixtures and equipment 28,925 27,232 22,141
-------- -------- --------
63,287 61,043 57,732
Less accumulated depreciation and amortization (35,662) (32,200) (30,895)
-------- -------- --------
27,625 28,843 26,837
Other Assets 2,226 2,227 1,788
-------- -------- --------
Total Assets $ 80,029 $ 79,337 $ 86,291
-------- -------- --------
-------- -------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Trade accounts payable $ 12,216 $ 7,997 $ 13,623
Accrued compensation and related costs 1,467 2,825 2,346
Accrued liabilities 2,133 3,636 3,774
Short-term borrowings 14,500 0 11,000
Income taxes payable 0 1,857 0
Current portion of capital lease obligations 0 866 1,148
Current portion of long-term debt 0 1,405 1,221
-------- -------- --------
Total current liabilities 30,316 18,586 33,112
Capital Lease Obligations 0 461 527
Long-Term Debt 0 683 1,164
Deferred Rents 3,630 3,805 3,884
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $.0001; authorized
17,000,000 shares; outstanding
7,942,289; 8,072,109; and 8,007,098 shares 1 1 1
Capital in excess of par value 34,810 34,528 34,313
Retained earnings 12,131 21,273 13,290
-------- -------- --------
Total capital and retained earnings 46,942 55,802 47,604
Less: Treasury stock (236,100 shares) at cost 859 0 0
-------- -------- --------
Total Stockholders' Equity 46,083 55,802 47,604
-------- -------- --------
Total Liabilities and Stockholders' Equity $ 80,029 $ 79,337 $ 86,291
-------- -------- --------
-------- -------- --------
</TABLE>
See notes to financial statements
4 of 12
<PAGE>
NATURAL WONDERS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------------
OCTOBER 31, 1998 NOVEMBER 1, 1997
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (9,142) $ (6,615)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 5,411 4,566
Loss on sale of asset 978 12
Change in operating assets and liabilities:
Merchandise inventories (15,509) (25,675)
Prepaid expenses and other assets (6,139) (5,079)
Trade accounts payable 4,219 8,448
Accrued compensation and related costs (1,358) (177)
Accrued liabilities (1,503) 976
Income tax payable (1,857) (139)
Deferred rent (175) (2,044)
--------- ----------
Net cash used in operating activities (25,075) (25,727)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (6,900) (3,200)
Sales of short-term investments 20,300 21,100
Proceeds from sale of equipment 28 8
Purchases of property and equipment (5,198) (4,721)
Business acquisition 0 (738)
--------- ----------
Net cash provided by investing activities 8,230 12,449
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations (1,327) (3,565)
Principal payments on long-term debt (2,088) 0
Net borrowing on line of credit 14,500 11,000
Purchase of treasury stock (896) 0
Issuance of common stock under employee stock purchase program 37 45
Exercise of stock options and warrants 282 18
--------- ----------
Net cash provided by financing activities 10,508 7,498
NET DECREASE IN CASH AND CASH EQUIVALENTS (6,337) (5,780)
CASH AND CASH EQUIVALENTS:
Beginning of year 6,351 7,667
--------- ----------
End of period $ 14 $ 1,887
--------- ----------
--------- ----------
CASH PAID DURING PERIOD:
Interest $ 285 $ 419
Income taxes $ 1,857 $ 1,994
</TABLE>
See notes to financial statements
5 of 12
<PAGE>
NATURAL WONDERS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS FOR THE PERIOD ENDED OCTOBER 31, 1998
1. The financial statements are unaudited and reflect all adjustments
(consisting only of normal recurring adjustments) which, in the opinion
of management, are necessary for a fair presentation of the financial
position and operating results for the interim periods. The results of
operations for the quarter ended October 31, 1998 are not necessarily
indicative of the results to be expected for the entire fiscal year
ending January 30, 1999.
This financial information should be read in conjunction with the
audited financial statements and notes thereto included in the Company's
1997 Annual Report to Stockholders and Form 10-K for the fiscal year
ended January 31, 1998 as filed with the Securities and Exchange
Commission.
2. In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("FASB") No. 130,
"Reporting Comprehensive Income", which requires that an enterprise
report, by major components and as a single total, the change in its net
assets during the period from nonowner sources; and No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
which establishes annual and interim reporting standards for an
enterprise's operating segments and related disclosures about its
products, services, geographic area, and major customers. Adoption of
these statements will not materially impact the Company's financial
position, results of operations or cash flows. Both statements are
effective for fiscal years beginning after December 15, 1997, with
earlier application permitted. In June 1998, the FASB issued SFAS No.
133, "Accounting for Derivative instruments and Hedging Activities."
SFAS No. 133 requires an entity to recognize all derivatives as either
assets or liabilities on its balance sheet at their fair value. The
Company plans to adopt SFAS No. 133 on January 30, 2000, as required.
Adoption of this standard is not expected to have a material impact on
the Company's consolidated financial statements.
3. In fiscal 1997 the Board of Directors of the Company authorized the
repurchase of up to $2,000,000 of the Company's outstanding common stock.
Beginning in February 1998, the Company began repurchasing stock and as of
the end of the third quarter of fiscal 1998 had purchased 242,400 shares
for a total of $896,000.
6 of 12
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
GENERAL
As of October 31, 1998, Natural Wonders operated 194 stores in 36 states
compared to 171 stores in 36 states as of November 1, 1997. In the first nine
months of 1998, nine new permanent stores were opened, three stores were
closed, and 17 temporary holiday stores were opened as compared to three new
permanent stores and five temporary holiday stores opened in the first nine
months of fiscal 1997, as well as 12 stores acquired from What a World!,
Inc., on May 22, 1997.
SALES
During the third quarter of 1998, sales decreased 2.9% over the same
period in 1997. The decrease was primarily due to decreased comparable store
sales. Comparable store sales decreased 8.8% in the third quarter of 1998, as
compared to the same period in 1997. The decrease in the comparable store
sales in the third quarter was primarily due to continued weakness in the
Discovery, Apparel and Media merchandising areas. In the first nine months of
1998, sales increased 1.2% over the same period in 1997, due to more stores,
partially offset by decreased comparable store sales of 6.0%.
COST OF GOODS SOLD AND STORE OCCUPANCY EXPENSES
Cost of goods sold and store occupancy expenses include distribution
center costs and other expenses associated with acquiring inventory. As a
percentage of sales, these costs increased to 76.8% in the third quarter of
1998 from 70.2% in the third quarter of 1997 and 77.4% in the first nine
months of 1998 from 73.1% in the first nine months of 1997. The increase in
costs as a percentage of sales was primarily due to the low sales level.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses, (SG&A), are primarily
non-occupancy store expenses and corporate overhead. As a percentage of
sales, these costs decreased to 42.6% in the third quarter of 1998 from
43.0% in the third quarter of 1997. The decrease in the costs as a
percentage of sales in the third quarter was primarily due to efforts to
control costs, mostly offset by lower sales levels. In the first nine months
of 1998 these costs increased from 41.0% in 1997 to 41.8% in 1998, primarily
due to lower sales levels, partially offset by cost control efforts.
7 of 12
<PAGE>
OPERATING INCOME
As a result of the foregoing, the operating loss was $4,748,000 or 19.4%
of sales in the third quarter of 1998 versus $3,317,000 or 13.2% of sales in
the third quarter of 1997. For the first nine months of 1998, the operating
loss was $14,428,000 or 19.2% of sales compared to an operating loss of
$10,467,000 or 14.1% of sales in the first nine months of 1997.
INTEREST AND OTHER, NET
Interest and Other, Net was 0.0% of sales in the third quarter of 1998
compared to 1.1% in the third quarter of 1997 and 0.1% of sales for the first
nine months of 1998 compared to 0.5% of sales in the first nine months of
1997.
NET LOSS
As a result of the foregoing, the net loss increased to $2,996,000 or
12.2% of sales in the third quarter of 1998 from $2,189,000 or 8.7% of sales
in the third quarter of 1997. For the first nine months of 1998, the net loss
increased to $9,142,000 or 12.2% of sales compared to $6,615,000 or 8.9% of
sales in the first nine months of 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital in recent years have been net
cash flow from operations. Seasonal working capital requirements have been
met through short-term bank borrowings. The Company currently has no long
term debt.
During the first nine months of fiscal 1998, cash and investments
decreased $19,737,000. This was primarily due to seasonal operating losses,
(historically incurred in the first three fiscal quarters), an increase in
merchandise inventories and fixtures for new stores, the pay down of capital
lease and long-term debt obligations, and payments for new information
systems and income taxes. Additionally, in fiscal 1997 the Board of Directors
of the Company authorized the repurchase of up to $2,000,000 of the Company's
outstanding common stock. Beginning in February 1998, the Company began
repurchasing stock and as of the end of the third quarter of fiscal 1998 had
purchased 242,400 shares for a total of $896,000.
Compared to the third quarter in the prior year, cash and investments
decreased due to higher seasonal operating losses, lower accounts payable,
fixed asset acquisitions, stock repurchases and paydowns of long-term debt
and capital leases. This was offset in part by short-term borrowings and
lower inventory levels.
During the remainder of 1998, the Company does not plan to open any new
stores but, during the holiday season, will open 10 more temporary store
locations. The Company anticipates that cash for the remainder of 1998 will
primarily be used for capital expenditures and merchandise inventory for
temporary locations, repayment of debt, and to purchase inventory for the
Company's existing stores, particularly prior to and during the peak holiday
selling season.
8 of 12
<PAGE>
The Company has conducted a review of its computer systems to identify
those areas that could be affected by the Year 2000 issue. The Company
presently believes, with the new merchandise and financial information system
placed in service in February 1998, the Year 2000 will not pose significant
operational problems. The Company also believes that customers are not likely
to be affected by the Year 2000 issue. There can be no guarantee that the
systems of other companies on which the Company's systems rely will be
timely converted and would not have an adverse effect on the Company's
systems. The Company will utilize both internal and external resources to
reprogram, or replace, and test the software for the Year 2000 modifications.
The Company does not expect expenditures related to the Year 2000 issue to be
material and as such, costs associated with Year 2000 have not and are not
expected to have a significant impact on the Company's results of operations,
liquidity, or capital resources. The Company is currently reviewing systems
and operations in order to assess Year 2000 contingency needs.
The Company had a credit facility agreement with a commercial bank,
which included a revolving line of credit for $12,000,000 which expired on
June 1, 1998. The line of credit was also available for the issuance of
commercial and standby letters of credit up to $9,500,00 and $500,000
respectively. The Company had a second credit facility with another
commercial bank, which included a revolving line of credit for $3,000,000
which expired on June 30, 1998. Commercial and standby letters of credit were
also available up to $3,000,000. The Company has replaced both facilities
with a single facility at one of the banks. The new credit facility agreement
has a maximum total availability of $23,000,000 during the increase period,
which is from September 1, 1998 through December 31, 1998 and $12,000,000 for
the rest of its term, which is July 1, 1998 through August 31, 1998 and
January 1, 1999 through June 30, 1999. The facility includes borrowing on a
line of credit for up to $23,000,000 during the increase period and
$7,000,000 during the remainder of the term. The facility is also available
for the issuance of commercial and stand-by letters of credit for up to
$4,000,000 each during the increase period and $8,000,000 each for the rest
of the term. The total borrowings on the line of credit and the letters of
credit may not exceed $23,000,000 during the increase period or $12,000,000
during the remainder of the term. There is a 60 consecutive day out of
borrowing period for the line of credit between December 31, 1998 and the
maturity date of the line of credit. The Company has the option of choosing
interest payable at a rate based on LIBOR plus 1.5% or a rate equal to the
bank's prime rate. The agreement contains restrictive covenants, which include
achieving quarterly earnings/loss targets, maintaining certain financial
ratios, and requiring bank consent for the payment of dividends. The Company
was in compliance with the bank covenants as of October 31, 1998.
The Company believes that current cash and short-term investments
together with its cash flow from operations, long-term debt and funds
available under its credit facility agreement will be sufficient to fund the
Company's operations for the next 12 months.
INFLATION AND SEASONALITY
The Company does not believe that its operations have been materially
affected by inflation during the three recent fiscal years or in 1998 to
date. However, there is no assurance that its business will not be affected
by inflation in the future.
9 of 12
<PAGE>
The Company's business is subject to substantial seasonal variations in
demand. Historically, a significant portion of the Company's sales and
substantially all its net earnings have been realized during the fourth
quarter (which includes the November/December holiday season), and levels of
sales and net earnings have been significantly lower in the first three
quarters, usually resulting in losses in these quarters. If for any reason
the Company's sales were substantially below seasonal norms during the months
of November and December, the Company's annual results would be adversely
affected. The Company's quarterly results of operations may fluctuate
significantly as a result of comparable store sales levels, the timing of new
store openings and the amount of revenue contributed by new stores.
ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income", which requires that an enterprise report, by major
components and as a single total, the change in its net assets during the
period from non-owner sources; and No. 131, "Disclosures about Segments of an
Enterprise and Related Information" which establishes annual and interim
reporting standards for an enterprise's operating segments and related
disclosures about its products, services, geographic area, and major
customers. Adoption of these statements will not materially impact the
Company's financial position, results of operations or cash flows. Both
statements are effective for fiscal years beginning after December 15, 1997,
with earlier application permitted. In June 1998, the FASB issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires an entity to recognize all derivatives as either assets or
liabilities on its balance sheet at their fair value. The Company plans to
adopt SFAS No. 133 on January 30, 2000, as required. Adoption of this
standard is not expected to have a material impact on the Company's
consolidated financial statements.
FUTURE RESULTS
This report contains forward-looking statements regarding, among other
matters, the Company's future strategy, store opening plans, merchandising
strategy and growth. The forward-looking statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Act of 1995.
Forward-looking statements address matters which are subject to a number of
risks and uncertainties. In addition to the general risks associated with the
operation of specialty retail stores in a highly competitive environment, the
success of the Company will depend on a variety of factors such as consumer
spending which is dependent on economic conditions affecting disposable
consumer income such as employment, business conditions, interest rates and
taxation. The Company's continued growth also depends upon the demand for its
products, which in turn is dependent upon various factors, such as the
introduction and acceptance of new products and the continued popularity of
existing products, as well as the timely supply of all merchandise. Reference
is made to the Company's filings with the Securities and Exchange Commission
for further discussion of risks and uncertainties regarding the Company's
business.
10 of 12
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. EXHIBITS
Exhibit 11.1: Computation of Per Share Loss
Exhibit 27: Financial Data Schedule
b. REPORTS ON FORM 8-K
No reports on Form 8-K were filed with the Securities and Exchange
Commission during the third quarter of fiscal 1998.
11 of 12
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: December 14, 1998
NATURAL WONDERS,INC.
(Registrant)
/s/ Peter G. Hanelt
---------------------------------------------
Peter G. Hanelt,
Chief Executive Officer and
Chief Financial Officer
(Signing on behalf of the registrant and
as Principal Accounting and Financial Officer)
12 of 12
<PAGE>
EXHIBIT 11.1
NATURAL WONDERS, INC.
COMPUTATION OF PER SHARE NET LOSS
(Shares in thousands)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
--------------------------- ---------------------------
October 31, November 1, October 31, November 1,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net loss $(2,996) $(2,189) $(9,142) $(6,615)
-------- ------- ------- -------
-------- ------- ------- -------
Weighted average common
shares outstanding,
basic and diluted 7,978 8,005 8,037 7,995
Per share net loss,
basic and diluted $ (0.38) $ (0.27) $ (1.14) $ (0.83)
-------- ------- ------- -------
-------- ------- ------- -------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-30-1999
<PERIOD-START> AUG-02-1998
<PERIOD-END> OCT-31-1998
<CASH> 14
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 38,693
<CURRENT-ASSETS> 50,178
<PP&E> 63,287
<DEPRECIATION> 35,662
<TOTAL-ASSETS> 80,029
<CURRENT-LIABILITIES> 30,316
<BONDS> 0
0
0
<COMMON> 1
<OTHER-SE> 46,082
<TOTAL-LIABILITY-AND-EQUITY> 80,029
<SALES> 24,464
<TOTAL-REVENUES> 24,464
<CGS> 18,786
<TOTAL-COSTS> 18,786
<OTHER-EXPENSES> 10,426
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 158
<INCOME-PRETAX> (4,756)
<INCOME-TAX> (1,760)
<INCOME-CONTINUING> (2,996)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,996)
<EPS-PRIMARY> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>