<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 JULY 31, 1999
( ) 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 August 27, 1999: 7,865,103 shares of common
stock.
1 of 12
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NATURAL WONDERS, INC.
INDEX
<TABLE>
<CAPTION>
Page
Number
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Condensed Statements of Operations 3
Quarters and six months ended July 31, 1999 and August 1, 1998
Condensed Balance Sheets 4
July 31, 1999, January 30, 1999 and August 1, 1998
Condensed Statements of Cash Flows 5
Six months ended July 31, 1999 and August 1, 1998
Notes to Condensed Financial Statements 6 - 7
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
SIGNATURE 12
</TABLE>
2 of 12
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NATURAL WONDERS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHES ENDED
-------------------------- --------------------------
JULY 31, AUGUST 1, JULY 31, AUGUST 1,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 25,415 $ 27,443 $ 46,967 $ 50,708
Cost of goods sold and
store occupancy expenses 20,831 19,961 39,781 39,398
----------- ----------- ---------- ----------
Gross margin 4,584 7,482 7,186 11,310
Selling, general & administrative expenses 10,833 9,942 20,446 20,991
----------- ----------- ---------- ----------
Operating loss (6,249) (2,480) (13,260) (9,681)
Interest expense 35 57 39 125
Interest income and other, net 0 26 98 52
----------- ----------- ---------- ----------
Loss before taxes (6,284) (2,491) (13,201) (9,754)
Income tax benefit 2,325 922 4,885 3,609
----------- ----------- ---------- ----------
Net loss $ (3,959) $ (1,569) $ (8,316) $ (6,145)
----------- ----------- ---------- ----------
----------- ----------- ---------- ----------
Net loss per common share basic and diluted: $ (0.50) $ (0.13) $ (1.05) $ (0.78)
Weighted average common shares outstanding
basic and diluted: 7,928 8,084 7,940 8,066
Stores open at end of period 177 175 177 175
</TABLE>
See notes to financial statements
3 of 12
<PAGE>
NATURAL WONDERS, INC.
CONDENSED BALANCE SHEETS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
JULY 31, JANUARY 30, AUGUST 1,
1999 1999 1998
-------------------- -------------------- --------------------
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 233 $ 4,841 $ 298
Short-term investments 0 7,380 0
Merchandise inventories 22,242 22,707 26,263
Prepaid income taxes 5,006 1,403 3,639
Prepaid expenses and other current assets 4,583 4,318 5,426
-------------------- -------------------- --------------------
Total current assets 32,064 40,649 35,626
Property and Equipment:
Leasehold improvements 29,976 30,077 30,103
Property and equipment under capital lease 0 0 4,993
Furniture, fixtures and equipment 31,031 34,106 29,080
-------------------- -------------------- --------------------
61,007 64,183 64,176
Less accumulated depreciation and amortization (34,491) (37,510) (35,493)
-------------------- -------------------- --------------------
26,516 26,673 28,683
Other Assets 3,497 3,526 2,217
-------------------- -------------------- --------------------
Total Assets $ 62,077 $ 70,848 $ 66,526
-------------------- -------------------- --------------------
-------------------- -------------------- --------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Trade accounts payable $ 5,362 $ 8,500 $ 3,979
Accrued compensation and related costs 2,275 2,300 2,052
Accrued liabilities 2,071 3,037 3,326
Short-term borrowings 4,219 0 2,650
Income taxes payable 0 0 121
Current portion of capital lease obligations 0 0 672
Current portion of long-term debt 0 0 373
-------------------- -------------------- --------------------
Total current liabilities 13,927 13,837 13,173
Capital Lease Obligations 0 0 63
Long-Term Debt 0 0 178
Deferred Rents 3,340 3,561 3,691
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $.0001; authorized
17,000,000 shares; issued and outstanding
7,868,703; 7,951,392; 8,058,289 shares 1 1 1
Capital in excess of par value 33,750 34,073 34,292
Retained earnings 11,059 19,376 15,128
-------------------- -------------------- --------------------
Total stockholders' equity 44,810 53,450 49,421
-------------------- -------------------- --------------------
Total Liabilities and Stockholders' Equity $ 62,077 $ 70,848 $ 66,526
-------------------- -------------------- --------------------
-------------------- -------------------- --------------------
</TABLE>
See notes to financial statements
4 of 12
<PAGE>
NATURAL WONDERS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------
JULY 31, 1999 AUGUST 1, 1998
------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (8,316) $ (6,145)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 3,575 3,419
Loss on disposition of asset 72 183
Change in operating assets and liabilities:
Merchandise inventories 465 (3,079)
Prepaid expenses and other assets (3,839) (3,722)
Trade accounts payable (3,138) (4,018)
Accrued compensation and related costs (25) (772)
Accrued liabilities (966) (310)
Income tax payable 0 (1,737)
Deferred rent (222) (114)
----------- -----------
Net cash used in operating activities (12,394) (16,295)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments 0 (6,902)
Sales of short-term investments 7,380 20,300
Proceeds from sale of equipment 0 0
Purchases of property and equipment (3,491) (3,440)
Business acquisition 0 0
----------- -----------
Net cash provided by investing activities 3,889 9,958
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on capital lease obligations 0 (592)
Principal payments on long-term debt 0 (1,538)
Net borrowing on line of credit 4,219 2,650
Purchase of treasury stock (351) (532)
Issuance of common stock under employee stock purchase program 29 39
Exercise of stock options and warrants 0 257
----------- -----------
Net cash provided by financing activities 3,897 284
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,608) (6,053)
CASH AND CASH EQUIVALENTS
Beginning of period 4,841 6,351
----------- -----------
End of period $ 233 $ 298
----------- -----------
----------- -----------
CASH PAID DURING PERIOD:
Interest $ 39 $ 129
Income taxes $ 69 $ 1,737
</TABLE>
See notes to financial statements
5 of 12
<PAGE>
NATURAL WONDERS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
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, results of operations, and cash flows for the periods presented.
The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for any full fiscal
year.
These financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the Company's 1998
Annual Report to Stockholders and Form 10-K for the fiscal year ended
January 30, 1999 as filed with the Securities and Exchange Commission.
2. New Accounting Pronouncements: SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" will be effective for the Company, as
delayed by SFAS No. 137, in June 2000. SFAS No. 133 established accounting
and reporting standards for derivative instruments embedded in other
contracts, and hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The
Company has not yet evaluated the impact of SFAS No. 133 on its financial
statements.
3. The Company had a credit facility agreement with a commercial bank for the
purpose of financing seasonal working capital needs. The total borrowings
on the line of credit and the letters of credit could not exceed
$23,000,000 during the increase period or $12,000,000 during the remainder
of the term. The Company was out of compliance with the bank covenants as
of May 1, 1999 and received a waiver valid through June 15, 1999. The
Company entered into an amended and restated line effective June 15, 1999.
The new line is for a term of three years, with a maximum credit line of
$30,000,000, and is provided by the same commercial bank, together with an
additional lender acting as administrative agent. The line provides for
revolving advances up to the lesser of 60% of the value of eligible
inventory, 80% of the net retail liquidation value of eligible inventory,
or the maximum credit line. As of July 31, 1999, total availability under
the line was $9,138,000. The line includes up to $5,000,000 for the
issuance of commercial and standby letters of credit. The line of credit
must be fully repaid for a 30 day consecutive period between January 1 and
February 15 each year. The Company has the option of choosing interest
payable at a rate based on LIBOR plus 2.25% or a rate equal to the bank's
prime rate. The agreement, contains restrictive covenants, which include
maintaining certain minimum tangible net worth levels and requiring bank
consent for the payment of dividends. As of July 31, 1999, the Company was
in compliance with these covenants. The agreement also includes certain
prepayment penalties.
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<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 July 31, 1999, Natural Wonders operated 177 stores in 36 states
compared to 175 stores in 36 states as of August 1, 1998. In the first six
months of 1999, three new stores and one holiday store were opened, and seven
stores were closed (three holiday stores from 1998, two permanent stores, and
two for remodeling) as compared to five new stores opened and one permanent
store closed in the first six months of fiscal 1998.
SALES
During the second quarter of 1999 and six months year to date, sales
decreased 7.4%, over the same periods in 1998. The decreases were primarily due
to the decrease in comparable store sales. Comparable store sales decreased 8.3%
in the second quarter of 1999, and 9.0% year to date, as compared to the same
periods in 1998. The decreases in the second quarter and year to date comparable
store sales were primarily attributable to the impact of the ongoing core
merchandise assortment transition to higher quality, unique gifts focused on
science and nature.
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 82.0% in the second quarter of 1999 from
72.7% in the second quarter of 1998, and increased to 84.7% year to date,
compared to 77.7% in the comparable period in 1998. The increase in costs as a
percentage of sales in the second quarter and year to date was primarily due to
the impact of the reduction in comparable store sales on store occupancy fixed
expense.
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 increased to 42.6% in the second quarter of 1999 from 36.2% in the
second quarter of 1998. For the first six months of 1999, they were 43.5%
compared to 41.4% in 1998. The increase in the costs as a percentage of sales
in the second quarter and year to date was primarily due to the impact of the
reduction in comparable store sales on store non-occupancy fixed expenses.
7 of 12
<PAGE>
OPERATING INCOME
As a result of the foregoing, the operating loss was $6,249,000 or 24.6% of
sales in the second quarter of 1999 versus $2,460,000 or 9.0% of sales in the
second quarter of 1998. The operating loss for the first six months of 1999 was
$13,260,000 or 28.2% of sales compared to $9,681,000 or 19.1% for the first six
months of 1998.
NET INTEREST AND OTHER EXPENSE
Net interest and other expense remained at 0.1% of sales in the second
quarter of 1999 compared to the second quarter of 1998, and (0.01) % for the
first six months of 1999 compared to 0.1% for the same period of 1998.
NET LOSS
As a result of the foregoing, the net loss increased to $3,959,000 or 15.6%
of sales in the second quarter of 1999 from $1,569,000 or 5.7% of sales in the
second quarter of 1998. The net loss increased to $8,316,000 or 17.7% of sales
for the first six months of 1999 from $6,145,000 or 12.1% of sales for the same
period in 1998.
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.
During the first six months of fiscal 1999, cash and investments decreased
$11,988,000. This was primarily due to seasonal operating losses, historically
incurred in the first three fiscal quarters, construction and fixtures for new
stores and decreased accounts payable. 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 second quarter of 1999 has purchased
334,657 shares for a total of $1,215,000.
Compared to the second quarter in the prior year, cash and investments
remained flat. The increase in short-term borrowings and accounts payable and
lower merchandise inventories was offset by higher seasonal operating losses,
construction and fixture purchases for new and remodeled stores, and the
repurchase of stock.
During the remainder of 1999, the Company plans to open 5 new stores and,
during the holiday season, approximately 20 temporary store locations. The
Company anticipates that cash for the remainder of 1999 will primarily be used
for capital expenditures and merchandise inventory for new stores and temporary
locations, store remodeling and to purchase inventory for the Company's existing
stores, particularly prior to and during the peak holiday selling season.
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
8 of 12
<PAGE>
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 significantly affected by the Year
2000 issue. However, there can be no guarantee that the systems of other
companies on which the Company's systems rely will be converted on a timely
basis and would not have an adverse effect on the Company. The Company will
utilize both internal and external resources to reprogram or replace, and test
the software for the Year 2000 modifications. During 1998, the Company rolled
out a new operating system along with related merchandising, distribution and
accounting software, and upgraded the payroll system. In early 1999 the Company
also upgraded the existing human resources information system to be Year 2000
compliant, and is implementing a new system in the third quarter, that is also
Year 2000 compliant. All systems that need to be reviewed have been identified
and the Company is now in the process of reviewing questionnaires sent out to
the vendors and testing systems for compliance. 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.
To date, the Company has not accelerated any system replacements or incurred any
costs for upgrades or additional personnel in order to make any systems Year
2000 compliant. It is the opinion of management that the reasonably likely
worst case scenario would arise from utility or banking industry problems,
rather than internal system or operational issues. The Company is currently
developing Year 2000 contingency plans.
The Company had a credit facility agreement with a commercial bank for the
purpose of financing seasonal working capital needs. The total borrowings on the
line of credit and the letters of credit could not exceed $23,000,000 during the
increase period or $12,000,000 during the remainder of the term. The Company was
out of compliance with the bank covenants as of May 1, 1999 and received a
waiver valid through June 15, 1999. The Company entered into an amended and
restated line effective June 15, 1999. The new line is for a term of three
years, with a maximum credit line of $30,000,000, and is provided by the same
commercial bank, together with an additional lender acting as administrative
agent. The line provides for revolving advances up to the lesser of 60% of the
value of eligible inventory, 80% of the net retail liquidation value of eligible
inventory, or the maximum credit line. As of July 31, 1999, total availability
under the line was $9,138,000. The line includes up to $5,000,000 for the
issuance of commercial and standby letters of credit. The line of credit must be
fully repaid for a 30 day consecutive period between January 1 and February 15.
The Company has the option of choosing interest payable at a rate based on LIBOR
plus 2.25% or a rate equal to the bank's prime rate. The agreement, contains
restrictive covenants, which include maintaining certain minimum tangible net
worth levels and requiring bank consent for the payment of dividends. As of July
31, 1999, the Company was in compliance with these covenants. The agreement
also includes certain prepayment penalties.
The Company believes that current cash and short-term investments together
with its cash flow from operations, and funds available under its credit
facility agreement will be sufficient to fund the Company's operations for the
next 12 months.
9 of 12
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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 1999 to date.
However, there is no assurance that its business will not be affected by
inflation in the future.
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, as was the case in 1998, 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
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" will be effective for the Company, as delayed by SFAS No. 137, in
June 2000. SFAS No. 133 established accounting and reporting standards for
derivative instruments embedded in other contracts, and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The Company has not yet evaluated the impact of SFAS No. 133 on
its 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 Reform 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. The success of the
Company's operations depends upon a number of factors relating to consumer
spending, including 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 25, 1998 at
its principal offices in Fremont, California. Of the shares outstanding as of
the record date, 6,822,067 shares were present at the meeting or represented by
proxies, representing approximately 85.8% of the total votes eligible to be
cast.
At the meeting the stockholders voted to elect one (1) Class III director
of the Company to each serve a three year term and until his successor is duly
elected and qualified. The name of the Class III director elected at the Annual
Meeting and the votes cast are set forth below.
<TABLE>
<CAPTION>
For Withheld
--- --------
<S> <C> <C>
Pearson C Cummin III 6,645,614 176,453
</TABLE>
The following Class I directors continued to hold office:
Peter L. Harris, David H. Folkman
The following Class II directors continued to hold office:
Peter G. Hanelt, Julius Jensen III
The Company's stockholders also voted to approve the following:
- To ratify the appointment of Deloitte & Touche LLP as the Company's
independent auditors for the fiscal year ending January 29, 2000.
There were 6,809,948 affirmative votes, 7,710 negative votes, and
4,409 abstentions.
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 second quarter of fiscal 1999.
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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: September 15, 1999
NATURAL WONDERS, INC.
(Registrant)
/s/ Peter G. Hanelt
--------------------------------------
Peter G. Hanelt,
Chief Executive Officer
President
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 Six Months Ended
--------------------------------------------------
July 31, 1999 August 1, 1998 July 31, 1999 August 1, 1998
--------------------------------- -----------------------------
<S> <C> <C> <C> <C>
Net loss $(3,959) $(1,569) $(8,316) $(6,145)
-------- -------- -------- --------
-------- -------- -------- --------
Weighted average common shares
Outstanding, basic and diluted 7,928 8,084 7,940 8,066
Per share net loss, basic and diluted $ (0.50) $ (0.19) $(1.05) $(0.76)
-------- -------- ------- -------
-------- -------- ------- -------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-29-2000
<PERIOD-START> MAY-02-1999
<PERIOD-END> JUL-31-1999
<CASH> 233
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 22,242
<CURRENT-ASSETS> 32,064
<PP&E> 61,007
<DEPRECIATION> 34,491
<TOTAL-ASSETS> 62,077
<CURRENT-LIABILITIES> 13,927
<BONDS> 0
0
0
<COMMON> 1
<OTHER-SE> 44,809
<TOTAL-LIABILITY-AND-EQUITY> 62,077
<SALES> 25,415
<TOTAL-REVENUES> 25,415
<CGS> 20,831
<TOTAL-COSTS> 20,831
<OTHER-EXPENSES> 10,833
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 35
<INCOME-PRETAX> (6,284)
<INCOME-TAX> (2,325)
<INCOME-CONTINUING> (3,959)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,959)
<EPS-BASIC> (0.50)
<EPS-DILUTED> (0.50)
</TABLE>
