SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: MAY 5, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-26185
ZANY BRAINY, INC.
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2663337
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2520 Renaissance Boulevard
King of Prussia, Pennsylvania 19406
(Address of Principal Executive Offices) (Zip 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 as 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 [_]
As of June 25, 2001, there were 32,329,420 outstanding shares of the issuer's
common stock, par value $.01 per share.
ZANY BRAINY, INC.
FORM 10-Q
QUARTER ENDED MAY 5, 2001
INDEX
Page Number
-----------
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Operations for the thirteen weeks ended May 5, 2001
and April 29, 2000 1
Consolidated Balance Sheets as of May 5, 2001 and February 3, 2001 2
Consolidated Statements of Cash Flows for the thirteen weeks ended May 5, 2001
and April 29, 2000 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 12
PART II OTHER INFORMATION 13
Unless the context indicates otherwise, the terms "Zany Brainy" and "Company"
refer to Zany Brainy, Inc. and, where appropriate, one or more of its
subsidiaries.
PART 1
ITEM 1: FINANCIAL STATEMENTS
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
(in thousands, except per share data)
Thirteen Weeks Ended
May 5, 2001 April 29, 2000
----------- --------------
NET SALES $ 66,207 $ 63,435
COST OF GOODS SOLD, including occupancy costs 55,880 50,758
--------- --------
Gross profit 10,327 12,677
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES 27,782 24,562
--------- --------
Operating income/(loss) (17,455) (11,885)
INTEREST EXPENSE, NET (1,612) (273)
--------- --------
Income (loss) before income tax benefit (expense) (19,067) (12,158)
INCOME TAX BENEFIT (EXPENSE) - 4,661
--------- --------
NET INCOME (LOSS) ($19,067) ($7,497)
========= ========
NET (LOSS) PER SHARE: $ (0.59) $ (0.24)
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic and Diluted 32,329 31,056
The accompanying notes are an integral part of these statements.
1
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
UNAUDITED
(in thousands except share data)
May 5, 2001 February 3, 2001
---------------- -------------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 1,731 $ 2,352
Receivables, net 2,002 2,270
Inventories, net 106,455 120,017
Prepaid expenses 4,388 6,874
---------------- -------------------
Total current assets 114,576 131,513
PROPERTY AND EQUIPMENT, net 62,163 66,153
OTHER ASSETS, net 1,639 1,497
---------------- -------------------
$178,378 $199,163
================ ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Bank overdraft $ - $ 7,314
Line of credit 44,103 52,723
Accounts payable 46,163 37,117
Accrued liabilities 23,898 18,081
Current portion of long-term debt 33 26
Capitalized lease obligations 2,471 2,588
---------------- -------------------
Total current liabilities 116,647 117,849
---------------- -------------------
DEFERRED RENT 8,883 8,868
---------------- -------------------
LONG TERM DEBT, net of current portion 656 663
---------------- -------------------
CAPITALIZED LEASE OBLIGATIONS, net of current portion 1,657 2,204
---------------- -------------------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 100,000,000 shares authorized at May 5, 2001;
32,329,420 shares issued and outstanding at May 5, 2001 and February 3, 2001 323 323
Additional paid-in capital 145,336 145,334
Accumulated deficit (95,145) (76,078)
---------------- -------------------
Total shareholders' equity 50,514 69,579
---------------- -------------------
$178,378 $199,163
================ ===================
The accompanying notes are an integral part of these statements.
2
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
(in thousands)
Thirteen Weeks Ended
May 5, 2001 April 29, 2000
--------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) ($19,067) ($7,497)
Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities:
- -------------------------------------------------------------------------------------------
Depreciation and amortization 4,212 3,661
Provision for deferred rent 15 197
Amortization of deferred compensation 2 3
Deferred income tax benefit - (5,102)
Noncash compensation expense - 333
Loss on disposal of assets 77 -
(Increase) decrease in operating assets:
Receivables 268 2,290
Inventories 13,562 (1,755)
Prepaid expenses 2,486 145
Other assets 10 13
Increase (decrease) in operating liabilities:
Accounts payable 9,046 (10,902)
Accrued liabilities 5,817 (7,000)
--------------- ----------------
Net cash provided by (used in) operating activities 16,428 (25,614)
--------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (181) (3,305)
Investment in joint venture - (6,862)
--------------- ----------------
Net cash used in investing activities (181) (10,167)
--------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Payments) borrowings on line of credit, net (8,620) 12,120
Payments on capitalized lease obligations (664) (700)
Change in bank overdrafts (7,314) -
Debt issuance costs (270) -
Maturities of long-term debt - (5)
Proceeds from exercise of stock options - 43
--------------- ----------------
Net cash provided by (used in) financing activities (16,868) 11,458
--------------- ----------------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (621) (24,323)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,352 25,041
--------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,731 $ 718
=============== ================
The accompanying notes are an integral part of these statements.
3
ZANY BRAINY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 5, 2001
UNAUDITED
1. BASIS OF PRESENTATION
- -------------------------
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and should be read in conjunction with the audited
financial statements as of February 3, 2001 included in our annual report on
Form 10-K for the fiscal year February 3, 2001 as filed with the Securities and
Exchange Commission (see Note 2). Certain information and footnote disclosures
required by accounting principles generally accepted in the United States for
complete financial statements have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. In the opinion
of management, the accompanying unaudited financial statements contain all
material adjustments, consisting of normal recurring accruals, necessary to
present fairly our financial position, results of operations and cash flows for
the periods indicated, and have been prepared in a manner consistent with the
February 3, 2001 financial statements. In light of the seasonal nature of our
business, the results of operations for the thirteen weeks ended May 5, 2001 are
not necessarily indicative of operating results for a full fiscal year.
2. CHAPTER 11 REORGANIZATION
- -----------------------------
On May 15, 2001 (the "Petition Date"), Zany Brainy, Inc., Children's Product,
Inc., Children's Development, Inc., Noodle Kidoodle, Inc., Children's
Distribution, LLC and Zany Brainy Direct, LLC (collectively, the "Debtors"),
filed voluntary petitions for relief under Chapter 11 of Title 11 of the United
States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for
the District of Delaware (the "Bankruptcy Court"). The Debtors are managing
their businesses as debtors-in-possession.
Subsequent to the commencement of the Chapter 11 cases, the Debtors sought and
obtained several orders from the Bankruptcy Court which were intended to
stabilize their businesses and enable the Debtors to continue business
operations as debtors-in-possession. To date, the most significant of these
orders (i) permitted the Debtors to operate their consolidated cash management
system during the Chapter 11 cases in substantially the same manner as it was
operated prior to the commencement of the Chapter 11 cases; (ii) authorized
payment of pre-petition wages, vacation pay, and employee benefits and
reimbursement of employee business expenses; (iii) authorized payment of pre-
petition sales and use taxes owed by the Debtors; (iv) authorized the Debtors to
pay certain pre-petition obligations to critical vendors, common carriers and
workers' compensation insurance to aid the Debtors in maintaining operation of
their businesses; and (v) authorized the Debtors to obtain interim and final
debtor-in-possession financing.
In bankruptcy, the rights of, and the Debtors' ultimate payments to, pre-
petition creditors and shareholders may be substantially altered. This could
result in claims being liquidated in the bankruptcy cases at less (and possibly
substantially less) than 100% of their face value, and the equity of our common
shareholders being diluted or cancelled. In addition, pursuant to the
provisions of the Bankruptcy Code, the Debtors are not permitted to pay any
claims or obligations that arose prior to the Petition Date ("Pre-petition
Claims") unless specifically authorized by the Bankruptcy Court. Similarly,
claimants may not enforce any claims against the Debtors that arose prior to the
Petition Date unless specifically authorized by the Court. The Debtors also
have the right, as debtors-in-possession, subject to the Bankruptcy Court's
approval, to assume or reject any executory contracts and unexpired leases in
existence on the Petition Date. Parties having claims as a result of such
rejection may file claims with the Court, which will be addressed as part of the
Chapter 11 cases. The Bankruptcy Code also provides that the Debtors have an
exclusive period during which only they may propose and file and solicit
acceptances of a plan of reorganization. This period may be extended upon
request of the Debtors and subsequent Bankruptcy Court approval. If the Debtors
fail to file a plan of reorganization during the exclusive period, as extended,
or, after such plan has been filed, if the Debtors fail to obtain acceptance of
such plan from the requisite classes of creditors and equity security holders
during the exclusive solicitation period, any party in interest may file their
own plan of reorganization for the Debtors.
A creditors committee (the "Committee") comprised of 7 unsecured creditors has
been appointed in the Chapter 11 cases. In accordance with the Bankruptcy Code,
the Committee has the right to be heard on matters that come before the
Bankruptcy Court in the Chapter 11 cases.
Due to material uncertainties, it is not possible to determine the additional
amount of claims that may arise or ultimately be filed, or to predict the length
of time the Debtors will operate under the protection of Chapter 11 of the
Bankruptcy Code, the outcome of the bankruptcy cases in general, whether the
Debtors will continue to operate under their current organizational structure,
or the effect of the cases on the Debtors' business or on the claims and
interests of the various creditors and security holders.
4
Although the Chapter 11 bankruptcy filing raises substantial doubt about the
Company's ability to continue as a going concern, the accompanying financial
statements have been prepared on a going-concern basis. This basis contemplates
the continuity of operations, realization of assets, and discharge of
liabilities in the ordinary course of business. The statements also present the
assets of the Company at historical cost. A plan of reorganization could
materially change the amounts currently disclosed in the financial statements.
The Company believes, based on information presently available to it, that cash
available from operations and the DIP Financing (see Note 8) will provide
sufficient liquidity to allow it to continue as a going concern for the
foreseeable future. However, the ability of the Company to continue as a going
concern (including its ability to meet post-petition obligations of the Debtors)
and the appropriateness of using the going concern basis for its financial
statements are dependent upon, among other things, (i) the Company's ability to
obtain sufficient credit and payment terms from vendors, (ii) the Company's
ability to comply with the terms of the DIP Financing and any cash management
order entered by the Bankruptcy Court in connection with the Chapter 11 cases,
(iii) the ability of the Company to maintain adequate cash on hand, (iv) the
ability of the Company to generate cash from operations, (v) confirmation of a
plan of reorganization under the Bankruptcy Code, and (vi) the Company's ability
to achieve profitability following such confirmation. As a result of these
uncertainties, there can be no assurance that existing or future sources of
liquidity will be adequate.
3. SUPPLEMENTAL CASH FLOWS INFORMATION
- ---------------------------------------
For the thirteen weeks ended May 5, 2001 and April 29, 2000, the Company paid
$1,186,000 and $384,000, respectively, for interest expense. For the thirteen
weeks ended May 5, 2001 and April 29, 2000, the Company paid $149,000 and
$691,000, respectively, for income taxes.
4. RECLASSIFICATIONS
- ---------------------
Certain reclassifications have been made to the prior year's financial
statements to conform to the current year presentation.
5. THE MERGER
- --------------
Effective July 26, 2000, Night Owl Acquisition, Inc., our wholly owned
subsidiary, and Noodle Kidoodle, Inc. ("Noodle") were merged in a tax-free,
stock-for-stock transaction that was accounted for as a pooling of interests.
Under the terms of the Merger agreement, we issued 1.233 shares of Zany Brainy,
Inc. common stock for each outstanding share of Noodle common stock for an
aggregate issuance of approximately 9.4 million shares of our common stock to
the former Noodle stockholders.
The Company's historical financial statements have been retroactively restated
to reflect the acquisition of Noodle as though they had been combined from the
beginning of each of the periods presented. Revenue and net income (loss) as
previously reported for the thirteen weeks ended April 29, 2000 and as restated
for the pooling of interests transaction is as follows (in thousands):
Thirteen Weeks Ended
--------------------------------------
April 29, 2000
--------------------------------------
Revenues Net income
--------------- ---------------
Zany Brainy, Inc (as previously reported) $39,363 ($5,050)
Noodle Kidoodle, Inc. (as previously reported) 24,072 (2,475)
Adjustments - 28 (a)
--------------- ---------------
Restated $63,435 ($7,497)
=============== ===============
(a) Includes adjustments to conform Noodle's accounting policy for inventory
capitalization to the Company's accounting policy.
5
As a result of the Merger, the Company entered into a restructuring and
integration plan. Accruals were established for certain items related to this
plan.
The utilization of the initial accruals as of the date of the merger and changes
through May 5, 2001 is as follows (in thousands):
July 29, 2000 Charges Utilized May 5, 2001
-------------- ----------- ----------- -------------------
Merger and Integration Costs
- ----------------------------
Inventory write-downs $ 8,650 $ - $ (6,577) $ 2,073
Professional fees 5,025 - (5,018) 7
Store closures - 600 (490) 110
Other integration costs 905 350 (875) 380
Restructuring Costs
- -------------------
Severance and change in control
costs 3,000 - (3,000) -
Disposal of property 900 - 900 -
------- -------- --------- -------
$18,480 $ 950 $ (16,860) $ 2,570
======= ======== ========= =======
During the first quarter of fiscal year 2001, the Company reversed $490,000 of
the accrual for store closures due a change in estimate which has been included
in selling, general and administrative expenses in the accompanying statement of
operations.
Management expects the integration plan to be completed in the second quarter of
fiscal 2001.
6. INVENTORIES
- ---------------
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method based on moving average and includes certain
buying and distribution costs relating to the processing of merchandise.
7. NET INCOME (LOSS) PER SHARE
- -------------------------------
Net income (loss) per share is calculated utilizing the principles of SFAS No.
128, "Earnings Per Share" ("EPS"). The weighted average impact of stock options
and warrants was excluded from the calculation of diluted loss per share for all
periods presented as they were anti-dilutive due to the net loss.
8. LINE OF CREDIT
- ------------------
In July 2000, the Company entered into a three-year credit facility (the "Credit
Facility") covering a maximum principal amount of $115.0 million, secured by
inventories and other assets, subject to a borrowing base, as defined as a
percentage of eligible inventories.
On February 28, 2001, the Company received a letter from the lender under the
Credit Facility notifying it that it failed to comply with a number of covenants
under the Credit Facility and that such failures constituted events of default
under the Credit Facility. On March 9, 2001, the lender notified the Company
that, as a result of the events of default, the Company's interest rate for the
loans under the Credit Facility was being increased to the default rate of
interest, which was the prime rate plus 200 basis points.
On May 15, 2001, the Company filed voluntary petitions for relief under Chapter
11 of Title 11 of the United States Code in the United States Bankruptcy Court
for the District of Delaware (the "Filing"). In connection with the Filing, the
Company obtained a two-year, $115.0 million debtor-in-possession credit facility
from Wells Fargo Retail Finance, LLC, as Agent for itself and other lenders that
may join the credit facility from time-to-time (the "DIP Facility"). The DIP
Facility is secured by substantially all of the Company's assets. The DIP
Facility includes a credit line of up to $100.0 million bearing interest at the
prime rate plus 1.75% or, if we elect, at an annual rate of LIBOR plus 3.5%, and
an additional line of credit of $15.0 million bearing interest at 14.5% per
annum.
The Company's DIP Facility contains covenants that require it to satisfy ongoing
financial requirements and which limit its ability to borrow additional money,
pay dividends, divest assets, make additional corporate investments and increase
compensation paid to directors, officers and senior management employees. The
DIP Facility also prohibits a change in control. In the event of default, the
annual interest rate will increase by 2.0%.
6
Under the DIP Facility, the Company's borrowing availability is tied to a
percentage of eligible inventory. Such formula currently includes limitations
based on a percentage of the value of eligible inventory that adjusts seasonally
and a general limitation that the Company cannot borrow any amounts that exceed
100% of the liquidation value of eligible inventory. The amounts calculated
based on eligible inventory are subject to additional reserves imposed by the
bank.
In connection with the DIP Facility, the Company was required to pay an
origination and arrangement fee of $1.3 million or 1.25% on the credit line, an
origination fee of $450,000 or 3.0% on the maximum additional line, and will be
required to pay an annual agent's fee of $200,000, certain unused credit line,
collateral and letter of credit fees, as defined in the agreement.
In conjunction with the institution of the DIP Facility, the Company repaid all
outstanding borrowings under its Credit Facility with Congress Financial
Corporation ("Congress") and terminated that facility on May 17, 2001. At the
time of termination, the Company was required to pay a $1.7 million termination
fee and wrote off approximately $932,000 of unamortized deferred financing costs
which were expensed in the period of termination.
Borrowings under the DIP Facility are immediately reduced by transfers from the
Company's bank accounts, primarily including store retail receipts, on a daily
basis.
On June 25, 2001, the Company had an outstanding balance on our DIP facility of
approximately $53.0 million and remaining borrowing capacity of approximately
$11.4 million.
9. INCOME TAXES
- ----------------
As of the quarter ended May 5, 2001, management had provided a full valuation
reserve of $41.0 million against its deferred tax assets. This is based on
management's assessment that it is not more likely than not that the net
deferred tax asset generated during the period will be realized.
10. COMMON STOCK OPTIONS AND WARRANTS
- --------------------------------------
During the first quarter of fiscal 2001, the Company granted approximately 1.5
million options to employees. There were no exercises and minimal cancellations.
In fiscal year 2000, the Company granted warrants to Online Retail Partners,
Inc. in conjunction with the dissolution of the Internet joint venture, ZB
Holdings LLC, to purchase 1 million shares of the Company's common stock at an
exercise price of $6.00 per share. These warrants vest over five years and will
expire in 2010. In addition, warrants to purchase 15,000 shares of common stock
are outstanding. These warrants have an exercise price of $4.00 per share and
expire in January 2003.
11. COMMITMENTS AND CONTINGENCIES
- ----------------------------------
Employee Agreements
- -------------------
On June 15, 2001, the Company filed a Motion of the Debtors and Debtors in
Possession for an Order Authorizing and Approving Severance Pay and Retention
Bonus Plan for Certain Employees, Authorizing the Debtors to Enter into Certain
Amended and Restated Change in Control and Employment Agreements, and Approving
Incentive Plan Pursuant to Sections 105(a) and 363(b) of the Bankruptcy Code
(the "Motion"). The Motion requests authority to enter into the proposed plans
to provide for severance, retention and incentive benefits to certain employees
of the Company under certain circumstances. The Motion also requests authority
to enter into Amended and Restated Employment Agreements with the Chief
Executive Officer and the Chief Financial Officer, and Amended and Restated
Change in Control Severance, Noncompetition and Nonsolicitation Agreements with
three key employees. The Motion is subject to Bankruptcy Court approval and is
expected that the Motion will be considered by the Bankruptcy Court at a hearing
scheduled for June 29, 2001. The Motion is also subject to any objections filed
by other parties in interest.
The severance benefits payable to certain employees, pursuant to the motion that
was filed, would range from one week base salary for each year of service with
the Company, with a maximum benefit of four weeks to six months of base salary,
depending on the employee's position with the Company. The Severance Plan would
cover approximately 739 employees ranging from hourly corporate employees and
associate Store Managers to Directors and Vice Presidents. In addition, the
five members of the Company's senior management with employment or severance
agreements would be eligible to receive severance in accordance with their
respective agreements.
The retention bonus plan would provide for certain employees to receive a
retention bonus if such employee remains employed by the Company through and
including the effective date of a confirmed plan of reorganization. Under the
retention bonus plan, certain portions of the bonus may be payable prior to
emergence from bankruptcy depending on the timing of such emergence or if there
is a
7
change in control. The retention bonus plan would provide for bonuses ranging
from 10 percent to 35 percent of annual base salary. In addition, the Chief
Financial Officer would be eligible to receive a retention bonus equal to 50% of
his annual base salary, and the President and Chief Executive Officer, in lieu
of any amounts that may be payable in his Employment Agreement, would be
eligible to receive a retention bonus of $1.0 million.
The proposed incentive program would provide certain employees the opportunity
to earn financial rewards based upon the achievement of realistically determined
corporate and individual goals and is based on similar programs that have been
place for several years. Under certain circumstances, an employee may also be
eligible to receive some or all of his or her incentive bonus if such employee
is terminated.
There can be no assurance that the Motion and the Plans will be approved by the
Bankruptcy Court in its current form.
General
- -------
From time to time, the Company is named as a defendant in legal actions arising
from its normal business activities. In connection with the Company's inability
to pay creditors, the Company was named in numerous pre-petition lawsuits.
Although the amount of any liability that could arise with respect to currently
pending actions cannot be estimated, in the opinion of the Company, any such
liability would not have a material adverse effect on our financial position or
operating results.
12. INTERNET OPERATIONS
- ------------------------
On May 8, 2001, the Company suspended offerings of product sales on the internet
site. The Company currently offers merchandise at our retail locations and
through our catalogs with toll-free ordering.
13. RECENT DEVELOPMENTS
- ------------------------
On May 31, 2001, the Company informed the Nasdaq staff that it would no longer
pursue a hearing before a Nasdaq Listing Qualifications Panel to review the
delisting determination letter that we received from the Nasdaq staff on May 1,
2001. The staff's letter stated that the Company's shares were subject to
delisting from the Nasdaq National Market due to the failure of the Company's
common stock to maintain a minimum bid price of $1.00 per share as specified in
Nasdaq Marketplace Rule 4310(c)(4). As a result of our recently filed voluntary
petition for protection under the Bankruptcy Code, the Company determined that
appealing the staff's determination was not likely to result in a positive
outcome. The Company was notified on June 1, 2001 that its shares were being
delisted from Nasdaq. The Company's shares are currently quoted in the National
Daily Quotation Sheets, commonly referred to as the "pink sheets," published by
the National Quotation Bureau LLC. The Company cannot provide any assurances
that there will continue to be any market for our shares or that our shares will
continue to trade.
8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Zany Brainy is a leading specialty retailer of high quality toys, games, books
and multimedia products for children, with 187 stores operating in 34 states as
of May 5, 2001.
Recent Developments
On May 15, 2001, we and five of our subsidiaries (collectively, the "Debtors")
filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in
the Bankruptcy Court.
As a result of the filing, we are now required to file periodically with the
Bankruptcy Court various documents, including certain financial information on
an unconsolidated basis. This information includes statements of financial
affairs, schedules of assets and liabilities, and monthly operating reports in
forms prescribed by federal bankruptcy law.
We caution that such materials are prepared according to requirements of federal
bankruptcy law. While they accurately provide then-current information required
under federal bankruptcy law, they are nonetheless unconsolidated, unaudited,
and are prepared in a format different from that used in our consolidated
financial statements filed under the securities laws. Accordingly, we believe
that the substance and format do not allow meaningful comparison with our
regular publicly-disclosed consolidated financial statements.
The materials filed with the Bankruptcy Court are not prepared for the purpose
of providing a basis for an investment decision relating to our stock, or for
comparison with other financial information filed with the Securities and
Exchange Commission.
On June 15, 2001, the Company filed a Motion of the Debtors and Debtors in
Possession for an Order Authorizing and Approving Severance Pay and Retention
Bonus Plan for Certain Employees, Authorizing the Debtors to Enter into Certain
Amended and Restated Change in Control and Employment Agreements, and Approving
Incentive Plan Pursuant to Sections 105(a) and 363(b) of the Bankruptcy Code
(the "Motion"). The Motion requests authority to enter into the proposed plans
to provide for severance, retention and incentive benefits to certain employees
of the Company under certain circumstances. The Motion also requests authority
to enter into Amended and Restated Employment Agreements with the Chief
Executive Officer and the Chief Financial Officer, and Amended and Restated
Change in Control Severance, Noncompetition and Nonsolicitation Agreements with
three key employees. The Motion is subject to Bankruptcy Court approval and is
expected that the Motion will be considered by the Bankruptcy Court at a hearing
scheduled for June 29, 2001. The Motion is also subject to any objections filed
by other parties in interest.
Most of the Debtors' filings with the Court are available to the public at the
office of the Clerk of the Bankruptcy Court. Those filings may also be obtained
through private document retrieval services. We undertake no obligation to make
any further public announcement with respect to the documents filed with the
Court or any matters referred to in them.
9
Results of Operations
The following table sets forth our financial data expressed as a percentage
of net sales, and operating data for the periods indicated.
Thirteen Weeks Ended
May 5, 2001 April 29, 2000
Net sales 100.0% 100.0%
Cost of goods sold, /1/
including occupancy costs 84.4 80.0
--------------- -----------------
Gross profit 15.6 20.0
Selling, general and
administrative expenses 42.0 38.7
--------------- -----------------
Operating (loss) (26.4) (18.7)
Interest (expense), net (2.4) (0.5)
--------------- -----------------
(Loss) before taxes (28.8) (19.2)
Income tax benefit - 7.4
--------------- -----------------
Net (loss) (28.8%) (11.8%)
=============== =================
Comparable store net sales (decrease) /2/ (8.7%) (20.1%)
Total number of stores at end of period 187 165
Stores opened during period 0 4
/1/ Cost of goods sold includes buying, distribution and occupancy costs
/2/ A store becomes comparable in the 14th full month of store operations
Thirteen Weeks Ended May 5, 2001 Compared to Thirteen Weeks Ended April 29, 2000
NET SALES. Net sales increased $2.8 million, or 4.4%, to $66.2 million in the
thirteen weeks ended May 5, 2001 from $63.4 million in the comparable 2000
period. The increase was primarily due to an increase in sales of $7.8 million
related to the additional 23 stores in the first quarter of fiscal year 2001
compared to the first quarter of fiscal year 2000. This increase was partially
offset by negative comparable store sales of $5.5 million. The remainder of the
sales increase was due to increases in catalog and internet sales.
As a result of the Company's financial difficulties, many vendors have yet to
resume normal shipment terms and quantities and the negative sales trends
continued in May 2001. While we expect that vendors will resume normal
shipments, the negative sales trends could continue until this happens.
GROSS PROFIT. Gross profit decreased $2.4 million, or 18.5%, to $10.3 million
during the first quarter, from $12.7 million in the same period last year. The
decrease was primarily attributable to the inability to leverage store
occupancy, buying and distribution costs due to a decrease in comparable store
sales and lower product margins. Gross profit decreased to 15.6% of net sales
for the period, from 20.0% in the comparable 2000 period. It is likely that, in
connection with the Company's planned summer clearance events, product margins
will decline in the second quarter 2001.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses include all direct store level expenses, and all
corporate level costs not directly associated with or allocable to cost of
sales. Selling, general and administrative expenses increased $3.2 million, or
13.1%, to $27.8 million during the first quarter, from $24.6 million in the same
period last year. The increase is primarily related to the additional 23 stores
in the first quarter of fiscal year 2001 compared to the first quarter of fiscal
year 2000.
INTEREST EXPENSE, NET. Net interest expense was approximately $1.6 million for
the period, an increase of $1.3 million from the comparable period in 2000. This
increase was due to an increase in borrowings under our credit facility and
higher interest rates.
INCOME TAX BENEFIT. A 100% valuation allowance was established during the
thirteen weeks ended May 5, 2001 for the tax benefit generated in the period due
to the Company's net loss. This is based on management's assessment that it is
not more likely than not that the net deferred tax asset generated during the
period will be realized. For the comparable period in 2000, we recorded an
income tax benefit of $4.7 million.
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LIQUIDITY AND CAPITAL RESOURCES
Our main sources of liquidity have been cash flows from operations and
borrowing under our credit facilities.
Cash flows provided by operating activities were $16.4 million for the
thirteen weeks ended May 5, 2001 compared to cash used in operating activities
of $25.6 million for the same period for the previous year. This change is
primarily due to a decrease in inventory, net of payables, of $35.3 million and
an increase in accrued liabilities of $12.8 million partially offset by an
increase in net loss after the noncash effect of deferred income taxes.
Cash flows used in investing activities were $0.2 million for the thirteen-
week period ending May 5, 2001, a decrease of approximately $10.0 million
compared to the same period for the previous year. This decrease was due to
$3.3 million in purchases of property, plant and equipment in the first quarter
of 2000 compared to $0.2 million in the current quarter and an investment in our
Internet joint venture with Online Retail Partners, Inc., ZB Holdings LLC, of
$6.9 million in the first quarter of 2000. The Internet joint venture was
dissolved and liquidated in December 2000.
Cash flows used in financing activities were $16.9 million for the thirteen
weeks ended May 5, 2001 compared to cash provided by financing activities of
$11.5 million for the same period for the previous year. The change was
primarily a result of a decrease in bank overdrafts of $7.3 million and a
decrease in the balance under the line of credit, of $20.7 million.
On February 28, 2001, Congress Financial Corporation ("Congress") asserted
that we were in default under the three-year credit facility (the "Credit
Facility") we had entered into in July 2000. As a result of the defaults
asserted by the bank, outstanding borrowings under the Credit Facility began to
accrue interest at a rate equal to 2% above the highest alternative pre-default
rates (the "Default Rate"). Under the Credit Facility, our borrowing
availability was tied to a seasonal percentage of eligible inventory. Such
formula included a limitation that we could not borrow any amounts that exceeded
the lesser of (a) 65% of the cost of eligible inventory or (b) 85% of the
appraisal value of eligible inventory, subject to additional reserves imposed by
the bank.
In connection with the Filing, the Company obtained a two-year, $115.0 million
debtor-in-possession credit facility from Wells Fargo Retail Finance, LLC, as
Agent for itself and other lenders that may join the credit facility from time-
to-time (the "DIP Facility"). The DIP Facility is secured with substantially
all of the Company's assets. The DIP facility includes a credit line of up to
$100.0 million bearing interest at the prime rate plus 1.75% or, if we elect, at
an annual rate of LIBOR plus 3.5%, and an additional line of credit of $15.0
million bearing interest at 14.5% per annum. The DIP Facility requires us to
comply with various financial covenants and contains certain restrictions upon
the operations of the business, including restrictions upon the ability to
borrow additional money, pay dividends, divest assets, make additional corporate
investments and increase compensation paid to directors, officers and senior
management employees. On June 25, 2001, we had an outstanding balance under
the DIP Facility of approximately $53.0 million ($10.0 million bearing interest
at 14.5% and approximately $43.0 million bearing at 8.75%). Of this amount,
approximately $45.0 million, including a $1.7 million termination fee, was used
to repay the Credit Facility which was terminated on May 17, 2001.
We believe, based on information presently available to us, that cash
available from operations and the DIP Facility will provide sufficient liquidity
to allow us to continue as a going concern for the foreseeable future. However,
our ability to continue as a going concern (including our ability to meet post-
petition obligations of the Debtors) and the appropriateness of using the going
concern basis for our financial statements are dependent upon, among other
things, (i) the Company's ability to obtain sufficient credit and payment terms
from vendors, (ii) Company's ability to comply with the terms of the DIP
Financing and any cash management order entered by the Bankruptcy Court in
connection with the Chapter 11 cases, (iii) the ability of the Company to
maintain adequate cash on hand, (iv) the ability of the Company to generate cash
from operations, (v) confirmation of a plan of reorganization under the
Bankruptcy Code, and (vi) the Company's ability to achieve profitability
following such confirmation. As a result of those uncertainties, there can be no
assurance that existing or future sources of liquidity will be adequate.
Seasonality of Business
Seasonal shopping patterns affect our business. A significant portion of our
sales occurs in the fourth quarter, coinciding with the Christmas holiday
shopping season. Therefore, results of operations for the entire year depend
heavily on fourth quarter results and the success of the Christmas selling
season. Based upon previous experience, we do not expect to earn a profit in the
first three quarters of a fiscal year in the foreseeable future.
Internet Sales
On May 8, 2001, we suspended our offering of product sales on the internet
until further notice. Future availability for online shopping is subject to the
outcome of the bankruptcy and the availability of resources to support the site.
The internet operation has not been profitable since its launch in October 1999
and it is anticipated to continue to incur losses when and if a re-launch takes
place.
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ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
Securities Litigation Act of 1995
This report contains, in addition to historical information, forward-looking
statements by the Company with regard to the effect of the outcome of any
pending or threatened litigation in which we are involved, whether there will be
a trading market for and quotation of our common stock, our relationship with
our lenders, our ability to continue as a going concern, the liquidity of the
Company and our expected profit during the first three quarters of a fiscal
year, our relationship with our vendors, the effect of any summer clearance
events and losses that may be associated with any relaunched version of our
internet shopping site, which may constitute forward-looking statements with the
meaning of the Private Securities Litigation Reform Act of 1995. Words such as
"may," "should," "anticipate," "believe," "plan," "estimate," "expect," and
"intend," and other such similar expressions are intended to identify forward-
looking statements. These statements are based on management's current
expectations and are subject to a number of uncertainties and risks that could
cause actual results to differ materially from those described in the forward-
looking statements. Factors that may cause such difference, but are not limited
to, our ability to relaunch our internet sales site, the sales resulting from
that site, the availability under the DIP Facility, the development in and the
outcome of the Chapter 11 cases, the availability of additional capital, whether
vendors resume normal shipments, the results of summer clearance events and the
adverse effects on the Company's business as a result of general economic
conditions, as well as the risks set forth in the Company's filings with the
Securities and Exchange Commission. All forward-looking statements included in
this document are based on information available to the Company as of the date
of this document, and the Company assumes no obligation to update these
cautionary statements or any forward-looking statements.
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PART II
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Amended and Restated Employment Agreement with Thomas G. Vellios dated May
1, 2001
(b) Reports on Form 8-K:
1. On March 15, 2001, the Company filed a Current Report on Form 8-K to
report that the bank under the Company's three-year secured credit
facility (the "Credit Facility") had asserted a default under the Credit
Facility.
2. On March 20, 2001, the Company filed a Current Report on Form 8-K to
report the formation of an informal committee of the Company's unsecured
trade creditors (the "Committee") and the execution of a standstill
agreement with regard to paying any past due debts.
3. On March 30, 2001, the Company filed a Current Report on Form 8-K to
report the extension of the standstill agreement between the Company and
the Committee through and including April 16, 2001.
4. On April 16, 2001, the Company filed a Current Report on Form 8-K to
report the extension of the standstill arrangement between the Company and
the Committee through and including April 30, 2001.
5. On May 1, 2001, the Company filed a Current Report on Form 8-K to report
the extension of the standstill arrangement between the Company and the
Committee through and including May 7, 2001.
6. On May 10, 2001, the Company filed a Current Report on Form 8-K to report
the extension of the standstill arrangement between the Company and the
Committee through and including May 14, 2001.
7. On May 15, 2001, the Company filed a Current Report on Form 8-K to report
that the Company had filed voluntary petitions for relief under Chapter 11
of Title 11 the United States Code in the United States Bankruptcy Court
for the District of Delaware.
8. On May 31, 2001, the Company filed a Current Report on Form 8-K to report
the Company's notification of the Nasdaq staff that it would no longer
pursue a hearing before a Nasdaq Listing Qualifications Panel to review
the delisting determination letter that the Company received from the
Nasdaq staff on May 1, 2001.
9. On June 1, 2001, the Company filed a Current Report on Form 8-K to report
the Company's delisting from the Nasdaq National Market, effective June 1,
2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be duly signed on its behalf by the
undersigned thereunto duly authorized.
ZANY BRAINY, INC.
Date:________________________________ ___________________________________
By: Thomas G. Vellios
Title: Chief Executive Officer
Date:________________________________ ___________________________________
By: Robert Helpert
Title: Chief Financial Officer
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