SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15 (d) of the Securities and Exchange Act
of 1934.
For Quarter ended July 31, 1999 Commission File Number 0-26185
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Zany Brainy, Inc.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2663337
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
2520 Renaissance Boulevard, King of Prussia, Pennsylvania 19406
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610) 278-7800
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Not Applicable
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Former name, former address and fiscal year, if changed since last report.
Indicate by check whether the registrant (1) has filed all reports 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 No X
--- ---
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the lastest practicable date.
Class Outstanding at July 31, 1999
---------------------------- ----------------------------
Common Stock, par value $.01 21,508,711
ZANY BRAINY, INC.
FORM 10-Q
QUARTER ENDED July 31, 1999
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Income for the three and six months ended July
31, 1999 and August 1, 1998................................................. Page 1
Consolidated Balance Sheets as of July 31, 1999 and August 1, 1998......... Page 2
Consolidated Statements of Cash Flows for the six months ended July 31,
1999 and August 1, 1998..................................................... Page 3
Notes to Consolidated Financial Statements.................................. Page 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS........................ Page 7
PART II - OTHER INFORMATION...................................................... Page 16
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------------------------- --------------------------------------
July 31, 1999 August 1, 1998 July 31, 1999 August 1, 1998
------------------ ----------------- ----------------- ------------------
NET SALES $ 44,141 $ 29,654 $ 84,719 $ 57,105
COST OF GOODS SOLD, including
occupancy costs 32,368 22,110 61,756 42,246
------------------ ----------------- ----------------- ------------------
Gross profit 11,773 7,544 22,963 14,859
SELLING, GENERAL, AND
ADMINISTRATIVE EXPENSES 15,205 11,592 28,191 21,251
------------------ ----------------- ----------------- ------------------
Operating loss (3,432) (4,048) (5,228) (6,392)
INTEREST INCOME 1,873 1,152 3,208 2,402
INTEREST EXPENSE (1,923) (1,381) (3,685) (2,757)
------------------ ----------------- ----------------- ------------------
Loss before income tax benefit (3,482) (4,277) (5,705) (6,747)
INCOME TAX BENEFIT 1,324 - 2,168 -
------------------ ----------------- ----------------- ------------------
NET LOSS $ (2,158) $ (4,277) $ (3,537) $ (6,747)
=================== ================= ================== ==================
NET INCOME (LOSS) PER COMMON
SHARE:
Basic $ (0.15) $ (0.80) $ (0.35) $ (1.26)
Diluted $ (0.15) $ (0.80) $ (0.35) $ (1.26)
WEIGHTED AVERAGE SHARES
OUTSTANDING:
Basic 14,748 5,369 10,067 5,366
Diluted 14,748 5,369 10,067 5,366
The accompanying notes are an integral part of these statements
1
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands except share data)
July 31, January 30,
1999 1999
-------------- --------------
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents $ 23,217 $ 1,695
Receivables, net 5,203 3,390
Inventories, net 60,454 43,252
Deferred tax asset 6,481 4,313
Prepaid expenses 3,067 940
-------------- --------------
Total current assets 98,422 53,590
PROPERTY AND EQUIPMENT, net 29,882 25,905
DEFERRED TAX ASSET 2,024 2,024
OTHER ASSETS, net 392 622
============== ==============
$ 130,720 $ 82,141
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Current portion of capitalized lease obligations $ 1,591 $ 1,682
Line of credit - -
Accounts payable 22,544 16,161
Accrued liabilities 13,333 10,205
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Total current liabilities 37,468 28,048
DEFERRED RENT 3,761 2,942
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CAPITALIZED LEASE OBLIGATIONS, net of current portion 2,052 2,860
-------------- --------------
SHAREHOLDERS' EQUITY:
Convertible Preferred stock, $.01 par value, 5,000,000 shares and 4,000,000
shares authorized at July 31, 1999 and January 30, 1999, respectively, 0 and
2,402,955 shares
issued and outstanding, respectively
- 24
Common stock, $.01 par value, 100,000,000 shares and 25,000,000 shares
authorized at July 31, 1999 and January 30, 1999, respectively, 21,508,711
and 5,383,571 shares issued and outstanding, respectively
215 54
Additional paid-in capital
103,374 60,826
Accumulated deficit
(16,150) (12,613)
-------------- --------------
Total shareholders' equity 87,439 48,291
============== ==============
$ 130,720 $ 82,141
============== ==============
The accompanying notes are an integral part of these statements
ZANY BRAINY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Twenty-Six Weeks Ended
-----------------------------------------
July 31, 1999 August 1, 1998
----------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,537) $ (6,747)
Adjustments to reconcile net loss to net cash
used in operating activities--------
Depreciation and amortization 3,748 2,873
Provision for deferred rent 819 375
Deferred income tax benefit (2,168) 123
Changes in assets and liabilities--------
(Increase) decrease in
Receivables (1,813) 174
Inventories (17,202) (10,195)
Prepaid expenses (2,127) (1,589)
Other assets 230 -
Increase (decrease) in
Accounts payable 6,382 5,329
Accrued liabilites 3,128 1,635
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Net cash used in operating activities (12,540) (8,023)
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (7,725) (1,896)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds on line of credit, net - 6,005
Net proceeds from sale of common stock 42,313 -
Payments on capitalized leases (898) (671)
Proceeds from exercise of stock options 241 52
Proceeds from exercise of warrants 130 -
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Net cash used in financing activities 41,787 5,385
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 21,522 (4,534)
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CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,695 5,030
--------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 23,217 $ 497
========= ==========
The accompanying notes are an integral part of these statements
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and should be read in conjunction with the audited financial
statements as of January 30, 1999 included in our registration statement on Form
S-1 (No 333-74719) as filed with the Securities and Exchange Commission and in
our prospectus dated June 2, 1999 (the "Prospectus"). Certain information and
footnote disclosures required by generally accepted accounting principles 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 flow for
the periods indicated, and have been prepared in a manner consistent with the
January 30, 1999 financial statements. Particularly in light of the seasonal
nature of our business, the results of operations for the thirteen and twenty-
six weeks ended July 31, 1999 are not necessarily indicative of operating
results for a full fiscal year.
2. INITIAL PUBLIC OFFERING
In June, we sold 4,722,669 shares of Common stock at $10.00 per share
($9.30 after an underwriting discount of $.70 per share) in an initial public
offering (the "Offering"). All shares of Preferred stock outstanding prior to
the Offering were converted into 11,250,273 shares of Common stock. The Offering
generated proceeds of $43.9 million ($42.3 million after deducting transaction
expenses of $1.6 million). We used $18.4 million to pay down our line of credit
balance plus accrued interest and $4.4 million for six new store openings and
the relocation of the distribution center. The remainder of the net proceeds
will be used for additional new store openings and general corporate purposes,
and are primarily invested in short term repurchase agreements fully
collateralized by United States Treasury treasury securities.
3. SUPPLEMENTAL CASH FLOWS INFORMATION
For the 26 weeks ended August 1, 1998 and July 31, 1999, we paid $325,000
and $604,000, respectively, for interest expense. Capitalized lease obligations
of $1,080,000, and $0 were incurred on equipment leases entered into during the
26 weeks ended August 1, 1998 and July 31, 1999, respectively.
4
4. MERCHANDISE INVENTORIES
Merchandise inventories are valued at the lower of average cost (first-in,
first-out) or market. Costs associated with certain buying and distribution
activities are included in inventories.
5. NET LOSS PER SHARE
Net loss per share is calculated utilizing the principles of Statement of
Financial Accounting Standards No. 128, "Earnings per Share".
The weighted average impact of stock options, warrants and Preferred stock
was excluded from the calculation of diluted loss per share for all periods
presented as they were anti-dilutive due to our operating loss.
6. LINE OF CREDIT
In June 1999, our existing line of credit was paid down with proceeds from
the Offering and the existing credit facility was terminated. We entered into a
3 year credit facility covering a maximum principal amount of $30,000,000,
subject to a borrowing base. The borrowing base is defined as 50% of all
eligible inventory. This unsecured line of credit bears interest at the prime
rate, the annual Federal Funds Rate plus .5%, or, if we elect, at an annual rate
of LIBOR plus 1.75%. As of July 31, 1999, we had no outstanding balance and had
$9.7 million in letters of credit outstanding against the line. The credit
facility requires us to comply with various covenants. The covenants state that
we must maintain certain quarterly and annual ratios. A fixed charge coverage
ratio of 1.1 to 1.0 must be maintained from June 14, 1999 through the end of the
third quarter of 1999. Additionally, we must maintain a leverage ratio as of the
last day of each quarter of not more than .40 to 1.0. Finally, we must maintain
a minimum tangible net worth of not less than $70,000,000 plus 75% of net income
as of the last day of each fiscal year. We are in compliance with these debt
covenants as of July 31, 1999.
7. STOCK OPTIONS AND WARRANTS
As of July 31, 1999, we had options to purchase 3,425,283 shares of Common
stock outstanding of which options to purchase 1,321,535 shares are currently
exercisable at a weighted average price of $3.45. 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. In June 1999,
warrants to purchase 32,550 shares of Common stock at $4.00 per share were
exercised.
5
Information with respect to all options outstanding is as follows
(unaudited):
Weighted
Option Price Average Price
Shares Per Share Per Share
--------------- ---------------- --------------------
Options Outstanding, January 30, 1999 2,852,862 $ 0.67 - $ 9.00 $ 3.84
Granted 773,750 $ 3.33 - $11.75 11.50
Exercised (97,218) $ 0.67 - $ 4.00 2.47
Canceled (104,111) $ 3.33 - $11.75 5.68
--------------- ---------------- --------------------
Options Outstanding, July 31, 1999 3,425,283 $ 2.67 - $11.75 $ 5.55
=============== ================ ====================
8. COMMITMENTS AND CONTINGENCIES
We intend to implement an internet shopping site through a joint venture
(the "Venture"). We have entered into a non-binding term sheet with a Venture
partner, which calls for a $5.0 million investment from Zany Brainy to the
Venture.
From time to time, we are named as a defendant in legal actions arising
from our normal business activities. Although the amount of any liability that
could arise with respect to currently pending actions cannot be estimated, in
our opinion, any such liability will not have a material adverse effect on our
financial position, operating results or liquidity.
6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Zany Brainy is a rapidly growing specialty retailer of high quality toys, games,
books and multimedia products for children, with 91 stores operating in 23
states as of July 31, 1999.
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 Twenty-Six Weeks Ended
-------------------------------- ---------------------------------
July 31, 1999 August 1, 1998 July 31, 1999 August 1, 1998
------------- -------------- ------------- --------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold/1/ 73.3 74.6 72.9 74.0
------------- -------------- ------------- ---------------
Gross profit 26.7 25.4 27.1 26.0
Selling, general and administrative
expenses 34.5 39.1 33.3 37.2
------------- -------------- ------------- --------------
Operating loss (7.8) (13.7) (6.2) (11.2)
Interest expense, net 0.1 0.8 0.6 0.6
------------- -------------- ------------- --------------
Loss before income tax benefit (7.9) (14.5) (6.8) (11.8)
Income tax benefit 3.0 - 2.6 -
------------- -------------- ------------- --------------
Net loss (4.9%) (14.5%) (4.2%) (11.8%)
============= ============== ============= ==============
Comparable store net sales/2/ 8% 13% 9% 10%
============= ============== ============= ==============
Total number of stores at
end of period 91 57 91 57
============= ============== ============= ==============
Stores opened during period 9 4 16 5
============= ============== ============= ==============
/1/ Cost of sales includes buying, distribution, and occupancy costs
/2/ A store becomes comparable in the 14/th/ full month of store operations
Thirteen Weeks Ended July 31, 1999 (Second Quarter) Compared to Thirteen Weeks
Ended August 1, 1998 (Second Quarter)
NET SALES. Net sales increased $14.5 million, or 48.8%, to $44.1 million
in the thirteen weeks ended July 31, 1999 from $29.7 million in the comparable
1998 period. This increase resulted from (i) a comparable store increase of 8%,
(ii) sales from 16 new stores opened thus far in fiscal 1999, and (iii) sales
from stores opened in fiscal 1998 which are not included in our comparable sales
base. We believe the increase in comparable sales for the second quarter is
attributable to, among other things, increased sales from our annual train event
during the month of July, additional book sales generated from our annual Summer
Reading Club, and our annual back-to-school "Zany Zone" circular, which
7
reached customers toward the end of the quarter. While Beanie Babies still
represented more than 5% of our sales during this thirteen week period, Beanie
Babies' sales were, as planned, significantly less than last year's Beanie
Babies' sales for the comparable period. We expect, and have planned for, Beanie
Babies' sales to remain significantly below last year's levels for the remainder
of the fiscal year. A recent announcement by Ty, Inc., the manufacturer of
Beanie Babies, that it is retiring all Beanie Babies as of December 31, 1999 may
impact Beanie Babies' sales.
GROSS PROFIT. Gross profit increased $4.2 million, or 56.1%, to $11.8
million during the second quarter, from $7.5 million in the same period last
year. The gross profit increased to 26.7% of net sales for the period, from
25.4% in the comparable 1998 period. The increase of 1.3% was primarily due to
greater leveraging of buying, occupancy and distribution expenses.
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 $3.6 million, or
31.1%, to $15.2 million in the period, from $11.6 million in the same period
last year. Selling, general and administrative expenses decreased to 34.5% of
net sales from 39.1% of net sales due to leveraging of store personnel and other
expenses. The dollar increase in selling, general and administrative expenses
was primarily attributable to $2.2 million in store payroll and other selling
expenses associated with 34 additional stores following the second quarter of
1998. Preopening expense increased $300,000 over the same period last year due
to the opening of nine new stores, an increase of five stores from the same
period last year. Corporate expenses increased $500,000 to support the
additional store growth.
INTEREST EXPENSE, NET. Net interest expense was approximately $50,000 for
the period, a decrease of $179,000 from the comparable period in 1998. This
decrease was due to the repayment of debt with the proceeds from the Offering.
We earned interest income of $146,000 on the investment of the remaining
proceeds from the Offering.
INCOME TAX BENEFIT. For the thirteen weeks ended July 31, 1999, we
recorded an income tax benefit of $1.3 million primarily related to the Federal
tax benefit of the net loss. For the thirteen weeks ended August 1, 1998, no
8
benefit was recorded with respect to the net operating loss carryforward because
we established a valuation allowance. The effective tax rate for the second
quarter of fiscal 1999 was 38.0%.
Twenty-Six Weeks Ended July 31, 1999 (First Half) Compared to Twenty-Six Weeks
Ended August 1, 1998 (First Half)
NET SALES. Net sales increased $27.6 million, or 48.4%, to $84.7 million
for the twenty-six weeks ended July 31, 1999 from $57.1 million in the
comparable 1998 period. This increase resulted from (i) a comparable store
increase of 9%, (ii) sales from 16 new stores opened thus far in fiscal 1999,
and (iii) sales from stores opened in fiscal 1998 which are not included in our
comparable sales base. While Beanie Babies still represented more than 5% of
our sales during this twenty-six week period, Beanie Babies' sales were, as
planned, significantly less than last year's Beanie Babies' sales for the
comparable period. We expect, and have planned for, Beanie Babies' sales to
remain significantly below last year's levels for the remainder of the fiscal
year. A recent announcement by Ty, Inc., the manufacturer of Beanie Babies,
that it is retiring all Beanie Babies as of December 31, 1999 may impact Beanie
Babies' sales.
GROSS PROFIT. Gross profit increased $8.1 million, or 54.5%, to $23.0
million during the period, from $14.9 million in the same period last year. The
gross profit increased to 27.1% of net sales for the period, from 26.0% in the
comparable 1998 period. The increase of 1.1% was primarily due to greater
leveraging of buying, occupancy and distribution expenses.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $6.9 million, or 32.7%, to $28.2 million in
the period, from $21.3 million in the same period last year. Selling, general
and administrative expenses decreased to 33.3% of net sales from 37.2% of net
sales due to leveraging of store personnel, selling and general and
administrative expenses. The dollar increase in such expenses was primarily
attributable to $4.1 million in store payroll and other selling expenses
associated with 34 additional stores opened following the second quarter of
1998. Preopening expense increased $800,000 over the same period last year due
to the opening of 16 new stores, an increase of 11 stores from the same period
last year. Corporate expenses increased $800,000 to support the additional
store growth.
9
INTEREST EXPENSE, NET. Net interest expense was approximately $477,000 for
the period, an increase of $122,000 from the comparable period in 1998. This
increase was due to increased borrowing on our bank line for the period.
INCOME TAX BENEFIT. For the twenty-six weeks ended July 31, 1999, we
recorded an income tax benefit of $2.2 million primarily related to the Federal
tax benefit of the net loss. For the twenty-six weeks ended August 1, 1998, no
benefit was recorded with respect to the net operating loss carryforward because
we established a valuation allowance. The effective tax rate for the first half
of fiscal 1999 was 38.0%.
LIQUIDITY AND CAPITAL RESOURCES
Our main sources of liquidity have been cash flows from operations,
proceeds from the Offering, and borrowing under our credit facilities. We
require cash principally to finance capital investment in new stores, new store
inventories, and seasonal working capital. We opened 16 stores through the 26
weeks ended July 31, 1999.
Cash flows used in operating activities were $12.5 million for the 26 weeks
ended July 31, 1999, an increase of $4.5 million over the same period for the
previous year. This increase was primarily the result of a net increase of $6.0
million in inventory to support 34 new stores opened and future stores under
construction, and an increase in the accounts receivable of $2.0 million,
partially offset by a reduction in operating loss of $3.2 million.
Cash flows used in investing activities were $8.6 million for the 26 week
period ending July 31, 1999, an increase of $6.0 million over the same period
for the previous year. The increase was due to increased capital spending for
new store growth.
Cash flows provided by financing activities during the six-month period
ending July 31, 1999 reflect the net proceeds of $42.3 million from the sale of
common stock associated with the Offering. For the comparable period last year,
cash was provided through borrowings of $6.0 million on our credit facility. We
used $18.4 million of the proceeds of the Offering to repay our credit facility
and $4.4 million for six new store openings and the relocation of the
10
distribution center. The remainder of the proceeds will be used for new store
openings and general corporate purposes and are invested in US government
secured short-term investments.
On June 14, 1999, we entered into a three year credit facility with First
Union National Bank in the amount of $30,000,000 with an interest rate of the
Base Rate or Libor plus 1.75%. The Base Rate is defined as the higher of (1) the
Federal Funds Rate plus .5% per annum or (2) the Prime Rate. A credit facility
with another bank was terminated upon the completion of the Offering. The
ability to terminate the credit facility prior to the expiration date, without
penalty, was based on Zany Brainy becoming a public company. Additionally, we
have a commitment with a bank for a new lease line up to $5.0 million. We expect
to complete this agreement in the third quarter.
We believe that our operating cash flow together with unused portion of our
credit facility and other financing arrangements will be sufficient to finance
current operating requirements including capital expenditures and new store
openings for at least the next twelve months.
Seasonality of Business
Seasonal shopping patterns affect our business. A significant portion of
sales occur 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 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.
New Facilities
We relocated our corporate headquarters from Wynnewood, PA to King of
Prussia, PA at the end of June 1999. We lease approximately 53,000 square feet
in our new facility. The new lease has an initial term of ten years with two
five-year renewal options.
Additionally, we relocated our distribution center from Delaware to New
Jersey in July 1999. We lease approximately 250,000 square feet in the new
facility. The distribution center is responsible for shipping approximately 80%
of products to our stores; the remaining 20% of products are directly shipped
from vendors.
11
Develop an Internet Sales Channel
We intend to implement an internet shopping site through a joint venture
(the "Venture"). We have entered into a non-binding term sheet with a Venture
partner, which calls for a $5.0 million investment from Zany Brainy to the
Venture. In addition, the Venture may require substantial participation of our
management and affiliates for certain resources and reduce Zany Brainy's equity
ownership of our internet business. In addition, selling our products on the
internet could divert customers from our stores and depress existing store
sales. We cannot assure that we will implement an internet shopping site or
that, if implemented, we will generate profits from the internet business. In
addition, in the event we do establish an internet business, we may have to
recognize all or a portion of any losses associated with the business.
Year 2000 Compliance
We are continuing our comprehensive review of our computer systems and
other micro processor-based equipment to identify how the Year 2000 issue may
affect them .
Our core business is run on SFR, an enterprise software system. The
functions supported by SFR include buying, replenishment, physical distribution,
general ledger and payables. SFR is a product of CDS, a subsidiary of Sterling
Software. CDS has discontinued operations. The upgrade to version 7.0, which is
Year 2000 compliant, was completed in the first quarter of 1999.
Late in 1998, we agreed to purchase new enterprise software from JDA. This
software will replace SFR for all of the functional areas currently served by
SFR. This software has been certified Year 2000 compliant by the Information
Technology Association of America and runs on IBM AS400 hardware which has been
certified by IBM to be Year 2000 compliant. We intend to have the conversion
process completed and ready for implementation in December 1999. However, given
the increased business volume during the Christmas season, we have decided to
defer implementation until after the Christmas selling season. In the event the
SFR system fails to operate on January 1, 2000, we believe we will be in the
position to implement Year 2000 compliant JDA software.
Our in-store systems consist of two application suites and a common
Microsoft NT server network which is Intel based. The application suites are
supplied by ICL Retail, Inc. ("ICL"), and provide point-of-sale (POS) and store
inventory systems (SIS) support for store management functions. We have
determined that the POS and SIS systems are
12
not Year 2000 compliant, but have received compliant versions from ICL. We have
completed testing and are currently piloting the systems in several stores.
Due to potential compatibility issues, we plan to upgrade the Microsoft NT
operating systems in all stores. The new operating system has been certified by
Microsoft to be Year 2000 compliant. We have completed testing of the new
operating system, and will update the service pack in the third quarter. Upon
installation of this update, the system will be Year 2000 compliant. Some of the
store register hardware is not Year 2000 compliant, but we believe that we can
achieve compliance by rebooting the system and adjusting time and date
parameters. We intend to take these measures prior to the opening of business
following December 31, 1999.
We have assessed the readiness of our server, SIS workstation hardware,
email applications and software demonstration stations. We plan to have our
store systems achieve Year 2000 compliance for software, operating systems and
hardware in the third quarter of 1999.
If store systems should cease to operate on January 1, 2000, we have
several options available to continue to process sales and receipts in the
stores. In a worst case scenario, the existing disaster procedure to hand-write
receipts would be put into place. The receipt of purchase records and transfers
would also be recorded manually. If the situation were a result of the
registers' and servers' failure to recognize the new year, the capability exists
to set the system dates back to 1999 and continue to process sales transactions.
Sales receipts would need to be date stamped by hand. Additional effort would be
required to ensure sales and receipt data is subsequently processed correctly.
This would require incremental manual intervention. While the cost of the manual
intervention would not be material, the use of manual intervention would
significantly disrupt store operations.
If our telecommunications and credit card processing service providers are
not Year 2000 compliant on a timely basis, our operations could be materially
adversely affected. If our telecommunications providers are not compliant we
would be required to migrate the service to a compliant vendor. If the credit
card processor is not compliant, we would be required to approve and settle
credit requests manually.
As of the end of our second quarter, we have incurred approximately $30,000
in costs associated with Year 2000 issues, all of which is attributable to
software upgrades, including version 7.0 of SFR. The total costs associated with
modifications, upgrades and/or replacements to become Year 2000 compliant is not
expected to be material to our financial position. Remaining costs of
approximately $145,000 are estimated to be incurred to make us Year 2000
compliant. These costs will be expensed as incurred. We intend to use funds from
operations to cover these costs.
13
We have not developed a formal contingency plan. If year 2000 problems
are discovered, they will be addressed as they occur.
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk.
No material changes.
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION ACT OF 1995
This report and the documents incorporated by reference herein contain
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. When used in this report and the documents incorporated herein by
reference, the words "anticipate," "believe," "estimate," and similar
expressions are generally intended to identify forward-looking statements. These
forward-looking statements include, among others, the statements in Management's
Discussion and Analysis about the following: our use of the remainder of the
proceeds from the Offering; our expectations with respect to completing an
agreement with a bank to provide us with a lease line of up to $5.0 million; the
sufficiency of our operating cash flow over the next 12 months; our expectations
with respect to our inability to earn a profit in the first three quarters of a
fiscal year in the foreseeable future; the impact any internet venture would
have on our equity ownership of our internet business; our expectations with
respect to Beanie Babies' sales; the potential negative effects selling our
products on the internet could have on our existing store sales and our customer
base; our expectations with respect to implementing a profitable internet
shopping site; the impact of any losses associated with an internet business;
our ability to complete our enterprise software conversion from JDA to SFR, and
to have JDA ready for implementation in December 1999; our ability to implement
Year 2000 compliant JDA software in the event that SFR fails; our plans to
upgrade the Microsoft NT operating systems in all stores in the third quarter;
our plans for, and the sufficiency of, existing disaster procedures in the event
of Year 2000 failure; the impact on our operations if our telecommunications and
credit card processing service providers are not Year 2000 compliant; estimated
costs associated with becoming Year 2000 compliant, and sources of funds for
these costs; and our plans to address any Year 2000 problems that may arise.
There are important factors that could cause actual results to differ materially
from those expressed or implied by such forward-looking statements including,
but not limited to, the following: a decline in the level of demand for our
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products; actions by our competitors; a decline in general economic and business
conditions and in the specialty retail or toy industry in particular; our
inability to manage our growth, open new stores on a timely basis and expand in
new and existing markets; our inability to successfully negotiate a lease line
agreement with a bank; the failure to enter into definitive agreements with our
internet venture partner and to successfully implement an internet shopping
site; unanticipated cash requirements to support current operations or expansion
of our business; unanticipated costs of Year 2000 compliance; and our ability to
attract, train and retain highly qualified associates. These and other risks and
uncertainties affecting Zany Brainy are discussed in greater detail in this
report and in other filings by Zany Brainy with the Securities and Exchange
Commission.
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PART II - OTHER INFORMATION
Item 1. Changes in Securities and Use of Proceeds
On June 2, 1999, the registration statement relating to our initial public
offering of our Common stock, $.01 par value (the "Offering"), was ordered
effective by the Securities and Exchange Commission. All shares offered pursuant
to the Registration Statement, including shares covered by the underwriters'
over-allotment option were sold. Donaldson, Lufkin & Jenrette, BT Alex Brown,
William Blair & Company, U.S. Bancorp Piper Jaffray, and DLJdirect Inc. were the
managing underwriters of the Offering. The Offering terminated June 15, 1999
upon the consummation of the sale of all shares subject to the underwriters'
over-allotment option. The number of shares registered, the aggregate price of
the offering amount registered, the amount sold and the aggregate offering price
in the amount sold by us and certain of our shareholders in the Offering were as
follows:
Aggregate Price of
Number of the offering amount Aggregate Offering
Shares Registered Registered Amount Sold Price of the amount sold
----------------- ---------- ----------- ------------------------
Zany Brainy 4,722,669 $47,226,690 4,722,669 $47,226,690
The Selling Shareholders 2,292,331 $22,923,310 2,292,331 $22,923,310
We incurred the following expenses with respect to the Offering during the
period February 1999 through June 1999, none of which were direct or indirect
payments to our directors, officers, or their associates or to persons owning
10% or more of any class of equity securities of the Company or to affiliates of
the Company
Underwriting Discounts and
Commissions Other Expenses Total Expenses
----------- -------------- --------------
$3,305,868 $1,607,539 $4,913,407
The net offering proceeds to the Company after deducting the foregoing
discounts, commissions, fees and expenses were $42.3 million. A reasonable
estimate of how these proceeds were used by the Company during the period June
7, 1999 through July 31, 1999 is as follows:
Investments in short-term securities $19,500,000
Repayment of Line of Credit Agreement 18,400,000
New Store Openings and Distribution Center Relocation 4,400,000
None of the foregoing expenses constituted direct or indirect payments to
directors, officers, or their associates or to persons owning 10% or more of any
class of equity securities of the Company or to affiliates of the Company.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Zany Brainy, Inc.
Date: September 9, 1999 By: /s/ Keith C. Spurgeon
----------------- ----------------------
Keith C. Spurgeon
Chairman & Chief
Executive Officer
Date: September 9, 1999 By: /s/ Robert A. Helpert
----------------- ----------------------
Robert A. Helpert
Chief Financial Officer,
Secretary and Treasurer
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