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<DAILY TROUBLE>
Tuesday, July 6, 1999

Noodle Kidoodle Inc.
(Nasdaq: NKID)
Phone: 516-677-0500
Website: www.noodlekidoodle.com
Price (7/2/99): $5 9/16

"Kids Learn Best When They're Having Fun!"
- Noodle Kidoodle slogan

HOW DID IT FIND TROUBLE?

So, are we having fun yet? Specialty toy retailer Noodle Kidoodle seemed to have it all coming together last year. The chain reported its first annual profit in its six year history. Same-store sales were soaring, up an amazing 16%. Apart from healthy storefront expansion, it also opened shop online. Even the youngest of Noodle Kidoodle shoppers had reason to expect nothing but good things from the company.

Wall Street had other plans. After caressing the hands-on retailer, sending its shares as high as $11 5/8 over Thanksgiving 1998, it walked away and dubbed it a turkey.

In light of the emergence of eToys (Nasdaq: ETYS) and the fact that Toys "R" Us (NYSE: TOY) is storming online, it seems that having an Internet toy store is no longer virgin terrain. One can speculate that it's just a matter of time before Amazon.com (Nasdaq: AMZN) launches its own plaything peddling store.

On the bricks-and-mortar front, there are now earnings concerns. Over the past few months, expectations for this fiscal year have shrunk from $0.48 to just $0.37 a share -- lower than last year's $0.49 showing.

Can Noodle Kidoodle come out and play? Sorry folks, it's grounded.

BUSINESS DESCRIPTION


Since the first Noodle Kidoodle store opened in Greenvale, New York in 1993, the chain has grown to 46 locations nationwide. The units carry as many as 25,000 learning toys, including many that a consumer won't find at the mainstream discounters.

All of the toy, game, book, software, and video offerings are non-violent and gender neutral. Under its "please touch" policy the store is broken up into different play areas where the merchandise gets put to the test by kids. Expansion plans call for as many as 15 new units this year.

FINANCIAL FACTS

Income Statement
12-month sales: $112.7 million
12-month income: $3.7 million*
12-month EPS: $0.49*
Profit Margin: 3.3%
Market Cap: $42.3 million
(*Before accounting changes)

Balance Sheet
Cash: $4.8 million
Current Assets: $32.5 million
Current Liabilities: $18.9 million
Long-term Debt: $0.7 million

Ratios
Price-to-earnings: 11.4
Price-to-sales: 0.38

HOW COULD YOU HAVE SEEN IT COMING?

Forrester Research expects online annual toy sales to hit $1.5 billion in four years. That's a staggering amount even if it represents just 5% of the toy market. But why did investors chase Noodle Kidoodle once it became dot-com'd?

The chain has always prided itself on being a hands-on experience. The stores are filled with merchandise that often needs to be taken out of the box and handled to fully appreciate. It's not the brand name click-and-shop goodies that its bigger peers carry -- and discount.

The online world will serve Toys "R" Us, eToys, and market share leader Wal-Mart (NYSE: WMT) well. Folks know the Nintendo game, Furby, or Barbie they want going in, so the e-convenience will always be welcome. However, will the Net be conducive to selling science kits and home puppet theaters at full price?

No question, it's important for Noodle Kidoodle to have an online presence. Its closest competitor, Zany Brainy (Nasdaq: ZANY), went public last month and is now armed with the capital to launch its own online store later this year. But in these particular cases the Internet will probably serve more as a community-building tool than a merchant haven. The Internet will be an effective medium to communicate store events or general promotions, but this is one toy niche where the offline stores, and their fundamentals, are what should command investor attention.

The fact that comparable store sales increases have fallen over the last three quarters -- well off last year's double-digit highs -- may have been alarming, but even May's 4% hike is nothing to scoff at. This appears to be another case of a stock being catapulted as a Net play. Unfortunately, you can't play with Noodle Kidoodle online.

WHERE TO FROM HERE?

Earnings are expected to bounce back next year -- more than doubling to $0.75 a share. The company is also reaping the one prized fruit of its deficit-ridden past -- $16.5 million in net loss carryovers. If earnings track the company's 30% annual expansion rate, it means the company will continue to live tax-free for at least the next two years.

In the meantime, despite shareholder indifference the company is pushing forward with new stores. The original plans to open as few as a dozen new units will probably finish out the year with 15 rookie Noodle Kidoodles. There is plenty of room for growth with a third of the existing stores located in New York alone. Even Zany Brainy raising capital last month will not clutter a niche market dominated by much smaller players.

While it's hard to bank on next year's ambitious analyst estimates, value investors have probably noticed the single-digit earnings multiple that the $0.75 per share projection implies. It's a P/E younger than some of the store's biggest fans, the children. As long as the company can expand without any more growing pains, something it has yet to prove, Noodle Kidoodle might prove to be a worthy holding. Investors learn best when they're having fun -- and making money.

-Rick Aristotle Munarriz (tmfedible@aol.com)

Change the World... work for the Fool.

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