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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

[ ] 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 0-32613

EXCELLIGENCE LEARNING CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (831) 333-2000

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

(Title of Class)

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 [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the average high and low prices of the common stock on The Nasdaq SmallCap Market of $2.61 on March 3, 2003, was approximately $22,241,867. As of March 3, 2003, there were 8,521,788 shares of the registrant’s common stock outstanding, 3,010,286 of which were held by non-affiliates.

Documents Incorporated by Reference

Certain portions of the registrant’s proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the registrant’s 2002 fiscal year are incorporated by reference in Part III hereof.

PART I.

Item 1. Business.

General

On April 30, 2001, Earlychildhood LLC, a California limited liability company (“Earlychildhood”), and SmarterKids.com, Inc., a Delaware corporation (“SmarterKids.com”), combined (the “Combination”) pursuant to a Contribution Agreement and Plan of Reorganization and Merger (as amended, the “Combination Agreement”). As a result of the Combination, Earlychildhood and SmarterKids.com each became a wholly-owned subsidiary of LearningStar Corp., a Delaware corporation. On May 3, 2002, the Company changed its corporate name to “Excelligence Learning Corporation” following receipt of stockholder approval of the new name at the Company’s annual meeting of stockholders held on May 1, 2002.

The principal assets of Excelligence Learning Corporation (“Excelligence” or the “Company”) are the membership interests of Earlychildhood and the shares of SmarterKids.com owned by Excelligence. Earlychildhood and SmarterKids.com, directly or indirectly through their subsidiaries, hold substantially all of the assets of Excelligence’s business. As more fully described herein, the Company’s Early Childhood segment is conducted through Earlychildhood and SmarterKids.com and its Elementary School segment is conducted through Educational Products, Inc. (“EPI”), a wholly-owned subsidiary of Earlychildhood.

The following discussion relates to the businesses of Excelligence, which are comprised of the combined businesses previously conducted by Earlychildhood and SmarterKids.com. For convenience, the terms “Company,” “Excelligence,” “we,” “our” and “us” are used in this report to refer to Excelligence and its subsidiaries collectively, unless the context requires the terms to refer to Excelligence individually.

Corporate Website

The Company makes available its quarterly, annual and other periodic and current reports required by the Securities and Exchange Commission (the “Commission”) at its corporate website, free of charge, to individuals interested in acquiring such reports. The reports can be accessed at www.excelligencelearning.com as soon as reasonably practicable after the reports are electronically filed with the Commission.

Recent Developments

On February 19, 2003, the Company consummated its acquisition of Marketing Logistics Inc., an online retailer of early childhood furniture and equipment. Consideration for the acquisition included $800,000 in cash and 100,000 shares of the Company’s common stock. Following the acquisition, Marketing Logistics began doing business as Early Childhood Manufacturers Direct.

Company Overview

The Company is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. The Company serves early childhood professionals, educators and parents by providing quality educational products and programs for children from infancy to 12 years of age. With its proprietary product offerings, a multi-channel distribution strategy and extensive management expertise, the Company aims to further children’s education and to reinforce the connection between children’s learning at school and at home.

During fiscal year 2002, the Company operated in two business segments: Early Childhood and Elementary School, each of which is described below. Effective January 1, 2002, the Company ceased reporting its consumer division as a separate business segment and made it the consumer distribution channel for the Early Childhood

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segment. Financial information, including revenues from external customers, a measure of profit or loss and total assets, for each segment of the Company during 2002 is contained in the financial statements listed on the accompanying Index to Consolidated Financial Statements, set forth on page F-1, which are incorporated herein by reference.

Early Childhood Segment.    The Company’s Early Childhood segment includes the brand names Discount School Supply (“DSS”), SmarterKids.com and Earlychildhood NEWS. Through its Early Childhood segment, the Company develops, markets and sells educational products through multiple distribution channels to early childhood professionals and parents. The Company also provides information to teachers and other education professionals regarding the development of children from infancy through age eight.

Under the brand name Discount School Supply, the Company manufactures, imports and sells company-developed and third party products focused on the early childhood market. The Company sells a wide variety of early childhood products in the following categories: active play, arts and crafts, carpets, dramatic play, furniture, infant and toddler, language, manipulatives, math, music, puzzles, sand and water, science and teacher resources.

The principal component of the Discount School Supply product line is its comprehensive arts and crafts product offerings. Anchored by its company-developed lines of art materials, BioColor^® and Colorations^®, DSS provides a wide variety of arts and crafts, art materials and accessories for use throughout the early childhood market. DSS also distributes third-party products, including brand names such as Crayola^®, Lego^®, and Elmer’s^®.

The Discount School Supply catalog has been the Company’s primary vehicle for customer acquisition and sales in its Early Childhood segment. The Discount School Supply catalog is distributed three times annually to a growing customer base of education professionals, schools and parents. A refresher version of each of these catalogs is typically distributed 45 to 75 days after the initial distribution. The distribution of three catalogs enables the Company to adjust pricing and product strategies faster than competitors distributing catalogs less frequently. Included within the catalog are projects and curriculum ideas for using Discount School Supply products that are targeted to assist customers in educating children and in fostering their learning process. This educational content enables the Company to position the Discount School Supply catalog not only as a sales tool, but also as a learning resource for education professionals, teachers and parents. It also supports an extended useful life for the catalog that competing catalogs that only sell products may not be able to attain. For the fiscal year ended December 31, 2002, the Company distributed over 2.3 million Discount School Supply catalogs.

The Company has warehouses across the United States located to optimize shipping and delivery efficiencies and to permit delivery of an order from the Discount School Supply catalog within 48 hours to over 90% of the U.S. population. See “Item 2. Properties.” During fiscal year 2002, the Company achieved a greater than 97% success rate in shipping orders that were placed by 2:00 p.m., customer’s local time, on the same day. The Company believes that its ability to ship and deliver its products in a timely manner has been a consistent competitive differentiator.

Earlychildhood NEWS is the Company’s award-winning print and web-based magazine focused on the growth and development of children from infancy through age eight. Earlychildhood NEWS offers information, curriculum and educational programs primarily to teachers and is published in print form six times annually. The most recently published version was mailed to approximately 53,000 readers. Earlychildhood NEWS is also published continually online at www.earlychildhoodnews.com. Readers of Earlychildhood NEWS may participate online in sharing boards, browse a reading room of selected articles and ask questions which are answered by early childhood experts, pediatricians and child psychologists. The objective of Earlychildhood NEWS is to bring teachers together to share information, ideas and products.

Earlychildhood NEWS sponsors Newslink, a weekly opt-in e-mail program that brings its subscribers a collection of topical articles gathered from an array of news media. In addition, Newslink includes seasonal crafts and product information linked to the Earlychildhood NEWS website.

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Earlychildhood NEWS also sponsors a Professional Development Program through the University of Wisconsin-Stout, home of the nation’s second largest early childhood education program. Through the Professional Development Program, early childhood educators are able to improve their professionalism and to keep their credentials current. Since the Professional Development Program started in 1995, over 12,000 teachers have participated in the program. The Professional Development Program reinforces the Company’s position as a resource for educational information and products.

SmarterKids.com is the Early Childhood segment’s consumer distribution channel. As such, certain products offered in the Discount School Supply catalog may be purchased on the SmarterKids.com website. Because the Company is focused on education, many of the products offered on the SmarterKids.com website often may not be found on other websites that offer children’s products.

Elementary School Segment.    The Company’s Elementary School segment sells school supplies and other products specifically targeted for use by children in kindergarten through sixth grade, to elementary schools, teachers and other education organizations. Those parties then resell these products either as a fundraising device for the benefit of a particular school, student program or other community organizations, or as a service project to the school.

Through its Elementary School segment, the Company offers products and programs to support several different fundraising alternatives, including traditional sales programs of gift-wrap or candy and its company-developed product called SchoolWrapPacs^®. SchoolWrapPacs^® are school supply sets individually packaged to the specifications of the teachers in each grade and are designed to meet the needs of their classrooms. The Company primarily sells SchoolWrapPacs^® to parent teacher organizations, or PTOs, which then resell the product to parents as a fundraising activity or as a service to the school. This program can provide parents and teachers with a convenient and cost-effective way to purchase school supplies, while simultaneously supporting the school’s fundraising efforts. During the 2002 back-to-school season, the Company sold approximately 976,000 SchoolWrapPacs^®, which generated approximately 79% of the Elementary School segment’s sales for the fiscal year ended December 31, 2002.

Industry Overview

The Company’s business is concentrated in the educational products industry. The educational products industry consists of the sale of educational school supplies, furniture and equipment (excluding textbooks) to school districts, individual schools, childcare programs and teachers who purchase products for school and classroom use.

The size of the preschool and elementary school-age population and levels of student enrollment fundamentally drive the demand for educational products. According to the U.S. Department of Education, the preprimary school-age population (consisting of children ages three to five) is expected to be approximately 11.6 million by 2007. According to the National Child Care Association (the “NCCA”), the number of children under the age of four will increase by 1.2 million between the years 2002 and 2010, representing a six percent increase. The U.S. Department of Education also estimates that enrollment in kindergarten through eighth grade will be 37.3 million by 2007. The Company believes that, given the size of the preschool and elementary school-age populations and levels of student enrollment, the educational products industry will continue to experience significant demand in coming years.

The demand for educational products is also driven by expenditures on childcare services. Both state and federal funding support childcare and early childhood education initiatives. According to the three largest federal funding programs (Head Start/Early Head Start, the Child Care Development Fund (the portion used for children under the age of five) and Title 1 (for kindergarten and pre-kindergarten)), federal expenditures for early education and care have increased from $10.4 billion in the 2000-2001 school year to $11.1 billion in the 2001-2002 school year, with spending projected to be $11.6 billion in the 2002-2003 school year. State spending for

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pre-kindergarten programs increased nationally by 2.5% in the 2001-2002 school year, and with growth expected to increase 5.2% this year, state spending for these programs is projected to be $2.9 billion for the 2002-2003 school year. According to a NCCA study reviewing both government and private expenditures, Americans spent $38 billion in 2001 on licensed childcare programs and were projected to spend $41 billion in 2002. The U.S. Department of Education reports that President George W. Bush’s “No Child Left Behind Act” resulted in federal funding of more than $22 billion in 2002 alone, including programs for Reading First and Early Reading First. President George W. Bush’s administration also earmarked $45 million for research into the most effective ways to teach young children. In addition to academic and government initiatives, the Company acknowledges that budgeted spending by state and federal governments or agencies are only planned and may not ultimately become real expenditures, and that some states are currently reporting challenging economic climates and deficits. However, the Company believes that increasing emphasis by state and federal governments on the importance of early childhood care and education and on education in general will result in planned expenditures being made. Given the Company’s focus on sales of educational products to children in childcare programs, preschools and elementary schools, the Company believes that it will benefit from this increased spending on early childhood care and education.

The educational products industry is also dependent on the number of schools and teachers educating the preschool and elementary school-age populations. According to the 2002 Family Child Care Licensing Study conducted by The Children’s Foundation, a private, national educational non-profit organization, there were 113,298 licensed childcare centers in the United States, an increase of about 1.6% over 2001. The NCCA found that 934,000 people were employed in the licensed childcare sector in 2002. The National Center for Education Statistics reports that 93,273 public elementary schools operated in 2000-2001, an increase of almost 7.1% over the 87,125 schools reported in 1995. Of the total schools, 58% or about 55,000 are primary schools spanning kindergarten or pre-kindergarten and going no higher than eighth grade. According to the NCCA, approximately 1.4 million educators worked at the elementary school level in 2000-2001. The number of school districts in the 2000-2001 school year was approximately 15,000. The Company believes that these figures support a consistent marketplace for the products and services that it offers.

Academic research continues to highlight the importance of learning in the early age groups, i.e. ages one through seven, and the media is increasingly focusing on the importance of parental involvement during this critical stage of growth and brain development. The Company believes that parents are taking on an increasingly significant role in setting educational standards for their children’s development. In their efforts to help their children learn, to improve their children’s standardized test scores, and to make learning fun, parents are more actively selecting and purchasing a wide variety of educational products for their children to use at home. With thousands of educational products to choose from and few reliable sources of information regarding those products, parents are faced with the challenge of finding quality educational products and selecting the right products for their children. Through the Company, parents have access to comprehensive and trusted educational content and product information to help them make informed purchase decisions regarding their children’s learning.

Competitive Strengths

The Company has positioned itself as a key player in the educational products industry by focusing on its company-developed products, competitive pricing, effective customer service and delivery, the distribution and redistribution of its Discount School Supply catalog an aggregate of six times per year and an aggressive marketing strategy. The Company aggressively markets its art materials and consumables, for example, by featuring paints, craft materials and paint accessories foremost in its catalogs and on its websites and by utilizing these products in workshops for teachers. While its competitors also feature products in this category and even offer out-sourced, private-labeled paints, the Company develops and manufactures paint formulations in-house. This allows the Company to exclusively offer products such as BioColor^® and “Liquid WaterColor,” to have greater control of product availability and to improve its margins. The Company seeks to enhance its product offerings by providing its customers with information regarding activities in which such products can be used,

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allowing certain customers to participate in workshops and giving certain customers access to other services offered by the Company. For example, the Company’s print and online publication Earlychildhood NEWS, as well as its online sharing boards and product promotions, provide an opportunity for teachers to obtain and share information about product uses and learning experiences critical to advancing the quality of early childhood education. As customers increasingly interact with and become aware of the Company’s many distribution methods, including Discount School Supply’s catalog, website and direct sales force, and EPI’s fundraising programs and website, the Company seeks to become synonymous with convenience, quality and value.

By joining its SmarterKids.com website more closely to the core school-based business of DSS, the Company has reinforced its unique selling proposition: that parents may choose for their children at home the same products that teachers choose for classroom use. The Company has redesigned and linked the SmarterKids.com website to the Discount School Supply website, and uses the Company’s various distribution channels, including its Discount School Supply catalog, Earlychildhood NEWS, its sales force and its websites, to identify the SmarterKids.com website as the channel through which consumers can access substantially all of the Company’s products. The Company utilizes cross-marketing initiatives to encourage teachers to refer parents to the SmarterKids.com website.

The Company believes that its competitive strengths include, among other things, the following:

Company-Developed Products.    The Company exclusively distributes its company-developed products in the United States, and, in certain cases, has assigned international distribution rights to third parties. Through the research, development and marketing of its own brands, the Company is able to monitor and control the quality of many of its products, as well as offer high quality items at competitive prices while realizing favorable profit margins.

Workshops for Education Professionals.    The Company aggressively markets its products by offering a menu of workshops to teachers and owners and directors of child care centers. The workshops, which are conducted by members of the Company’s national sales force, allow the Company to make hands-on demonstrations of its products. The workshops also qualify to earn teachers continuing education credits toward maintenance of their professional credentials. These workshops have resulted in increased sales, customer retention and competitive margins, as most of the products demonstrated in the workshops are company-developed and exclusively distributed by the Company. The programs also provide the Company with a useful channel for customer feedback as well as personal interaction with the Company’s representatives that a catalog alone cannot provide.

Contextual Merchandising.    The Company merchandises its products in an effort to maximize the educational benefit to each of its customers. For example, its sales force is trained to understand which products are relevant to pre-kindergarten children and which products are more educationally appropriate for children in kindergarten or above. The Company believes that this tailored, or “contextual,” merchandising has helped to foster a long-term bond between its sales force and its customer base.

Compelling Educational Content and Educational Expertise.    The Company employs educators and product development professionals to work together to select products of educational value for its customers and compile other resources for the Company’s customers, including educational articles, product reviews and professional advice for parents and teachers. The Company works in conjunction with early childhood educators in various settings, including public and private preschools and universities, to test products in classroom use. In addition, the Company’s national sales force is comprised of education consultants who are familiar with the preschool and elementary school environment and the demands placed on early childhood educators’ time. The Company’s free services, including e-mail, subscriptions to Earlychildhood NEWS, and its opt-in email program Newslink, provide information, curriculum and educational programs that supplement the Company’s product offerings. In addition, the SmarterKids.com website integrates educational content with access to products highlighted in such content.

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Convenient and Easy-to-Use Websites.    Each of the Company’s websites is convenient and easy to use. The Earlychildhood website offers secure shopping through the link to www.discountschoolsupply.com. The Earlychildhood website also offers content from Earlychildhood NEWS, including authoritative articles, professional advice and sharing boards. The SmarterKids.com website is organized around age and grade levels, which is the way that parents typically think about the educational development of their children. Each of the Company’s websites offers search and browsing capabilities that enable teachers and parents to find products easily and can be accessed 24 hours a day, seven days a week.

Products and Services

The Company provides educational products and offers a variety of services to teachers, other education professionals and consumers. The Company combines its expertise in children’s education with the sale of company-developed products and a diverse selection of third-party products to assist education professionals and parents in sharing information, ideas and products. Through its various distribution channels, the Company has streamlined merchandising and distribution of its products and more efficiently offered its services to ensure that customers can access the Company’s products conveniently and effectively. To promote and sell its products, the Company relies on its wide-scale distribution of the Discount School Supply catalog, its presence at industry trade shows, its national sales force and its Discount School Supply website. By making the SmarterKids.com website the consumer distribution channel for the Company’s Early Childhood segment, the Company combined its expertise in children’s education with accessible information created for parents to help them make better purchase decisions for their children.

In 2003, the majority of the products offered to consumers on the SmarterKids.com website will be those products which were previously offered primarily to teachers and other education professionals. By offering consumers products that are chosen by teachers and approved for school use, the Company hopes to maximize its position as a developer, manufacturer and retailer of educational products. In some instances, these products may be offered to consumers in different packaging, different sizes or with special instructions appropriate for home use.

Original Company-Developed Products.    The principal component of the Company’s product line is its comprehensive arts and crafts product offerings. Anchored by BioColor^® and Colorations^®, the Company provides a wide variety of arts and crafts materials and accessories to children throughout the early childhood market. The Company also sells SchoolWrapPacs^® to the elementary school markets, which are in turn resold primarily through PTOs for service or fundraising programs.

Broad Selection of Third-Party Products.    In addition to its company-developed products, the Company offers a broad assortment of carefully reviewed and selected third-party educational products, including brand names such as Crayola^®, Lego^®, and Elmer’s^®. These products enhance the Company’s product offerings, allowing the Company to reach teachers and other education professionals looking for a diverse range of products to fulfill the educational needs of the children in their classrooms. The Company is continually updating its product line based on customer responses and sales feedback monitored by its product specialists.

Carefully Selected and Reviewed Educational Products.    The Company only sells products in its Discount School Supply catalog and on the Discount School Supply and SmarterKids.com websites that meet its quality standards. The Company consults with certified educators who assist the Company in selecting products that have educational or developmental value. Once selected, each product is put through a review process to determine its suitability based on the skills taught, effectiveness in addressing each skill, and the appropriate grade level(s).

The services offered by the Company include a variety of workshops presented by its sales force to educators, as well as archives of developmentally appropriate activities for children on each of its websites, in each case provided to enable teachers and parents to make easier and more effective use of the Company’s products.

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Marketing and Sales

The Company utilizes three primary channels to market and promote its products:

Catalogs.    Catalogs represent the Company’s primary outreach channel and are an important component of the Company’s customer acquisition and branding efforts. Unlike its main competitors who send out only one principal catalog per year, the Company distributes three different catalogs per year (with a redistribution of the same catalog with a different cover in between new catalogs) under its Discount School Supply brand name. Distributing three different catalogs per year provides the Company with flexibility to change prices and calibrate pricing to customer response rate. The Discount School Supply catalogs are distributed in the months of January (edition redistributed in March), May (edition redistributed in July) and August (edition redistributed in September) to coincide with the periods when school purchasing decisions are generally made. The Company distributed over 2.3 million Discount School Supply catalogs during the fiscal year ended December 31, 2002.

Direct Sales Representatives.    As of December 31, 2002, the Company’s sales force consisted of 64 sales representatives. Of those representatives, 15 members acted as education consultants focused on catalog sales through the Company’s Early Childhood segment, and 49 focused on sales through the Company’s Elementary School segment. Sales representatives promote company-developed products, such as BioColor^® and Colorations^®, and programs, such as SchoolWrapPacs^®, to teachers and administrators through in-school demonstrations and workshops that are designed to elicit higher customer response and better retention rates. Within the Elementary School segment, sales representatives educate PTOs and teachers about the benefits and convenience associated with SchoolWrapPacs^® and the Company’s other products.

Online Marketing.    The Earlychildhood.com website has been designed to become one of the principal vehicles used by the Company to reach customers and provide them with an array of information and services related to the Early Childhood and Elementary School segments product lines. The Company promotes its SmarterKids.com website through the Earlychildhood.com website by encouraging teachers to refer parents to SmarterKids.com for the same products teachers choose for the classroom. In addition, through e-marketing promotional services, the Company has relationships with over 2,000 websites that feature links to its SmarterKids.com website. These websites range from online malls to the websites of individuals.

Seasonality

The Company’s seasonal sales trends coincide with the start of each school year. Accordingly, approximately 50% of the Early Childhood and Elementary School segments’ consolidated annual sales are generated in the third calendar quarter. The Company’s working capital needs are greatest during the second calendar quarter as inventory levels are increased to meet seasonal demands. See “Risk Factors—Our business is highly seasonal.”

Customers and Suppliers

The Company sells its products to institutions, such as public and private schools, school districts, early learning centers, childcare programs and PTOs, as well as to parents and education professionals. The Company is not dependent on any single customer or group of customers. For the fiscal year ended December 31, 2002, the Company’s largest customer accounted for less than one percent of the Company’s consolidated revenues.

The Company purchases services, products and materials from over 700 suppliers. As such, the Company does not have significant supplier concentration and experiences little or no supplier risks, as most of the product sources are standard and obtainable from multiple vendors. The Company also sources a significant number of its products overseas. Products sourced overseas accounted for approximately 25% of the Company’s sales for the fiscal year ended December 31, 2002.

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Competition

Competition in the educational products industry is based on price, timely service and product selection. The Company’s major competitors in the educational products industry are School Specialty, Inc., Lakeshore Learning Materials, The Kaplan Companies and U.S. Toy Company. The Company also competes, to a much lesser extent, with mass-market retail chains such as Target and Wal-Mart, with other custom-packers of school supplies such as Innisbrook, as well as with retail and online booksellers and toy stores, including Toys “R” Us, Inc., Barnes & Noble, K•B Toys and Amazon.com. The Company believes that the primary advantage it has over its competitors is its combination of an aggressive pricing structure with a range of proprietary products and customer service.

The Company believes that the following factors are essential for it to remain competitive in its industry:

Intellectual Property

The Company regards the protection of its intellectual property as critical to its future success and relies on a combination of copyright, trademark, service mark, trade secret laws, license agreements and contractual restrictions to establish and protect its proprietary rights, which include rights in its products, website architecture and technology, content and services. The Company has entered into confidentiality and invention assignment agreements with certain employees and contractors in order to limit disclosure of its proprietary information and to protect its ownership interest in its website architecture and technology. However, the Company cannot ensure that these contractual arrangements or the other steps taken by it to protect its intellectual property will prove sufficient to prevent misappropriation of its technology or deter independent third-party development of similar items.

The Company conducts business on the Internet and through other channels by utilizing a variety of trademarks and domain names. There are a number of other trademarks and domain names similar to those of the Company. The owners of these trademarks and domain names could bring an infringement action against the Company at any time and there is a risk that such owners would overcome any defenses that the Company could raise. If the owners of such trademarks and domain names were to prevail in such an action, the Company could lose the ability to use its trademarks and domain names and could be subject to substantial damages. Because certain of the Company’s trademarks are descriptive marks, there is also a risk that third parties might use trademarks that are similar to those of the Company. If third parties began using trademarks similar to the Company’s trademarks, it could adversely affect the Company’s business by materially decreasing the value of its trademarks and harming its brands and reputation. If the Company is required to change any of its trademarks or domain names, it could lose customers and brand equity, which would have a material adverse effect on the Company’s business and financial condition. Although the Company may attempt to acquire or license the right to use potentially relevant third-party trademarks and domain names, it may not be successful.

The following is a list of the Company’s registered trademarks and service marks: SmarterKids.com^®, SmarterKids^®, Smart Kids’^®, Virtual Knowledge^®, Virtual Entertainment^®, Earlychildhood NEWS^®, Flexitemp^®, Little Bit O’ Paint^®, Basic Brights^®, First Art^®, The Imagination Playground^®, BioColor^®, Rainbow^®, Dandi-Li-On^®, Squeezables^®, LifeLong Learning Starts Here^®, Proboard^®, EPI^®, Econoboard^®, Colorations^®, BioPutty^®, Child Care Central^®, Completing the Circle Between Teachers and Parents^®, SchoolWrapPac^®, Moo-Nay^® and the design logo of a child reaching for a star. The Company also has the following pending trademarks and service mark applications: Excelligence, and Colors Like Me. The Company

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has the following registered patents: Foam Paint Set, BioColor (German patent registration), and Portable Cot Apparatus. In addition, the Company has a pending patent application relating to the SmartPicks product selection algorithm it uses on the SmarterKids.com website.

Technology

The Company has implemented a broad array of scalable systems for catalog and website management, customer service, electronic transaction management and data interchange, e-mail, order processing, payment processing, warehouse management, office administrative services and accounting. These systems use a combination of proprietary and commercially available technologies.

The Company develops or selects systems that are based on industry-standard architectures that have been designed to minimize downtime in case of outages or catastrophic occurrences. The Company’s transaction processing methods and databases are designed without arbitrary capacity constraints and are scalable to any volume of demand that the Company expects to encounter. The Company utilizes load balancing systems and redundant equipment to provide for fault tolerance. In the fourth quarter of 2002, the Company implemented a data warehouse system to facilitate reporting and decision-making processes. In December 2002, the Company partnered with DirectNet Solutions to automate vendor communications, improving efficiency and response time with vendors and customers.

The Company’s systems infrastructure is supported in-house at its corporate headquarters in Monterey, California. In February 2002, the SmarterKids.com website technology was relocated from Exodus Communications in Waltham, Massachusetts to the Company’s corporate headquarters. Most of the systems are monitored 24 hours a day, seven days a week through applications and technology that contact systems personnel when problems are identified. Systems backups are done on a regular cycle, and tapes are stored both in-house and offsite at a secure facility.

Governmental Regulation

The Company is subject to the provisions of the Consumer Product Safety Act, which enables the Consumer Product Safety Commission to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury. The Consumer Product Safety Commission may also require the repurchase by the manufacturer of articles that are banned. Similar laws exist in some states. In addition, the Company’s manufacturing operations are subject to numerous federal, state and local environmental and occupational health and safety laws and regulations, which include laws and regulations governing waste disposal, air and water emissions, workplace exposure and other matters. All art materials produced by the Company are evaluated and certified as non-toxic by the Duke University Department of Occupational and Environmental Health. These products are packaged in accordance with federal labeling standards for art materials.

The Company’s catalog business, like the catalog industry in general, is subject to regulation by a variety of state and federal laws relating to, among other things, advertising and sales taxes. The Federal Trade Commission regulates advertising and trade practices and the Consumer Product Safety Commission has issued regulations governing the safety of the products sold by the Company. Under current law, catalog retailers are permitted to make sales in states where they do not have a physical presence without collecting sales tax. The Company believes that it collects sales taxes in states where it is required to do so.

The Company is also subject to various other federal, state and local laws and regulations applicable to its business. The Company believes that it is in substantial compliance with these laws and regulations.

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Backlog

The Company has no firm backlog. The Company’s customers typically purchase products on an as-needed basis. The Company believes that, as of December 31, 2002, backlog was not a meaningful indicator of future business prospects due to the large volume of products delivered from shelf inventories.

Employees

As of December 31, 2002, the Company and its subsidiaries had 368 full-time employees, including 233 in its Early Childhood segment and 135 in its Elementary School segment. From time to time, the Company also employs independent contractors to support its operations. The Company has not experienced any work stoppage and considers its relations with its employees to be good. None of the Company’s employees belongs to a collective bargaining unit.

Forward-Looking Statements

Certain information included in this Annual Report on Form 10-K and other materials filed or to be filed by the Company with the Commission (as well as information in oral statements and other written statements made or to be made by the Company) contains 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. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary language noting important factors that could cause actual results to differ materially from those projected in such statements. Such forward-looking statements involve risks and uncertainties that could significantly affect anticipated results in the future and include information relating to plans for future expansion and other business development activities as well as other capital spending, financing sources and the effects of regulation and competition. The Company has based its forward-looking statements on current expectations and projections about future events and assumes no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so in connection with its ongoing requirements under federal securities laws to disclose material information that may be made by or on behalf of the Company in this Annual Report on Form 10-K or otherwise.

When used in this Annual Report on Form 10-K and in other statements made by or on behalf of the Company, the words “believes,” “anticipates,” “expects,” “plans,” “intends,” “expects,” “estimates,” “projects,” “could” and other similar words or expressions, which are predictions of or indicative of future events, conditions and trends, identify forward-looking statements. Such forward-looking statements are subject to a number of important risks, uncertainties and assumptions that could significantly affect anticipated results in the future. These risks, uncertainties and assumptions about the Company and its subsidiaries include, but are not limited to, the following:

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In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Annual Report on Form 10-K might not occur.

Risk Factors

Set forth below are certain risk factors related to the Company’s business. The risk factors described below may not include all of the risk factors that could affect future results. Actual results could differ materially from those anticipated as a result of various factors, including those set forth in the following risk factors and in the Company’s other periodic and current reports on file with the Commission from time to time.

We may not continue to be profitable if we are unable to increase our revenues while controlling operating costs.

In order to continue to be profitable, we need to generate greater revenues and operating profits while controlling costs and operating expenses. In the fiscal year ended December 31, 2002, we realized a net profit of $2.5 million as compared to a net loss of $36.0 million for the fiscal year ended December 31, 2001. Included in the 2001 net loss was an impairment charge related to the carrying value of long-lived assets in our former consumer segment of $29.6 million, and merger integration charges related to the combination of Earlychildhood and SmarterKids.com of $1.8 million. Also included in the loss was amortization of goodwill and a one-time charge related to the early extinguishment of debt of $5.5 million and $500,000, respectively. A tax benefit primarily related to the impairment charge of $6.5 million was also included as a reduction in the net loss for the year. During 2002, we implemented significant cost-cutting measures in order to achieve profitability. These cost-cutting measures may not be sufficient for us to continue to sustain profitability and we may incur losses in the future. If we incur significant losses in the future and are unable to sustain profitability, it may have a negative impact on our stock price and our results of operations could be materially and adversely affected.

Restrictive loan covenants may limit our ability to draw on our credit facility, which could adversely affect our results of operations and our financial condition.

Our business is capital intensive and requires significant levels of inventory leading up to our peak business period, which we fund using our $25.0 million secured credit facility with GMAC Business Credit, LLC (the “GMAC Facility”). The GMAC Facility contains certain covenants which require us to satisfy ongoing financial requirements and which may limit our ability to make capital expenditures during the term of the facility. Our borrowing availability under the GMAC Facility is calculated weekly on a formula basis that is determined based on the carrying amounts of our eligible inventory at cost and eligible receivable balances.

As of December 31, 2001, we were in violation of one of the financial covenants under the GMAC Facility. On March 13, 2002, we entered into an amendment to the GMAC Facility, pursuant to which GMAC waived the covenant violation and reset the financial covenants under the GMAC Facility. On March 21, 2002, we entered into a second amendment to the GMAC Facility, pursuant to which GMAC reduced the minimum excess availability requirement from $4.0 million to $2.5 million through July 31, 2002, thus providing additional availability of $1.5 million during our peak inventory purchasing season. In connection with the execution of the second amendment, our Chief Executive Officer agreed to guarantee up to $500,000 of the additional loan availability under the GMAC Facility. On July 31, 2002, the minimum excess availability requirement was reset to $4.0 million and the guarantee by our Chief Executive Officer expired. As of December 31, 2002, the Company was in compliance with all the financial covenants as set forth in the GMAC Facility.

As of December 31, 2002 and March 3, 2003, the Company had $0 and $1.1 million, respectively, in outstanding borrowings under the GMAC Facility. Available borrowing capacity as of December 31, 2002 and March 3, 2003 was $2.7 million and $3.6 million, respectively. We cannot ensure that amounts available under the GMAC Facility will be sufficient to fund our liquidity needs. Our ability to fund our operations, make scheduled debt payments and planned capital expenditures and to remain in compliance with financial covenants under the GMAC Facility will depend on our future operating performance and cash flow, which in turn, is

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subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control.

We are dependent upon the size of the preschool and elementary school-age populations, levels of enrollment and expenditures per child in child care programs and elementary schools.

Our ability to grow our business depends in part on the size of the population in early childhood programs, preschools and elementary schools, the levels of enrollment of such population in child care centers and elementary schools and the level of expenditures per child in child care programs and elementary schools. The level of enrollment in early childhood programs and preschools depends in part on parents’ attitudes toward early childhood education, while the level of student enrollment in elementary schools is largely a function of demographics. Expenditures per child are a function of prevailing political and social attitudes toward education, as well as government budgets. Any significant and sustained decline in the size of the preschool and elementary school-age populations, levels of enrollment and/or expenditures per student could have an adverse effect on our business, financial condition and results of operations.

Our business is highly seasonal and our annual results are highly dependent on the success of our third quarter results.

We are affected by seasonal shopping patterns. A significant portion of the sales in our Early Childhood and Elementary School segments occur in the third quarter, coinciding with the start of the U.S. school year. As a result, our results of operations for the entire year depend largely on third quarter results. We typically earn approximately 50% of our annual net revenues in the third quarter and operate at a net loss in the first, second and fourth quarters. Factors that could cause our sales and profitability to suffer due to this seasonality include:

This seasonality causes our operating results to vary significantly from quarter to quarter.

Our operations could be disrupted if our information systems fail.

Our business depends on the efficient and uninterrupted operation of our computer and communications software and hardware systems. We regularly make investments to maintain, enhance and replace these systems. We must assess and appropriately expand the capacity of our information systems to accommodate the anticipated growth of the Company or our operations could suffer.

We also depend heavily on certain software that is utilized in our order taking, customer service, inventory management, and fulfillment operations. If problems with this software develop, our operations could be slowed or interrupted, reducing the volume of goods sold and shipped and the attractiveness of products, services and information offered, causing damage to our reputation.

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We are subject to intense competition which may impede or prevent us from attaining greater market share and could impair the growth of our revenues.

Intense competition and increased consolidation, which could result in one company’s dominance in the marketplace, may result in loss of market share for the Company and ultimately reduce the Company’s revenues.

The Company directly competes with companies such as School Specialty, Inc., Lakeshore Learning Materials, The Kaplan Companies and U.S. Toy Company. There has been consolidation among these competitors over the last several years; specifically, ABC School Supply, Inc. and J.L. Hammett Co.’s Earlychildhood Division were purchased by School Specialty, Inc. In addition, some competitors, including The Kaplan Companies and School Specialty, Inc., have launched websites that compete with our websites.

We also compete, to a lesser extent, with mass-market retailers such as Target and Wal-Mart, other packers of school supplies such as Innisbrook, as well as retail and online booksellers and toy stores, including Toys “R” Us, Inc., Barnes & Noble, K•B Toys and Amazon.com. These companies have greater brand recognition and greater resources than we do. We could be at a disadvantage in responding to these competitors’ merchandising and pricing strategies.

Our sales and profitability could suffer if, among other things:

If our suppliers and distributors alter purchasing terms, our margins and profitability will suffer.

Many of our suppliers provide incentives, such as return privileges, volume purchasing allowances and cooperative advertising. A reduction or discontinuation of these incentives could increase costs and decrease our margins and profitability.

If a shipment of products that we import is interrupted or delayed, our inventory levels and sales could decline.

We import some of our product offerings from foreign manufacturers. These foreign manufacturers are located in countries such as Japan, China, Taiwan, Germany and South Korea. We are subject to the following risks inherent in relying on foreign manufacturers:

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Interruptions or delays in our imports could cause shortages in product inventory and a decline in our sales unless we secure alternative supply arrangements. Even if we could locate alternative sources, these alternative products may be of lesser quality or more expensive. Our sales could also suffer if our suppliers experience similar problems with foreign manufacturers.

We are dependent on certain key employees.

Our business depends to a significant extent on the abilities and continued service of current executive officers and senior management, including Ron Elliott, our Chief Executive Officer. If Mr. Elliott or any other key employee were to become unable or unwilling to continue in his or her role, or if we are unable to attract and retain other qualified employees, our business could be adversely affected. Although we have employment contracts with certain of our key executives, we do not have agreements with other key members of our management. We do not have and do not intend to obtain key person life insurance covering any of our executive officers or other members of our management.

We may be unable to protect our intellectual property, which could impair brand and reputation.

Our efforts to protect our proprietary rights may be inadequate. We regard our intellectual property as important to our marketing strategy. To protect our proprietary rights, we generally rely on copyright, trademark and trade secret laws, confidentiality agreements with employees and third parties and license agreements with consultants and suppliers. However, a third party could, without authorization, copy or otherwise appropriate information from us. Furthermore, certain of our trademarks are descriptive marks that have not been and likely will not be registered with the United States Patent and Trademark Office, and third parties may use trademarks similar to ours, potentially diminishing our brand name and reputation. Employees, consultants and others who participate in development activities could breach their confidentiality agreements, and we may not have adequate remedies for any such breach. If we fail or are unable to protect our proprietary rights, it could materially decrease our value and our brand and reputation could be impaired. See “—Intellectual Property.”

The cost of materials used to manufacture our products is subject to volatility, which could reduce our profitability.

The unavailability of raw materials or a substantial increase in their prices could reduce our profitability and have a negative impact on our ability to produce proprietary products. We currently sell certain company-manufactured products, including non-toxic tempera paints, finger paints, glues and other water-based art mediums. We may, from time to time, experience difficulty in obtaining adequate raw material requirements at competitive prices, and experience shortages of raw materials used in our manufacturing process, which could reduce our profitability.

We are subject to regulation by federal and state environmental authorities and may be subject to environmental claims relating to our manufacturing processes.

If we fail to comply with environmental laws and regulations in the manufacturing of our products, we may incur material liabilities in the form of administrative, civil, or criminal enforcement by government agencies or other parties, which would reduce our profitability and cause our stock price to decline. Our manufacturing operations are subject to numerous federal, state, and local environmental and occupational health and safety laws and regulations, which include laws and regulations governing waste disposal, air and water emissions, the handling of hazardous substances, workplace exposure, and other matters.

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At this time, we are not required to make any material capital expenditures to remain in compliance with applicable environmental laws and regulations, but we may be required to do so in the future. We may also be required to make expenditures to maintain environmental control systems, to remedy spills or leaks of toxic materials stored in our facilities, or to dispose of hazardous materials required in our manufacturing process. These expenditures could reduce our profitability. In addition, the adoption of new environmental laws and regulations, changes in existing laws and regulations, or their interpretation, stricter enforcement of existing laws and regulations, or governmental or private claims for damage to persons, property, or the environment resulting from our business may force us to expend additional capital and resources on environmental compliance.

We may be exposed to product liability lawsuits and other claims if we fail to comply with government safety standards.

Children can sustain injuries from products that we sell and we may be subject to claims or lawsuits resulting from such injuries. There is a risk that claims or liabilities may exceed all of our insurance coverage. Moreover, we may be unable to retain adequate liability insurance in the future. We are also subject to regulation by the Consumer Product Safety Commission and similar state regulatory authorities and certain of our products could be subject to recalls and other actions by these authorities. See “—Governmental Regulation.”

Certain of our affiliates have significant influence over us, which could limit our other stockholders’ ability to influence corporate decisions.

As of March 3, 2003, our Chief Executive Officer and two of our other stockholders, owned, in the aggregate, approximately 63% of our common stock on a fully diluted basis. As a result, these stockholders, if they were to act together, would be able to control all matters requiring approval of a majority of our stockholders, including any merger, sale of assets and other significant corporate transactions. This control could:

Provisions of our charter and bylaws and Delaware law may have anti-takeover effects that could prevent a change in control of the Company.

Certain provisions of our restated certificate of incorporation and amended and restated bylaws and Delaware law may have the effect of delaying or preventing a change of control of the Company.

Our restated certificate of incorporation authorizes our board of directors to issue, without stockholder approval, shares of preferred stock with voting, conversion and other rights and preferences that could adversely affect the voting power or other rights of the holders of our common stock. The issuance of preferred stock or of rights to purchase preferred stock could be used to discourage an unsolicited acquisition proposal. In addition, the possible issuance of preferred stock could discourage a proxy contest, make more difficult the acquisition of a substantial block of our common stock or limit the price that investors might be willing to pay in the future for shares of our common stock. Our restated certificate of incorporation and amended and restated bylaws also provide that:

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In addition, we are subject to certain “anti-takeover” provisions of the Delaware General Corporation Law which, subject to certain exceptions, restrict certain transactions and business combinations between a corporation and a stockholder owning 15% or more of the corporation’s outstanding voting stock, or an interested stockholder, for a period of three years from the date the stockholder becomes an interested stockholder.

Item 2. Properties.

The Company’s corporate headquarters are located at 2 Lower Ragsdale Drive in Monterey, California. The 26,000 square-foot leased office space also houses the administrative functions of the Company’s Early Childhood segment. The Company does not own any real property and leases the following facilities:

The Company also leases 39,000 square feet of office space in Needham, Massachusetts, pursuant to a lease that expires in October 2004. The Company used this facility to house the SmarterKids.com operations until February 2002, when the Company moved those operations to Monterey, California. The Company has subleased approximately 25% of the facility and is currently in the process of seeking a subtenant for the remaining space.

Item 3. Legal Proceedings.

The Company and its subsidiaries are, from time to time, party to legal proceedings arising in the normal course of business. In management’s opinion, there are no pending claims or litigation, the outcome of which would have a material effect on the Company’s consolidated results of operations, financial position or cash flows.

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2002.

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PART II.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

The Company’s common stock is currently traded on The Nasdaq SmallCap Market under the symbol “LRNS.” The Company’s common stock began being publicly traded on May 1, 2001 following consummation of the Combination. The following table sets forth the high and low price per share of the Company’s common stock during fiscal year 2002 and 2001:

On March 3, 2003, there were 8,521,788 outstanding shares of the Company’s common stock held by 61 holders of record.

The Company has not paid and does not presently intend to declare cash dividends. The Company currently intends to retain future earnings to finance its operations and fund the growth of its business. Any payment of future dividends will be at the sole discretion of the Company’s Board of Directors and will depend upon, among other things, the Company’s earnings, results of operations, financial condition, capital requirements, level of indebtedness, contractual restrictions in respect of the payment of dividends, future prospects and other factors deemed relevant to such determination by the Board of Directors. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

On April 30, 2001, in connection with the Combination, the former holders of membership interests in Earlychildhood contributed all of their membership interests to Excelligence and, in exchange therefore, Excelligence issued 5,798,573 shares of its common stock to those former Earlychildhood members. The shares of Excelligence common stock issued to the former Earlychildhood members were issued in reliance upon an exemption from the registration requirements of the Securities Act of 1933 provided by Section 4(2) thereof.

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Item 6. Selected Financial Data.

SELECTED CONSOLIDATED FINANCIAL DATA

(in thousands, except share and per share data)

The following statements of operations and balance sheet data have been derived from the audited consolidated financial statements of Excelligence Learning Corporation and its predecessor entities. The historical results presented herein are not necessarily indicative of future results and should be read in conjunction with the consolidated financial statements and notes thereto beginning on page F-1 of this Annual Report on Form 10-K.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion contains forward-looking statements that involve risks and uncertainties that could significantly affect anticipated results in the future. See “Item 1—Risk Factors.” Given these risks and uncertainties, the Company can give no assurance that any forward-looking statements, which speak only as of the date of this report, will in fact transpire and, therefore, the Company cautions investors not to place undue reliance on them. The Company makes these forward-looking statements under the provision of the “Safe Harbor” section of the Private Securities Litigation Reform Act of 1995. Actual results may vary materially from those projected, anticipated or indicated in any forward-looking statements. In this Annual Report on Form 10-K, the words “anticipates,” “believes,” “expects,” “intends,” “future,” “could,” and similar words or expressions (as well as other words or expressions referencing future events, conditions, or circumstances) identify forward-looking statements. The Company assumes no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so in connection with its ongoing requirements under Federal securities laws to disclose material information. The following discussion and analysis should be read in conjunction with the financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

Overview

Excelligence was incorporated in the State of Delaware on November 6, 2000 for the purpose of effecting the Combination. Prior to the Combination, Excelligence was nominally capitalized and its balance sheet was comprised solely of common stock subscriptions receivable of $10.00 and common stock of $10.00, representing 1,000 shares of outstanding common stock at a par value of $0.01 per share. The Combination was completed on April 30, 2001 and Earlychildhood and SmarterKids.com each became a wholly-owned subsidiary of Excelligence.

Immediately following the Combination, the former holders of outstanding membership interests in Earlychildhood and options to purchase membership interests in Earlychildhood owned approximately two-thirds of the capital stock of Excelligence and the former holders of outstanding common stock of SmarterKids.com and options and warrants to purchase shares of common stock of SmarterKids.com owned approximately one-third of the capital stock of Excelligence. As the former Earlychildhood members had a controlling interest in Excelligence immediately following the Combination, the transaction has been recorded as if Earlychildhood acquired SmarterKids.com, with Earlychildhood deemed to be the predecessor of Excelligence. Accordingly, the following discussion addresses the results of operations of Earlychildhood and its predecessor prior to April 30, 2001 and the financial position and results of operations of Excelligence thereafter. A further discussion of the Combination is included under “Combination with SmarterKids.com” below.

The Company is a developer, manufacturer and retailer of educational products, which are sold to child care programs, preschools, elementary schools and consumers. Through a predecessor entity, the Company began operations in 1985. The Company utilizes multiple sales, marketing and distribution channels, including:

All of the foregoing is supported by a national sales force, which, as of December 31, 2002, numbered 64 people.

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In fiscal year 2002, the Company operated in two business segments: Early Childhood and Elementary School. The Early Childhood segment includes the brand names Discount School Supply, SmarterKids.com and Earlychildhood NEWS. The Early Childhood segment develops, manufactures and sells educational products through multiple distribution channels to early childhood professionals and parents. The Early Childhood segment also provides information to teachers and other education professionals regarding the development of children from infancy through age eight. The Elementary School segment sells school supplies and other products specifically targeted for use by children in kindergarten through sixth grade to elementary schools, teachers and other education organizations for fundraising activities. In fiscal year 2001, the Company operated a third business segment, identified as the consumer segment. The consumer segment included SmarterKids.com’s operations, which sold educational products online to consumers through the SmarterKids.com website. Effective January 1, 2002, the consumer segment became the consumer distribution channel of the Early Childhood segment and ceased being reported by the Company as a separate business segment.

Combination with SmarterKids.com

On November 14, 2000, Earlychildhood entered into the Combination Agreement to combine with SmarterKids.com. The Combination Agreement provided for (i) the holders of all of Earlychildhood’s outstanding membership interests to contribute their entire ownership interest in Earlychildhood in exchange for Excelligence common stock and (ii) S-E Educational Merger Corp., a wholly-owned subsidiary of Excelligence, to be merged with and into SmarterKids.com and the outstanding shares of SmarterKids.com to be converted into shares of common stock of Excelligence. In addition, the Combination Agreement provided for holders of options to purchase Earlychildhood membership interests to have their options exchanged for options to purchase Excelligence common stock, holders of options to purchase SmarterKids.com common stock to have their options converted into options to purchase Excelligence common stock and holders of warrants to purchase SmarterKids.com common stock to have their warrants cancelled. Immediately after the exchange, Earlychildhood’s members and option holders owned approximately two-thirds of Excelligence common stock on a fully diluted basis.

On April 30, 2001, the Combination was completed. The following table reflects Excelligence common shares and options to purchase common shares, which were issued upon completion of the Combination:

The Combination was accounted for as a purchase of SmarterKids.com by Earlychildhood. The purchase price of approximately $49.1 million is based on the estimated fair value of shares of Excelligence common stock and options issued upon conversion of shares of SmarterKids.com common stock and options and cancellation of SmarterKids.com warrants, plus transaction costs.

Results of Operations

Revenues

Revenues were $100.8 million, $92.8 million and $80.4 million for 2002, 2001 and 2000, respectively. The increase in revenue from 2001 to 2002 of 8.6% was primarily due to internal growth of 11.4%, or $7.1 million, in

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the Early Childhood segment. This increase in the Early Childhood segment is primarily the net result of an increase of 15% in the Discount School Supply catalog revenue channel and a decrease of 37% in the consumer distribution channel (SmarterKids.com). The decrease in revenue in the consumer distribution channel was anticipated for 2002. Overall growth in the Early Childhood segment was primarily achieved through aggressive pricing and marketing strategies, offering new proprietary products and by effectively increasing circulation of the Discount School Supply catalog. The Elementary School segment revenue increased by 2.4%, or $722,000, in 2002. The increase in revenue from 2000 to 2001 of 15.5% was primarily due to growth of 20.1%, or $10.5 million, within the Early Childhood segment. The acquisition of SmarterKids.com in 2001 added an additional $4.0 million, or 6.3%, of the Early Childhood segment’s revenue in 2001.

The Company’s goal in 2003 is to achieve revenue growth in the Early Childhood and Elementary School segments through increasing circulation of its Discount School Supply catalog, offering new proprietary products, soliciting new customers, implementing more aggressive pricing, marketing strategies and enhancing the Company’s websites. The Company’s ability to realize this growth may be negatively affected by changes in the national economy that reduce government or private funding of educational programs or that increase joblessness and may result in parents removing their children from childcare programs.

Gross Profit

Gross profit was $36.3 million, $33.1 million and $29.7 million for 2002, 2001 and 2000, respectively. The increase in gross profit in 2002 of $3.2 million was primarily related to an increase in revenues of 11.4%, or $7.1 million, in the Early Childhood segment. This increase in gross profit within the Early Childhood segment was achieved through effective pricing and purchasing strategies. The increase in gross profit in 2001 of $3.4 million was primarily due to revenue growth of 20.1%, or $10.5 million, within the Early Childhood segment. Also, the acquisition of SmarterKids.com in 2001 added an additional $4.0 million of the Early Childhood segment’s revenue in 2001.

Gross profit as a percentage of sales was 36.0%, 35.7% and 37.0% for 2002, 2001 and 2000, respectively. The increase in gross profit as a percentage of sales in 2002 was attributable to more effective purchasing and managing of inventory. The decrease in gross profit as a percentage of sales in 2001 was primarily attributable to lower gross profit percentages associated with the Early Childhood segment as a result of the acquisition of SmarterKids.com, as well as a write-down for inventory discontinued in the fourth quarter. SmarterKids.com, which was acquired in the Combination, did not exist in 2000.

The Company accounts for shipping costs as cost of goods sold for shipments made directly from vendors to customers and also for shipments from the Company’s warehouses. The amount of shipping costs related to shipments from the Company’s warehouses for the years ended December 31, 2002, 2001 and 2000 was $6.5 million, $6.0 million and $4.5 million, respectively, or 6.4%, 6.5% and 5.6% as a percentage of sales, respectively. The amount of shipping costs related to shipments made directly from vendors to customers for the years ended December 31, 2002, 2001 and 2000 was $2.5 million, $1.3 million and $1.1 million, respectively, or 2.5%, 1.4% and 1.3% as a percentage of sales, respectively.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include wages and commissions, catalog costs, operating expenses (which include customer service and certain warehouse costs), administrative costs (which include information systems, accounting and human resources), e-business costs, equity-based wages and depreciation of property and equipment.

Selling, general and administrative expenses were $32.6 million, $39.2 million and $30.5 million for 2002, 2001, and 2000, respectively. The decrease in selling, general and administrative expenses in 2002 is attributable to the Company’s overall cost-cutting strategies, which included layoffs primarily associated with personnel

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assumed in the acquisition of SmarterKids.com, salary and hiring freezes and a reduction of the Company’s 401(k) matching contributions.

The increase in selling, general and administrative expenses in 2001 is partially attributable to the addition of a new warehouse facility in Salinas, California, the expansion of the Harrisburg, Pennsylvania warehouse facility and the costs associated with the closure of the Needham, Massachusetts facility and severance for personnel assumed in the acquisition of SmarterKids.com. The remaining costs were related to investments in marketing and infrastructure for the Early Childhood segment, including personnel, catalog production and fulfillment capacity, as well as $500,000 of Combination-related expenses incurred primarily during the second and third quarters of 2001.

The Company does not anticipate significant personnel reductions in 2003. However, the Company will continue to focus on the achievement of selling, general and administrative operating efficiencies.

Impairment Charges

In the second quarter of 2001, the Company migrated its consumer website operations to the SmarterKids.com website platform. As a result, the Earlychildhood.com website applications and infrastructure were abandoned, resulting in an impairment charge of $580,000 relating to the remaining unamortized development costs. In the fourth quarter of 2001, the Company determined that the goodwill, intangible assets and property and equipment acquired in the Combination was impaired. Based on the estimated discounted cash flows related to those assets, the Company recorded an impairment charge of $29.0 million, which represented all long-lived assets acquired in the Combination.

Amortization of Goodwill and Other Intangible Assets

Amortization of goodwill and other intangible assets was $288,000, $5.5 million and $964,000 for 2002, 2001, and 2000, respectively. The decrease in amortization in 2002 is a result of the Company’s adoption of SFAS No. 142, Goodwill and Other Intangible Assets, whereby goodwill is no longer amortized, but tested for impairment on an annual basis. Amortization expense for 2002 and going forward relates to the amortization of other intangibles. The increase in 2001 was primarily the result of the amortization of goodwill and other intangible assets associated with the Combination. Such SmarterKids.com goodwill and other intangible assets were written off in the fourth quarter of 2001.

Interest Expense

Interest expense was $428,000, $921,000 and $1.7 million for 2002, 2001 and 2000, respectively. The decrease in interest expense in 2002 is primarily attributable to the Company carrying a lower average outstanding balance on the GMAC business line of credit throughout the year as compared to 2001. This was achieved by the Company’s improved operating results. The decrease in interest expense in 2001 is primarily due to the repayment of long-term debt related to Earlychildhood’s credit facility with BNP Paribas (the “Paribas Credit Facility”), which was terminated in connection with the Combination, with cash acquired as a result thereof.

Income Taxes

Income tax expense was $548,000 in 2002, while income tax benefit was $6.5 million in 2001 and income tax expense was $286,000 in 2000. Income tax expense in 2002 was lower than the statutory tax rate primarily due to the reduction of the deferred tax valuation allowance. Income tax benefit increased in 2001 due to the Company’s effective change from a non-taxable limited liability company (“LLC”) to a C corporation in connection with the Combination. The effective tax rate in 2001 was less than the statutory rate due to the effect of non-deductible charges relating to amortization and impairment of goodwill.

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The Company has recorded a deferred tax asset in an amount that is more likely than not to be realized. In the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) approved for issuance SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 amends FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The provisions of SFAS No. 143 are effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company is currently evaluating the impact of the adoption of the provisions of the pronouncement.

On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill resulting from a business combination no longer be amortized to earnings, but instead be reviewed for impairment. A further discussion of the adoption of SFAS No. 142 and its effect on the Company is included in note 8 to the Company’s consolidated financial statements.

In May 2002, the FASB approved for issuance SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 requires gains and losses from extinguishment of debt to be classified as an extraordinary item only if the criteria in APB No. 30 have been met. Further, lease modifications with economic effects similar to sale-leaseback transactions must be accounted for in the same manner as sale-leaseback transactions. While the technical corrections to existing pronouncements are not substantive in nature, in some instances they may change accounting practice. The Company adopted the provisions of SFAS No. 145 required for financial statements on January 1, 2003. As such, for financial statements for periods beginning after January 1, 2003, the Company’s extraordinary loss for debt extinguishments will be recorded as other expense.

In June 2002, the FASB approved for issuance SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses accounting and reporting for costs associated with exit and disposal activities and supercedes Emerging Issues Task Force Issue No. 94-3 (EITF 94-3), Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, as defined by the Statement. Under EITF 94-3, an exit cost was recognized at the date an entity committed to an exit plan. Additionally, SFAS No. 146 provides that exit and disposal costs should be measured at fair value and that the associated liability will be adjusted for changes in estimated cash flows. The provisions of SFAS No. 146 are effective for exit and disposal activities that are initiated after December 31, 2002. The Company is currently evaluating the impact of the provisions of SFAS No. 146.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of Statement 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. In addition, SFAS No. 148 improves the timeliness of those disclosures by

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requiring that this information be included in interim as well as annual financial statements. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. A further discussion of the adoption of SFAS No. 148 and its effect on the Company is included in note 2 to the Company’s consolidated financial statements.

Liquidity and Capital Resources

Historically, the Company’s primary cash needs have been for operations, capital expenditures and acquisitions. The primary sources of liquidity have been the GMAC Facility, the Paribas Credit Facility and capital contributions from former Earlychildhood members. As of December 31, 2002, the Company had net working capital of $17.5 million.

During 2002, the Company’s operating activities provided $7.7 million of cash. The cash provided from operating activities was primarily related to operating income and working capital. The Company used $1.1 million in cash for investing activities in 2002, for which the Company purchased property and equipment in the amount of $1.2 million and received payment on a receivable from a related party. The Company used $5.6 million in cash for financing activities, primarily for principal payments made against the GMAC Credit Facility.

During 2001, the Company’s operating activities used $8.6 million of cash. The use of cash was primarily related to operating losses and working capital. The Company generated $18.4 million in cash from investing activities in 2001, primarily from the cash acquired in the Combination. In 2001, $8.4 million was used in financing activities due to repayment of the Paribas Credit Facility, offset in part by borrowings under the GMAC Facility. As a result of the Combination, the Company received access to approximately $21.0 million of SmarterKids.com pre-Combination cash balance and short-term investments. In addition, in April 2001, the Company entered into the GMAC Facility. At the same time, The Company repaid its obligations aggregating almost $16.4 million under the Paribas Credit Facility and the Paribas Credit Facility was terminated.

During 2000, the Company’s predecessor, Earlychildhood, used $8.1 million in cash for operating activities. The use of cash was primarily related to operating losses resulting from spending on e-business operations and increases in inventories. Earlychildhood used $3.3 million of cash for investing activities in the year ended December 31, 2000, primarily related to capital expenditures. Earlychildhood generated $11.4 million in cash from financing activities. The cash generated from financing activities was primarily related to capital contributions by Earlychildhood’s members.

The GMAC Facility includes a $25.0 million line of credit with a maturity of April 30, 2004, an interest rate of LIBOR plus 3.0% (6.0% at December 31, 2002) and, except as described in the following paragraph, a minimum excess availability requirement of $4.0 million at all times, which effectively limits the Company’s borrowing capacity to a maximum of $21.0 million. The GMAC Facility has a credit limit at any time of an amount equal to the sum of 80% of the aggregate face amount of eligible accounts receivable plus the lowest of (i) 50% of the Company’s inventory; (ii) 85% times net liquidation percentage of inventory (the liquidation percentage is periodically set by the lender); or (iii) the result of $18.0 million minus the eligible portion of EPI’s inventory. As of December 31, 2002, the Company had no amounts outstanding and an available borrowing capacity of $2.7 million under the GMAC Facility.

The GMAC Facility requires adherence to certain financial covenants and contains restrictions related to capital expenditures during the term of the facility. As of December 31, 2002, the Company was in compliance with all the financial covenants as set forth in the GMAC Facility.

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The following table summarizes the Company’s contractual obligations as of December 31, 2002 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

Included in non-cancelable operating leases is $2.0 million in future cash requirements related to the abandonment of the Needham facility. Such charges may be paid out over the remaining lease term, which expires October 2004. On November 12, 2002, the Company signed a 24 month lease agreement to sublease 25.5%, or 10,000 square feet, of the Needham facility. The Company is actively seeking a subtenant for the remaining space but can offer no assurances as to when, or if, a subtenant will be found.

Management believes that available cash on hand and availability under the GMAC Facility will provide adequate funds for the Company’s foreseeable working capital needs and planned capital expenditures. The Company’s ability to fund its operations, repay debt, make planned capital expenditures and to remain in compliance with its financial covenants under the GMAC Facility depends on its future operating performance and cash flow, which in turn, are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond its control.

As of December 2002, the Company did not have any guarantees, including loan guarantees, standby letters of credit or indirect guarantees.

The following forward-looking statements reflect the Company’s expectations for the full year 2003. Actual results may differ materially given the potential changes in general economic conditions and the various other risks discussed in “Item 1. Risk Factors.”

Management’s goal is to achieve revenue growth in 2003 through increasing circulation of its Discount School Supply catalog, offering new proprietary products, soliciting new customers for its Early Childhood and Elementary School segments, and implementing more aggressive pricing strategies in both segments. The Company’s ability to realize this growth may be negatively affected by, among other things, changes in the national economy that reduce government or private funding of educational programs or that increase joblessness and may result in parents removing their children from childcare programs.

For fiscal year 2003:

EBITDA is calculated by adding back to operating income (loss): depreciation and amortization. EBITDA information should not be considered as an alternative to any measure of performance as promulgated under generally accepted accounting principles (such as operating income or income before extraordinary items) nor

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should it be considered as an indicator of the Company’s overall financial performance. The Company’s calculations of EBITDA may be different from the calculations used by other companies and therefore comparability may be limited.

Critical Accounting Policies and Estimates

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, Excelligence evaluates its estimates, including those related to bad debts, product returns, intangible assets, inventories, and merger integration. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue Recognition and Accounts Receivable

The Company recognizes revenues from product sales upon the delivery of products. Provisions for estimated returns and allowances are recorded as a reduction to sales and cost of sales based on historical experience. The Company determines that collectibility of accounts receivable is reasonably assured through standardized credit review to determine each customer’s credit worthiness. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

The Company values inventories at the lower of cost or market, using the first-in, first-out method. Inventory cost is based on amounts paid to vendors plus the capitalization of certain labor and overhead costs necessary to prepare inventory to be saleable. The Company writes down its inventory for estimated obsolescence, damaged or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Deferred Tax Valuation Allowance

The Company has recorded a deferred tax asset in an amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the value of the deferred tax asset, in the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

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Impairment of Long-Lived Assets

The Company assesses the need to record impairment losses on long-lived assets used in operations, including goodwill and other intangibles, when indicators of impairment are present. On an on-going basis, management reviews the value and period of amortization or depreciation of its long-lived assets. Recoverability of long-lived assets to be held and used is measured by comparison of the carrying amount the asset group to the undiscounted future cash flow expected to be generated by the asset group. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.

On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 provides that goodwill should not be amortized but instead be tested for impairment annually at the reporting unit level. In accordance with SFAS No. 142, the Company completed a transitional goodwill impairment test as of January 1, 2002 and its annual impairment test as of December 31, 2002. The Company’s goodwill impairment tests are based on a comparison of carrying value and fair value of its two reporting units, the Early Childhood and Elementary School segments. As of January 1, 2002 and December 31, 2002, the fair value of the Company’s reporting units exceeded their carrying value. Prior to the adoption of SFAS No. 142, the Company evaluated the recoverability of its long-lived assets due to SmarterKids.com failure to meet expected sales during the fourth quarter of fiscal year 2001 and its continued operating losses during fiscal year 2001. Such long-lived assets related to SmarterKids.com were determined not to be recoverable and recorded an impairment charge in fiscal year 2001. Impairment was measured based on the discounted future cash flows of the related operations.

Merger Integration Liabilities

The Company has established liabilities relating to the abandonment of the Needham facility. This liability was primarily based on the excess of required lease payments over estimated sublease income. Due to the volatility in the commercial real estate market, the estimate of sublease income is extremely subjective. If there is a further decline in the commercial real estate market, if it takes longer than expected to sublet the remaining space at the facility or if such space when sublet is subleased at rates lower than the Company’s current estimates, the amounts the Company will ultimately realize could be different from the amounts assumed in arriving at the Company’s estimate of the cost of the lease abandonment.

Income Taxes

The Company is taxed as a C corporation and files a consolidated tax return with its wholly-owned subsidiaries. The Company’s predecessor, Earlychildhood, was an LLC that had elected to be taxed as a partnership for federal and state income tax purposes. As an LLC taxed as a partnership, Earlychildhood’s income or loss, and deductions, were reported by its members, who were taxed on such income or loss. EPI is a C corporation and therefore is subject to federal and state income taxes. The Company’s consolidated statements of operations reflect the income tax expense based on the actual tax position of the Company and its subsidiaries, Earlychildhood and EPI, in effect for the respective periods. In addition, the consolidated statements of operations reflect income tax expense (benefit), on a pro forma basis as if Earlychildhood had elected to be taxed as a C corporation for federal and state income tax purposes beginning January 1, 2001.

The Company has recorded a deferred tax asset in an amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the value of the deferred tax asset, in the event that the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

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Seasonality

The Company’s seasonal sales trends coincide with the start of each school year. Accordingly, approximately 50% of the Early Childhood and Elementary School segments’ consolidated annual sales are generated in the third calendar quarter. The Company’s working capital needs are greatest during the second calendar quarter as inventory levels are increased to meet seasonal demands. See “Item 1. Risk Factors—Our business is highly seasonal.”

Inflation

Inflation has and is expected to have only a minor effect on the Company’s results of operations and sources of liquidity.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

The following discussion of market risk includes “forward-looking statements” that involve risks and uncertainties that could significantly offset anticipated results in the future. Actual results could differ materially from those projected in the forward-looking statements. The Company does not use derivative financial instruments for speculative or trading purposes.

Interest Rate Risk

The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable and a revolving line of credit. Market risks relating to operations result primarily from a change in interest rates. The Company’s borrowings are primarily dependent upon LIBOR rates. As of December 31, 2002, the Company had no borrowings under the GMAC Facility and available borrowing capacity of $2.7 million. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” The estimated fair value of borrowings under the GMAC Facility is expected to approximate its carrying value.

Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents, accounts receivable and its revolving line of credit. The Company has no customer comprising greater than 10% of its revenues. However, receivables arising from the normal course of business are not collateralized and management continually monitors the payment of its accounts receivable and the financial condition of its customers to reduce the risk of loss. The Company does not believe that its cash and cash equivalents are subject to any unusual credit risk beyond the normal credit risk associated with commercial banking relationships.

Foreign Currency Risk

The Company purchases some of its products from foreign vendors. Accordingly, The Company’s prices of imported products are subject to variability based on foreign exchange rates. However, The Company’s purchase orders are denominated in U.S. dollars and the Company does not enter into long-term purchase commitments.

Item 8. Financial Statements and Supplementary Data.

The financial statements contained in the accompanying Index to Consolidated Financial Statements, set forth on page F-1 and covered by the Independent Auditors’ Report, are incorporated herein by reference and filed as a part of this Annual Report on Form 10-K.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

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PART III.

Item 10. Directors and Executive Officers of the Registrant.

The information required by this item will be set forth under “Directors and Executive Officers” and “Compliance with Section 16(a) Under the Securities Exchange Act of 1934” in the Company’s definitive proxy statement to be filed with the Commission in connection with the Company’s 2003 annual meeting of stockholders, and reference is expressly made thereto for the specific information incorporated by reference herein.

Item 11. Executive Compensation.

The information required by this item will be set forth under “Executive Compensation” in the Company’s definitive proxy statement to be filed with the Commission in connection with the Company’s 2003 annual meeting of stockholders, and reference is expressly made thereto for the specific information incorporated by reference herein.

The information required by this item will be set forth under “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in the Company’s definitive proxy statement to be filed with the Commission in connection with the Company’s 2003 annual meeting of stockholders, and reference is expressly made thereto for the specific information incorporated by reference herein.

Item 13. Certain Relationships and Related Transactions.

The information required by this item will be set forth under “Certain Transactions” in the Company’s definitive proxy statement to be filed with the Commission in connection with the Company’s 2003 annual meeting of stockholders, and reference is expressly made thereto for the specific information incorporated by reference herein.

Item 14. Controls and Procedures.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports made pursuant to the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Company completed its evaluation.

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PART IV.

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a)    Financial Statements

(1)    The financial statements contained in the accompanying Index to Consolidated Financial Statements, set forth on page F-1 and covered by the Independent Auditors’ Report, are incorporated herein by reference and filed as a part of this Annual Report on Form 10-K.

(2)    The financial schedule appearing on page F-25 and covered by the Independent Auditors’ Report is incorporated herein by reference and filed as part of this Annual Report on Form 10-K.

(3)    Exhibits.

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(b)    Reports on Form 8-K.

None.

(c)    The exhibits required by Item 601 of Regulation S-K have been listed above.

(d)    Financial Statement Schedules.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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: March 7, 2003

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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Section 302 Certification:

Chief Executive Officer

I, Ron Elliott, certify that:

Date: March 7, 2003

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Section 302 Certification:

Chief Financial Officer

I, Rich Delaney, certify that:

Date: March 7, 2003

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

The following consolidated financial statements are filed as part of this Annual Report on Form 10-K:

F-1

Independent Auditors’ Report

The Board of Directors

Excelligence Learning Corporation and subsidiaries:

We have audited the consolidated balance sheets of Excelligence Learning Corporation and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, equity and cash flows for each of the years in the three-year period ended December 31, 2002. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule on valuation and qualifying accounts as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Excelligence Learning Corporation and subsidiaries as of December 31, 2002 and 2001 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth herein.

As discussed in Note 8 to the consolidated financial statements, effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets.”

/s/    KPMG LLP

San Francisco, California

February 14, 2003

F-2

EXCELLIGENCE LEARNING CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except for par value and share amounts)

See accompanying notes to consolidated financial statements.

F-3

EXCELLIGENCE LEARNING CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except for share and per share amounts)