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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, 1997
[_] 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: 0-29184
ONSALE, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0408319
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1350 WILLOW ROAD, SUITE 202
MENLO PARK, CALIFORNIA 94025
(Address of principal executive offices)
Registrant's telephone number, including area code: (650) 470-2400
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 $0.001 PER SHARE
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 the 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. [_]
The aggregate market value of the voting and nonvoting common equity
held by non-affiliates of the Registrant, as of the close of business on
February 26, 1998, was approximately $193,424,656.
As of February 26, 1998, Registrant had outstanding 18,703,804 shares
of Common Stock, $0.001 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's 1997 annual report to stockholders to be
furnished to the Securities and Exchange Commission pursuant to Rule 14a-3(b)
are incorporated by reference in Part II of this Annual Report on Form 10-K
(this "Report"). Portions of the Company's definitive proxy statement to be
filed with the Securities and Exchange Commission relative to the Company's 1998
annual meeting of stockholders are incorporated by reference in Part III of this
Report. With the exception of those portions that are specifically incorporated
by reference in this Report, such annual report to stockholders and proxy
statement shall not be deemed to be filed as part of this Report or incorporated
herein by reference.
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TABLE OF CONTENTS
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PAGE
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PART I
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Item 1. Business..................................... 3
Item 2. Properties................................... 22
Item 3. Legal Proceedings............................ 22
Item 4. Submission of Matters to a Vote of Security
Holders...................................... 22
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters.............. 23
Item 6. Selected Financial Data...................... 23
Item 7. Management's Discussion and Analysis of
Financial Condition and Results
of Operations................................ 24
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk............................ 24
Item 8. Financial Statements and Supplementary Data.. 24
Item 9. Changes in and Disagreements With
Accountants on Accounting and Financial
Disclosure................................... 24
PART III
Item 10. Directors and Executive Officers of the
Registrant................................... 25
Item 11. Executive Compensation....................... 25
Item 12. Security Ownership of Certain Beneficial
Owners and Management........................ 25
Item 13. Certain Relationships and Related
Transactions................................. 25
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K.......................... 26
Signatures.................................................. 29
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___________________
ONSALE was incorporated in California in July 1994 and reincorporated
in Delaware in March 1997. As used in this Report, unless the context otherwise
requires, the terms "Company" and "ONSALE" refer to ONSALE, a California
corporation, and its successor Delaware corporation, ONSALE, Inc. The Company's
Web site is located at http://www.onsale.com. Information contained in the
Company's Web site shall not be deemed to be a part of this Report. The
Company's principal executive offices are located at 1350 Willow Road, Suite
202, Menlo Park, California 94025. The Company's telephone number is (650) 470-
2400.
___________________
ONSALE(R), the ONSALE tag logo and Yankee Auction(R) are registered
trademarks, and Auction Supersite/TM/, Dutch Auction/TM/, Put your money where
your mouse is/TM/, Steals and Deals/TM/ and The ONSALE Exchange/TM/ are
trademarks of the Company. This Report also includes trade names and trademarks
of other companies.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
ONSALE is an electronic retailer pioneering a new sales format--the
interactive online auction--designed to serve as an efficient and entertaining
marketing channel for products that typically are unavailable through
conventional distribution. The Company currently specializes in selling excess
merchandise, such as refurbished and close-out products, over the Web to
businesses, resellers and consumers. The Company sells a wide variety of such
merchandise, including computers, peripherals, consumer electronics, housewares,
sports and fitness equipment, and vacation packages. ONSALE's online auctions
provide an exciting sales format that leverages the unique characteristics of
the Web, such as interactivity and a sense of community.
INDUSTRY BACKGROUND
Electronic Commerce on the Internet
The Internet has evolved into a unique marketing channel, just as
retail stores, mail order catalogs and television shopping have previously
evolved as unique channels. By directly operating their own Web sites, Internet
retailers can interact with customers in real-time by frequently adjusting their
product mix, pricing and visual presentation. In addition, the global reach of
the Internet allows retailers to build large, geographically dispersed customer
bases more quickly than traditional retailers and catalog marketers. Unlike
traditional marketing channels, Internet retailers do not have the burdensome
costs of a significant retail store infrastructure, the continuous printing and
mailing costs of a catalog marketer or the store personnel or call center costs
borne by traditional retailers and catalog marketers.
As the number of Internet retailers has expanded, however, the
importance of strong brand recognition has become critical to the success of
these companies. Brand development is especially important for online retailers
to establish trust and loyalty with consumers in the absence of face-to-face
interaction. As a result, online retailers have begun to establish long-term
strategic partnerships and alliances with content, commerce and service
providers to build brand recognition, stimulate traffic, enhance their
offerings, take advantage of cross-marketing opportunities and build barriers to
entry.
Market for Excess Merchandise
Each year, manufacturers dispose of significant volumes of excess
merchandise, including refurbished and close-out merchandise. Refurbished
products are those that typically require a nominal amount of service, such as
minor repairs, cleaning and repackaging, prior to being sold as refurbished
goods. Close-out merchandise includes new products that have or will shortly
become obsolete, typically due to a change in selling seasons or the
introduction of new models.
While the market for refurbished and close-out products is difficult
to measure, the Company believes that several billion dollars of such
merchandise is sold each year. The PC and consumer electronics markets in
particular are characterized by significant quantities of such merchandise due
to short product life cycles and the prevalence of returned items through the
consumer retailing channel. In addition, many other markets are characterized
by significant supplies of excess merchandise. For example, the travel industry
is beset by a continual supply of excess inventory that faces time-imposed
obsolescence.
The disposal of excess goods represents a substantial burden on many
vendors. Excess goods are sold through a fragmented industry consisting of
auction houses, catalogs, company stores or "outlets," resellers and specialized
retailers, as well as large superstores and mass merchants that are not
committed to the resale of these goods and generally sell them as a
supplementary product line or "loss leader." Since vendors lack control over
pricing and product placement in this fragmented channel, the prices they
realize on products are often affected. These channel conflicts also undermine
channel loyalty and the vendor's brand image. Vendors have an interest in
accessing a
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distribution channel that enables them to dispose of significant quantities of
merchandise quickly and at the best prices possible, without affecting their
traditional sales channels.
ONSALE TODAY
ONSALE is an electronic retailer pioneering a new sales format--the
interactive online auction--designed to serve as an efficient and entertaining
marketing channel for products that typically are unavailable through
conventional distribution. The Company currently specializes in selling excess
merchandise, such as refurbished and close-out products, over the Web to
businesses, resellers and consumers. The Company sells a wide variety of such
merchandise, including computers, peripherals, consumer electronics, housewares,
power tools, sports and fitness equipment, and vacation packages. ONSALE's
online auctions provide an exciting sales format that leverages the unique
characteristics of the Web, such as interactivity and a sense of community. The
Company's auction format enables customers to bid against one another in a
freely competitive market liberated from the constraints of less flexible
pricing that typically characterize traditional retailing. The Company believes
that the customer enthusiasm generated by this format, the emergence of the
Internet as an effective new sales medium and the Company's highly automated
infrastructure combine to create a significant retailing opportunity.
ONSALE has sold approximately $148 million of merchandise to more than
251,000 customer accounts from its first auction in May 1995 through December
31, 1997. To date, the Company has auctioned over 1.4 million merchandise
units, of which over 329,000 were auctioned in the fourth quarter of 1997.
Over 507,000 visitors to the Company's Web site have registered as bidders
with the Company, with over 97,000 registering in the fourth quarter of 1997
alone.
ONSALE's Auction Supersites provide customers a compelling format to
purchase a wide variety of merchandise through interactive online auctions. In
addition to prominently featured specials, the Company's Auction Supersites
organize items into targeted merchandise stores ("Supersites"), which are
further categorized by product type. ONSALE presently operates a Computer
Products Supersite, Consumer Electronics Supersite and a Sports & Fitness
Supersite on which it continually posts merchandise descriptions and images. In
addition, ONSALE operates a self-service "person-to-person" Supersite--The
ONSALE Exchange. ONSALE operates auctions every day and generally offers over
900 different merchandise items at any given time. The Company sells quantities
from one to several hundred of each item, generally ranging in price from $25 to
$3,000 on which customers can bid 24 hours a day, 7 days a week. Each week, tens
of thousands of customers visit the Company's site to review the latest
merchandise and bid on items of interest. When customers are outbid, they
receive an email message alerting them and permitting them to increase their bid
via the Company's Web site. At the designated closing time, the winning bidders
are selected and an email message is sent to them confirming their purchases.
The entire auction process, from the posting of the items through the auction
closing, has been automated by the Company through the use of internally
developed proprietary software. In addition, the Company has developed
proprietary software that automates product fulfillment functions, including
billing, shipping and tracking.
The Company believes that online auctions represent an exciting sales
format that leverages the unique characteristics of the Internet, such as
interactivity and the sense of community built by customers competitively
bidding in an auction environment. Furthermore, the Company believes the
knowledge, interests and spending habits of the typical Internet user make a
wide variety of merchandise ideal for this sales format and that excess
merchandise is particularly well suited for the online auction format because
there is no widely accepted fair market value for those items. The difference of
opinion among potential purchasers regarding the value of such goods encourages
the spirited bidding of the interactive auction process. In contrast to the
market for new merchandise where vendors traditionally set a fixed price, both
the vendors and customers for excess merchandise accept variability in pricing.
The Company's Internet auctions are designed to offer customers the following
benefits:
. Compelling Merchandise and Pricing. The Company's rotating merchandise
mix gives customers the opportunity to bid on desirable items and
includes a number of different product categories, mostly from well
known, name brand manufacturers. Every auction cycle includes new
items, which keeps the Web site fresh and appealing. This changing
product/price mix and the auction format give the Company's visitors
the opportunity to obtain exceptional deals every time they visit the
site. This compelling sales format has led to repeat customers who bid
on average 7.2 times, and purchased on average 2.6 times, during the
quarter ended December 31, 1997.
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. Entertainment and Excitement. The Company's auctions are designed to
be fun and exciting, adding the "lure of the bargain" and the "thrill
of the hunt" to the retailing experience. The Company's customers do
not simply purchase merchandise--they "win" it. Competition and
gamesmanship are inherent in the Company's auction format, which the
Company believes enables it to attract and maintain a large and loyal
customer base. Further, the Company frequently changes the
presentation of its Web site to enhance customer interest.
. Community. As part of their bids, bidders are allowed to place brief
comments that are displayed on the list of currently winning bids on
each merchandise item page. Bidders use these comments to communicate
with other bidders in attempts to "psyche out" or cooperate with other
bidders. These comments, which generally are humorous, good-natured
and in the spirit of competition, build a sense of community. This
interactive shopping medium creates a sense of being "where the action
is."
. Convenience. The Company brings retail shopping directly into
customers' homes and offices. Customers do not need to travel to fixed
locations during limited hours to purchase items. ONSALE's Web site
enables customers to place bids at any time during the day or night,
in an unintimidating atmosphere and without the pressure of
salespeople or auctioneers.
The Company believes that it also provides substantial benefits to
vendors. By pioneering a novel sales format in a new medium available to a very
broad audience, the Company believes that it offers vendors a way to sell excess
merchandise quickly at attractive prices with minimal interference with other
marketing channels. The Company's business format is designed to offer vendors
the following benefits:
. Efficient Distribution Solution. ONSALE's frequent auctions provide
manufacturers a distribution channel designed to accommodate
unpredictable, odd lot quantities and to reach a geographically broad
group of consumers. The Company believes it represents an efficient
alternative to existing channels and a practical solution to a large
and growing problem for vendors--the disposal of excess merchandise.
. Resolution of Channel Conflict. Sales of excess merchandise through
ONSALE are designed to avoid the channel conflicts inherent in other
distribution channels, where similar or identical merchandise sells at
different prices. By selling to a geographically broad customer base,
the Company reduces the cannibalizing effect that the sales of excess
merchandise can have on the distribution of new products in a limited
local area.
. Superior Inventory Liquidation. Manufacturers and vendors in the
process of liquidating excess merchandise are compelled to liquidate
inventory in a quick and expedient manner due to rapid price declines
while attempting to get the best prices possible for their
merchandise. The frequency of the Company's auctions and its ability
to add new items continuously allow the Company to post items for
auction immediately upon receipt of the merchandise and increases the
vendors' ability to dispose of inventory quickly. By selling inventory
quickly, vendors are able to avoid some of the inventory price erosion
and obsolescence that are typical in other channels and to obtain
attractive prices for their products. In addition, the Company's
automated systems simplify the liquidation process, creating a
convenient sales channel for vendors.
BUSINESS STRATEGY
The Company's objective is to become one of the dominant retailers on
the Internet. The Company intends to leverage its position as a leading Internet
retailer of excess merchandise by pursuing the following key strategies:
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Increase Market Awareness and Brand Recognition
The Company believes that ONSALE is a leading brand name in online
commerce. The Company operates in a market in which its brand franchise is
critical to attracting high quality vendors and a high level of customer
traffic. Accordingly, the Company's strategy is to promote, advertise and
increase its visibility through a variety of marketing and promotional
techniques, including forming relationships with and advertising on leading Web
sites and conducting an ongoing public relations campaign. The Company intends
to continue to build relationships with leading online content providers and
commerce companies to drive traffic to its Web site, secure merchandise supply
and build barriers to entry.
Expand Lines of Merchandise
The Company believes a broad array of merchandise can be sold
effectively through its online auction format. The Company recently expanded its
lines of merchandise to include sports and fitness equipment, vacation packages
and specialty foods. The Company actively test markets new types of merchandise
and has successfully auctioned items as diverse as new automobiles and trucks,
high-end computer servers and autographed sports memorabilia.
Provide Compelling Retailing Experience for Customers
The Company believes auction buyers are attracted by the potential
bargain prices and the inherent excitement of competitively winning desired
merchandise. Accordingly, the Company intends to continue offering customers a
wide array of opportunities to buy desired merchandise at bargain prices and to
rotate the selection of merchandise.
Expand and Strengthen Long-Term Vendor Relationships
The Company's ability to attract, secure and obtain large quantities
of branded merchandise for its Internet auctions is key to its success. The
Company continues to build its merchandise buying staff to facilitate securing
long-term relationships with a variety of merchandise vendors. The Company seeks
to be its vendors' preferred choice for liquidating excess merchandise. The
Company intends to strengthen its vendor relationships by offering better
purchasing terms and more convenient service through more automated order
processing and superior logistical arrangements. In addition, the Company
believes its rapid auction process makes it a convenient sales channel for
vendors to liquidate large volumes of merchandise.
Develop Incremental Revenue Opportunities
The Company believes that a significant opportunity exists to
develop incremental revenue opportunities, including expanding its product mix
with other products that are well suited for the Internet's electronic format.
The Company also believes that the high level of traffic on its Web site
provides an attractive alternative for advertising on its Web site. In the
third quarter of 1997, the Company began selling banner advertising and
promotional placements on its Web site. To date, advertising revenue has not
been significant. In addition, the Company intends to expand its sales to
customers outside its current markets of the United States, Canada and Mexico.
Build on Leading Technology
The Company believes that one of its competitive advantages is its
internally developed proprietary software that is specifically designed for
Internet auctions. This software conducts automated auctions with thousands of
customers, processes those customers' orders and payments, coordinates and
performs order fulfillment and provides certain customer support functions. The
Company intends to enhance its software to provide an even more compelling
shopping experience, as well as to streamline its order processing, warehousing
and distribution, and customer support functions.
THE ONSALE PROCESS
The entire ONSALE auction process is fully automated. The Company
posts descriptions and images of the merchandise being offered for auction on
its Web site. The Company generally offers customers the opportunity to bid for
merchandise through the "Yankee auction" format. In this format, a number of
identical items of merchandise are
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offered for sale at the same time. When the auction closes, the highest bidders
win the available inventory at their actual bid prices. Thus, each winning
bidder may pay a price that is different from the prices paid by other winning
bidders. When bidders' prices are equal, priority is given to bids for larger
quantities and bids with earlier initial bid times. This allows customers to
employ a variety of strategies that make bidding interesting. "Open reserve"
auctions are a variation on Yankee auctions, where instead of a "minimum bid,"
the seller posts a "reserve bid price." The buyers can place bids for any dollar
amount above or below the posted reserve bid price. However, the seller is not
obligated to accept bids and complete transactions below the posted reserve bid
price. The seller may choose to lower the reserve bid price to meet a buyer's
bid before the auction closes.
To bid, a customer completes and submits a simple electronic
registration form found on the Company's Web site. Once registered, the
customer can bid and buy at will. As bids are received, ONSALE's Web pages are
instantly updated to display the current high bidders' initials, city and state,
and an optional comment to personalize the bidding. Customers are notified by
email when they are outbid and can then respond via the Company's Web site to
increase the bid. In addition, customers can monitor their bid status on
ONSALE's Web site or via "Bidwatch," a free downloadable software module that
displays current auction status in real time. Once an auction has closed, the
Company's auction software informs the winning bidders by email and creates an
order. For Principal Sales transactions, the customer's credit card is then
charged and the merchandise is shipped either by the Company or its vendor. For
Agent Sales and The ONSALE Exchange transactions, the vendor/seller is
responsible for collection of bid proceeds and shipment of merchandise. See
"Vendor Relationships."
MERCHANDISE
The Company offers more than 900 different merchandise items in each
daily auction. This merchandise consists primarily of computers, peripherals,
consumer electronics, housewares, sports and fitness equipment, and vacation
packages. The Company believes that rotating its merchandise keeps its Web site
fresh and appealing and encourages customers to revisit the site frequently. The
Company believes a well-coordinated merchandise assortment is key to its
success, and employs a staff of seasoned buyers from the computer and consumer
electronics industries to achieve this goal.
The Company primarily offers merchandise in the following categories:
Personal Computers. The Company offers PCs, including IBM- and Macintosh-
compatible desktops and notebooks.
Printers, Monitors and Scanners. The Company offers laser, laser jet and
color jet printers, color and black and white monitors, related accessories
and toner cartridges, and flatbed scanners.
Computer Peripherals. The Company sells memory chips, disc drives, CPU
chips, controllers, CD-ROMs, multimedia accessories, modems, motherboards,
video cards, mice and keyboards.
Network Equipment. The Company sells a variety of network equipment,
including servers, repeaters, hubs and routers, and Ethernet and token ring
cards and accessories.
Consumer Electronics. The Company sells home theater items (such as VCRs,
receivers, speakers and CD players), photography equipment (such as
camcorders and cameras), portable televisions, portable audio and car
stereo equipment (such as AM/FM cassette and CD players, speakers and
tuners), and home office items (such as facsimile machines, answering
machines and telephones). The Company is continuing to expand its offerings
of consumer electronics.
Housewares. The Company sells microwave ovens, coffee makers, food
steamers, shower massage units and breadmakers.
Sports & Fitness Equipment. The Company sells golf clubs, tennis
racquets, in-line skates and a variety of other equipment and
memorabilia.
Vacation Packages. The Company sells stays of varying lengths at vacation
properties.
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Most merchandise sold by the Company carries a warranty provided by
the vendor, which greatly reduces the Company's customer service expenses. The
Company is entirely dependent upon vendors to supply it with merchandise for
sale through the Company's Internet auctions and the availability of
merchandise is unpredictable. In 1996 and 1997, approximately 30% of the
Company's gross merchandise sales were derived from merchandise acquired from
the five most significant vendors in that year, although no vendor accounted
for more than 10% of gross merchandise sales. The Company has no long-term
contracts or arrangements with its vendors that guarantee the availability of
merchandise for its auctions. There can be no assurance that the Company's
current vendors will continue to sell merchandise to the Company or otherwise
provide merchandise for sale in the Company's auctions or that the Company
will be able to establish new vendor relationships that ensure merchandise
will be available for auction on the Company's Web site. The Company also
relies on many of its vendors to process and ship merchandise to customers.
The Company has limited control over the shipping procedures of its vendors,
and shipments by these vendors have often been subject to delays. Although
most merchandise sold by the Company carries a warranty supplied either by the
manufacturer or the vendor and the Company is not obligated to accept
merchandise returns, the Company in fact has accepted returns from customers
for which the Company did not receive reimbursement from its vendors or
manufacturers. If the Company is unable to develop and maintain satisfactory
relationships with vendors on acceptable commercial terms, if the Company is
unable to obtain sufficient quantities of merchandise, if the quality of
service provided by such vendors falls below a satisfactory standard or if the
Company's level of returns exceeds its expectations, the Company's business,
results of operations and financial condition will be materially adversely
affected.
VENDOR RELATIONSHIPS
The Company obtains merchandise directly from computer, electronics
and sporting goods manufacturers and indirectly through other vendors. Since
merchandise availability is unpredictable, strong vendor relationships are
critical to the Company's success. See "Risk Factors--Reliance on Merchandise
Vendors." As a result, the Company's buying staff maintains ongoing contact,
frequently on a daily basis, with its vendors to learn when new merchandise
becomes available. The Company obtains merchandise from vendors through one of
two primary arrangements, either the Principal Sales model or the Agent Sales
model.
. Principal Sales Model. The Company acts as a direct purchaser of
merchandise or as a consignment seller for vendors. By purchasing
merchandise, the Company assumes the full inventory and price risk
involved in selling such merchandise. The Company believes its ability
to liquidate its inventory quickly through its Internet auctions
somewhat mitigates the cost of carrying inventory and the price
erosion risk. The Company intends to increase its purchasing of
merchandise from vendors, particularly from manufacturers, because the
Company believes it will have better control over its merchandise
supply and achieve higher gross margins over time. The Company's
ability to achieve higher gross margins, however, depends on the
ability of its buying staff to purchase inventory at attractive prices
relative to the resale value of the inventory at auction, and there
can be no assurance that the Company's buying staff will continue to
purchase items at attractive prices relative to their resale value at
auction. Sales of purchased inventory accounted for approximately 50%
of the Company's gross merchandise sales in the fourth quarter of
1997.
For sales on consignment, the Company takes title to the merchandise
upon completion of an auction, charges a customer's credit card and
either ships the merchandise directly or arranges for a third party
to complete delivery to the customers. Subsequently, the Company
pays the vendor any amounts due for the purchase of the related
inventory. By selling merchandise on consignment, the Company avoids
the risk that it will not be able to liquidate its inventory in a
timely manner. However, the Company is at risk of loss for the
collection of all of the auction proceeds, delivery of the
merchandise and returns from customers. Consignment sales
represented approximately 28% of the Company's gross merchandise
sales in the fourth quarter of 1997. See "Risk Factors--Risks of a
Principal Sales Model."
. Agent Sales and The ONSALE Exchange. The Company also sells
merchandise by acting as a sales agent for vendors. Under this
arrangement, at the conclusion of an auction the Company forwards the
order information to the vendor, which then charges the customer's
credit card and ships the merchandise. The Company receives a
commission based upon a percentage of the
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price. In an agency relationship, the Company does not take title to
the merchandise, and the vendor bears the risk of credit card charge
backs. The Company, however, must rely on the vendor to charge
customers and ship merchandise on a timely basis. Agent Sales and The
ONSALE Exchange accounted for approximately 22% of the Company's gross
merchandise sales in the fourth quarter of 1997. See "Risk Factors--
Reliance on Merchandise Vendors."
The ONSALE Exchange allows individuals and small businesses to sell
merchandise over the Web using the Company's auction management
system. Beginning in November 1997, ONSALE permitted such sellers to
list items for auction in specific merchandise categories such as:
books, music and movies; memorabilia; toys; coins, stamps and
currency; computers; software; home electronics; travel and tickets;
household items; watches and jewelry; collectibles; and trading cards.
The seller enters a description of each item and, if he or she
chooses, posts a photo image. The seller also establishes the minimum
bid level for each item. Bidders not already registered with the
Company need to register and then can place bids on items on The
ONSALE Exchange using their ONSALE customer number. If and when
bidders are outbid, they receive an email notification and can
increase their bids through the Company's Web site. At the end of the
auction, the highest bidder(s) and the seller are both notified that
the auction has closed. The seller may then obtain from The ONSALE
Exchange the names of the auction winner(s) and runners up. The buyer
and seller can consummate their transaction directly with each other
using cash, check or credit card or through the services of an
independent online escrow service using one of a variety of major
credit cards. The Company charges the seller a commission of up to 4%
shortly after the Company provides to the seller the names of the
auction winner(s) and runners up. The Company has already expended
substantial funds in preparing for and initiating this new Auction
Supersite and expects significant continuing expenditures. As a
consequence, it will take substantial incremental volumes of auction
business in order for the Company to recoup its expenditures to date
and operate The ONSALE Exchange profitably. See "Risk Factors--Risks
of Launching The ONSALE Exchange."
SALES AND MARKETING
The Company sells to consumers, businesses and resellers. See "Risk
Factors--Developing Market; Uncertain Acceptance of the Internet as a Medium for
Commerce" and "Risk Factors--Uncertain Acceptance of the ONSALE Brand; Evolving
and Unpredictable Business Model." To achieve its objective of becoming
one of the dominant retailers on the Internet, the Company has developed a
marketing strategy based on strengthening its brand name and increasing customer
traffic to its Web site. In addition to forming relationships of the types
described above, the Company employs a mix of media and promotional activities
to achieve these goals.
Internet Advertising. The Company places advertisements on various
high-profile and high-traffic conduit Web sites. These advertisements usually
take the form of banners that encourage readers to click through directly to the
Company's Web site.
Public Relations Campaign. The Company's marketing team engages an
ongoing public relations campaign. This campaign has resulted in the Company's
being featured in numerous television shows and newspaper and magazine articles.
Links from Other Web Sites. Approximately 1,000 Web sites have links
to ONSALE's Web site. The Company believes such links are a significant factor
in increasing brand awareness and generating customer traffic to the Company's
Web site.
Customer Electronic Mail Broadcasts. The Company actively markets to
its own base of customers through email broadcasts. All bidders in the Company's
auctions are automatically added to the Company's electronic mailing list.
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MERCHANDISE DISTRIBUTION
The Company has a relationship with Gage Marketing Group to provide
most of its fulfillment and logistics requirements. The Company also rents
warehouse space in northern California to handle a portion of its inventory and
distribution needs, and relies on many of its vendors to process and ship
merchandise to customers. The Company has limited control over the shipping
procedures of its vendors, and shipments by certain of these vendors have been
subject to delays. See "Risk Factors--Reliance on Merchandise Vendors" and "Risk
Factors--Reliance on Other Third Parties."
CUSTOMER SUPPORT AND SERVICE
The Company believes that its ability to establish and maintain long-
term relationships with its customers and encourage repeat visits and purchases
is dependent, in part, on the strength of its customer support and service
operations staff. The Company employs a staff of full-time customer support
and service personnel who are responsible for handling customer inquiries,
answering customer questions about the bidding process, tracking shipments,
investigating problems with merchandise and acting as liaisons between customers
and the Company's vendors. In addition, the Company has automated certain of its
customer support and service functions. The Company is actively working to
enhance its customer support and service operations through a variety of
measures including improved customer reporting systems. The Company has
introduced a software system that allows customers to track the shipment of
their purchases through the Company's Web site. See "Risk Factors--Reliance on
Merchandise Vendors" and "Risk Factors--Management of Growth."
TECHNOLOGY AND OPERATIONS
The Company uses a combination of its own proprietary technology and
commercially available licensed technology to conduct its Internet auctions.
Proprietary Technology
The Company has devoted significant resources to developing its
proprietary software technology. The Company believes that its success depends,
in part, on the Company's internally developed proprietary auction management
software, which implements a variety of customized auction, markdown and sales
formats. See "Risk Factors--Risks Associated with Technological Change;
Dependence on the Internet." The Company's proprietary software components are
organized into the following groups:
Auction Management Applications. The Company uses a set of
continuously running application programs that manage the auctions and
sales, update merchandise Web pages to show the currently winning
bidders, and send a variety of email messages to customers informing them
that they have been outbid or have won merchandise.
Transaction Processing Applications. The Company uses a set of
applications for receiving and validating bids, entering registrations to
place the customer on the Company's mailing list, listing currently active
and recent winning and losing bids, and reviewing and submitting customer
service requests.
Order Processing Applications. The Company uses a set of applications
for processing successful bids as they are converted into customer orders.
These applications charge customer credit cards, print order information,
transmit order information electronically to the Company's contract
warehouses and vendors, and deposit transaction information into the
Company's accounting system.
Marketing Applications. The Company has developed a set of email
applications for sending broadcast emails to customers on a frequent basis.
This software extracts email addresses from the Company's mailing list,
sends emails to the designated recipients and automatically services
requests from customers requesting to be removed from the mailing list.
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Commercially Available Licensed Technology
The Company's strategy has been to license commercially available
technology whenever possible rather than seek a custom-made or internally-
developed solution. The Company believes that this strategy enables it to lower
its operating costs and to respond to changing demands due to growth and
technological shifts. This strategy also allows the Company to focus its
development efforts on creating and enhancing the specialized, proprietary
software that is unique to the Company's business.
Engineering
The Company historically has developed and expects to continue to
develop its proprietary auction management and marketing software. The Company's
engineering strategy includes the enhancement of features and functionality of
its existing software components, the development of new software components,
and the integration of off-the-shelf components into its environment. The
Company currently is investing significant resources in software development and
expects to continue to do so in the future. The Company believes its future
success depends on its ability to continue developing and enhancing its
proprietary software.
Operations
The Company's Web site operations staff consists of systems
administrators who manage, monitor and operate the Company's Web site. The
continued uninterrupted operation of the Company's Web site is essential to its
business, and it is the job of the site operations staff to ensure, to the
greatest extent possible, the reliability of the Company's Web site. The
Company uses Internet service providers to provide connectivity to the Internet,
Internet traffic and data routing services and email services. The Company
believes that these telecommunication and Internet service facilities are
essential to the Company's operation and anticipates upgrading these
facilities to faster, though more costly, telecommunication services in the
future. See "Risk Factors--Management of Growth" and "Risk Factors--Risk of
System Failure; Single Site."
COMPETITION
The electronic commerce market, particularly over the Internet, is
new, rapidly evolving and intensely competitive, and the Company expects
competition to intensify in the future. The Company currently or potentially
competes with a variety of other companies depending on the type of merchandise
and sales format offered to customers. These competitors include (i) various
Internet auction houses such as Z AUCTION, First Auction (the auction site for
Internet Shopping Network, a wholly owned subsidiary of Home Shopping Network
Inc.), Surplus Direct (a wholly owned subsidiary of Egghead, Inc.) and eBay (in
connection with the Company's newly introduced The ONSALE Exchange), (ii) a
number of indirect competitors that specialize in electronic commerce or derive
a substantial portion of their revenue from electronic commerce, including
Internet Shopping Network, New England Circuit Exchange, America Online, Inc.
and Cendant Corporation, (iii) a variety of other companies that offer
merchandise similar to that of the Company but through physical auctions and
with which the Company competes for sources of supply, and (iv) companies with
substantial customer bases in the computer and peripherals catalog business,
including Micro Warehouse, Inc., Insight Enterprises, Inc., Creative Computers,
Inc., and CDW Computer Centers, Inc., that may already operate competitive
auction sites and may devote more resources to Internet commerce in the future.
In particular, America Online has taken a minority equity interest in Internet
Liquidators International, Inc. ("ILI") and announced that the two companies
have formed a strategic partnership under which revenue from ILI's auction
platforms is shared with America Online and America Online provides a direct
link for ILI's members to reach ILI's electronic commerce site on the Web.
Ingram Micro Inc., the largest worldwide distributor of corporate technology
products and services, has recently introduced a wholesale auction site
available only to its registered resellers. The Company believes that Ziff-
Davis has reserved a Web domain name including the word "auction" and that
CompUSA is considering opening an auction site on the Web for its refurbished
products.
The Company believes that the principal competitive factors affecting
its market include its ability to secure merchandise for sale, attract new
customers to its site at favorable customer acquisition costs, operate its Web
site in an uninterrupted manner, and develop and enhance its proprietary auction
management software. Although the Company believes that it currently competes
favorably with respect to such factors, there can be no assurance that the
Company
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can maintain its competitive position against current and potential
competitors, especially those with greater financial, marketing, service,
support, technical and other resources than the Company.
Current and potential competitors have established or may establish
cooperative relationships among themselves or directly with vendors to obtain
exclusive or semi-exclusive sources of merchandise. Accordingly, it is possible
that new competitors or alliances among competitors and vendors may emerge and
rapidly acquire market share. In addition, manufacturers might elect to
liquidate their products directly. Increased competition is likely to result in
reduced operating margins, loss of market share and a diminished brand
franchise, any one of which could materially adversely affect the Company's
business, results of operations and financial condition. Many of the Company's
current and potential competitors have significantly greater financial,
technical, marketing and other resources than the Company. As a result, they may
be able to secure merchandise from vendors on more favorable terms than the
Company, and they may be able to respond more quickly to changes in customer
preferences or to devote greater resources to the development, promotion and
sale of their merchandise than can the Company.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company's performance and ability to compete are dependent to a
significant degree on its proprietary technology. The Company relies on a
combination of patent, trademark, copyright and trade secret laws, as well as
confidentiality agreements and technical measures, to establish and protect its
proprietary rights. The Company has applied for five patents in the United
States covering various aspects of electronically managed Internet auctions and
various aspects of providing customer service via automated email. There can be
no assurance that patents will issue from any of the Company's pending
applications, that any patents granted to the Company will not be challenged and
invalidated, or that any claims allowed from pending patents will be of
sufficient scope or strength to provide meaningful protection or any commercial
advantage to the Company. The Company has registered the ONSALE(R), the ONSALE
tag logo and Yankee Auction(R) trademarks in the United States and claims
trademark rights in, and has applied for trademark registrations in the United
States for, a number of other marks. There can be no assurance that the Company
will be able to secure significant protection for these trademarks. It is
possible that competitors of the Company or others will adopt product or service
names similar to "ONSALE" and the Company's other trademarks, thereby impeding
the Company's ability to build brand identity and possibly leading to customer
confusion. The inability of the Company to protect the name "ONSALE" adequately
would have a material adverse effect on the Company's business, results of
operations and financial condition. The Company's proprietary software is
protected by copyright laws. The source code for the Company's proprietary
software is also protected under applicable trade secret law. As part of its
confidentiality procedures, the Company generally enters into agreements with
its employees and consultants and limits access to and distribution of its
software, documentation and other proprietary information. There can be no
assurance that the steps taken by the Company will prevent misappropriation of
its technology or that agreements entered into for that purpose will be
enforceable. Notwithstanding the precautions taken by the Company, it might be
possible for a third party to copy or otherwise obtain and use the Company's
software or other proprietary information without authorization or to develop
similar software independently. Policing unauthorized use of the Company's
technology is difficult, particularly because the global nature of the Internet
makes it difficult to control the ultimate destination or security of software
or other data transmitted. The laws of other countries may afford the Company
little or no effective protection of its intellectual property.
The Company has in the past received, and may in the future receive,
notices from third parties claiming infringement by the Company's software or
other aspects of the Company's business. While the Company is not currently
subject to any such claim, any future claim, with or without merit, could result
in significant litigation costs and diversion of resources including the
attention of management, and require the Company to enter into royalty and
licensing agreements, which could have a material adverse effect on the
Company's business, results of operations and financial condition. Such royalty
and licensing agreements, if required, may not be available on terms acceptable
to the Company or at all. In the future, the Company may also need to file
lawsuits to enforce the Company's intellectual property rights, to protect the
Company's trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation, whether successful or
unsuccessful, could result in substantial costs and diversion of resources,
which could have a material adverse effect on the Company's business, results of
operations and financial condition.
The Company also relies on a variety of technologies that it licenses
from third parties, including its database and Internet server software, which
is used in the Company's Web site to perform key functions. There can be no
assurance that these third party technology licenses will continue to be
available to the Company on commercially
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reasonable terms. The loss of or inability of the Company to maintain or obtain
upgrades to any of these technology licenses could result in delays in
completing its proprietary software enhancements and new development until
equivalent technology could be identified, licensed or developed, and
integrated. Any such delays would materially adversely affect the Company's
business, results of operations and financial condition.
EMPLOYEES
As of December 31, 1997, the Company employed 129 people. The Company also
employs independent contractors for software development, technical
documentation, artistic design and product fulfillment. None of the Company's
employees is represented by a labor union, and the Company considers its
employee relations to be good. Competition for qualified personnel in the
Company's industry is intense, particularly for software development and other
technical staff. The Company believes that its future success will depend in
part on its continued ability to attract, hire and retain qualified personnel.
See "Risk Factors--Management of Growth" and "Risk Factors--Dependence on Key
Personnel; Need For Additional Personnel."
RISK FACTORS
This Report (including without limitation the following Risk Factors)
contains forward-looking statements (within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934) regarding the Company and its business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this Report.
Additionally, statements concerning future matters such as the development of
new services, technology enhancements, purchase of equipment, credit
arrangements, possible changes in legislation and other statements regarding
matters that are not historical are forward-looking statements.
Although forward-looking statements in this Report reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties, and actual results
and outcomes may differ materially from results and outcomes discussed in the
forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation those discussed
below as well as those discussed elsewhere in this Report. Readers are urged
not to place undue reliance on these forward-looking statements, which speak
only as of the date of this Report. The Company undertakes no obligation to
revise or update any forward-looking statements in order to reflect any event
or circumstance that may arise after the date of this Report. Readers are
urged to carefully review and consider the various disclosures made by the
Company in this Report, which attempts to advise interested parties of the
risks and factors that may affect the Company's business, financial condition,
results of operations and prospects.
LIMITED OPERATING HISTORY
The Company was founded in July 1994 and began conducting auctions on
the Internet in May 1995. Accordingly, there is a limited operating history upon
which to base an evaluation of the Company and its business and prospects. The
Company's business and prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving markets
such as electronic commerce. Such risks for the Company include a dependence on
key vendors for merchandise, an evolving and unpredictable business model,
management of growth, the Company's ability to anticipate and adapt to a
developing market, acceptance by customers of the Company's Internet auctions
and excess merchandise sold at such auctions, development of equal or superior
Internet auctions by competitors, and the ability to identify, attract, retain
and motivate qualified personnel. To address these risks, the Company must,
among other things, continue to expand its vendor channels and buyer resources,
manage product obsolescence and pricing risks, maintain its customer base and
attract significant numbers of new customers, respond to competitive
developments, implement and execute successfully its business strategy and
continue to develop and upgrade its technologies and retailing services. There
can be no assurance that the Company will be successful in doing what is
required to address these risks. The Company's revenue depends substantially
upon the level of auction activity, which is, in turn, related to the
availability of merchandise from the Company's vendors and the expansion of its
customer base. This availability is difficult to forecast with any degree of
certainty. Accordingly, a substantial reduction in merchandise
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availability would have a material adverse effect on the Company's business,
results of operations and financial condition. In addition, the Company
historically has had relatively low operating margins and plans to continue to
increase its operating expenses significantly in order to increase the size of
its staff, expand its marketing efforts to enhance its brand image, increase its
visibility on other companies' high traffic Web sites, purchase larger volumes
of merchandise to be sold at auction, increase its software development efforts,
and support its growing infrastructure. As a result, the Company expects to
experience substantial quarterly net losses through at least the first half of
1999. There can be no assurance that increases in such operating expenses will
be offset by increased revenues; accordingly, the Company's business, results of
operations and financial condition could be materially adversely affected.
Further, in view of the rapidly evolving nature of the Company's business and
its limited operating history, the Company believes that period-to-period
comparisons of its financial results are not necessarily meaningful and should
not be relied upon as an indication of future performance. See "Item 7. -
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results have fluctuated in the past, and are
expected to continue to fluctuate in the future, due to a number of factors,
many of which are outside the Company's control. These factors include (i) the
Company's ability to attract new customers at a steady rate, manage its
inventory mix and the mix of products offered at auction, meet certain pricing
targets, liquidate its inventory in a timely manner, maintain gross margins
and maintain customer satisfaction, (ii) the availability and pricing of
merchandise from vendors, (iii) the Company's ability to manage customer
returns and shrinkage resulting from theft, loss, and misrecording of
inventory, (iv) product obsolescence and pricing erosion, (v) consumer
confidence in encrypted transactions in the Internet environment, (vi) the
timing, cost and availability of advertising on other entities' Web sites,
(vii) the amount and timing of costs relating to expansion of the Company's
operations, (viii) the announcement or introduction of new types of
merchandise, service offerings or customer services by the Company or its
competitors, (ix) technical difficulties with respect to consumer use of the
auction format on the Company's Web site, (x) delays in revenue recognition at
the end of a fiscal period as a result of shipping or logistical problems,
(xi) delays in shipments as a result of strikes or other problems with the
Company's delivery service providers, the loss of the Company's credit card
processor, or the loss of the Company's Internet service providers, and (xii)
general economic conditions and economic conditions specific to the Internet
and electronic commerce. As a strategic response to changes in the competitive
environment, the Company may from time to time make certain service, marketing
or supply decisions or acquisitions that could have a material adverse effect
on the Company's quarterly results of operations and financial condition. The
Company also expects that, in the future, it like other retailers may
experience seasonality in its business. For example, like other Internet
retailers, the Company experiences lower revenues in the month of August. Due
to all of the foregoing factors, in some future quarter the Company's
operating results may not meet the expectations of securities analysts and
investors. In such event, the trading price of the Company's Common Stock
would likely be materially adversely affected. In addition, the Company
expects to experience substantial quarterly net losses through at least the
first half of 1999. See "--Limited Operating History" and "Item 7.-
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
DEPENDENCE ON RELATIONSHIPS WITH OTHER ONLINE COMPANIES
The Company depends to some extent and is increasing its dependence on
relationships with other online companies. These relationships include but are
not limited to agreements for anchor tenancy, promotional placements,
sponsorships and banner advertisements. All of these agreements are short-term
and none provides for guaranteed renewal. The risks of this dependence include
(i) the uncertainty that significant spending on these relationships will
increase the Company's revenues substantially or at all, (ii) the possibility
that potential revenue increases resulting from such spending will not occur
within the time periods that the Company is expecting, (iii) the possibility
that space on other Web sites or the same sites may increase in price or cease
to be available on reasonable terms or at all, (iv) the possibility that a
competitor will purchase exclusive rights to attractive space on one or more key
sites and (v) the possibility that, if these relationships are successful, the
Company may not be able to obtain adequate amounts of merchandise to meet the
increased demand that is generated.
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RELIANCE ON MERCHANDISE VENDORS
The Company is entirely dependent upon vendors to supply it with
merchandise for sale through the Company's Internet auctions and the
availability of merchandise is unpredictable. In 1996 and 1997, approximately
30% of the Company's gross merchandise sales were derived from merchandise
acquired from the five most significant vendors for that year, respectively,
although no vendor accounted for more than 10% of gross merchandise sales. The
Company has no long-term contracts or arrangements with its vendors that
guarantee the availability of merchandise for its auctions. There can be no
assurance that the Company's current vendors will continue to sell merchandise
to the Company or otherwise to provide merchandise for sale in the Company's
auctions or that the Company will be able to establish new vendor relationships
that ensure merchandise will be available for auction on the Company's Web site.
The Company also relies on many of its vendors to ship merchandise to customers.
The Company has limited control over the shipping procedures of its vendors, and
shipments by these vendors have often been subject to delays. Although most
merchandise sold by the Company carries a warranty supplied either by the
manufacturer or the vendor and the Company is not obligated to accept
merchandise returns, the Company in fact has accepted returns from customers for
which the Company did not receive reimbursements from its vendors or
manufacturers. If the Company is unable to develop and maintain satisfactory
relationships with vendors on acceptable commercial terms, if the Company is
unable to obtain sufficient quantities of merchandise, if the quality of service
provided by such vendors falls below a satisfactory standard or if the Company's
level of returns exceeds its expectations, the Company's business, results of
operations and financial condition will be materially adversely affected. See
"Business--Merchandise," "Business--Vendor Relationships" and "Business--
Customer Support and Service."
RELIANCE ON OTHER THIRD PARTIES
In addition to its merchandise vendors, the Company's operations
depend on a number of third parties. The Company has limited control over these
third parties and no long-term relationships with any of them. The Company does
not own a gateway onto the Internet, but instead relies on an Internet service
provider to connect the Company's Web site to the Internet. From time to time,
the Company has experienced temporary interruptions in its Web site connection
and also its telecommunications access. Continuous or prolonged interruptions in
the Company's Web site connection or in its telecommunications access would have
a material adverse effect on the Company's business, results of operations and
financial condition. The Company's internally-developed auction software depends
on operating system, database and server software that was developed and
produced by and licensed from third parties. The Company has from time to time
discovered errors and defects in the software from these third parties and, in
part, relies, on these third parties to correct these errors and defects in a
timely manner. Approximately 85% of the sales for which the Company is
responsible for shipment is fulfilled by its contract warehouse, Gage.
Accordingly, any service interruptions experienced by this warehouse as a result
of labor problems or otherwise could have a material adverse effect on the
Company's business, results of operations and financial condition. The Company
uses United Parcel Service as its delivery service for substantially all of its
products. Should United Parcel Service be unable to deliver the Company's
products for a sustained time period as a result of a strike or other reason,
the Company's business, results of operations and financial condition would be
adversely affected. Wells Fargo Bank, through its relationship with First Data
Corporation, is the Company's sole processor of credit card transactions. If the
Company is unable to develop and maintain satisfactory relationships with such
third parties on acceptable commercial terms, or the quality of products and
services provided by such third parties falls below a satisfactory standard, the
Company's business, results of operations and financial condition will be
materially adversely affected. See "Business--Merchandise Distribution" and
"Business--Technology and Operations."
MANAGEMENT OF GROWTH
The Company has rapidly and significantly expanded its operations and
anticipates that significant expansion of its operations will continue to be
required in order to address potential market opportunities. This rapid growth
has placed, and is expected to continue to place, a significant strain on the
Company's management, operational and financial resources. The Company expanded
from 14 employees at June 30, 1996 to 129 employees at December 31, 1997, and
its sales increased from approximately 3,300 units per week at the beginning of
the third quarter of 1996 to over 24,000 units per week at the end of the fourth
quarter of 1997. The Company's new employees include a number of key managerial
and technical employees who have not yet been fully integrated into the
Company's management team, and the Company expects to add additional key
personnel in the near future, including a Chief Financial Officer.
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There can be no assurance that the Company will be able to identify appropriate
candidates for its management needs, successfully recruit such persons, or
retain the agencies of such persons. Increases in the number of employees and
the volume of merchandise sales have placed significant demands on the Company's
management, which until January 1997 included only three executive officers. In
order to manage the expected growth of its operations, the Company will be
required to expand existing operations, particularly with respect to customer
service and merchandising, to improve existing and implement new operational,
financial and inventory systems, procedures and controls, including improvement
of its financial and other internal management systems, on a timely basis, and
to train, manage and expand its already growing employee base. The Company also
intends to replace its existing finance and accounting system in the second
quarter of 1998. The Company also will be required to expand its accounting
staff. Further, the Company's management will be required to maintain
relationships with various merchandise vendors, freight companies, warehouse
operators, other Web sites and services, Internet service providers and other
third parties and to maintain control over the strategic direction of the
Company in a rapidly changing environment. In addition, during the next six
months, the Company expects to begin offering credit to certain of its customers
that have been prequalified as having appropriate credit ratings and,
accordingly, will be required to manage the associated risks of accounts
receivable expansion and collection. Such credit would typically be used to
expand the Company's customer base to include large purchasers that presently
find it difficult or are unable to purchase under the Company's auction
procedures, which require use of a credit card number. The Company expects that
its new offerings will allow government, educational and large corporate
institutions to buy on an open account or purchase order basis up to a
predetermined credit limit and will allow VARs and other resellers and
individuals reluctant to trust their credit card numbers to the security of the
Internet to purchase on a COD (cash on delivery) basis. There can be no
assurance that the Company's current personnel, systems, procedures and controls
will be adequate to support the Company's future operations, that management
will be able to identify, hire, train, retain, motivate and manage required
personnel or that management will be able to manage and exploit existing and
potential market opportunities successfully. If the Company is unable to manage
growth effectively, the Company's business, results of operations and financial
condition will be materially adversely affected. See "Business--Employees" above
and "Item 10. - Directors and Executive Officers of the Registrant."
RISKS OF A PRINCIPAL SALES MODEL
Through much of 1997, the Company had limited inventory and price risk
because it either acted as a sales agent for vendors that retained title to the
merchandise auctioned by the Company or took merchandise from vendors on
consignment. By the third quarter of 1997, the Company was purchasing a majority
of its merchandise from vendors and thereby assuming the inventory and price
risks of these products to be sold at auction. These risks are especially
significant because much of the merchandise currently auctioned by the Company
(e.g., computers, peripherals and consumer electronics) is characterized by
rapid technological change, obsolescence and price erosion. With the Company
increasingly relying on purchased inventory, its success will depend on its
ability to liquidate its inventory rapidly through its auctions, the ability of
its buying staff to purchase inventory at attractive prices relative to its
resale value at auction, and its ability to manage customer returns and the
shrinkage resulting from theft, loss and misrecording of inventory. Due to the
inherently unpredictable nature of auctions, it is impossible to determine with
any certainty whether an item will sell for more than the price paid by the
Company. Further, because minimum bid prices for the merchandise listed on the
Company's Web site generally are lower than the Company's acquisition costs for
such merchandise, there can be no assurance that the Company will achieve
positive gross margins on any given sale. If the Company is unable to liquidate
its purchased inventory rapidly, if the Company's buying staff fails to purchase
inventory at attractive prices relative to its resale value at auction, or if
the Company fails to predict with accuracy the resale prices for its purchased
merchandise, the Company may be forced to sell its inventory at a discount or at
a loss and the Company's business, results of operations and financial condition
would be materially adversely affected. See "Business--Merchandise" and
"Business--Vendor Relationships."
COMPETITION
The electronic commerce market, particularly over the Internet, is
new, rapidly evolving and intensely competitive, and the Company expects
competition to intensify in the future. The Company currently or potentially
competes with a variety of other companies depending on the type of merchandise
and sales format offered to customers. These competitors include (i) various
Internet auction houses such as Z AUCTION, First Auction (the auction site for
Internet Shopping Network, a wholly-owned subsidiary of Home Shopping Network
Inc.), Surplus Direct (a wholly-owned subsidiary of Egghead, Inc.) and eBay (in
connection with the Company's newly introduced
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The ONSALE Exchange), (ii) a number of indirect competitors that specialize in
electronic commerce or derive a substantial portion of their revenue from
electronic commerce, including Internet Shopping Network, New England Circuit
Exchange, America Online, Inc. and Cendant Corporation, (iii) a variety of other
companies that offer merchandise similar to that of the Company but through
physical auctions and with which the Company competes for sources of supply, and
(iv) companies with substantial customer bases in the computer and peripherals
catalog business, including Micro Warehouse, Inc., Insight Enterprises, Inc.,
Creative Computers, Inc., and CDW Computer Centers. Some or all of these
competitors may already operate competitive auction sites and may devote more
resources to Internet commerce in the future. In particular, America Online has
taken a minority equity interest in Internet Liquidators International, Inc.
("ILI") and announced that the two companies have formed a strategic partnership
under which revenue from ILI's auction platforms is shared with America Online
and America Online provides a direct link for ILI's members to reach ILI's
electronic commerce site on the Web. Ingram Micro Inc., the largest worldwide
distributor of computer technology products and services, has recently
introduced a wholesale auction site available only to its registered resellers.
The Company believes that Ziff-Davis has reserved a Web domain name including
the word "auction" and that CompUSA is considering opening an auction site on
the Web for its refurbished products.
Current and potential competitors have established or may establish
cooperative relationships among themselves or directly with vendors to obtain
exclusive or semi-exclusive sources of merchandise. Accordingly, it is possible
that new competitors or alliances among competitors and vendors may emerge and
rapidly acquire market share. In addition, manufacturers might elect to
liquidate their products directly. Increased competition is likely to result in
reduced operating margins, loss of market share and a diminished brand
franchise, any one of which could materially adversely affect the Company's
business, results of operations and financial condition. Many of the Company's
current and potential competitors have significantly greater financial,
technical, marketing and other resources than the Company. As a result, they may
be able to secure merchandise from vendors on more favorable terms than the
Company, and they may be able to respond more quickly to changes in customer
preferences or to devote greater resources to the development, promotion and
sale of their merchandise than can the Company. See "Business--Competition."
RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE; DEPENDENCE ON THE INTERNET
The Internet and electronic commerce industries are characterized by
rapid technological change, changes in user and customer requirements, frequent
new service or product introductions embodying new technologies and the
emergence of new industry standards and practices that could render the
Company's existing Web site and proprietary technology obsolete. The Company's
performance will depend, in part, on its ability to license leading
technologies, enhance its existing services, develop new proprietary technology
that addresses the increasingly sophisticated and varied needs of its
prospective customers, and respond to technological advances and emerging
industry standards and practices on a timely and cost-effective basis. The
development of Web site and other proprietary technology entails significant
technical and business risks. There can be no assurance that the Company will be
successful in using new technologies effectively or adapting its Web site and
proprietary technology to customer requirements or emerging industry standards.
If the Company is unable, for technical, legal, financial or other reasons, to
adapt in a timely manner in response to changing market conditions or customer
requirements, or if the Company's Web site and proprietary technology do not
achieve market acceptance, the Company's business, results of operations and
financial condition would be materially adversely affected.
The success of the Company's services will depend in large part upon
the development of an infrastructure for providing Internet access and services.
The Internet could lose its viability due to delays in the development or
adoption of new standards and protocols intended to handle increased levels of
Internet activity or due to increased governmental regulation. There can be no
assurance that the infrastructure or complementary services necessary to make
the Internet a viable commercial marketplace will be developed or that, if they
are developed, the Internet will become a viable marketing and sales channel for
excess merchandise such as that offered by the Company. If the infrastructure or
complementary services necessary to make the Internet a viable commercial
marketplace are not developed or if the Internet does not become a viable
commercial marketplace, the Company's business, results of operations and
financial condition will be materially adversely affected. See "Business--
Industry Background" and "Business--Technology and Operations."
17
<PAGE>
DEVELOPING MARKET; UNCERTAIN ACCEPTANCE OF THE INTERNET AS A MEDIUM FOR COMMERCE
The market for the Company's services has only recently begun to
develop and is rapidly changing. As is typical for a new and rapidly evolving
industry, demand and market acceptance for recently introduced services and
products over the Internet are subject to a high level of uncertainty and there
exist few proven services and products. Moreover, since the market for the
Company's Internet auctions is new and evolving, it is difficult to predict the
size of this market or its future growth rate, if any. The success of the
Company's Internet auctions will depend upon the adoption of the Internet as a
medium for commerce by a broad base of consumers and vendors. There can be no
assurance that widespread acceptance of Internet commerce in general, or of the
Company's Internet auctions in particular, will occur. The Company has
historically relied on consumers and vendors who have historically used
traditional means of commerce to purchase and sell merchandise. For the Company
to be successful, these consumers and vendors must accept and utilize novel ways
of conducting business and exchanging information. In addition, vendors must be
persuaded to adopt new selling models. Moreover, critical issues concerning the
commercial use of the Internet, such as ease of access, security, reliability,
cost and quality of service, remain unresolved and may affect the growth of
Internet use or the attractiveness of conducting commerce online. There can be
no assurance that there will be broad acceptance of the Internet as an effective
medium for commerce by consumers and vendors or that the market for the
Company's Internet auctions will develop successfully or achieve widespread
acceptance. If the market for Internet-based online auctions fails to develop,
develops more slowly than expected or becomes saturated with competitors, or if
the Company's Internet auctions do not achieve market acceptance, the Company's
business, results of operations and financial condition will be materially
adversely affected. See "Item 7. - Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business--Business
Strategy."
UNCERTAIN ACCEPTANCE OF THE ONSALE BRAND; EVOLVING AND UNPREDICTABLE BUSINESS
MODEL
The Company believes that the importance of brand recognition will
increase as more companies engage in commerce over the Internet. Development and
awareness of the ONSALE brand will depend largely on the Company's success in
maintaining its position as a leader in Internet commerce. If vendors do not
perceive the Company as an effective marketing and sales channel for their
merchandise, or consumers do not perceive the Company as offering an
entertaining and desirable way to purchase merchandise, the Company will be
unsuccessful in promoting and maintaining its brand. Furthermore, in order to
attract and retain customers and to promote and maintain the ONSALE brand in
response to competitive pressures, the Company is finding it necessary to
increase its marketing and advertising budgets and otherwise to increase
substantially its financial commitment to creating and maintaining brand loyalty
among vendors and consumers. If the Company is unable to or incurs significant
expenses in an attempt to achieve or maintain a leading position in Internet
commerce or to promote and maintain its brand, the Company's business, results
of operations and financial condition will be materially adversely affected. See
"Business--Business Strategy" and "Business--Sales and Marketing."
The Company's business model continues to evolve. The Company has
expanded the focus of its operations beyond the auction and sale of refurbished
and close-out computers, peripherals and consumer electronics to the auction and
sale of other excess merchandise. The Company expects to continue to develop its
business model and to explore other opportunities such as the use of the
Company's Web site as an advertising medium for services and products of other
companies. As its business model evolves, the Company risks diluting its brand,
confusing customers and decreasing interest from vendors. In addition, the
Company could be exposed to additional or new risks associated with these new
opportunities. If the Company were unable to address these risks, the Company's
business, results of operations and financial condition would be materially
adversely affected.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
The Company is not currently subject to direct regulation by any
government agency, other than regulations applicable to businesses generally,
laws applicable to auction companies and auctioneers, and laws or regulations
directly applicable to access to or commerce on the Internet. However, due to
the increasing popularity and use of the Internet, it is possible that a number
of laws and regulations may be adopted with respect to the Internet, covering
issues such as user privacy, pricing, and characteristics and quality of
products and services. Furthermore, the growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws
that may impose additional burdens on those companies conducting business over
the Internet. The adoption of any additional laws or regulations may decrease
the growth of the Internet, which, in turn, could decrease the demand for
18
<PAGE>
the Company's Internet auctions and increase the Company's cost of doing
business or otherwise have an adverse effect on the Company's business, results
of operations and financial condition. Moreover, the applicability to the
Internet of existing laws in various jurisdictions governing issues such as
property ownership, auction regulation, sales tax, libel and personal privacy is
uncertain and may take years to resolve. In addition, as the Company's service
is available over the Internet in multiple states and foreign countries, and as
the Company sells to numerous consumers resident in such states and foreign
countries, such jurisdictions may claim that the Company is required to qualify
to do business as a foreign corporation in each such state and foreign country.
The Company is qualified to do business in only three states, and failure by the
Company to qualify as a foreign corporation in a jurisdiction where it is
required to do so could subject the Company to taxes and penalties. Any such new
legislation or regulation, or the application of laws or regulations from
jurisdictions whose laws do not currently apply to the Company's business, could
have a material adverse effect on the Company's business, results of operations
and financial condition.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's future performance depends to a significant degree upon
the continued contributions of members of the Company's senior management and
other key personnel, particularly its co-founder, President and Chief Executive
Officer, S. Jerrold Kaplan, and its co-founder, Vice President of Development
and Operations and Chief Technical Officer, Alan S. Fisher. The loss of either
of these individuals could have a material adverse effect on the Company's
business, results of operation and financial condition. The Company does not
have long-term employment agreements with any of its key personnel and maintains
no key person life insurance. In addition, the Company believes that its future
success will depend upon its ability to identify, attract, hire, train, motivate
and retain other highly skilled personnel.
Competition for such personnel is intense. There can be no assurance that the
Company will be successful in attracting, assimilating or retaining the
necessary personnel, and the failure to do so could have a material adverse
effect on the Company's business, results of operations and financial condition.
See "Business--Employees" and "Item 10. - Directors and Executive Officers
of the Registrant."
RISKS OF LAUNCHING THE ONSALE EXCHANGE
In November 1997, the Company launched The ONSALE Exchange, a new
Auction Supersite that allows individuals and small businesses to describe and
sell their own merchandise over the Web using the Company's auction management
system. The Company has employed additional engineers and devoted substantial
engineering time to enhancing its software for this purpose and will be required
to continue to spend money to update and improve this software. In addition, the
Company has hired and may continue to hire additional personnel who will monitor
this new Auction Supersite and perform customer service functions. Finally, the
Company contemplates significant expenditures to purchase advertising for this
new auction medium. The Company charges sellers a small commission for providing
the names of the auction winner(s) and runners-up to the sellers. The Company
anticipates that the average sale on The ONSALE Exchange will be significantly
smaller than its historical average sale. Thus, for The ONSALE Exchange business
to be profitable, the Company will need to auction substantial volumes of
merchandise on behalf of such sellers. The Company has no direct experience in
running a private-party to private-party auction business and consequently is
unable to measure the attractiveness of The ONSALE Exchange to its target
audience. There can be no assurance that this business will be profitable or
that its operations will not have a material adverse effect on the Company's
business, results of operations and financial condition. In addition, this
business entails the risks that there is an existing, more established
competitor in this new market, that sellers might post inappropriate or illegal
items on the Company's Web site, that portions of the Company's core business
may be cannibalized as a result of potential merchants electing to sell products
directly using The ONSALE Exchange rather than selling such products to the
Company to be resold by the Company on a Principal Sales basis, that the
Company's brand may be diluted by conducting an additional business under the
ONSALE name, that the Company's image may be harmed by the Company's role in
connecting buyers and sellers who then have an unsatisfactory experience and
that buyers, who are invited to comment on their impressions of sellers, may
include libelous material for which the Company could be held responsible. See
"Risk Factors--Competition" and "Business--Agent Sales and The ONSALE Exchange."
19
<PAGE>
RISK OF SYSTEM FAILURE; SINGLE SITE
The Company's success is largely dependent upon its communications
hardware and computer hardware, substantially all of which is located at a
leased facility in Mountain View, California. The Company's systems are
vulnerable to damage from earthquake, fire, floods, power loss,
telecommunications failures, break-ins and similar events. The Company does not
presently have fully redundant systems and has not yet completed implementing a
formal disaster recovery plan. A substantial interruption in these systems
would have a material adverse effect on the Company's business, results of
operations and financial condition. The Company's coverage limits on its
property and business interruption insurance may not be adequate to compensate
the Company for all losses that may occur. Despite the implementation of network
security measures by the Company, its servers are also vulnerable to computer
viruses, physical or electronic break-ins, attempts by third parties
deliberately to exceed the capacity of the Company's systems and similar
disruptive problems. Computer viruses, break-ins or other problems caused by
third parties could lead to interruptions, delays, loss of data or cessation in
service to users of the Company's services and products. The occurrence of any
of these risks could have a material adverse effect on the Company's business,
results of operations and financial condition. See "Item 2. - Properties."
RISK OF FACILITIES MOVE
Over the course of the next few months, the Company anticipates moving
its accounting, engineering and Web site operations from their existing space in
four buildings in Mountain View, California, to additional space in the
Company's corporate office space in Menlo Park, California. During this period,
the Company will have the additional burden of operating multiple sites that are
no longer contiguous. The Company will also incur additional expenses related to
the move itself. Finally, the Company will be forced to take its auctions off-
line over the course of the move, which could result in reduced revenues if this
extends for any significant time.
INTERNET COMMERCE SECURITY RISKS
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. The
Company relies on encryption and authentication technology licensed from third
parties to provide the security and authentication necessary to effect secure
transmission of confidential information. There can be no assurance that
advances in computer capabilities, new discoveries in the field of cryptography
or other events or developments will not result in a compromise or breach of the
algorithms used by the Company to protect customer transaction data. If any such
compromise of the Company's security were to occur, it could have a material
adverse effect on the Company's business, results of operations and financial
condition. A party who is able to circumvent the Company's security measures
could misappropriate proprietary information or cause interruptions in the
Company's operations. The Company may be required to expend significant capital
and other resources to protect against the threat of such security breaches or
to alleviate problems caused by such breaches. Concerns over the security of
Internet transactions and the privacy of users may also inhibit the growth of
the Internet generally, and the Web in particular, especially as a means of
conducting commercial transactions. To the extent that activities of the Company
or third party contractors involve the storage and transmission of proprietary
information, such as credit card numbers, security breaches could expose the
Company to a risk of loss or litigation and possible liability. There can be no
assurance that the Company's security measures will prevent security breaches or
that failure to prevent such security breaches will not have a material adverse
effect on the Company's business, results of operations and financial condition.
See "Business--Technology and Operations."
PROTECTION OF INTELLECTUAL PROPERTY
The Company's performance and ability to compete are dependent to a
significant degree on its proprietary technology. The Company relies on a
combination of patent, trademark, copyright and trade secret laws, as well as
confidentiality agreements and technical measures, to establish and protect its
proprietary rights. The Company has applied for five patents in the United
States covering various aspects of electronically managed Internet auctions and
various aspects of providing customer service via automated email. There can be
no assurance that patents will issue from any of the Company's pending
applications, that any patents granted to the Company will not be challenged and
invalidated, or that any claims allowed from pending patents will be of
sufficient scope or strength to provide meaningful protection or any commercial
advantage to the Company. The Company has registered the ONSALE(R), the ONSALE
tag logo and Yankee Auction(R) trademarks in the United States and claims
trademark rights in, and has
20
<PAGE>
applied for trademark registrations in the United States for, a number of other
marks. There can be no assurance that the Company will be able to secure
significant protection for these trademarks. It is possible that competitors of
the Company or others will adopt product or service names similar to "ONSALE"
and the Company's other trademarks, thereby impeding the Company's ability to
build brand identity and possibly leading to customer confusion. The inability
of the Company to protect the name "ONSALE" adequately would have a material
adverse effect on the Company's business, results of operations and financial
condition. The Company's proprietary software is protected by copyright laws.
The source code for the Company's proprietary software also is protected under
applicable trade secret law. As part of its confidentiality procedures, the
Company generally enters into agreements with its employees and consultants and
limits access to and distribution of its software, documentation and other
proprietary information. There can be no assurance that the steps taken by the
Company will prevent misappropriation of its technology or that agreements
entered into for that purpose will be enforceable. Notwithstanding the
precautions taken by the Company, it might be possible for a third party to copy
or otherwise obtain and use the Company's software or other proprietary
information without authorization or to develop similar software independently.
Policing unauthorized use of the Company's technology is difficult, particularly
because the global nature of the Internet makes it difficult to control the
ultimate destination or security of software or other data transmitted. The laws
of other countries may afford the Company little or no effective protection of
its intellectual property.
The Company has in the past received, and may in the future receive,
notices from third parties claiming infringement by the Company's software or
other aspects of the Company's business. While the Company is not currently
subject to any such claim, any future claim, with or without merit, could result
in significant litigation costs and diversion of resources including the
attention of management, and require the Company to enter into royalty and
licensing agreements, which could have a material adverse effect on the
Company's business, results of operations and financial condition. Such royalty
and licensing agreements, if required, may not be available on terms acceptable
to the Company or at all. In the future, the Company may also need to file
lawsuits to enforce the Company's intellectual property rights, to protect the
Company's trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation, whether successful or
unsuccessful, could result in substantial costs and diversion of resources,
which could have a material adverse effect on the Company's business, results of
operations and financial condition.
The Company also relies on a variety of technologies that it licenses
from third parties, including its database and Internet server software, which
is used in the Company's Web site to perform key functions. There can be no
assurance that these third party technology licenses will continue to be
available to the Company on commercially reasonable terms. The loss of or
inability of the Company to maintain or obtain upgrades to any of these
technology licenses could result in delays in completing its proprietary
software enhancements and new development until equivalent technology could be
identified, licensed or developed, and integrated. Any such delays would
materially adversely affect the Company's business, results of operations and
financial condition.
CONTROL BY PRINCIPAL STOCKHOLDERS, OFFICERS AND DIRECTORS
The Company's officers, directors and greater than 5% stockholders
(and their affiliates), in the aggregate, beneficially own approximately 74% of
the Company's outstanding Common Stock. As a result, such persons, acting
together, will have the ability to control all matters submitted to stockholders
of the Company for approval (including the election and removal of directors and
any merger, consolidation or sale of all or substantially all of the Company's
assets) and to control the management and affairs of the Company. Accordingly,
such concentration of ownership may have the effect of delaying, deferring or
preventing a change in control of the Company, impede a merger, consolidation,
takeover or other business combination involving the Company or discourage a
potential acquirer from making a tender offer or otherwise attempting to obtain
control of the Company, which in turn could have an adverse effect on the market
price of the Company's Common Stock. See "Item 10. -Directors and Executive
Officers of the Registrant" and "Item 12. - Security Ownership of Certain
Beneficial Owners and Management."
POSSIBLE VOLATILITY OF STOCK PRICE
The market price of the shares of Common Stock has been, and is likely
to be, highly volatile and could be subject to wide fluctuations in response to
factors such as actual or anticipated variations in the Company's results of
operations, announcements of technological innovations, new sales formats by the
Company or its competitors, developments with respect to patents, copyrights or
proprietary rights, changes in financial estimates by securities analysts,
conditions and trends in the Internet and electronic commerce industries,
adoption of new accounting
21
<PAGE>
standards affecting the retail sales industry, general market conditions and
other factors. Further, the stock markets, and in particular the Nasdaq National
Market, have experienced extreme price and volume fluctuations that have
particularly affected the market prices of equity securities of many technology
companies and that often have been unrelated or disproportionate to the
operating performance of such companies. The trading prices of many technology
companies' stocks, including the Common Stock of the Company, are at or near
historical highs and reflect price earnings ratios substantially above
historical levels. There can be no assurance that these trading prices and price
earnings ratios will be sustained. These broad market factors may adversely
affect the market price of the Company's Common Stock. These market
fluctuations, as well as general economic, political and market conditions such
as recessions, interest rates or international currency fluctuations, may
adversely affect the market price of the Common Stock. In the past, following
periods of volatility in the market price of a company's securities, securities
class action litigation has often been instituted against such company. Such
litigation, if instituted, could result in substantial costs and a diversion of
management's attention and resources, which would have a material adverse effect
on the Company's business, results of operations and financial condition.
ITEM 2. PROPERTIES.
The Company currently is in the process of relocating its accounting,
engineering and Web site operations facilities from an office complex in
Mountain View, California, comprised of four separate buildings totaling
approximately 14,950 square feet, under leases that expire in October 1997
through July 1999, to a new principal building in Menlo Park, California,
consisting of approximately 46,875 square feet, under leases that expire in July
1998 to November 2002. The Company anticipates that the relocation will be
completed by May 31, 1998, at which time all space in the Mountain View office
complex will have been subleased or the lease concerning such space will have
been terminated. The Company believes that it has adequate space for its current
needs. As the Company expands, it expects that suitable additional space will be
available on commercially reasonable terms, although no assurance can be made in
this regard. The Company does not own any real estate. The Company continues to
rely on a contract warehouse for the significant majority of its fulfillment and
logistics requirements.
ITEM 3. LEGAL PROCEEDINGS.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
22
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE AND NUMBER OF HOLDERS OF RECORD OF COMMON STOCK
The information regarding market prices and numbers of holders of
record of the Company's Common Stock, which is set forth on page 29 of the
Company's 1997 annual report to stockholders furnished to the Securities and
Exchange Commission pursuant to Rule 14a-3(b) (the "Company's 1997 Annual Report
to Stockholders"), is incorporated herein by reference and is filed herewith as
a portion of Exhibit 13.01 hereto.
DIVIDEND POLICY
The Company has not paid any cash dividends on its capital stock to
date. The Company currently anticipates that it will retain any future earnings
for use in its business and does not anticipate paying any cash dividends in the
foreseeable future.
USE OF PROCEEDS
On April 17, 1997, the Company had an initial public offering (the
"Offering") of its Common Stock, $0.001 par value. The Company registered
3,220,000 shares of Common Stock on a Form S-1 Registration Statement
(Registration No. 333-18489), which was declared effective by the Securities and
Exchange Commission on April 17, 1997. The Company ultimately sold 2,875,000
shares of Common Stock (including 375,000 shares pursuant to the exercise of the
over-allotment option for the Offering). The aggregate price to the public was
$17,250,000; the underwriting discount aggregated $1,207,500; and the proceeds
to the Company before deducting offering expenses aggregated $16,042,500. No
shares were sold by stockholders of the Company.
From April 17, 1997 to December 31, 1997, the aggregate amount of
expenses incurred for the Company's account in connection with the Offering
(other than the underwriting discount set forth above) was $1.2 million,
including $403,000 paid to the underwriters' counsel. None of the expenses
was a direct or indirect payment to directors, officers or their associates,
persons owning 10% or more of the Common Stock of the Company or affiliates of
the Company; all expenses were direct or indirect payments to independent third
parties. The net offering proceeds to the Company after deducting both the
underwriting discount and the aggregate offering expenses were $14.8 million.
From April 17, 1997 to December 31, 1997, the amount of the net
proceeds applied to various categories of expenditures were as follows (in
thousands):
<TABLE>
<S> <C>
Purchase of property and equipment................................. $1,171
Working capital.................................................... 5,327
- ---------------
</TABLE>
All expenditures were direct or indirect payments to independent
third parties and none of the payments was a direct or indirect payment to
directors, officers or their associates, persons owning 10% or more of the
Common Stock of the Company, or affiliates of the Company, except payment of
salaries to employees owning 10% or more of the Company's Common Stock.
ITEM 6. SELECTED FINANCIAL DATA.
The information required by this Item, which is set forth under the
caption "Selected Financial Data" on page 8 of the Company's Annual Report to
Stockholders, is incorporated herein by reference and is filed herewith as a
portion of Exhibit 13.01 hereto.
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The information required by this Item, which is set forth in the
section titled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" on pages 9-17 of the Company's 1997 Annual Report to
Stockholders, is incorporated herein by reference and is filed herewith as a
portion of Exhibit 13.01 hereto.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item, which is set forth on pages
18-28 of the Company's 1997 Annual Report to Stockholders, is incorporated
herein by reference and is filed herewith as a portion of Exhibit 13.01 hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
24
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item, which is set forth in the
sections titled "Nominees" under "Proposal No. 1 - Election of Directors,"
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the definitive proxy statement to be filed with the Securities
and Exchange Commission relative to the Company's annual meeting of stockholders
to be held May 18, 1998 (the "Definitive Proxy Statement") is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item, which is set forth in the
sections titled "Director Compensation" under "Proposal No. 1 - Election of
Directors" and "Executive Compensation" and "Employment Agreements" in the
Definitive Proxy Statement, is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item, which is set forth in the
section titled "Security Ownership of Certain Beneficial Owners and Management"
in the Definitive Proxy Statement, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item, which is set forth in the
section titled "Certain Relationships and Related Transactions" in the
Definitive Proxy Statement, is incorporated herein by reference.
25
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following financial statements and financial statement
schedule are filed or incorporated by reference as part of this Report.
(1) Financial Statements.
The following financial statements and report thereon are
incorporated by reference to the Company's 1997 Annual Report to
Stockholders.
Report of Independent Accountants
Balance Sheets as of December 31, 1997 and 1996
Statements of Operations for the Years Ended December 31,
1997 and 1996 and for the Period from Inception (July
1994) to December 31, 1995
Statements of Cash Flows for the Years Ended December 31,
1997 and 1996 and for the Period from Inception (July
1994) to December 31, 1995
Statements of Stockholders' Equity (Deficit) for the Years
Ended December 31, 1997 and 1996 and for the Period from
Inception (July 1994) to December 31, 1995
Notes to Financial Statements
(2) Financial Statement Schedule.
Schedule Description Page
-------- ----------- ----
II Valuation and Qualifying Accounts S-1
-- Report of Independent Accountants
on Financial Statement Schedule S-2
All other financial statement schedules are omitted because
the information called for is not required or is shown either in the
financial statements or the notes thereto.
26
<PAGE>
(3) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
- -------------- -------------
<S> <C>
2.01 Form of Agreement and Plan of Reorganization between the
Registrant and ONSALE.*
3.01 Registrant's Certificate of Incorporation.*
3.02 Registrant's Bylaws.*
4.01 Investors Rights Agreement, dated as of September 12, 1996.*
4.02 Registrant's Certificate of Incorporation (see Exhibit 3.01).*
4.03 Registrant's Bylaws (See Exhibit 3.02).*
9.01 Voting Trust Agreement, dated as of July 21, 1994, by and among
Software Partners, Inc., Alan Fisher and Razi Mohiuddin.*
10.01 Registrant's 1995 Equity Incentive Plan and related
documents.*(1)
10.02 Registrant's 1996 Directors Stock Option Plan and related
documents.*(1)
10.03 Registrant's 1996 Employee Stock Purchase Plan and related
documents.*(1)
10.04 Form of Indemnity Agreement entered into by Registrant with each
of its directors and executive officers.*(1)
10.05 Offer letter to John F. Sauerland, dated as of June 28,
1996.*(1)
10.06 Offer letter to Martha Greer, dated December 18, 1996.*(1)
10.07 Lease Agreement between The Landmark and Registrant, dated as of
May 20, 1996.*
10.08 Sublease Agreement between RogueWave, Inc. and Registrant, dated
as of October 19, 1996.*
10.09 Sublease Agreement between Software Partners, Inc. and the
Registrant, dated as of November 18, 1996.*
10.10 Service Agreement between Gage Marketing Group and the
Registrant, dated as of December 4, 1996.*/**
10.11 Hewlett-Packard and ONSALE Agreement between Hewlett-Packard
Company and the Registrant, dated as of July 31, 1995.*/**
10.12 Credit Card Processing Services Agreement between First USA
Merchant Services, Inc. and the Registrant, dated as of June 16,
1996.*
10.13 Merchant Card Services Agreement between Wells Fargo Bank and
the Registrant, dated as of March 6, 1996.*
10.14 Founder's Restricted Stock Purchase Agreement between S. Jerrold
Kaplan and the Registrant, dated as of July 21, 1994.*(1)
10.15 Founder's Restricted Stock Purchase Agreement between Software
Partners, Inc. and the Registrant, dated as of July 21, 1994*(1)
10.16 Assignment Agreement between Software Partners, Inc. and the
Registrant, dated as of July 21, 1994.*
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
<C> <S>
10.17 Offer letter to Merle McIntosh, dated February 25, 1997.*(1)
10.18 Restricted Stock Purchase Agreement between the Company and
Peter Harris, dated as of December 6, 1996 and related
documents.*(1)
10.19 Loan and Security Agreement between the Registrant and Silicon
Valley Bank and related warrant to purchase Common Stock dated
March 12, 1997.*
10.20 Employment Agreement between the Registrant and Dennis Shepard
dated April 28, 1997.***(1)
10.21 Lease Agreement between Lincoln Menlo VI and Registrant, dated
August 9, 1997.****
10.22 Sublease Agreement between Nuance Communications, Inc. and
Registrant, dated as of August 1997.****
10.23 Loan Agreement and related agreements between Dennis Shepard and
the Registrant, dated February 19, 1998.(1)
13.01 Pages 8, 9-17, 18-28 and 29 of Registrant's 1997 Annual
Report to Stockholders.
23.01 Consent of Price Waterhouse LLP, independent accountants.
24.01 Power of Attorney (see "Signatures" on Page 29 of this Report).
27.01 Financial Data Schedule for year ended December 31, 1997.
27.02 Restated Financial Data Schedule for the quarters ended March
31, 1997, June 30, 1997 and September 30, 1997, and for the year
ended December 31, 1996.
- --------------
</TABLE>
* Incorporated by reference to the exhibit with the same number to the
Registrant's Form S-1 Registration Statement (Registration No. 333-
18489) filed on December 20, 1996.
** Confidential treatment has been granted with respect to certain portions
of this Agreement.
*** Incorporated by reference to Exhibit 10.20 to the Registrant's Form 10-Q
for the quarter ended June 30, 1997.
**** Incorporated by reference to the exhibit with the same number to the
Registrant's Form S-1 Registration Statement (Registration No. 333-
37171) filed on October 3, 1997.
(1) Indicates a management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
A report on Form 8-K was filed by the Company on October 22, 1997.
Under Item 5 of the Form, the Company identified the press release of the
Company on the previous day announcing its results of operations for the three
and nine months ended September 30, 1997, and, under Item 7 of the Form, the
Company identified that the financial statements attached to that press release
were filed as Exhibit 99.1 to the Form.
28
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
ONSALE, INC.
Date: March 31, 1998 By: /s/ S. Jerrold Kaplan
-----------------------------
S. Jerrold Kaplan
President and Chief
Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints S.
Jerrold Kaplan and Alan S. Fisher, and each of them, his or her true and lawful
attorneys-in-fact and agents, with full power of substitution, for him or her,
and in his or her name, place and stead, in any and all capacities, to sign any
and all amendments to this Annual Report on Form 10-K, and to file the same,
with all exhibits thereto and all documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he or she might do in person,
hereby ratifying and confirming all that said attorneys-in-fact and agents, or
his, her or their substitute or substitutes, may lawfully do or cause to be done
by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this Report has been signed below by the following persons on behalf
of the Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
- --------------------------- ----------------------------------- --------------
<S> <C> <C>
PRINCIPAL EXECUTIVE OFFICER:
/s/ S. Jerrold Kaplan President and Chief Executive March 31, 1998
- --------------------------- Officer
S. Jerrold Kaplan and a Director
PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER:
/s/ Leslie S. Benson Vice President, Controller March 31, 1998
- --------------------------- and Acting Chief Financial
Leslie S. Benson Officer
ADDITIONAL DIRECTORS:
/s/ Alan S. Fisher Director March 31, 1998
- ---------------------------
Alan S. Fisher
/s/ Peter L. Harris Director March 31, 1998
- ---------------------------
Peter L. Harris
/s/ Peter H. Jackson Director March 31, 1998
- ---------------------------
Peter H. Jackson
/s/ Kenneth J. Orton Director March 31, 1998
- ---------------------------
Kenneth J. Orton
</TABLE>
29
<PAGE>
SCHEDULE II
ONSALE, INC.
VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
----------
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Year Ended December 31, 1997
Allowance for doubtful accounts.............. $66 $154 $ 66 $154
=== ==== ==== ====
Year Ended December 31, 1996
Allowance for doubtful accounts.............. $16 $130 $ 80 $ 66
=== ==== ==== ====
Period from Inception (July 1994) to
December 31, 1995
Allowance for doubtful accounts.............. $-- $ 16 $ -- $ 16
=== ==== ==== ====
</TABLE>
S-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of ONSALE, Inc.
Our audits of the financial statements referred to in our report
dated February 12, 1998 appearing on page 28 of the 1997 Annual Report to
Stockholders of ONSALE, Inc. (which report and financial statements are
incorporated by reference in this Annual Report on Form 10-K) also included an
audit of the Financial Statement Schedule listed in Item 14(a)(2) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related financial statements.
/s/ Price Waterhouse LLP
San Jose, California
February 12, 1998
S-2
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NUMBER EXHIBIT TITLE
- -------------- -------------
<C> <S>
10.23 Loan Agreement and related agreements between Dennis Shepard
and the Registrant, dated February 19, 1998.
13.01 Pages 8, 9-17, 18-28 and 29 of Registrant's 1997 Annual
Report to Stockholders.
23.01 Consent of Price Waterhouse LLP, independent accountants.
24.01 Power of Attorney (see "Signatures" on Page 29 of this Report).
27.01 Financial Data Schedule.
27.02 Restated Financial Data Schedule for the quarters ended March
31, 1997, June 30, 1997 and September 30, 1997, and for the year
ended December 31, 1996.
</TABLE>
- ---------------
<PAGE>
EXHIBIT 10.23
LOAN AGREEMENT
This Loan Agreement (this "AGREEMENT") is made as of February 19, 1998 (the
"EFFECTIVE DATE") by and Dennis Shepard ("BORROWER") and ONSALE, Inc.
("LENDER").
A. Lender and Borrower desire that Lender loan certain sums to Borrower
(the "LOAN"), on and subject to the terms and conditions contained in this
Agreement, a Secured Full Resource Promissory Note (the "NOTE") and a Stock
Pledge Agreement (the "PLEDGE AGREEMENT").
NOW, THEREFORE, in consideration of the mutual promises, representations,
warranties and conditions set forth in this Agreement, Lender and Borrower
hereby agree as follows:
1. AMOUNT AND TERMS OF LOAN.
------------------------
1.1 LOAN. Subject to all the terms and conditions of this Agreement,
----
and in reliance on the representations, warranties and covenants of Borrower set
forth in this Agreement, Lender agrees to loan Borrower the principal amount of
One Hundred and Twenty-Five Thousand Dollars ($125,000) (the "LOAN").
Notwithstanding the foregoing, Lender will not be obligated to make the Loan to
Borrower unless and until Borrower has executed and delivered to Lender the Note
(as defined in Section 1.3) and the Pledge Agreement (as defined in Section
1.4).
1.2 MATURITY OF LOAN. The unpaid principal amount of the Loan and all
----------------
unpaid interest accrued thereon, together with any other fees, expenses or costs
incurred in connection therewith, will be immediately due and payable to Lender
in full on August 18, 1998 (the "MATURITY DATE").
1.3 NOTE. Borrower's indebtedness to Lender for the Loan shall be
----
evidenced by a Secured Full Recourse Promissory Note of Borrower in the form
attached hereto as Exhibit A (the "NOTE"). The Note will provide that interest
---------
on the unpaid principal of the Loan will accrue at a rate of five and forty-
seven hundredths percent (5.47%) semi-annually until the later of (A) the
Maturity Date, or (B) such time as all amounts owing in connection with the Note
have been repaid in full; provided, however, that in no event shall the interest
-------- -------
exceed the highest rate permitted under applicable law.
1.4 PLEDGE AGREEMENT. Borrower's indebtedness to Lender for the Loan
----------------
shall be secured by an interest in any shares of the Lender's Common Stock
issued to Borrower pursuant to that certain Stock Option Agreement between the
Company and Borrower dated as of May 12, 1997 and additional Collateral (as
defined in the Pledge Agreement).
1.5 PREPAYMENT. Prepayment of unpaid principal and/or interest due
----------
under this Note may be made at any time without penalty. All payments will be
made in lawful tender of the United States and will be applied (a) first, to the
payment of accrued interest, and (b) second (to the extent that the amount of
such prepayment exceeds the amount of all such accrued
<PAGE>
interest), to the payment of principal. Borrower agrees that the proceeds of any
sale of the Lender's stock by Borrower shall be applied to the Note until such
time as the Note is paid in full. Borrower further agrees that any bonus to be
paid by the Lender to the Borrower shall be applied to the Note until such time
as the Note has been paid in full.
1.6 AT WILL EMPLOYMENT. Borrower remains an "at will" employee of
------------------
the Lender, and nothing in this Agreement or any exhibit thereto shall be
construed as a promise of continued employment.
2. CONDITIONS PRECEDENT TO LOANS. The obligation of Lender to make the
-----------------------------
Loan is subject to receipt by Lender (or written waiver by Lender) of the Note
and the Pledge Agreement.
3. DEFAULT. Upon and after the occurrence of any Event of Default (as
-------
defined in the Note), Lender may take any or all of the actions set forth in the
Note and the Pledge Agreement. All such remedies shall be cumulative
4. MISCELLANEOUS.
-------------
4.1 ENTIRE AGREEMENT. This Agreement, the Note, the Pledge Agreement
----------------
constitute the entire agreement and understanding among the parties with respect
to the subject matter thereof and supersede any prior understandings or
agreements of the parties with respect to such subject matter.
4.2 SUCCESSORS AND ASSIGNS. The terms and conditions of this
----------------------
Agreement will inure to the benefit of and be binding upon the respective
successors and assigns of the parties.
4.3 GOVERNING LAW. The laws of the State of California (irrespective
-------------
of its conflict of law principles) shall govern the validity of this Agreement,
the construction of its terms, and the interpretation and enforcement of the
rights and duties of the parties hereto. The parties agree that any controversy
or claim arising out of or relating to this Agreement shall be litigated in a
United States District Court sitting in California.
4.4 COUNTERPARTS. This Agreement may be executed in one or two
------------
counterparts, each of which will be deemed an original, but together will
constitute one and the same instrument.
4.5 SEVERABILITY. Any invalidity, illegality or unenforceability of
------------
any provision of this Agreement in any jurisdiction will not invalidate or
render illegal or unenforceable the remaining provisions hereof in such
jurisdiction and will not invalidate or render illegal or unenforceable such
provision in any other jurisdiction.
4.6 ATTORNEYS' FEES. If any party hereto commences or maintains any
---------------
action at law or in equity (including counterclaims or cross-complaints) against
the other party hereto by reason of the breach or claimed breach of any term or
provision of this Agreement, then the
2
<PAGE>
prevailing party in said action will be entitled to recover its reasonable
attorneys' fees and court costs incurred therein.
IN WITNESS WHEREOF, the parties have duly executed and delivered this
Agreement as of the Effective Date.
BORROWER: LENDER:
ONSALE, Inc.
By: /s/ Dennis Shepard By: /s/ S. Jerrold Kaplan
________________________________ __________________________________
Dennis Shepard S. Jerrold Kaplan, President and
Chief Executive Officer
ATTACHMENTS:
- -----------
Exhibit A - Promissory Note
Exhibit B - Pledge Agreement
3
<PAGE>
SECURED FULL RECOURSE PROMISSORY NOTE
-------------------------------------
Menlo Park, California
$125,000 February 19, 1998
1. OBLIGATION. In exchange for a loan (the "Loan") to the undersigned
---------- ----
("Borrower") by ONSALE, Inc., a Delaware corporation (the "Company"), receipt of
- ---------- -------
which is hereby acknowledged, Borrower hereby promises to pay to the order of
the Company on or before August 18, 1998, at the Company's principal place of
business at 1350 Willow Road #202, Menlo Park, CA 94025, or at such other place
as the Company may direct, the principal sum of One Hundred and Twenty-Five
Thousand Dollars ($125,000) together with interest compounded semi-annually on
the unpaid principal at the rate of Five and Forty-Seven Hundredths percent
(5.47%), which rate is not less than the minimum rate established pursuant to
Section 1274(d) of the Internal Revenue Code of 1986, as amended, on the
earliest date on which there was a binding contract in writing for the Loan;
provided, however, that the rate at which interest will accrue on unpaid
- -------- -------
principal under this Note will not exceed the highest rate permitted by
applicable law.
2. SECURITY. Payment of this Note is secured by a security interest in
--------
any shares of the Company's Common Stock (the "Shares") in the event that such
------
Shares are issued pursuant to that certain Stock Option Agreement dated May 12,
1997, granted by the Company to Borrower.
3. DEFAULT; ACCELERATION OF OBLIGATION. Borrower will be deemed to be in
-----------------------------------
default under this Note and the principal sum of this Note, together with all
interest accrued thereon, will immediately become due and payable in full: (a)
upon Borrower's failure to make the payment when due under this Note; or (b) in
the event Borrower ceases to be employed by the Company for any reason, with or
without cause.
4. REMEDIES ON DEFAULT. Upon any default of Borrower under this Note, the
-------------------
Company will have, in addition to its rights and remedies under this Note and
the Pledge Agreement executed by Borrower of even date herewith, full recourse
against any real, personal, tangible or intangible assets of Borrower, and may
pursue any legal or equitable remedies that are available to it.
5. PREPAYMENT. Prepayment of principal and/or interest due under this
----------
Note may be made at any time without penalty. Unless otherwise agreed in
writing by the Company, all payments will be made in lawful tender of the United
States and will be applied first to the payment of accrued interest, and the
remaining balance of such payment, if any, will then be applied to the payment
of principal. Borrower agrees that the proceeds of any sale of the Shares by
Borrower or for the benefit of Borrower shall be applied to the balance of this
Note until the
4
<PAGE>
Note has been paid in full. Borrower further agrees that any bonus to be given
to Borrower by Lender shall be applied to the balance of this Note until the
Note has been paid in full.
6. GOVERNING LAW; WAIVER. The validity, construction and performance of
---------------------
this Note will be governed by the internal laws of the State of California,
excluding that body of law pertaining to conflicts of law. Borrower hereby
waives presentment, notice of non-payment, notice of dishonor, protest, demand
and diligence.
7. ATTORNEYS' FEES. If suit is brought for collection of this Note,
---------------
Borrower agrees to pay all reasonable expenses, including attorneys' fees,
incurred by the holder in connection therewith whether or not such suit is
prosecuted to judgment.
8. AT WILL EMPLOYMENT. Borrower remains an "at will" employee of the
------------------
Company, and nothing in this agreement shall be construed as a promise of
continued employment.
IN WITNESS WHEREOF, Borrower has executed this Note as of the date and year
first above written.
By: /s/ Dennis Shepard
_______________________________
Dennis Shepard
955 Foxchase Dr. #630
San Jose, CA 95123
5
<PAGE>
STOCK PLEDGE AGREEMENT
----------------------
This Agreement is made and entered into as of February 19, 1998 between
ONSALE, Inc., a Delaware corporation (the "Company"), and Dennis Shepard
-------
("Pledgor").
- ---------
R E C I T A L S
- - - - - - - -
A. In exchange for Pledgor's Secured Full Recourse Promissory Note to the
Company of even date herewith (the "Note"), the Company has loaned to Pledgor
----
$125,000.
B. Pledgor has agreed pursuant to this Agreement that repayment of the
Note will be secured by the pledge of Pledgor's shares of the Company's Common
Stock (the "Shares") to be issued to Pledgor upon the exercise of options to
------
purchase shares of the Company's Common Stock granted to Purchaser pursuant to
that certain Stock Option Agreement between the Company and Pledgor dated as of
May 12, 1997.
NOW, THEREFORE, the parties agree as follows:
1. CREATION OF SECURITY INTEREST. Pursuant to the provisions of the
-----------------------------
California Commercial Code, Pledgor hereby grants to the Company, and the
Company hereby accepts, a first and present security interest in the Shares as
collateral to secure the payment of Pledgor's obligation to the Company under
the Note. For purposes of this Agreement, the Shares pledged to the Company
hereby, together with any additional collateral pledged pursuant to Section 4
hereof, will hereinafter be collectively referred to as the "Collateral."
----------
2. REPRESENTATIONS AND WARRANTIES. Pledgor hereby represents and
------------------------------
warrants to the Company that Pledgor has good title (both record and beneficial)
to the Collateral, free and clear of all claims, pledges, security interests,
liens or encumbrances of every nature whatsoever, and that Pledgor has the right
to pledge and grant the Company the security interest in the Collateral granted
under this Agreement. Pledgor further agrees that, until the entire principal
sum and all accrued interest due under the Note has been paid in full, Purchaser
will not, without the Company's prior written consent, (i) sell, assign or
transfer, or attempt to sell, assign or transfer, any of the Collateral, or (ii)
grant or create, or attempt to grant or create, any security interest, lien,
pledge, claim or other encumbrance with respect to any of the Collateral.
3. RIGHTS ON DEFAULT. In the event of default (as defined in the
-----------------
Note) by Pledgor under the Note, the Company will have full power to sell,
assign and deliver the whole or any part of the Collateral at any broker's
exchange or elsewhere, at public or private sale, at the option of the Company,
in order to satisfy any part of the obligations of Pledgor now existing or
hereinafter arising under the Note. On any such sale, the Company or its
assigns may purchase all or any part of the Collateral. In addition, at its
sole option, the Company may elect to retain all the Collateral in full
satisfaction of Pledgor's obligation under the Note, in accordance with the
provisions and procedures set forth in the California Commercial Code.
6
<PAGE>
4. ADDITIONAL REMEDIES. The rights and remedies granted to the
-------------------
Company herein upon default under the Note will be in addition to all the
rights, powers and remedies of the Company under the California Commercial Code
and applicable law and such rights, powers and remedies will be exercisable by
the Company with respect to all of the Collateral. Pledgor agrees that the
Company's reasonable expenses of holding the Collateral, preparing it for resale
or other disposition, and selling or otherwise disposing of the Collateral,
including attorneys' fees and other legal expenses, will be deducted from the
proceeds of any sale or other disposition and will be included in the amounts
Pledgor must tender to redeem the Collateral. All rights, powers and remedies
of the Company will be cumulative and not alternative. Any forbearance or
failure or delay by the Company in exercising any right, power or remedy
hereunder will not be deemed to be a waiver of any such right, power or remedy
and any single or partial exercise of any such right, power or remedy hereunder
will not preclude the further exercise thereof.
5. DIVIDENDS; VOTING. All dividends hereinafter declared on or
-----------------
payable with respect to the Collateral during the term of this pledge (excluding
only ordinary cash dividends, which will be payable to Pledgor so long as
Pledgor is not in default under the Note) will be immediately delivered to the
Company to be held in pledge under this Agreement. Notwithstanding this
Agreement, so long as Pledgor owns the Shares and is not in default under the
Note, Pledgor will be entitled to vote any shares comprising the Collateral,
subject to any proxies granted by Pledgor.
6. ADJUSTMENTS. In the event that during the term of this pledge,
-----------
any stock dividend, reclassification, readjustment, stock split or other change
is declared or made with respect to the Collateral, or if warrants or any other
rights, options or securities are issued in respect of the Collateral, then all
new, substituted and/or additional shares or other securities issued by reason
of such change or by reason of the exercise of such warrants, rights, options or
securities, will be immediately pledged to the Company to be held under the
terms of this Agreement in the same manner as the Collateral is held hereunder.
7. REDELIVERY OF COLLATERAL. Upon payment in full of the entire
------------------------
principal sum and all accrued interest due under the Note.
8. SUCCESSORS AND ASSIGNS. This Agreement will inure to the benefit
----------------------
of the respective heirs, personal representatives, successors and assigns of the
parties hereto.
9. GOVERNING LAW; SEVERABILITY. This Agreement will be governed by
---------------------------
and construed in accordance with the internal laws of the State of California,
excluding that body of law relating to conflicts of law. Should one or more of
the provisions of this Agreement be determined by a court of law to be illegal
or unenforceable, the other provisions nevertheless will remain effective and
will be enforceable.
10. MODIFICATION; ENTIRE AGREEMENT. This Agreement will not be
------------------------------
amended without the written consent of both parties hereto. This Agreement
constitutes the entire agreement of the parties hereto with respect to the
subject matter hereof and supersedes all prior agreements and understandings
related to such subject matter.
7
<PAGE>
11. AT WILL EMPLOYMENT. Borrower remains an "at will" employee of
------------------
the Company, and nothing in this Agreement shall be construed as a promise of
continued employment.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date and year first above written.
COMPANY PLEDGOR
By: /s/ S. Jerrold Kaplan /s/ Dennis Shepard
--------------------------- ----------------------------------
[Signature]
Name: S. Jerrold Kaplan
------------------------- ----------------------------------
Dennis Shepard
955 Foxchase Dr. #630
Its: CEO San Jose, CA 95123
---------------------------
8
<PAGE>
EXHIBIT 13.01
SELECTED FINANCIAL DATA
-----------------------
The following selected financial data should be read in conjunction with the
Company's financial statements and notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations." The Company's
historical results are not necessarily indicative of future results.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
---------------------------------------------
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995(1)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Merchandise $ 85,997 $12,573 $ 30
Commission and other revenue 2,984 1,696 110
- -------------------------------------------------------------------------------------------------------------------
Total revenue 88,981 14,269 140
Cost of revenue 77,723 11,539 27
- -------------------------------------------------------------------------------------------------------------------
Gross profit 11,258 2,730 113
- -------------------------------------------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 5,885 891 144
General and administrative 5,871 758 227
Engineering 2,873 714 182
- -------------------------------------------------------------------------------------------------------------------
Total operating expenses 14,629 2,363 553
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (3,371) 367 (440)
Interest and other income, net 899 37 --
- -------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (2,472) 404 (440)
Provision for income taxes -- (43) --
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (2,472) $ 361 $ (440)
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) per share(2):
Basic $(0.16) $0.03 $(0.04)
- -------------------------------------------------------------------------------------------------------------------
Diluted $(0.16) $0.03 $(0.04)
- -------------------------------------------------------------------------------------------------------------------
Shares used in net income (loss) per share calculations(2):
Basic 15,742 12,090 12,015
- -------------------------------------------------------------------------------------------------------------------
Diluted 15,742 13,536 12,015
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL FINANCIAL DATA:
Gross merchandise sales(3) $115,923 $30,727 $ 1,252
===================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents $ 56,566 $ 2,729 $ 20
Working capital (deficiency) 60,579 1,731 (449)
Total assets 67,143 5,680 73
Long-term obligations -- -- --
Total stockholders' equity (deficit) 62,269 2,328 (419)
</TABLE>
(1) The Company's results of operations for the period from inception (July
1994) to December 31, 1994 have been combined with the results of
operations for the year ended December 31, 1995 due to the Company's
limited activity during the earlier period. During 1994, the Company
incurred expenses and reported a net loss of $41,000.
(2) See Notes 1 and 12 of Notes to Financial Statements for an explanation of
the determination of the number of shares used in net income (loss) per
share calculations.
(3) Represents what the Company's total revenue would have been if sales where
the Company acted as a commissioned auction agent for its vendors ("Agent
Sales") were recorded as transactions where the Company purchased or
accepted consignment of merchandise from vendors for resale at auction
("Principal Sales"). This presentation of sales on a gross basis does not
affect the Company's gross profit or net income (loss). Management believes
that gross merchandise sales provide a more consistent comparison between
historical periods and to future periods than does total revenue. Gross
merchandise sales should not be considered in isolation or as a substitute
for other information prepared in accordance with generally accepted
accounting principles ("GAAP"). See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 1 of Notes to
Financial Statements.
8
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
---------------------------------------------
This Annual Report to Stockholders (including without limitation the following
section regarding Management's Discussion and Analysis of Financial Condition
and Results of Operations) contains forward-looking statements (within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) regarding the Company and its business,
financial condition, results of operations and prospects. Words such as
"expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates"
and similar expressions or variations of such words are intended to identify
forward-looking statements, but are not the exclusive means of identifying
forward-looking statements in this Annual Report. Additionally, statements
concerning future matters, such as technology enhancements, equipment
purchases, credit arrangements, and other statements regarding matters that
are not historical, are forward-looking statements.
Although forward-looking statements in this Annual Report reflect the good faith
judgment of the Company's management, such statements can only be based on facts
and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include without limitation the Company's
limited operating history and fluctuations in operating results; its dependence
on relationships with other online companies; its reliance on merchandise
vendors and other third parties; the inventory and price risks of the Company's
purchasing merchandise in principal transactions, including management of
customer returns and shrinkage resulting from theft, loss and misrecording of
inventory; actual and potential competition; the limited management and other
resources that the Company has available to address its rapid growth; dependence
on the Internet; technological change; uncertain acceptance of the ONSALE
brand; and reliance on automated technology, as well as factors discussed
elsewhere in this Annual Report and in detail in the Company's Annual Report
on Form 10-K filed with the Securities and Exchange Commission. Readers are
urged not to place undue reliance on these forward-looking statements, which
speak only as of the date of this Annual Report. The Company undertakes no
obligation to revise or update any forward-looking statements in order to
reflect any event or circumstance that may arise after the date of this Annual
Report. Readers are urged to carefully review and consider the various
disclosures made by the Company in this Annual Report, which attempt to advise
interested parties of the risks and factors that may affect the Company's
business, financial condition, results of operations and prospects.
OVERVIEW
ONSALE is an electronic retailer pioneering a new sales format - the interactive
online auction - designed to serve as an efficient and entertaining marketing
channel for products that are typically unavailable through conventional
distribution channels. The Company currently specializes in selling excess
merchandise, such as refurbished and close-out products, over the World Wide Web
to businesses, resellers and consumers. The Company was incorporated in July
1994 and commenced auctioning products on the Internet in May 1995. For the
period from inception (July 1994) to December 31, 1995, the Company's operating
activities related primarily to recruiting personnel, purchasing operating
assets, establishing vendor relationships and developing the computer
infrastructure necessary to conduct live auctions on the Internet. During that
period, the Company had total revenue of $140,000. The Company achieved
profitability in the first quarter of 1996 and increased its total revenue and
net income in each quarter of 1996. However, in early 1997 the Company elected
to expand its operations, including increasing its staffing and marketing
efforts, which resulted in higher operating expenses and net losses in the final
three quarters of 1997. The Company expects to experience substantial net
losses through at least the first half of 1999.
The Company obtains merchandise from vendors in either of two primary
arrangements: the Principal Sales model (merchandise revenue) and the Agent
Sales model (commission revenue). Under the Principal Sales model, the Company
either purchases merchandise or sells merchandise under consignment
relationships with vendors. For a discussion of the operation of each model, the
risks of each to the Company and the recognition of revenue for each, see Note 1
of Notes to Financial Statements. From its inception through the third quarter
of 1995, the Company derived all of its revenue from Agent Sales. However, as
the Company grew, it experienced increasing constraints on the amount of
merchandise it could obtain and sell under the Agent
9
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
------------------------------------------------
Sales model. Further, the Company believed that, by utilizing the Principal
Sales model, it could control the availability of merchandise more effectively,
improve customer service, and achieve higher gross margins over time. As a
result, the Company began to use the Principal Sales model for an increasing
number of transactions. For 1997, Principal Sales transactions represented 74.2%
of the Company's gross merchandise sales. Gross merchandise sales represent what
the Company's total revenue would have been if all sales for which the Company
acted as a commissioned auction agent for its vendors (Agent Sales) were
recorded as transactions in which the Company purchased or accepted consignment
of merchandise from vendors for resale at auction (Principal Sales). In the
fourth quarter of 1997 ONSALE introduced The ONSALE Exchange, a self-service
site that allows individuals and small businesses to sell their own merchandise
over the Web using the Company's auction management software.
The Company has an extremely limited operating history upon which to base an
evaluation of the Company and its business and prospects. The Company's business
and prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets such as
electronic commerce. Although the Company has experienced significant growth in
merchandise and commission and other revenue in recent periods, there can be no
assurance that the Company's revenue will continue at its current level or
increase. The Company's revenue depends substantially upon the level of auction
activity on its Web site, which, in turn, depends upon the availability of
merchandise from the Company's vendors. This availability is difficult to
forecast with any degree of certainty. A substantial reduction in merchandise
availability would have a material adverse effect on the Company's business,
results of operations and financial condition. In addition, the Company has
relatively low operating margins and plans to increase its operating expenses
significantly in order to increase the size of its staff, expand its marketing
efforts, purchase larger volumes of merchandise to be sold at auction and
support its growing infrastructure. To the extent that increases in operating
expenses are not offset by increased revenue, the Company's business, results
of operations and financial condition will be materially adversely affected.
RESULTS OF OPERATIONS
TOTAL REVENUE
Total revenue is comprised primarily of the gross value of Principal Sales and
commissions on Agent Sales. Commencing in the fourth quarter of 1997, total
revenue also includes revenue from the sale of advertising on the Company's Web
site and revenue from The ONSALE Exchange. Revenue from advertising and The
ONSALE Exchange was not significant during 1997. The Company had $140,000
of total revenue in the period from inception (July 1994) to December 31, 1995,
most of which was derived from Agent Sales. Gross merchandise sales for the same
period were $1.3 million. In 1996, total revenue and gross merchandise sales
grew to $14.3 million and $30.7 million, respectively. In 1997, total revenue
increased 522% to $89.0 million and gross merchandise sales increased 277% to
$115.9 million. The Company's growth in total revenue and gross merchandise
sales in each of these periods was due to investments in marketing designed to
promote and maintain brand awareness of the Company, significant growth in the
Company's customer base, increases in the amount of merchandise obtained from
vendors, increases in the number of auctions per week, technological advances in
the Company's systems allowing for a greater volume of sales, and the Company's
expanding variety of merchandise.
The following tables i) reconcile total revenue to gross merchandise sales for
the years ended December 31, 1997 and 1996, and for the period from inception
(July 1994) to December 31, 1995; and ii) set forth the composition of gross
merchandise sales for the years ended December 31, 1997 and 1996, and for the
period from inception (July 1994) to December 31, 1995.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
-----------------------------------------------
(IN THOUSANDS) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Total revenue $ 88,981 $14,269 $ 140
Plus: gross Agent Sales 29,926 18,154 1,222
Less: net Agent Sales (2,984) (1,696) (110)
- --------------------------------------------------------------------------------
Gross merchandise sales(1) $115,923 $30,727 $1,252
================================================================================
</TABLE>
10
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-------------------------------------------------
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
------------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Principal Sales model-purchased inventory $ 50,681 $ 2,308 $ --
Principal Sales model-consigned inventory 35,316 10,265 30
Agent Sales model 29,926 18,154 1,222
- ---------------------------------------------------------------------------------------------------
Gross merchandise sales(1) $115,923 $30,727 $1,252
===================================================================================================
</TABLE>
(1) The gross merchandise sales amounts represent what the Company's total
revenue would have been if all sales for which the Company acted as a
commissioned auction agent for its vendors (Agent Sales) were recorded as
transactions in which the Company purchased or accepted consignment of
merchandise from vendors for resale at auction (Principal Sales). The
presentation of sales on a gross basis does not affect the Company's gross
profit or net income (loss). Management believes that the information on
gross merchandise sales is relevant to a reader of the Company's financial
statements since it provides a more consistent comparison between
historical periods and a more accurate comparison to future periods than
does total revenue. Gross merchandise sales should not be considered in
isolation or as a substitute for other information prepared in accordance
with GAAP.
During 1997, the portion of the Company's gross merchandise sales derived from
Principal Sales increased to 74.2% from 40.9% during 1996. The Company has
increased its purchasing of merchandise from vendors, particularly from
manufacturers, because the Company believes it has the potential to achieve
higher gross margins over time by controlling the purchase of merchandise.
GROSS PROFIT
Overall gross profit was $11.3 million in 1997, $2.7 million in 1996 and
$113,000 for the period from inception (July 1994) to December 31, 1995. Gross
profit on Principal Sales for 1997 was $8.3 million or 9.6% of merchandise
revenue under the Principal Sales model. The remainder of gross profit in 1997
($3.0 million), which is primarily attributable to Agent Sales, represented
10.0% of gross merchandise sales made under the Agent Sales model. In 1996,
gross profit on Principal Sales was $1.1 million or 9.1% of merchandise revenue
made under the Principal Sales model after giving effect to the $108,000 of
costs related to the write off of certain receivables from Agent Sales
transactions. In 1996, gross profit on Principal Sales was adversely affected by
a non-recurring charge of $130,000, or 1.0% of merchandise revenue, which
resulted from the Company's shift in contract warehouses. The remainder of gross
profit in 1996 ($1.6 million), which is attributable to Agent Sales, represented
8.7% of gross merchandise sales made under the Agent Sales model. The increase
in gross margin on Agent Sales from 1996 to 1997 was attributable to the
Company's ability to negotiate more favorable terms with vendors as it grew in
size and, to a lesser extent, to the Company's beginning to sell advertising,
which has little cost of revenue associated with it. Because net commissions on
revenues from The ONSALE Exchange are expected to be a lower percentage than
commissions on Agent Sales, overall margins on gross merchandise sales may be
lower in the future if the revenues from The ONSALE Exchange grow more rapidly
than those from Agent Sales.
OPERATING EXPENSES
The Company's operating expenses have increased significantly since the
Company's inception. This trend reflects the costs associated with the Company's
expansion, including recruiting of personnel, development of the Company's
infrastructure, increased efforts to expand and market its services, and the
Company's continued focus on enhancing its internal accounting policies and
controls. The Company believes that continued expansion of its operations is
essential to enhancing its brand name and maintaining its market share.
Sales and Marketing. Sales and marketing expenses consist primarily of
advertising expenditures, payroll and related expenses for sales, marketing and
merchandise acquisition personnel, and promotional material. Sales and marketing
expenses were $5.9 million,
11
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
------------------------------------------------
$891,000 and $144,000 for the years ended December 31, 1997 and 1996, and
for the period from inception (July 1994) to December 31, 1995, respectively.
Sales and marketing expenses as a percentage of gross merchandise sales were
5.1%, 2.9% and 11.5% for the years ended December 31, 1997 and 1996, and for the
period from inception (July 1994) to December 31, 1995, respectively. The dollar
increases in sales and marketing expenses in each of these periods were
primarily attributable to expansion of the Company's Internet advertising,
increases in the Company's marketing staff, and increased expenses associated
with promotion and marketing of the Company's services. The Company expects
sales and marketing expenses to increase significantly in absolute dollars and
as a percentage of gross merchandise sales as it endeavors to enhance its brand
recognition through marketing alliances.
General and Administrative. General and administrative expenses consist
primarily of payroll and related expenses for customer service, executive,
accounting and logistical personnel, provision for doubtful accounts, facilities
expenses, recruiting and other general corporate expenses. General and
administrative expenses were $5.9 million, $758,000 and $227,000 for the years
ended December 31, 1997 and 1996, and for the period from inception (July 1994)
to December 31, 1995, respectively. General and administrative expenses as a
percentage of gross merchandise sales were 5.1%, 2.5% and 18.1% for the years
ended December 31, 1997 and 1996, and for the period from inception (July 1994)
to December 31, 1995, respectively. The dollar increases in general and
administrative expenses were due to increases in salaries and benefits,
primarily as a result of the hiring of additional officers and other personnel,
infrastructure development, and establishing reserves in connection with non-
recurring potential expenses related to suppliers. The Company expects general
and administrative expenses to increase in absolute dollars in 1998, and as a
percentage of gross merchandise sales at least through the first half of 1998,
as the Company expands its officer group, staff and facilities, and incurs
additional costs related to being a public company.
Engineering. Engineering expenses consist primarily of payroll and related
expenses for engineering personnel and consultants who develop, operate and
monitor the Company's Web site and related systems, and equipment costs.
Engineering expenses were $2.9 million, $714,000 and $182,000 for the years
ended December 31, 1997 and 1996, and for the period from inception (July 1994)
to December 31, 1995, respectively. Engineering costs as a percentage of gross
merchandise sales were 2.5%, 2.3% and 14.5% for the years ended December 31,
1997 and 1996, and for the period from inception (July 1994) to December 31,
1995, respectively. The dollar increases in engineering expenses in each of
these periods were primarily attributable to increased staffing and associated
costs relating to enhancing the features and functionality of the Company's Web
site and related systems. To date, all engineering costs have been expensed as
incurred. The Company expects engineering expenses to increase in absolute
dollars in the future but not to increase as a percentage of gross merchandise
sales. However, there can be no assurance that gross merchandise sales will
increase more rapidly than engineering expenses.
Interest and Other Income, Net. The Company's interest and other income, net was
$899,000 in 1997 and $37,000 in 1996. The Company had no interest and other
income, net in the period from inception (July 1994) to December 31, 1995. The
increase in interest and other income, net, from 1996 to 1997 was due to
increased cash balances resulting almost entirely from the proceeds from the
Company's initial public offering of approximately $14.8 million in April 1997
and its secondary offering, which netted proceeds of approximately $45.1
million in October 1997.
INCOME TAXES
The Company had a net loss of $2.5 million and thus no provision for income
taxes was recorded for 1997. For 1996, the Company generated income before
income taxes of $404,000 and recorded a provision for income taxes of $43,000,
representing an effective income tax rate of 10.6%. This effective tax rate was
below the statutory rate primarily because the Company utilized its net
operating loss carryforwards.
The Company had a net loss for the period from inception (July 1994) to
December 31, 1995, and thus no provision for income taxes was recorded for
that period. As of December 31, 1997, the Company had net operating loss carry-
forwards for federal and state income tax purposes of approximately $676,000
and $876,000, respectively, which expire beginning in 2011 and 2002,
respectively. See Note 9 of Notes to Financial Statements.
12
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-------------------------------------------------
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly statement of
operations data for the four quarters of 1997 and 1996. In the opinion of
management, this information has been prepared on substantially the same basis
as the financial statements appearing elsewhere in this Annual Report, and all
necessary adjustments, consisting only of normal recurring adjustments, have
been included in the amounts stated below to present fairly the unaudited
quarterly results when read in conjunction with the financial statements of the
Company and notes thereto appearing elsewhere in this Annual Report. The
operating results for any quarter are not necessarily indicative of the
operating results for any future period.
<TABLE>
<CAPTION>
QUARTERS ENDED
---------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31,
(DOLLARS IN THOUSANDS, ---------------------------------------------------------------------------------------
EXCEPT PER SHARE AMOUNTS) 1997 1997 1997 1997 1996 1996 1996 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Merchandise $32,243 $24,198 $17,860 $11,696 $ 7,622 $2,990 $1,493 $ 468
Commission and other revenue 788 863 715 618 684 586 317 109
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 33,031 25,061 18,575 12,314 8,306 3,576 1,810 577
Cost of revenue 29,316 21,735 16,146 10,526 7,076 2,665 1,380 418
- ------------------------------------------------------------------------------------------------------------------------------------
Gross profit 3,715 3,326 2,429 1,788 1,230 911 430 159
- ------------------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 2,612 1,935 948 390 379 339 115 58
General and administrative 2,412 1,376 1,294 789 362 275 89 32
Engineering 958 765 589 561 365 182 115 52
- ------------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 5,982 4,076 2,831 1,740 1,106 796 319 142
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (2,267) (750) (402) 48 124 115 111 17
Interest and other income, net 552 167 148 32 34 3 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (1,715) (583) (254) 80 158 118 111 17
(Provision) benefit for income taxes -- -- 28 (28) (18) (12) (11) (2)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(1,715) $ (583) $ (226) $ 52 $ 140 $ 106 $ 100 $ 15
===================================================================================================================================
Net income (loss) per share:
Basic $ (0.09) $ (0.03) $ (0.01) $ 0.01 $ 0.01 $ 0.01 $ 0.01 $ 0.00
===================================================================================================================================
Diluted $ (0.09) $ (0.03) $ (0.01) $ 0.00 $ 0.01 $ 0.01 $ 0.01 $ 0.00
====================================================================================================================================
Supplemental financial data:
Gross merchandise sales(1) $41,138 $32,301 $24,543 $17,941 $14,399 $9,246 $5,290 $1,792
====================================================================================================================================
</TABLE>
(1) Represents what the Company's total revenue would have been if sales where
the Company acted as a commissioned auction agent for its vendors (Agent
Sales) were recorded as transactions where the Company purchased or
accepted consignment of merchandise from vendors for resale at auction
(Principal Sales). This presentation of sales on a gross basis does not
affect the Company's gross profit or net income (loss). Management believes
that gross merchandise sales provide a more consistent comparison between
historical periods and to future periods than does total revenue. Gross
merchandise sales should not be considered in isolation or as a substitute
for other information prepared in accordance with GAAP.
As a result of its decision in early 1997 to expand its operations, the Company
believes that the results of operations for the quarters ended December 31 and
September 30, 1997 are most indicative of its current business model.
Accordingly, the following discussion focuses on those two quarters.
Total revenue for the quarter ended December 31, 1997 was $33.0 million, a 31.5%
increase over total revenue of $25.1 million for the quarter ended September 30,
1997. Gross merchandise sales for the quarter ended December 31, 1997 were $41.1
million, a 27.2% increase over the $32.3 million for the third quarter of 1997.
The Company's growth in total revenue and gross
13
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-------------------------------------------------
merchandise sales was due to investments in marketing designed to promote and
maintain brand awareness of the Company, growth in the Company's customer base,
increases in the amount of merchandise obtained from vendors, technological
advances in the Company's systems allowing for a greater volume of sales and the
Company's expanding variety of merchandise. During the fourth quarter of 1997,
the Company started selling sports and fitness equipment on a new auction
supersite and started its self-service auction site, The ONSALE Exchange.
Advertising revenue and revenue from The ONSALE Exchange, which were included in
commission and other revenue, were not significant during 1997. Principal Sales
represented 78.4% of gross merchandise sales in the fourth quarter of 1997, but
growth in revenue from The ONSALE Exchange and advertising could cause this
percentage, which has been steadily increasing, to stabilize. In January 1998,
the Company increased its number of auctions from five to seven per week.
During the quarter ended December 31, 1997, gross profit was $2.9 million under
the Principal Sales model and $788,000 under the Agent Sales model. For the
quarters ended December 31 and September 30, 1997, gross profit represented
11.2% and 13.3% of total revenue and 9.0% and 10.3% of gross merchandise
sales, respectively. The Company's gross margin in the quarter ended December
31, 1997 was adversely affected by a drop in market prices for personal
computers in the first part of the quarter, free shipping and other giveaways
related to promotional programs and the implementation of The ONSALE Exchange,
which generates lower gross margins than the Company's other sales. The Company
responded to the drop in personal computer gross margins by reducing its
expenses and selling virtually all of its computer inventory by the end of the
quarter.
For the quarters ended December 31 and September 30, 1997, sales and
marketing expenses were $2.6 and $1.9 million, or 6.3% and 5.9% of gross
merchandise sales, respectively. The increases in sales and marketing expenses
in each of these periods were primarily attributable to expansion of the
Company's Internet advertising, increases in the Company's marketing staff and
increased expenses associated with promotion and marketing of the Company's
services. The Company expects sales and marketing expenses to increase
significantly in absolute dollars and as a percentage of gross merchandise sales
as it endeavors to enhance its brand recognition through marketing alliances.
The Company has expended substantial amounts on promotion of The ONSALE
Exchange during the first quarter of 1998.
For the quarters ended December 31 and September 30, 1997, general and
administrative expenses were $2.4 and $1.4 million, or 5.8% and 4.3% of gross
merchandise sales, respectively. The dollar increases in general and
administrative expenses resulted from increases in salaries and benefits,
primarily due to hiring of additional officers and other personnel,
infrastructure development, and establishing reserves in connection with non-
recurring potential expenses related to suppliers. The Company expects general
and administrative expenses to increase in absolute dollars and as a percentage
of gross merchandise sales, at least through the first half of 1998, as the
Company expands its officer group, staff and facilities, and incurs the
additional costs related to being a public company. The Company incurred costs
in the quarter ended December 31, 1997 to move approximately half of its staff
to its new corporate facilities. The remaining staff will move during the first
half of 1998.
For the quarters ended December 31 and September 30, 1997, engineering
expenses were $1.0 million and $765,000, respectively, or 2.4% of gross
merchandise sales. The dollar increase in engineering expenses
was primarily attributable to increased staffing and associated costs relating
to enhancing the features and functionality of the Company's Web site and
related systems. To date, all engineering costs have been expensed as
incurred. The Company expects engineering expenses to increase in absolute
dollars in the future but not to increase as a percentage of gross merchandise
sales. However, there can be no assurance that gross merchandise sales will
increase more rapidly than engineering expenses.
14
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-------------------------------------------------
FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results have fluctuated in the past, and are expected to
continue to fluctuate in the future, due to a number of factors, many of which
are outside the Company's control. These factors include (i) the Company's
ability to attract new customers at a steady rate, manage its inventory mix and
the mix of products offered at auction, meet certain pricing targets, liquidate
its inventory in a timely manner, maintain gross margins and maintain customer
satisfaction, (ii) the availability and pricing of merchandise from vendors,
(iii) the Company's ability to manage customer returns and shrinkage resulting
from theft, loss, and misrecording of inventory, (iv) product obsolescence and
pricing erosion, (v) consumer confidence in encrypted transactions in the
Internet environment, (vi) the timing, cost and availability of advertising on
other Web sites, (vii) the amount and timing of costs relating to expansion of
the Company's operations, (viii) the announcement or introduction of new types
of merchandise, service offerings or customer services by the Company or its
competitors, (ix) technical difficulties with respect to consumer use of the
auction format on the Company's Web site, (x) delays in revenue recognition at
the end of a fiscal period as a result of shipping or logistical problems, (xi)
delays in shipments as a result of strikes or other problems with the Company's
delivery service providers or the loss of the Company's credit card processor
and (xii) general economic conditions and economic conditions specific to the
Internet and electronic commerce. As a strategic response to changes in the
competitive environment, the Company may from time to time make certain service,
marketing or supply decisions or acquisitions that could have a material adverse
effect on the Company's quarterly results of operations and financial condition.
The Company also expects that, in the future, it like other retailers may
experience seasonality in its business. Due to all of the foregoing factors, in
some future quarter the Company's operating results may not meet the
expectations of securities analysts and investors. In such event, the trading
price of the Company's Common Stock would likely be materially adversely
affected.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily through the
sale of Common Stock in the Company's initial public offering of approximately
$14.8 million in April 1997 and a secondary offering, which netted proceeds of
approximately $45.1 million in October 1997, the private sale of Series A
Preferred Stock and warrants for approximately $2.3 million in September 1996,
and the sale of $1.9 million of Series B Preferred Stock pursuant to the
exercise of the warrants in March 1997. Net cash used in operating activities
for 1997 was approximately $7.0 million, net cash provided by operating
activities for 1996 was $1.2 million and net cash used in operating activities
for the period from inception (July 1994) to December 31, 1995 was $210,000. The
net cash used in operating activities in 1997 was primarily attributable to the
Company's net loss from operations of $2.5 million and to increases in
merchandise inventory of $4.1 million (resulting from the Company's decision to
expand its Principal Sales model) and in accounts receivable of $2.0 million
(as the Company changed the timing of settlement of cash receipts relating to
certain major credit card transactions), partially offset by an increase in
accrued expenses of $1.5 million. The net cash provided by operating
activities during 1996 was primarily attributable to net income of $361,000
and increases in accounts payable of $2.2 million, deferred revenue of
$602,000 and accrued expenses of $363,000, partially offset by increases in
merchandise inventory, prepaid expenses and other current assets, and accounts
receivable of $1.5 million, $458,000 and $373,000, respectively. The net cash
used in operating activities from inception (July 1994) to December 31, 1995
was primarily attributable to the net loss from operations of $440,000,
partially offset by increases in accrued expenses and accounts payable of
$117,000 and $103,000, respectively.
Net cash of $62.4 million provided by financing activities in 1997 resulted
almost entirely from proceeds received from the Company's public stock
offerings and from the exercise of warrants and employee stock options. In
1996, a venture capital group purchased Series A Preferred Stock and certain
warrants for approximately $2.3 million. The Company used a portion of these
funds to repay advances from the Company's founders. Net cash of $270,000
provided by financing activities from inception (July 1994)
15
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUCSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
--------------------------------------------------
to December 31, 1995 resulted entirely from advances from the Company's
founders. Net cash used in investing activities comprised purchases of property
and equipment of $1.6 million, $606,000 and $40,000 for the years ended December
31, 1997 and 1996, and for the period from inception (July 1994) to December 31,
1995, respectively.
As of December 31,1997, the Company had approximately $56.6 million of cash and
cash equivalents. In the first quarter of 1997, the Company entered into a $4.0
million line of credit agreement with a financial institution that expires on
April 17, 1998. Borrowings under the line bear interest at an annual rate of
0.75% over the bank's prime rate (8.5% at December 31, 1997). Pursuant to the
line of credit, the financial institution has been granted a continuing security
interest in substantially all assets of the Company, now owned or hereafter
acquired, including intellectual property. Pursuant to the line of credit, the
Company is required to maintain certain financial ratios and is prohibited from
incurring a monthly and cumulative pretax loss in excess of certain specified
amounts. The Company was in compliance with or had received waivers for each of
these covenants at December 31, 1997. The Company also agreed to certain
negative covenants, including convenants not to incur additional indebtedness
or create additional security interests in the assets of the Company. There were
no borrowings under this line of credit during 1997 and the Company does not
intend to renew the line of credit.
As of December 31, 1997, the Company's principal commitments consist of
obligations of approximately $5.5 million under operating leases for its
corporate headquarters. Although the Company has no material commitments for
capital expenditures, it anticipates purchasing approximately $3.2 million of
property and equipment during 1998 associated with the Company's relocation to
its new facilities, for computer equipment, and opening its new warehouse in
northern California. In addition, the Company plans to spend approximately
$700,000 in the first quarter of 1998 for a new financial system. During 1997,
the Company entered into certain sponsorship agreements allowing it to appear as
the auction sponsor, and in some cases the exclusive auction sponsor, on
specific Web sites. These agreements require future payments of up to $2.3
million and under certain circumstances incremental fees based on the volume of
traffic to its Web site. These agreements expire at various times from January
to September 1998. As the Company continues to enter into more transactions
structured as Principal Sales, the Company will need to commit more cash to
support a larger merchandise inventory. Also, as a result of the Company's
intention to offer credit to certain customers in the next six months and
because of its rapid growth, the Company may require additional cash to support
the anticipated growth in accounts receivable. The Company expects its operating
expenses to increase significantly as a result of increased
16
ONSALE, Inc.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-------------------------------------------------
staffing, expanded marketing efforts, increased software development efforts,
and its growing infrastructure. As a result, the Company expects to experience
substantial quarterly net losses through at least the first half of 1999, and
thus may need to finance its increased inventory, accounts receivable, capital
expenditures and some portion of its operating expenses from its current cash
and cash equivalents balance. The Company believes that its current cash and
cash equivalent balance will meet its anticipated cash needs for working capital
and capital expenditures for at least the next 12 months. Thereafter, if cash
generated from operations is insufficient to satisfy the Company's liquidity
requirements, the Company may seek to sell additional equity or convertible debt
securities or obtain further credit facilities. The sale of additional equity or
convertible debt securities could result in additional dilution to the Company's
stockholders. There can be no assurance that financing will be available to the
Company in amounts or on terms acceptable to the Company.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any computer programs
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the Year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices, or engage in
similar normal business activities.
The Company's internally developed systems and its new accounting systems are
Year 2000 compliant. During 1998, the Company will work with its vendors and
third party processors to ensure compatibility with the Year 2000 issue. Costs
related to the Company's Year 2000 plan will be expensed as incurred and are not
currently expected to have a material effect on the results of operations of the
Company. The Company's estimate of costs related to Year 2000 compliance is a
forward-looking statement that is subject to risks and uncertainties, including
the risk that the operations of the Company's credit card processors and
merchandise vendors could be disrupted by Year 2000 problems.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), and SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 130
establishes standards for reporting and display of comprehensive income. SFAS
131 establishes standards for disclosing information about operating segments
for public business enterprises and supersedes FASB Statement No. 14. Both SFAS
130 and SFAS 131 are effective for fiscal years beginning after December 15,
1997.
17
ONSALE, Inc.
<PAGE>
BALANCE SHEETS
--------------
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PAR VALUE DATA) 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 56,566 $ 2,729
Accounts receivable, net of allowances of $154 and $66 2,390 395
Merchandise inventory 5,632 1,520
Prepaid expenses and other current assets 865 439
- --------------------------------------------------------------------------------------------------------------------
Total current assets 65,453 5,083
Property and equipment, net 1,535 578
Other assets 155 19
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 67,143 $ 5,680
====================================================================================================================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,408 $ 2,268
Accrued expenses 1,963 480
Deferred revenue 503 604
- --------------------------------------------------------------------------------------------------------------------
Total current liabilities 4,874 3,352
Commitments and contingencies (Notes 3, 10 and 11)
Stockholders' equity:
Convertible preferred stock, $0.001 par value; 2,000,000 shares authorized:
none and 365,191 shares issued and outstanding, respectively -- 1
Common stock, $0.001 par value; 30,000,000 shares authorized;
18,642,015 and 12,178,757 shares issued and outstanding, respectively 19 12
Additional paid-in capital 64,801 2,494
Accumulated deficit (2,551) (79)
Less: note receivable from stockholder -- (100)
- --------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 62,269 2,328
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 67,143 $ 5,680
====================================================================================================================
</TABLE>
See notes to these financial statements.
18
ONSALE, Inc.
<PAGE>
STATEMENTS OF OPERATIONS
------------------------
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
------------------------------------------------------
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue:
Merchandise $ 85,997 $ 12,573 $ 30
Commission and other revenue 2,984 1,696 110
- ------------------------------------------------------------------------------------------------------------------
Total revenue 88,981 14,269 140
Cost of revenue 77,723 11,539 27
- ------------------------------------------------------------------------------------------------------------------
Gross profit 11,258 2,730 113
- ------------------------------------------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 5,885 891 144
General and administrative 5,871 758 227
Engineering 2,873 714 182
- ------------------------------------------------------------------------------------------------------------------
Total operating expenses 14,629 2,363 553
- ------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (3,371) 367 (440)
Interest and other income, net 899 37 --
- ------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (2,472) 404 (440)
Provision for income taxes -- (43) --
- ------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (2,472) $ 361 $ (440)
==================================================================================================================
Net income (loss) per share:
Basic $ (0.16) $ 0.03 $(0.04)
==================================================================================================================
Diluted $ (0.16) $ 0.03 $(0.04)
==================================================================================================================
Shares used in net income (loss) per share calculations:
Basic 15,742 12,090 12,015
==================================================================================================================
Diluted 15,742 13,536 12,015
==================================================================================================================
</TABLE>
See notes to these financial statements.
19
ONSALE, Inc.
<PAGE>
STATEMENTS OF CASH FLOWS
------------------------
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
----------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (2,472) $ 361 $ (440)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 616 58 10
Issuance of common stock -- -- 21
Changes in assets and liabilities:
Accounts receivable, net (1,995) (373) (22)
Merchandise inventory (4,112) (1,519) (1)
Prepaid expenses and other assets (562) (458) --
Accounts payable 140 2,165 103
Accrued expenses 1,483 363 117
Deferred revenue (101) 602 2
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (7,003) 1,199 (210)
- ---------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of property and equipment (1,573) (606) (40)
- ---------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of preferred stock and warrants -- 2,345 --
Proceeds from note receivable from stockholder, net 100 -- --
Proceeds from issuance of common stock and
exercise of warrants, net 62,313 41 --
Advances due related parties, net -- (270) 270
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 62,413 2,116 270
- ---------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 53,837 2,709 20
Cash and cash equivalents at beginning of period 2,729 20 --
- ---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 56,566 $ 2,729 $ 20
===============================================================================================================
Supplemental disclosure of noncash financing activities:
Common stock issued for promissory note $ -- $ 100 $ --
===============================================================================================================
</TABLE>
See notes to these financial statements.
20
ONSALE, Inc.
<PAGE>
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------- ----------------
NOTE PAID-IN ACCUMULATED
(DOLLARS IN THOUSANDS) SHARES AMOUNT SHARES AMOUNT RECEIVABLE CAPITAL DEFICIT TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock to founders 12,000,000 $ 12 $ 8 $ 20
Issuance of common stock 43,398 -- 1 1
Net loss -- -- - $ (440) (440)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 12,043,398 12 9 (440) (419)
Issuance of common stock 20,000 -- $ (100) 100 -- --
Issuance of common stock pursuant to
exercise of options 15,000 -- -- 16 -- 16
Issuance of common stock upon
exercise of warrants 100,359 -- -- 25 -- 25
Issuance of Series A convertible preferred
stock at $6.39 per share and warrants
for cash 365,191 $ 1 -- -- -- 2,344 -- 2,345
Net income -- -- -- -- -- -- 361 361
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 365,191 1 12,178,757 12 (100) 2,494 (79) 2,328
Issuance of Series B convertible preferred
stock pursuant to exercise of warrants 202,910 1 -- -- -- 1,945 -- 1,946
Issuance of common stock upon initial public
offering, net of issuance costs -- -- 2,875,000 3 -- 14,805 -- 14,808
Conversion of Series A and B convertible
preferred stock into common stock upon
initial public offering (568,101) (2) 1,704,303 2 -- -- -- --
Issuance of common stock upon secondary
offering, net of issuance costs -- -- 1,709,300 2 -- 45,128 -- 45,130
Issuance of common stock pursuant to
exercise of options -- -- 157,057 -- -- 339 -- 339
Issuance of common stock pursuant to the
employee stock purchase plan -- -- 17,598 -- -- 90 -- 90
Repayment of note receivable from
stockholder -- -- -- -- 100 -- -- 100
Net loss -- -- -- -- -- -- (2,472) (2,472)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 -- $ -- 18,642,015 $ 19 $ -- $64,801 $ (2,551) $62,269
===================================================================================================================================
</TABLE>
See notes to these financial statements.
21
ONSALE, Inc.
<PAGE>
NOTES TO FINANCIAL STATEMENTS
-----------------------------
NOTE 1. THE COMPANY AND A SUMMARY OF
ITS SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
ONSALE, Inc. (the "Company" or "ONSALE") is a leading electronic retailer
pioneering a new sales format - the interactive online auction - designed to
serve as an efficient and entertaining marketing channel for products that
typically are unavailable through conventional distribution. The Company
conducts its business within one industry segment.
The Company was incorporated in California in July 1994 and commenced operations
in May 1995. In March 1997, the Company reincorporated in Delaware and exchanged
each share of each series of stock of the predecessor company into one share of
the corresponding series of stock of the Delaware successor.
The Company's results of operations from inception (July 1994) to December 31,
1994 have been combined with the results of operations for the year ended
December 31, 1995 due to the Company's limited activity during such period.
During 1994, the Company incurred expenses and reported a net loss of $41,000.
SIGNIFICANT ACCOUNTING POLICIES
Revenue recognition. The Company obtains merchandise from vendors in either of
two primary arrangements: the Principal Sales model (merchandise revenue) and
the Agent Sales model (commission revenue). Under the Principal Sales model,
the Company either purchases merchandise or sells merchandise under consignment
relationships with vendors.
Principal Sales-purchases. For sales of merchandise owned by ONSALE, the Company
is responsible for conducting the auction, billing the customer, shipping the
merchandise to the customer and processing merchandise returns. The Company
recognizes the full sales amount as revenue upon verification of the credit card
transaction authorization and shipment of the merchandise. In this type of
transaction, the Company bears both inventory and credit risk with respect to
sales of its inventory. In instances where the credit card authorization has
been received but the merchandise has not been shipped, the Company defers
revenue recognition until the merchandise is shipped.
Principal Sales-consignment. For sales on consignment, the Company either takes
physical possession of the merchandise or the vendor retains physical possession
of the merchandise. In either case, the Company is not obligated to take title
to the merchandise unless it successfully sells the merchandise at auction. Upon
completion of an auction, the Company takes title to the merchandise, charges
the customer's credit card and either ships the merchandise directly or arranges
for a third party to complete delivery to the customer. Subsequently, the
Company pays the vendor any amounts due for the purchase of the related
merchandise. The Company records the full sales amount as revenue upon
verification of the credit card authorization and shipment of the merchandise.
In consignment transactions, the Company is at risk of loss for collecting all
of the auction proceeds, delivery of the merchandise and returns from customers.
In instances where credit card authorization has been received but the
merchandise has not been shipped, the Company defers revenue recognition until
the merchandise is shipped.
Under the Principal Sales model, the Company will allow customers to return
products, in certain circumstances. Accordingly, the Company provides for
allowances for estimated future returns at the time of shipment based on
historical experience.
Agent Sales. Agent Sales revenue includes revenue from Agent Sales transactions
and revenue generated from transactions on The ONSALE Exchange. In Agent Sales
transactions, the Company conducts electronic auctions and processes orders in
exchange for a commission on the sale of the vendor's merchandise. Under this
arrangement, at the conclusion of an auction the Company forwards the order
information to the vendor, which then charges the customer's credit card for the
merchandise and ships the merchandise to the customer. In an Agent Sales
transaction, the Company does not take title to or possession of the
merchandise, and the vendor bears all of the risk of credit card chargebacks. In
the fourth quarter of 1997, the Company launched The ONSALE Exchange, which
allows small businesses and individuals to sell merchandise using its online
auction site. The seller is responsible for setting up the auction and
consummating the sales transaction, including collection of the sales price and
shipment of merchandise. The Company charges a commission to the seller for
facilitating the auction. For Agent Sales and The ONSALE Exchange transactions,
the Company recognizes the commissions as revenue upon completion of the auction
process and the forwarding of the auction sales information to the vendor or the
seller. The vendor or the seller is typically responsible for merchandise
returns.
Supplemental financial data. The Company's relationships with its vendors have
evolved from a purely Agent Sales business at the Company's inception to a
business that is now primarily comprised of Principal Sales transactions.
Gross merchandise sales represent what the Company's total revenue would have
been if all Agent Sales had been made as Principal Sales. Management believes
that the information on gross merchandise sales is relevant to a reader of the
Company's financial statements since it provides a more consistent comparison
between historical periods, and a more accurate comparison to future periods,
than does total revenue. Gross merchandise sales should not be considered in
isolation or as a substitute for other information prepared in accordance with
generally accepted accounting principles.
22
ONSALE, Inc.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
----------------------------------------
The reconciliation of total revenue in the Statements of Operations to gross
merchandise sales is as follows (unaudited):
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
-----------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- -------------------------------------------------------------------------
<S> <C> <C> <C>
Total revenue $ 88,981 $ 14,269 $ 140
Plus: gross Agent Sales 29,926 18,154 1,222
Less: net Agent Sales (2,984) (1,696) (110)
- -------------------------------------------------------------------------
Gross merchandise sales $ 115,923 $ 30,727 $ 1,252
=========================================================================
</TABLE>
Cash and cash equivalents. Cash and cash equivalents consist of funds in
checking accounts and money market funds. All highly liquid investments with a
maturity of three months or less from the date of purchase are considered cash
equivalents. Interest earned on these investments is included in interest
income.
The Company has adopted SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" and, accordingly, classifies investment securities
as either held-to-maturity, trading or available-for-sale. At December 31, 1997
and 1996, the Company did not hold any investment securities.
Merchandise inventory. Inventory is stated at the lower of cost or market, cost
being determined on a first-in, first-out basis.
Property and equipment. Property and equipment, including leasehold
improvements, are stated at cost less accumulated depreciation and
amortization. Depreciation is computed using the straight-line method over the
estimated useful lives of the respective assets, generally three to five
years. Leasehold improvements are amortized over the lesser of 5 years or the
lease term.
Advertising costs. All advertising costs are expensed as incurred. The Company
does not incur any direct-response advertising costs. Advertising expense was
approximately $1.9 million for the year ended December 31, 1997. For 1996 and
for the period from inception (July 1994) to December 31, 1995, advertising
costs were not significant.
Engineering expenses. Engineering expenses include expenses incurred by the
Company to develop, enhance, manage, monitor and operate the Company's Web site.
Engineering costs are expensed as incurred.
Income taxes. The Company provides for income taxes using an asset and liability
approach that recognizes deferred tax assets and liabilities for expected future
tax consequences of temporary differences between the book and tax basis of
assets and liabilities.
Dependence on merchandise vendors. The Company does not manufacture any of the
merchandise that it auctions. The Company's strategy has been to develop and
maintain relationships with brokers and original equipment manufacturers to
secure a continuing supply of merchandise to be auctioned.
Concentration of credit risk. Financial instruments that potentially subject the
Company to a concentration of credit risk consist of cash and cash equivalents
and accounts receivable. The Company's accounts receivable are derived from
Agent Sales earned from merchants located in the United States and Canada, and
the Company generally requires no collateral from its merchants. Principal Sales
are generally made through credit cards and are pre-approved. The Company
maintains an allowance for doubtful accounts receivable based upon the expected
collectibility of accounts receivable and potential credit losses.
Basic and diluted net income (loss) per share. The Company adopted SFAS No. 128,
"Earnings per Share" ("SFAS 128"), during the year ended December 31, 1997 and
retroactively restated net income (loss) per share data for all periods
presented. SFAS 128 requires the Company to report both basic earnings per share
and diluted earnings per share. Basic earnings per share is computed using the
weighted average number of common shares outstanding during the period. Diluted
earnings per share is computed using the weighted average number of common and
potentially dilutive common equivalent shares outstanding during the period.
Common equivalent shares are excluded from the computation if their effect is
antidilutive. SFAS 128 requires a reconciliation of the numerators and
denominators of the basic and diluted per share calculations (see Note 12).
Stock-based compensation. The Company accounts for its stock-based awards using
the intrinsic value method in accordance with APB No. 25, "Accounting for Stock
Issued to Employees," and its related interpretations and complies
with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation" (see Note 7).
Management estimates and assumptions. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Reclassifications. Certain prior years' balances have been reclassified to
conform with the current year's presentation.
Recent accounting pronouncements. In June 1997, the Financial Accounting
Standards Board issued SFAS No. 130, "Reporting Comprehensive Income" ("SFAS
130"), and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131"). SFAS 130 establishes standards for reporting
and display of comprehensive income. SFAS 131 establishes standards for
disclosing information about operating segments for public business enterprises
and supersedes SFAS No. 14. Both SFAS 130 and SFAS 131 are effective
for fiscal years beginning after December 15, 1997.
23
ONSALE, Inc.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. DETAILS OF BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
(DOLLARS IN THOUSANDS) 1997 1996
<S> <C> <C>
Property and equipment:
Computer equipment $ 1,765 $ 523
Furniture and fixtures 329 123
Leasehold improvements 125 --
- ---------------------------------------------------
2,219 646
Less: accumulated depreciation
and amortization (684) (68)
- ---------------------------------------------------
Property and equipment, net $ 1,535 $ 578
===================================================
Accrued expenses:
Reserve for sales returns $ 481 $ 11
Sales tax payable 357 133
Accrued credit card fees 303 --
Accrued shipping and handling 321 --
Other accrued expenses 501 336
- ---------------------------------------------------
Total accrued expenses $ 1,963 $ 480
===================================================
</TABLE>
NOTE 3. LINE OF CREDIT
In the first quarter of 1997, the Company entered into a $4.0 million line of
credit agreement with a financial institution that expires on April 17, 1998.
Borrowings under the line bear interest at an annual rate of 0.75% over the
bank's prime rate (8.5% at December 31, 1997). Pursuant to the line of credit,
the financial institution has been granted a continuing security interest in
substantially all assets of the Company, now owned or hereafter acquired,
including intellectual property. The Company is required to maintain certain
financial ratios and is prohibited from incurring a monthly and cumulative
pretax loss in excess of certain specified amounts. The Company was in
compliance with or had received waivers for each of these covenants at December
31, 1997. The Company also agreed to certain negative covenants, including
covenants not to incur additional indebtedness or create additional security
interests in the assets of the Company. There were no borrowings under this line
of credit during 1997 and the Company does not intend to renew the line of
credit.
NOTE 4. RELATED PARTY TRANSACTIONS
From inception (July 1994) through mid-1996, two of the Company's significant
stockholders provided certain advances to the Company for working capital and
property and equipment purchases. During 1996 and 1995, stockholders made
advances aggregating $496,000 to the Company. The advances did not bear
interest. The Company repaid these advances in December 1996.
In June 1996, two of the Company's significant stockholders agreed to act as
guarantors of the Company's obligations under the Company's agreement with First
USA Merchant Services, Inc. ("First USA") to have First USA process credit card
transactions for the Company. The two stockholders are each liable to First USA
for any liability or indebtedness the Company owes to First USA.
NOTE 5. CONVERTIBLE PREFERRED STOCK AND WARRANTS
The certificate of incorporation of the Company, as amended, authorizes 2.0
million shares of convertible preferred stock, of which 600,000 and 204,521
shares had been designated as Series A and Series B, respectively. In September
1996, the Company issued 365,191 shares of its Series A convertible preferred
stock ("Series A") at a purchase price of $6.39 per share, for aggregate
proceeds of $2.3 million. In connection with the issuance of the Series A
shares, the Company issued warrants to two investors to purchase an aggregate
of up to 202,910 shares of the Company's Series B convertible preferred stock
at $9.59 per share. On March 12, 1997, the investors exercised these warrants
in full. The aggregate proceeds to the Company were approximately $1.9
million. In April 1997, upon the closing of the Company's initial public
offering, these shares of Series A and Series B convertible preferred stock
converted automatically into 1,704,303 shares of common stock.
NOTE 6. COMMON STOCK
In April 1997, the Company completed its initial public offering and issued 2.5
million shares of its common stock to the public at a price of $6.00 per share.
The Company received approximately $12.7 million of cash, net of the
underwriting discount and offering expenses. On May 21, 1997, the Company's
underwriters exercised an option to purchase an additional 375,000 shares of
common stock, to cover over-allotments, at a price of $6.00 per share. The
Company received approximately $2.1 million of cash, net of the underwriting
discount and offering expenses.
In October 1997, the Company completed a second offering of 2.3 million shares
of common stock to the public at a price of $28.25 per share. 1,709,300 of these
shares were sold by the Company and the remaining 590,700 shares were sold by
certain selling stockholders. The Company received approximately $45.1 million
of cash, net of the underwriting discount and offering expenses.
The Company has the right to repurchase, at the original issue price, a
declining percentage of certain of the shares of common stock issued to the
founders under written agreements with such individuals. The Company's right to
repurchase such stock lapses in 48 equal monthly increments commencing in July
1994 as long as the employee is continuously employed by the Company. At
December 31, 1997, 1.5 million shares of common stock were subject to repurchase
by the Company.
24
ONSALE, Inc.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In July 1994, the Company issued a warrant to purchase 100,359 shares of common
stock at $0.25 per share in exchange for legal services. No value was ascribed
to the warrant as its fair value at the time of issuance was considered nominal.
The warrant was exercised in July 1996, resulting in aggregate proceeds to the
Company of $25,000.
NOTE. 7 EMPLOYEE BENEFIT PLANS
Equity Incentive Plan. Under the Company's 1995 Equity Incentive Plan (the
"1995 Plan"), 3.5 million shares of common stock have been reserved for issuance
pursuant to stock options, restricted stock and stock bonuses that may be
granted to employees, directors and consultants. Incentive stock options must be
granted with exercise prices of at least the fair market value of the Company's
common stock on the date of grant (at least 110% of the fair market value of the
Company's common stock in the case of holders of more than 10% of the Company's
voting stock), and nonqualified stock options must be granted with exercise
prices of at least 85% of fair market value of the Company's common stock on the
date of grant. Options generally vest over a 48-month period and expire over
terms not exceeding ten years from the date of grant.
Directors Stock Option Plan. In December 1996, the Company's Board of Directors
adopted the 1996 Directors Stock Option Plan (the "Directors Plan") and reserved
100,000 shares of common stock for issuance thereunder. The Company's
stockholders approved the Directors Plan in January 1997. Only outside directors
may be granted options under the Directors Plan. The Directors Plan provides for
an initial grant to outside directors of 15,000 shares. In addition, the
Directors Plan provides for automatic annual grants of 5,000 shares thereafter.
The exercise price must be 100% of the fair market value of the Company's common
stock on the date of grant. Options generally vest over a 48-month period and
expire over terms not exceeding ten years from the date of grant.
A summary of stock option activity under the 1995 Plan and Directors Plan is as
follows:
<TABLE>
<CAPTION>
OPTIONS WEIGHTED AVERAGE
OUTSTANDING EXERCISE PRICE
- ------------------------------------------------------------------------------
<S> <C> <C>
Balance at December 31, 1994
Granted 776,250 $0.03
Exercised -- --
Canceled -- --
- -------------------------------------------------------------------------
Balance at December 31, 1995 776,250 0.03
Granted 927,410 2.24
Exercised (15,000) 1.03
Canceled (75,750) 0.51
- -------------------------------------------------------------------------
Balance at December 31, 1996 1,612,910 1.27
Granted 923,550 8.81
Exercised (157,057) 2.16
Canceled (90,342) 5.44
- -------------------------------------------------------------------------
Balance at December 31, 1997 2,289,061 $4.09
=========================================================================
</TABLE>
At December 31, 1997, 659,053 options were fully vested and exercisable at
prices ranging from $0.03 to $18.13, and 1,138,882 options were reserved for
future grant under both plans.
The following table summarizes information about stock options outstanding as of
December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.03 - $ 0.03 731,300 8.0 years $ 0.03 363,009 $ 0.03
$0.07 - $ 0.07 11,500 8.3 0.07 4,250 0.07
$0.67 - $ 0.67 280,316 8.5 0.67 114,985 0.67
$1.50 - $ 2.00 243,150 8.8 1.78 55,244 1.79
$3.50 - $ 6.63 352,607 9.4 5.53 47,111 5.49
$7.00 - $ 11.00 537,888 9.2 7.78 71,696 7.01
$14.01 -$ 18.13 115,050 9.9 17.76 2,758 18.13
$22.40 -$ 22.40 5,000 9.7 22.40 -- --
$33.39 -$ 33.39 12,250 9.8 33.39 -- --
- -------------------------------------------------------------------------------------------------------------------
2,289,061 659,053
===================================================================================================================
</TABLE>
25
ONSALE, Inc.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-----------------------------------------
Employee Stock Purchase Plan. In December 1996, the Company's Board of Directors
adopted the 1996 Employee Stock Purchase Plan (the "Purchase Plan") and reserved
150,000 shares of common stock for issuance thereunder. The Company's
stockholders approved the Purchase Plan in January 1997. The Purchase Plan
permits eligible employees to acquire shares of the Company's common stock
through periodic payroll deductions of up to 15% of their annual compensation
not to exceed $21,250. Eligible employees may purchase up to 1,500 shares in
each six month period. The price at which the common stock is purchased under
the Purchase Plan is 85% of the lesser of the fair market value of the Company's
common stock on the first day of the applicable offering period or on the last
day of the respective purchase period. Each offering period will have a maximum
duration of 24 months, and shares of common stock will be purchased for each
participant at semi-annual intervals during each offering period. At December
31, 1997, 132,402 shares were reserved for future issuance under this plan.
Fair Value Disclosures. SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), requires the disclosure of pro forma net earnings and earnings per
share as if the Company had adopted the fair value method as of the beginning of
fiscal 1995. Under SFAS 123, the fair value of stock-based awards to employees
is calculated through the use of option pricing models, even though such models
were developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. These models also require subjective assumptions,
including future stock price volatility and expected time to exercise, which
greatly affect the calculated values.
For the year ended December 31, 1997, the fair value of each option on the date
of grant was determined using the Black-Scholes model. For the year ended
December 31, 1996 and the period from inception (July 1994) to December 31, 1995
the value of each option on the date of grant was estimated using the minimum
value method as the Company was not public.
To determine the value of each option on the date of grant, the following
assumptions were used for the stock option plans and the stock purchase plan for
the year ended December 31, 1997: annual dividend yield of 0%; volatility of
70%; risk-free interest rates of 6.4% and 6.0%, respectively; and weighted
average expected terms of five and two years, respectively. To determine the
value of each option on the date of grant, the following assumptions were used
for the year ended December 31, 1996 and for the period from inception (July
1994) to December 31, 1995: annual dividend yield of 0% for both years; risk-
free interest rates of 6.3% and 5.5%, respectively; and weighted average
expected option term of five years for both years. The weighted average fair
value of stock options granted for the years ended December 31, 1997 and 1996
and for the period from inception (July 1994) to December 31, 1995 was $5.58,
$0.58 and $0.01, respectively.
Had compensation cost been recognized in accordance with SFAS 123, the pro
forma net loss would have been $2.8 million or $0.18 for both basic
and diluted net loss per share in 1997, net income of $349,000 or $0.03
for both basic and diluted net income per share in 1996, and
net loss of $448,000 or $0.04 for both basic and diluted net loss
per share for the period from inception (July 1994) to December 31, 1995.
Because the determination of the fair value of the options granted for all
periods presented is based on the assumptions set forth above, the above
pro forma disclosure may not be indicative of the pro forma effects of option
grants on reported net income (loss) for future years.
NOTE 8. 401(K) PLAN
Effective November 1996, the Company adopted the ONSALE 401(k) Plan (the "401(k)
Plan") that qualifies as a deferred salary arrangement under Section 401 of the
Internal Revenue Code. Under the 401(k) Plan, participating employees may defer
a portion of their pretax earnings not to exceed 15% of their total
compensation. The Company, at its discretion, may make contributions for the
benefit of eligible employees. The Company's contributions for all periods
presented were not significant.
NOTE 9. INCOME TAXES
No provision for income taxes was recorded from inception (July 1994) through
December 31, 1995 as the Company incurred net operating losses during the
period. The benefit (provision) for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
(DOLLARS IN THOUSANDS) 1997 1996
- ------------------------------------------------------
<S> <C> <C>
Current:
Federal $(106) $ 117
State -- 32
- ------------------------------------------------------
(106) 149
- ------------------------------------------------------
Deferred:
Federal 95 (95)
State 11 (11)
- ------------------------------------------------------
106 (106)
- ------------------------------------------------------
$ -- $ 43
======================================================
</TABLE>
26
ONSALE, Inc.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-----------------------------------------
The provision for income taxes differs from the amount determined by applying
the U.S. statutory income tax rate to income before income taxes as summarized
below.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
-----------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
Tax provision at statutory rate $ (840) $ 137 $(150)
State income taxes, net of
federal benefit (144) 25 (26)
Non-recognition (recognition)
of tax benefit 1,088 (120) 176
Refund due to NOL
carryback of tax benefit (106) -- --
Other 2 1 --
- ----------------------------------------------------------------------------
$ -- $ 43 $ --
============================================================================
</TABLE>
Deferred income taxes reflect the tax effects of temporary differences between
carrying amounts of assets and liabilities for financial reporting and income
tax purposes. The Company provides a valuation allowance for deferred tax assets
when it is more likely than not, based on currently available evidence, that
some portion or all of the deferred tax assets will not be realized. Management
believes that the available objective evidence creates sufficient uncertainty
regarding the realizability of deferred tax assets such that a full valuation
allowance is required at December 31, 1997. Significant components of the
Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
(DOLLARS IN THOUSANDS) 1997 1996
- ---------------------------------------------------------
<S> <C> <C>
Net operating loss carryforwards $ 281 $ --
Reserves and accruals 770 162
Other 20 --
- ---------------------------------------------------------
1,071 162
Valuation allowance (1,071) (56)
- ---------------------------------------------------------
Net deferred tax asset $ -- $ 106
=========================================================
</TABLE>
At December 31, 1997, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $676,000 and $876,000
respectively, which expire beginning in 2011 and 2002, respectively.
NOTE 10. COMMITMENTS
The Company leases office space for its corporate headquarters. These leases
expire at various times from July 1998 to November 2002. Future annual minimum
lease payments under all non-cancelable operating leases as of December 31, 1997
are as follows:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
- ----------------------------------
Year Ending December 31,
<S> <C>
1998 $1,276
1999 1,296
2000 970
2001 1,010
2002 917
- ----------------------------------
$5,469
==================================
</TABLE>
Total rent expense for the years ended December 31, 1997 and 1996 and for the
period from inception (July 1994) to December 31, 1995 was approximately
$456,000, $86,000 and $18,000, respectively.
During 1997, the Company entered into certain sponsorship agreements allowing it
to appear as the auction sponsor, and in some cases the exclusive auction
sponsor, on specific Web sites. These agreements require future payments of up
to $2.3 million and under certain circumstances incremental fees based on the
volume of traffic to its Web site. These agreements expire at various times from
January to September 1998.
NOTE 11. LITIGATION
From time to time, the Company is subject to legal proceedings and claims in the
ordinary course of business, including claims of alleged infringement of
trademarks and other intellectual property rights. The Company is not currently
aware of any legal proceedings or claims that the Company believes will have,
individually or in the aggregate, a material adverse effect on the Company's
financial position or results of operations.
NOTE 12. BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
Net income (loss) per share is calculated in accordance with the provisions of
SFAS 128 as discussed in Note 1, which requires a reconciliation of the
numerators and denominators used in the basic and diluted net income (loss) per
share calculations as follows:
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(JULY 1994) TO
YEARS ENDED DECEMBER 31, DECEMBER 31,
--------------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------
Net income (loss) available to
common stockholders $(2,472) $ 361 $ (440)
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted average common
shares outstanding (basic) 15,742 12,090 12,015
Weighted average common
stock equivalents:
Stock options -- 928 --
Convertible preferred stock -- 518 --
- ------------------------------------------------------------------------------------------
Weighted average common
shares outstanding (diluted) 15,742 13,536 12,015
- ------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $ (0.16) $ 0.03 $ (0.04)
- ------------------------------------------------------------------------------------------
Diluted $ (0.16) $ 0.03 $ (0.04)
==========================================================================================
</TABLE>
For the year ended December 31, 1997 and for the period from inception (July
1994) through December 31, 1995, options to purchase approximately 2.3 million
and 776,000 shares, respectively, were outstanding but were not included in the
computation because they are antidilutive.
27
ONSALE, Inc.
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------------------------------------
To the Board of Directors and Stockholders of ONSALE, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations, of cash flows and of stockholders' equity (deficit) present fairly,
in all material respects, the financial position of ONSALE, Inc. at December 31,
1997 and 1996, and the results of its operations and its cash flows for each of
the two years in the period ended December 31, 1997 and for the period from
inception (July 1994) to December 31, 1995, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PRICE WATERHOUSE LLP
San Jose, California
February 12, 1998
28
ONSALE, Inc.
<PAGE>
CORPORATE INFORMATION
-----------------------------------------------------------------
EXECUTIVE OFFICERS
S. Jerrold Kaplan
President, Chief Executive Officer
Alan S. Fisher
Vice President of Development and Operations,
Chief Technical Officer
Leslie S. Benson
Vice President, Controller and Acting Chief Financial Officer
Merle W. McIntosh
Senior Vice President of Merchandise Acquisition
Martha D. Greer
Vice President of Merchandise Management
Dennis J. Shepard
Vice President Operations
DIRECTORS
S. Jerrold Kaplan
President, Chief Executive Officer
Chairman of the Board
Alan S. Fisher
Vice President of Development and Operations,
Chief Technical Officer
Peter L. Harris
Chairman, Chief Executive Officer and President,
Express Portraits
Peter H. Jackson
President and Chief Executive Officer,
Intraware, Inc.
Kenneth J. Orton
President and Chief Executive Officer,
Preview Travel, Inc.
HEADQUARTERS
ONSALE, Inc.
1350 Willow Road, Suite 202
Menlo Park, CA 94025
Tel: 650-470-2400
Fax: 650-470-6990
www.onsale.com
TRANSFER AGENT
Boston EquiServe
Investor Relations
150 Royall Street
MS 45-02-64
Canton, MA 02021
Tel: 781-575-3120
Fax: 781-828-8813
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
San Jose, CA
CORPORATE COUNSEL
Fenwick & West LLP
Palo Alto, CA
INVESTOR RELATIONS COUNSEL
The Financial Relations Board, Inc.
180 Montgomery Street, Suite 940
San Francisco, CA 94101
Tel: 415-986-1591
STOCK LISTING
The Company's stock is traded on the Nasdaq National Market under
the symbol ONSL. The following table sets forth the quarterly high and low
closing sales prices for the Company's common stock since its initial public
offering in April 1997:
QUARTERS ENDED HIGH LOW
June 30, 1997 9.25 4.75
September 30, 1997 32.25 8.50
December 31, 1997 34.63 13.25
As of December 31, 1997 there were 50 stockholders of record, excluding
stockholders whose stock is held in nominee or street name by brokers.
DIVIDEND POLICY
The Company's present policy is to retain its earnings to finance future
growth and, accordingly, it does not anticipate paying cash dividends in the
foreseeable future.
ANNUAL MEETING INFORMATION
May 18, 1998, at 10:00 a.m.,
ONSALE, Inc. Corporate Headquarters
1350 Willow Road, Suite 202
Menlo Park, CA 94025
29
ONSALE, Inc.
<PAGE>
EXHIBIT 23.01
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-25455) of ONSALE, Inc., of our report dated
February 12, 1998 appearing on page 28 of the Annual Report to Stockholders
which is incorporated in this Annual Report on Form 10-K. We also consent to the
incorporation by reference of our report on the Financial Statement Schedule,
which appears on page S-2 of this Form 10-K.
/s/ Price Waterhouse LLP
San Jose, California
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 56,566
<SECURITIES> 0
<RECEIVABLES> 2,544
<ALLOWANCES> (154)
<INVENTORY> 5,632
<CURRENT-ASSETS> 65,453
<PP&E> 2,219
<DEPRECIATION> (684)
<TOTAL-ASSETS> 67,143
<CURRENT-LIABILITIES> 4,874
<BONDS> 0
0
0
<COMMON> 19
<OTHER-SE> 62,250
<TOTAL-LIABILITY-AND-EQUITY> 67,143
<SALES> 88,981
<TOTAL-REVENUES> 88,981
<CGS> 77,723
<TOTAL-COSTS> 92,352
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,472)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,472)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,472)
<EPS-PRIMARY> (0.16)
<EPS-DILUTED> (0.16)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 APR-01-1997 JUL-01-1997 JAN-01-1996
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997 DEC-31-1996
<CASH> 2,692 12,669 11,182 2,729
<SECURITIES> 0 0 0 0
<RECEIVABLES> 361 679 2,398 461
<ALLOWANCES> (66) (66) (174) (66)
<INVENTORY> 2,828 6,708 7,183 1,520
<CURRENT-ASSETS> 6,013 20,173 20,810 5,083
<PP&E> 1,050 1,414 1,653 646
<DEPRECIATION> (128) 192 (349) (68)
<TOTAL-ASSETS> 7,500 21,416 22,210 5,680
<CURRENT-LIABILITIES> 3,079 2,454 3,680 3,352
<BONDS> 0 0 0 0
0 0 0 0
2 0 0 1
<COMMON> 12 17 17 12
<OTHER-SE> 4,407 18,945 18,513 2,315
<TOTAL-LIABILITY-AND-EQUITY> 7,500 21,416 22,210 5,680
<SALES> 12,314 18,575 25,061 14,269
<TOTAL-REVENUES> 12,314 18,575 25,061 14,269
<CGS> 10,256 16,146 21,735 11,539
<TOTAL-COSTS> 12,266 18,977 25,811 13,902
<OTHER-EXPENSES> 0 0 0 0
<LOSS-PROVISION> 0 0 0 0
<INTEREST-EXPENSE> 0 0 0 0
<INCOME-PRETAX> 80 (254) (583) 404
<INCOME-TAX> (28) 28 0 (43)
<INCOME-CONTINUING> 52 (226) (583) 361
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 52 (226) (583) 361
<EPS-PRIMARY> 0.01 (0.01) (0.03) 0.03
<EPS-DILUTED> 0.00 (0.01) (0.03) 0.03
</TABLE>
