<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 2, 1999
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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REEL.COM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 5735 94-3295023
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
OF INCORPORATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
REEL.COM, INC.
1400 65TH STREET, SUITE 250
EMERYVILLE, CA 94608
(510) 549-3333
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
ALEX BOND
CHIEF FINANCIAL OFFICER
REEL.COM, INC.
1400 65TH STREET, SUITE 250
EMERYVILLE, CA 94608
(510) 549-3333
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
COPIES TO:
<TABLE>
<S> <C> <C>
NORA L. GIBSON, ESQ. ROBERT J. MOORMAN, ESQ. KENNETH L. GUERNSEY, ESQ.
ARMANDO CASTRO, ESQ. STOEL RIVES LLP CYDNEY S. POSNER, ESQ.
PETER S. BUCKLAND, ESQ. 900 SW FIFTH AVENUE PAUL D. HUIE, ESQ.
PATRICK J. O'LOUGHLIN, ESQ. PORTLAND, OR 97204-1268 JASON THRONE, ESQ.
INGRID TUNG, ESQ. (503) 224-3380 COOLEY GODWARD LLP
BROBECK PHLEGER & HARRISON, LLP ONE MARITIME PLAZA, 20TH FLOOR
ONE MARKET, SPEAR STREET TOWER SAN FRANCISCO, CA 94111
SAN FRANCISCO, CA 94105 (415) 693-2000
(415) 442-0900
</TABLE>
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] ____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ____________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ____________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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<S> <C> <C>
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PROPOSE MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED PRICE(1) REGISTRATION FEE
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Common Stock, $.01 par value................................ $60,000,000 $15,840
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</TABLE>
(1) Estimated solely for the purpose of calculating the amount of the
registration fee pursuant to Rule 457(o) promulgated under the Securities
Act of 1933, as amended.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(a), MAY DETERMINE.
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<PAGE> 2
The information in this prospectus is not complete and may be changed.
Underwriters may not confirm sales of these securities until the
registration statement filed with the Securities and Exchange Commission
is effective. This prospectus is not an offer to sell these securities,
and it is not soliciting an offer to buy these securities in any state
where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED DECEMBER 2, 1999
PROSPECTUS
Shares
[LOGO]
Common Stock
This is an initial public offering of common stock by Reel.com. The
estimated initial public offering price will be between $ and $ per
share.
------------------------
Prior to this offering, there has been no public market for the common
stock. Reel.com has applied to have the common stock approved for quotation on
the Nasdaq National Market under the symbol REEL.
------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
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<S> <C> <C>
Initial public offering price............................... $ $
Underwriting discounts and commissions...................... $ $
Proceeds to Reel.com, Inc., before expenses................. $ $
</TABLE>
Reel.com has granted the underwriters an option for a period of 30 days to
purchase up to additional shares of common stock.
------------------------
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 8.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
HAMBRECHT & QUIST
BANC OF AMERICA SECURITIES LLC
DAIN RAUSCHER WESSELS
WIT CAPITAL CORPORATION
, 2000
<PAGE> 3
[ARTWORK]
<PAGE> 4
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Prospectus Summary.......................................... 4
Risk Factors................................................ 8
Forward-Looking Statements.................................. 25
Use of Proceeds............................................. 26
Dividend Policy............................................. 26
Capitalization.............................................. 27
Dilution.................................................... 28
Selected Financial Data..................................... 29
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 31
Business.................................................... 41
Management.................................................. 56
Certain Transactions........................................ 65
Principal Stockholders...................................... 71
Description of Capital Stock................................ 72
Description of Parent Company Indebtedness.................. 74
Shares Eligible for Future Sale............................. 75
Underwriting................................................ 77
Validity of the Issuance of the Common Stock................ 79
Experts..................................................... 79
Where You Can Find Additional Information................... 79
Index to Financial Statements............................... F-1
</TABLE>
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Information contained on our Website does not constitute part of this
prospectus. "Reel" is a registered trademark of Reel.com, Inc. "Reel.com,"
"Movie Matches," "Movie Anatomy" and "Reel Snapshot" are also trademarks of
Reel.com, Inc. All brand names and trademarks appearing in this prospectus are
the property of their respective holders.
This prospectus contains statistical data about the Internet and the filmed
entertainment industry. This data was obtained from industry publications and
reports. We have not independently verified this data and cannot guarantee its
accuracy or completeness.
3
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and our financial statements, appearing
elsewhere in this prospectus.
REEL.COM, INC.
Reel.com is a premier online destination for film-related content and
commerce. Through our Website, we provide consumers with an intuitive,
entertaining environment in which they can access a wide variety of film-related
information, such as news, film reviews, trivia, interviews, film clips and
editorial recommendations, and purchase a broad range of films. Our original
editorial content, coupled with our extensive selection of approximately 50,000
titles on videocassette and digital versatile disc, or DVD, provide a source of
film exploration and acquisition and encourage regular, active use of our
Website. With our audience of film consumers and enthusiasts, we believe we are
well positioned to offer a valuable marketing platform for film studios,
advertisers and merchants. In addition, our relationship with our parent
company, Hollywood Entertainment Corporation, which operates more than 1,500
Hollywood Video stores, provides us with substantial opportunities for marketing
to its members.
We have a strong online commerce brand and have experienced significant
momentum in our customer traffic and online sales. We were rated one of the top
10 most recognized Internet commerce brands by Opinion Research Corporation
International in August 1999, and we were recently named "the best place to buy
movies" by Yahoo! Internet Life. According to Media Metrix, the number of unique
visitors to our Website increased from 848,000 in January 1999 to approximately
1.4 million in September 1999. Our revenue has increased from approximately $8.6
million for the nine months ended September 30, 1998 to approximately $21.6
million for the nine months ended September 30, 1999.
THE OPPORTUNITY FOR AN ONLINE FILMED ENTERTAINMENT DESTINATION
Filmed entertainment is an increasingly popular pastime. According to
Forrester Research, Inc., there are over 70,000 titles in release, and Veronis,
Suhler & Associates, Inc. estimates that approximately 400 new films are
released each year. The broad appeal of films has led to substantial consumer
spending. Paul Kagan Associates, Inc. projects that domestic consumer spending
in 1999 will total $7.1 billion at the box-office, $16.5 billion for the rental
and sale of videocassettes and DVDs and $6.0 billion for cable and satellite
subscriptions.
There is an extensive amount of information relating to the large number of
films in existence as well as industry news, film reviews and biographical
information on actors and directors. The Internet creates an opportunity to
offer products in the context of relevant and entertaining content, enabling an
online film destination to market and drive demand for a wide range of films. We
believe a significant opportunity exists to create an online filmed
entertainment destination that is the premier source for film consumers and
enthusiasts to discover new films, search for film-related information and
purchase films and related products. By integrating many of the elements that
influence film-viewing decisions with a broad product selection, a filmed
entertainment destination can provide a one-stop information-gathering and
shopping experience. Such a destination could be an attractive platform for film
studios to promote new releases and other titles to a broad range of film
consumers.
4
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OUR SOLUTION
Reel.com is a leading online destination for discovering new films,
searching for film-related information and purchasing films. The key components
of our solution include:
- engaging content, such as news, film reviews, trivia, interviews, film
clips and editorial recommendations, to inform and entertain visitors;
- extensive product selection and a superior shopping experience; and
- powerful promotional outlet for studios and advertisers to reach a highly
desirable group of consumers.
OUR STRATEGY
Our objective is to become the leading online destination for film-related
content, commerce and community. Key elements of our strategy include:
- continuing to offer compelling value and enhance the customer experience
through expanding our selection, offering competitive pricing and
improving the functionality of our Website;
- capitalizing on our content team and strategic alliances to offer
informative and innovative content, including rich media;
- continuing to build and expand brand recognition to make the Reel.com
name synonymous with the best selection of filmed entertainment and
related original content available;
- building an online community for our users to interact and share
opinions, reviews, ideas and other film-related information;
- leveraging our online commerce position, brand, operating infrastructure
and customer base to increase advertising revenue and diversify revenue
streams; and
- capitalize on new technologies that increase bandwidth and enable the
digital distribution of full-length filmed entertainment directly to
consumers.
CORPORATE INFORMATION
Reel.com became a limited liability company in 1996 and a Delaware
corporation in April 1998. We were reorganized as a Delaware corporation and
wholly-owned subsidiary of Hollywood Entertainment in October 1998. Our
executive offices are located at 1400 65th Street, Emeryville, CA 94608, and our
telephone number is (510) 549-3333. References in this prospectus to "us" or
"we" are to Reel.com, Inc. References to our "parent" are to Hollywood
Entertainment Corporation. Our main Website address is www.reel.com. The
reference to our Internet address does not constitute incorporation by reference
of the information contained at this Website.
5
<PAGE> 7
THE OFFERING
COMMON STOCK OFFERED BY REEL.COM............ shares
COMMON STOCK TO BE OUTSTANDING AFTER THIS
OFFERING.................................... shares
USE OF PROCEEDS............................. For marketing activities,
repayment of indebtedness to our
parent, content and technology
development, capital
expenditures and other general
corporate purposes, including
working capital. See "Use of
Proceeds."
PROPOSED NASDAQ NATIONAL MARKET SYMBOL...... REEL
Unless otherwise indicated, all information in this prospectus relating to
our outstanding capital stock, options and warrants is based upon information as
of , 2000, assumes that the over-allotment option will not be
exercised, and reflects a for split of our outstanding shares of
common stock.
6
<PAGE> 8
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The information in this prospectus summary excludes shares
of common stock reserved for issuance under our stock incentive plans,
of which were subject to options outstanding as of ,
2000 at a weighted average exercise price of $ . It also assumes no exercise
of the underwriters' over-allotment option. The Actual column reflects our
capitalization as of September 30, 1999 on a historical basis, with adjustments
for the subsequent split of our outstanding shares of common stock. The Pro
Forma column in the table below reflects our Actual capitalization as of
September 30, 1999 with adjustments for the conversion of a loan amount of $
million from Hollywood Entertainment to additional paid-in capital,
automatically upon completion of this offering. The Pro Forma As Adjusted column
in the table below reflects our capitalization as of September 30, 1999 with the
preceding Pro Forma adjustments and the application of the estimated net
proceeds from our sale of common stock in this offering at an assumed initial
public offering price of $ per share. Our independent auditors' report on
our financial statements was prepared on the assumption that we will continue as
a going concern. The report acknowledges that we have incurred losses in each of
the last three fiscal years and that we anticipate that additional funding will
be required to sustain operations. These conditions cause substantial doubt as
to our ability to continue as a going concern. For a more complete discussion
regarding our historical financial information, please see the notes to our
financial statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- -----------------
1996 1997 1998(1) 1998 1999
---- ------ ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue................................................. $ -- $ 745 $15,040 $ 8,568 $21,613
Operating expenses:
Cost of net revenue..................................... -- 547 16,860 10,113 22,707
Marketing and sales..................................... 53 570 13,216 8,102 16,672
Product development..................................... 483 951 4,333 2,948 6,777
General and administrative.............................. 223 1,475 3,077 2,342 4,133
Amortization of intangible assets and goodwill(2)....... -- -- 12,544 -- 37,631
Write-off of purchased research and development(2)...... -- -- 1,900 -- --
Stock-based compensation(3)............................. -- -- 605 605 --
</TABLE>
- ---------------
(1) The summary financial data for fiscal 1998 combines data from the nine
months ended September 30, 1998, when we operated as an independent company,
and the three months ended December 31, 1998, when we operated as a
wholly-owned subsidiary of Hollywood Entertainment.
(2) Effective October 1, 1998, Hollywood Entertainment acquired all of the
outstanding shares of Reel.com, Inc. The acquisition was accounted for using
the purchase method of accounting. Of the total purchase price, $5.3 million
was allocated to net liabilities assumed, $8.7 million to identified
intangible assets, including developed database content of $1.1 million,
in-process research and development of $1.9 million, purchased trademark and
trade name of $3.6 million, workforce of $2.1 million and the remainder of
$93.5 million to goodwill. Except for in-process research and development,
which was immediately written off, the intangible assets are being amortized
over their estimated useful lives of two years.
(3) Amount represents stock-based compensation computed for stock options issued
to employees prior to our acquisition by Hollywood Entertainment.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- --------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 15 $ $
Total assets.............................................. 59,759
Long-term debt (less current portion)..................... 42,483
Stockholders' equity...................................... 5,744
</TABLE>
7
<PAGE> 9
RISK FACTORS
You should carefully consider the following risk factors and all other
information contained in this prospectus before purchasing our common stock.
Investing in our common stock involves a high degree of risk. Any of the
following risks could harm our business, results of operations and financial
condition and could result in a complete loss of your investment.
RISKS RELATED TO OUR BUSINESS
OUR PROSPECTS ARE DIFFICULT TO FORECAST BECAUSE WE HAVE ONLY BEEN OPERATING OUR
BUSINESS SINCE 1996.
We began selling film products in April 1997 and, accordingly, we have a
very limited operating history. Moreover, from October 1998 to the present, we
have not operated as an independent company, but rather as a subsidiary of our
parent, Hollywood Entertainment. In addition, most of our management team has
only recently joined our company and does not have experience working together.
You must consider our prospects in light of the risks frequently encountered by
companies in their early stages of development, particularly companies in the
new and rapidly evolving online commerce market. These risks include, but are
not limited to, the inability to respond promptly to changes in a rapidly
evolving and unpredictable business environment and the inability to manage
growth. To address these risks, we must, among other things:
- successfully implement our business and marketing strategies;
- expand our customer base;
- continue to develop and upgrade our Website and transaction-processing
and inventory-management systems;
- provide superior fulfillment and customer service;
- respond to competitive developments; and
- attract and retain qualified personnel.
If we are unable to successfully address these and other risks, our
business, prospects, financial condition and results of operations will be
adversely affected.
WE HAVE A HISTORY OF LOSSES AND WE EXPECT TO CONTINUE TO INCUR LOSSES FOR THE
FORESEEABLE FUTURE. IF WE ARE UNABLE TO OBTAIN SUFFICIENT FINANCING OUR ABILITY
TO CONTINUE AS A GOING CONCERN WOULD BE IN DOUBT.
To date, we have not been profitable, and aggregate losses from inception
through September 30, 1999 were $110.7 million, including $52.1 million related
to the amortization of intangible assets. For the nine months ended September
30, 1999, we incurred net losses of $69.0 million. We intend to invest heavily
in marketing and promotion, Website content and technology development, customer
service and distribution and the development of our administrative organization.
As a result, we expect to incur substantial operating losses for the foreseeable
future at rates significantly above current levels. Achieving profitability
depends on our ability to generate positive gross margins, which have
historically been negative, and achieve a substantially higher level of revenue.
We cannot assure you that we can achieve or sustain profitability.
We will require additional funding to sustain our operations. Our financial
statements included herein have been prepared assuming we continue as a going
concern and do not include any adjustments that might result should we be unable
to continue as a going concern.
8
<PAGE> 10
If we are unable to obtain sufficient financing, we will experience liquidity
problems and our ability to continue as a going concern would be in doubt.
OUR FUTURE OPERATING RESULTS ARE UNPREDICTABLE AND MAY FLUCTUATE. IF WE FAIL TO
MEET THE EXPECTATIONS OF SECURITIES ANALYSTS AND INVESTORS, THE MARKET PRICE OF
OUR COMMON STOCK MAY DECLINE SIGNIFICANTLY.
Our future operating results may fluctuate significantly due to a variety
of factors, many of which are outside of our control. These factors include, but
are not limited to:
- our ability to retain existing customers and attract new customers;
- the introduction of new or enhanced Web pages, services, products and
strategic alliances by us and our competitors;
- increased price competition or higher wholesale prices;
- the timing and popularity of future videocassette and DVD releases and
our access to those releases;
- our ability to manage inventory levels;
- fluctuations in the amount of consumer spending on videocassettes, DVDs
and related products;
- decreases in the number of visitors to our Website or our inability to
convert visitors on our Website into customers;
- the termination of existing, or failure to develop new, strategic
marketing relationships from which we derive traffic;
- fluctuations in the cost of online or offline advertising;
- unexpected increases in shipping costs or delivery times;
- government regulations related to use of the Internet for commerce;
- technical difficulties or system downtime or overall Internet performance
times;
- the amount and timing of operating costs and capital expenditures
relating to expansion of our business, operations and infrastructure;
- the timing of promotions and sales programs;
- general economic conditions and economic conditions specific to the
Internet and the videocassette and DVD industry; and
- seasonal consumer buying patterns.
Our limited operating history makes it difficult to accurately forecast our
revenue, operating expenses and operating results. As a result, we may be unable
to adjust our spending in a timely manner to compensate for any unexpected
revenue shortfall. We may also be unable to expand our operations in a timely
manner to meet customer demand should it exceed our expectations.
As a result of the factors listed above, our quarterly or annual results of
operations in future periods may not meet the expectations of securities
analysts or investors. This could result in a decline in the value of our common
stock.
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<PAGE> 11
EXPANDING THE REEL.COM BRAND QUICKLY AND EFFECTIVELY IS ESSENTIAL FOR OUR
SUCCESS. IF OUR STRATEGIC MARKETING ALLIANCES AND ONLINE AND TRADITIONAL
ADVERTISING ARE UNSUCCESSFUL, WE MAY BE UNABLE TO INCREASE OUR CUSTOMER BASE AND
BRAND RECOGNITION.
We believe that we must maintain and enhance the Reel.com brand to attract
more customers to our Website and to increase revenue through commerce and
advertising. If we do not continue to expand our brand, we may not be able to
capture sufficient market share or increase revenue enough to achieve
profitability. We rely on strategic alliances and online and traditional
advertising to attract customers to our Website. Our ability to generate higher
revenue will depend largely upon increased traffic and sales through these
arrangements and similar arrangements we may enter into in the future. We cannot
be certain that these marketing arrangements will generate a sufficient number
of new customers or revenue to justify their costs or that our methods for
advertising will successfully attract additional customers to our Website.
FAILURE TO CONTINUE TO DEVELOP COMPELLING CONTENT THAT ATTRACTS VISITORS AND
ADVERTISERS COULD ADVERSELY AFFECT OUR REVENUE.
Our future success depends on our ability to continue to develop content
that is appealing to our audience. If our content does not appeal to our
audience, our audience size could decrease, limiting our ability to sell
videocassettes and DVDs and to market this audience to advertisers. Our ability
to develop compelling content depends on several factors, including the
following:
- quality of our editorial staff;
- technical expertise of our production staff; and
- access to content controlled by studios and other third parties.
WE DO NOT HAVE AN ESTABLISHED ADVERTISING SALES FORCE.
Although, to date, our revenue from advertising has been immaterial, our
strategy is to increase our advertising revenue in the future. Currently, we do
not have an advertising sales force. To succeed, we will need to develop and
maintain an effective advertising sales force, provide content that attracts and
retains an audience that is appealing to advertisers and persuade advertisers
that advertising on our site would be advantageous. Failure to achieve one or
more of these elements would limit our ability to increase our advertising
revenue and impair our ability to implement our strategy.
IF WE ARE UNABLE TO DEVELOP AND MAINTAIN RELATIONSHIPS WITH MAJOR AND
INDEPENDENT FILM STUDIOS, OUR REVENUE AND PROFIT MARGINS COULD BE ADVERSELY
IMPACTED.
A key element of our strategy involves purchasing inventory directly from
major and independent studios. This approach may allow us to buy products at
lower prices than can be obtained through distributors. If we are unable to
maintain our relationships with the studios, we would have to purchase our
products from distributors and our profit margins could be adversely impacted.
We also conduct joint promotions with studios, and we believe our relationships
with them help us to develop content for our Website. For example, we rely upon
studios to provide us with access to high-profile personalities and other
sources for our original content. We do not have any written agreements for
these relationships, and if we were unable to maintain these relationships, we
would not have the same access to the content that we believe is necessary to
maintain and to grow our customer base.
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<PAGE> 12
IF DVD TECHNOLOGY DOES NOT BECOME MORE WIDELY ACCEPTED OR BECOMES OBSOLETE, OUR
REVENUE COULD BE ADVERSELY AFFECTED.
Consumers may not accept DVD technology on a widespread basis, or
acceptance may be delayed, due to:
- a reluctance or inability by studios or others to release titles in the
DVD format;
- consumer confusion because of competing technologies; and
- the costs associated with switching from VHS to DVD, including equipment
and films.
Also, the electronic online delivery of information through distribution
media, including the Internet, satellites or cable television, competes with DVD
technology. Recent and continuing developments in broadband online data delivery
have led to speculation regarding the decreasing viability of physical media
including DVDs. If DVD technology does not become more widely accepted or
becomes obsolete, our revenue could be reduced and our operating results could
be adversely affected.
IF WE DO NOT PROVIDE ADEQUATE SERVICE TO OUR CUSTOMERS, WE COULD LOSE CUSTOMERS
AND OUR REVENUE COULD BE REDUCED.
Our reputation and ability to attract, retain and serve our customers hinge
upon the reliable performance of our Website, network infrastructure and
transaction-processing systems. Interruptions in these systems could make our
Website unavailable and hinder our ability to take or fill orders, thereby
reducing our revenue. These interruptions could also diminish the overall
attractiveness of our product and service offerings to existing and potential
customers. We may not be able to project the volume of traffic or orders on our
Website. If we experience a substantial increase in traffic volume on our
Website or in the number of orders placed by customers, we will need to expand
and upgrade our network infrastructure, technology and inventory-management and
transaction-processing systems by adding additional hardware, software and
personnel. If we do not make these improvements or are unable to adequately
project our traffic volume, we may encounter:
- unanticipated system disruptions;
- slower response times;
- reduced accuracy and/or speed of order fulfillment;
- a decline in the quality of our customer service; and
- delays in reporting accurate financial information.
OUR BUSINESS RELIES ON OUR ABILITY TO MAINTAIN RELATIONSHIPS WITH OUR SUPPLIERS
TO OBTAIN SUFFICIENT QUANTITIES OF MERCHANDISE ON ACCEPTABLE COMMERCIAL TERMS.
IF WE FAIL TO OBTAIN MERCHANDISE ON ACCEPTABLE TERMS, OUR RESULTS OF OPERATIONS
COULD SUFFER.
Because we rely largely on rapid replenishment from our suppliers, our
business would be seriously harmed if we were unable to develop and maintain
relationships with suppliers that allow us to obtain sufficient quantities of
merchandise on a timely basis and on acceptable commercial terms. We purchase
our products from six primary suppliers, not including movie studios that supply
us with merchandise. If we were no longer able to conduct business with any of
our key suppliers, we would have to increase our reliance on the remaining
suppliers. We do not have written agreements with most of our suppliers. Our
contracts or arrangements with suppliers do not guarantee the availability of
merchandise, establish guaranteed prices or provide for the continuation of
particular pricing practices. If we conduct less business with
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<PAGE> 13
our key suppliers (as a result, for example, of conducting more business
directly with movie studios), those key suppliers might increase their prices,
which would have an adverse impact on our gross profit margins. Our current
suppliers may not continue to sell products to us on current terms or at all,
and we may not be able to establish new supply relationships to ensure delivery
of products in a timely and efficient manner or on terms acceptable to us. In
addition, we may not be able to get a sufficient quantity of products from our
suppliers to fill our orders. For example, from time to time the popularity of
certain films may require distributors to allocate their supplies. Further, our
supply arrangements typically do not restrict a supplier from selling products
to our competitors.
OUR GROWTH AND OPERATING RESULTS COULD BE ADVERSELY AFFECTED IF WE ARE UNABLE TO
EXPAND OUR DISTRIBUTION CENTER AND ORDER-PROCESSING CAPABILITIES.
We must increase the size of our distribution center and order-processing
operations in order to accommodate substantial increases in the total number of
videocassette and DVD titles available for sale and any significant increase in
the volume of customer orders. We anticipate that within the next 12 months, we
will have to expand or relocate our distribution center. If we are required to
relocate our distribution facility, or have difficulties expanding, our business
could be disrupted. We have recently installed an automated packaging system and
are upgrading our inventory-management systems. If we are unable to complete the
automation of our packaging and mailing systems, or the upgrade of our
inventory-management systems, or are unable to integrate these systems with our
Website and transaction-processing systems, our business, prospects, financial
condition and results of operations could be harmed.
WE DEPEND UPON THE UNITED STATES POSTAL SERVICE, UNITED PARCEL SERVICE OF
AMERICA, INC. AND DHL INTERNATIONAL LTD. TO DELIVER PRODUCTS ON A TIMELY AND
CONSISTENT BASIS. A DETERIORATION IN OUR RELATIONSHIP WITH UPS OR DHL COULD
IMPAIR OUR ABILITY TO TRACK SHIPMENTS, CAUSE SHIPMENT DELAYS AND INCREASE OUR
SHIPPING COSTS.
The United States Postal Service, or the USPS, ships approximately 80% of
the orders from our distribution center to our customers. The USPS does not
negotiate rates and the shipping rates are based strictly on class of service
and weight. If we cannot continue to pre-pay the USPS for its services, then we
will encounter difficulties in shipping our products. Repeated late payments or
other problems with our account with the USPS could result in losing our permit
and require manual manifesting.
DHL and UPS each ship approximately 10% of the orders from our distribution
center to our customers. A deterioration in our relationship with either carrier
could decrease our ability to track shipments, cause shipping delays and
increase our shipping costs and number of damaged or lost products. Termination
of our relationship with DHL could impair our international shipping until we
develop a new relationship.
If any carrier is unable to deliver products for us, whether due to labor
shortage, slow down or stoppage, deteriorating financial or business conditions
or for any other reason, we would be required to use alternative carriers for
the shipment of products to customers. Losing a carrier would require
temporarily shipping with another existing carrier and could result in higher
costs or lower quality service indefinitely or until a new relationship is
developed. Other potential adverse consequences of any loss of carrier could
include:
- delays in order processing and product delivery;
- increased cost of delivery, adversely impacting our gross margins; and
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- reduced shipment quality, which may result in damaged products and
customer dissatisfaction.
WE COULD FACE LIABILITY FOR PUBLISHING OR DISTRIBUTING CONTENT, AND OUR
BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS COULD SUFFER IF COSTS
RESULTING FROM THESE CLAIMS ARE NOT COVERED BY OUR INSURANCE OR EXCEED OUR
POLICY LIMITS.
We may be considered a publisher or distributor of both our own and
third-party content, and parties may download or copy material from our Website
and distribute it to others. As a result, parties may bring claims against us
for defamation, negligence, copyright or trademark infringement, invasion of
privacy and publicity, unfair competition or other theories based on the nature
and content of this material. For example, claims could be made against us if
material deemed inappropriate for viewing by young children could be accessed
through our Website. Our general liability insurance may not cover claims of
this type or may not adequately cover the costs we could incur in defending
potential claims. Our business, financial condition and operating results could
suffer if costs resulting from these claims are not covered by our insurance or
exceed our policy limits.
COMPETITION IN THE ONLINE COMMERCE MARKET IS INTENSE. IF WE ARE UNABLE TO
COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE COMPETITORS, OUR REVENUE AND
OPERATING RESULTS WOULD BE ADVERSELY AFFECTED.
The online commerce market is new, rapidly evolving and intensely
competitive, and we expect that competition will intensify in the future.
Barriers to entry are limited, and current and new competitors can launch
Websites at a relatively low cost. In addition, the broader retail video
industry is intensely competitive. We currently compete with a variety of online
vendors who specialize in DVDs and videocassettes, as well as those who also
sell books, music and other entertainment products. We also compete with
specialty video retailers, mass merchandisers, consumer electronic stores and
non-store retailers, including mail-order video clubs. Many of these traditional
retailers also support or may introduce dedicated Websites that compete directly
with ours. New technologies and the expansion of existing technologies may
increase the competitive pressures on us. For example, online applications that
rank specific titles from a variety of Websites based on price may channel
customers to online retailers that compete with us.
Many of our current and potential competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than we do. Our competitors
have and may continue to utilize aggressive pricing or inventory availability
practices and devote substantially more resources to Website and systems
development than we can. Increased competition may result in an adverse effect
on operating margins, loss of market share and diminished brand recognition. We
may not be able to compete successfully against current and future competitors.
Further, as a strategic response to changes in the competitive environment, we
may from time to time make pricing, service or marketing decisions or
acquisitions that could adversely affect our business, prospects, financial
condition and results of operations.
IF WE ARE NOT ABLE TO MANAGE OUR GROWTH OR EXPANSION, OUR OPERATING RESULTS AND
ABILITY TO SUSTAIN GROWTH COULD BE ADVERSELY AFFECTED.
We have expanded rapidly since we commenced operations in January 1996. We
anticipate that further expansion of our operations will be required to address
any significant growth in our customer base and to take advantage of our market
opportunities. During the first nine
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months of 1999, we expanded from 115 to 174 employees. Several key members of
management have only recently joined us. We may choose to expand our operations
by:
- developing a new Website;
- promoting new or complementary products or sales formats;
- expanding the breadth of product offerings and services offered;
- expanding our market presence through relationships with third parties;
- promoting advertising on our site; or
- expanding internationally.
Any future expansion, internally or through acquisitions, may place
significant demands on our managerial, operational, administrative and financial
resources. Furthermore, any new business or product line we launch that is not
favorably received by our customers could damage our reputation, brand or
results of operations. Our future performance and profitability will depend in
part on our ability to recruit, motivate and retain qualified personnel and on
the implementation of enhancements to our operational and financial systems. We
cannot be certain that our systems, procedures or controls will be adequate to
support our expanding operations or that management will be able to respond
effectively to any growth in our business.
BECAUSE OUR BUSINESS WILL PROBABLY BE AFFECTED BY SEASONAL BUYING PATTERNS, OUR
QUARTERLY OPERATING RESULTS WILL FLUCTUATE AND OUR SHARE PRICE MAY BE ADVERSELY
AFFECTED.
We believe that our revenue will be affected by seasonal consumer buying
patterns. Sales in the traditional video industry are typically highest in the
fourth quarter of each calendar year and may decline in the first quarter. To
date, our limited operating history and rapid growth make it difficult for us to
determine what effect, if any, seasonality has on our business. Shifts in
seasonal sales cycles may occur due to changes in the economy or other factors
affecting the market for our products. These shifts could cause our quarterly or
annual results of operations in future periods to fall below the expectations of
securities analysts or investors. This could result in a decline in the value of
our common stock.
OUR PERFORMANCE, INCLUDING OUR REVENUE GROWTH, DEPENDS ON OUR ABILITY TO OFFER
NEW AND EXPANDED PRODUCT OFFERINGS AND SERVICES.
Our strategy is to introduce new and expanded product offerings and
services and to enter into new relationships with third parties to generate
additional revenue, attract more customers, increase market share and respond to
competition. We may be unable to offer such products or services in a
cost-effective or timely manner, if at all. Furthermore, any new product or
service we offer that is not favorably received by consumers could damage our
reputation and brand, resulting in lower revenue. Expansion of our product
offerings or services in this manner would also require additional expenses and
development and may strain our management, financial and operational resources.
Our success also depends on our ability to accurately determine the products and
features sought by customers and to design and implement offerings that meet
these preferences in a timely and efficient manner. We may be unsuccessful in
determining customer requirements, and our offerings may not adequately satisfy
current or future customer demands. Furthermore, even if we correctly forecast
customer demands, we may be unable to offer the services and products that meet
these demands.
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OUR GROWTH AND OPERATING RESULTS DEPEND ON KEY PERSONNEL AND OUR ABILITY TO HIRE
ADDITIONAL PERSONNEL.
We depend substantially on the continued services and performance of our
senior management and other key employees, particularly Mark Wattles, our
Chairman and Chief Executive Officer. The loss of Mr. Wattles' services could
disrupt our business. Our future success also depends on our ability to
identify, attract, hire, train, retain and motivate other highly skilled
technical, managerial, editorial, merchandising, marketing and customer service
personnel. Competition for qualified personnel is intense, and we may not be
able to successfully attract, assimilate or retain sufficiently qualified
personnel.
WE RELY ON THIRD-PARTY VENDORS FOR MANY OF OUR SYSTEMS, AND OUR OPERATIONS COULD
BE ADVERSELY AFFECTED IF THESE ARRANGEMENTS WERE DISRUPTED OR TERMINATED.
We depend on Exodus Communications, Inc. to host our server system and
provide Internet connectivity. If the Exodus facilities in which our servers are
hosted were damaged, our business could be adversely affected. In addition, we
rely on third-party vendors who provide our on-line credit card processing and
our ability to provide secure Web pages. If any of these service providers were
to terminate these agreements early or if these agreements are not renewed, we
would be required to enter into relationships with other third-party providers.
The new systems could be more expensive to maintain than our current system and
may not function as well.
WE FACE THE RISK OF SYSTEM FAILURES. WE DO NOT MAINTAIN REDUNDANT FACILITIES AND
THE OCCURRENCE OF A SYSTEM FAILURE COULD DAMAGE OUR REPUTATION AND ADVERSELY
AFFECT OUR OPERATING RESULTS.
Our ability to receive and process orders successfully and provide
high-quality customer service depends on the efficient and uninterrupted
operation of our computer and communications systems. Our systems and operations
are vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, earthquake and similar events. Our systems are also
vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions. We warehouse all of our inventory at a single location. In addition
we operate our corporate office in a single location. Either of these facilities
may also be damaged by fire, flood, power loss, telecommunications failure,
break-ins, earthquake and similar events. We do not presently have redundant
systems or a sophisticated disaster recovery plan and do not carry sufficient
business interruption insurance to compensate us for losses that may occur.
OUR GROWTH AND OPERATING RESULTS COULD SUFFER IF WE ARE UNABLE TO MEET OUR
FUTURE CAPITAL REQUIREMENTS.
Based on our current operating plan, we anticipate that the net proceeds of
this offering, together with our available funds, will be sufficient to satisfy
our anticipated needs for working capital, capital expenditures and business
expansion for approximately the next 12 months. After that time, we may need
additional capital. Alternatively, we may need to raise additional funds sooner
in order to fund more rapid expansion, to develop new or enhanced services and
to respond to competitive pressures. If we raise additional funds by issuing
equity or convertible debt securities, the percentage ownership of our
stockholders will be diluted. Furthermore, any new securities could have rights,
preferences and privileges senior to those of our common stock. We currently do
not have any commitments for additional financing. We cannot be certain that
additional financing will be available when and to the extent required or that,
if available, it will be on acceptable terms. If adequate funds are not
available on
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acceptable terms, we may not be able to fund our expansion, develop or enhance
our products or services or respond to competitive pressures.
ANY FUTURE ACQUISITIONS WILL INVOLVE RISKS.
We may engage in acquisitions in the future. To the extent we complete
acquisitions, they could pose risks, including the diversion of management's
attention, the assimilation of the operations and personnel of the acquired
companies, the integration of acquired assets with existing assets, potential
adverse short-term effects on reported operating results, the amortization of
acquired intangible assets and the loss of key employees. Currently, we do not
have any commitments or agreements with respect to acquisitions.
IF WE ARE UNABLE TO PROTECT OUR TRADEMARKS AND PROPRIETARY RIGHTS, OUR
REPUTATION AND BRAND COULD BE ADVERSELY AFFECTED AND WE COULD LOSE CUSTOMERS.
We regard our trademarks, trade secrets and similar intellectual property,
such as our domain name, as critical to our business. We rely on trademark and
copyright law, trade secret protection and confidentiality and/or license
agreements with employees, customers, partners and others to protect our
proprietary rights. We have pursued the registration of our trademarks in the
United States and internationally and have applied for the registration of
trademarks and service marks that are important to our business. Effective
trademark, service mark, copyright and trade secret protection may not be
available in every country where our products are made available online. We
cannot be certain that we have taken adequate steps to protect our proprietary
rights, especially in countries where the laws may not protect our rights as
fully as in the United States. In addition, third parties may infringe upon or
misappropriate our proprietary rights, and we could be required to incur
significant expenses in preserving our intellectual property rights.
INTELLECTUAL PROPERTY CLAIMS AGAINST US COULD BE COSTLY AND RESULT IN THE LOSS
OF SIGNIFICANT RIGHTS.
Other parties may assert infringement claims against us. In the past, other
parties have sent us notice of claims of infringement of proprietary rights, and
we expect to receive other notices in the future. We cannot predict whether
third parties will assert claims of infringement against us, or whether any past
or future assertions or prosecutions will adversely affect our business. If we
are forced to defend against any infringement claims, even if they are without
merit or are determined in our favor, then we may face costly litigation and
diversion of technical and management personnel. As a result of these disputes,
we may have to develop non-infringing property or enter into royalty or
licensing agreements. These royalty or licensing agreements, if required, may
not be available on acceptable terms, if at all.
IF WE ARE UNABLE TO PROTECT OUR DOMAIN NAMES, OUR REPUTATION AND BRAND COULD BE
ADVERSELY AFFECTED AND WE COULD LOSE CUSTOMERS.
We currently hold various domain names relating to our brand, including
Reel.com. The acquisition and maintenance of domain names generally are
regulated by governmental agencies and their designees. The regulation of domain
names in the United States and in foreign countries may change in the near
future. Governing bodies may establish additional top-level domains, appoint
additional domain name registrars or modify the requirements for holding domain
names. As a result, we may be unable to acquire or maintain relevant domain
names in all countries in which we conduct business. Furthermore, the
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. We may be unable to
prevent third parties from acquiring domain names that
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are similar to, infringe upon or otherwise decrease the value of our trademarks
and other proprietary rights.
IF THE SOFTWARE, HARDWARE, COMPUTER TECHNOLOGY AND OTHER SYSTEMS AND SERVICES
THAT WE USE ARE NOT YEAR 2000 COMPLIANT, OUR OPERATING RESULTS, BRAND AND
REPUTATION COULD BE HARMED AND WE COULD LOSE CUSTOMERS.
Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
upcoming century change. If not corrected, many computer software applications
could fail or create erroneous results by, at or beyond the Year 2000. This
could result in system failures or miscalculations causing disruptions of
operations, including, among others, a temporary inability to process
transactions, send invoices or engage in similar normal business activities. We
use software, hardware, computer technology and other services that we developed
or purchased from third-party vendors that may fail due to the Year 2000 issue.
We are dependent on financial institutions to process our customers' credit card
payments. We are also dependent on telecommunications vendors to maintain our
network and the United States Postal Service and other third-party carriers to
deliver products to customers. If Year 2000 issues prevent our customers from
accessing the Internet, accessing our Website, processing orders through our
third-party systems or using their credit cards, or if we are unable to purchase
product from our suppliers or deliver product to our customers, our operations
would be materially adversely affected. We cannot currently predict how the Year
2000 issue will affect our computer systems, suppliers and shippers, including
the United States Postal Service, or the extent to which we would be vulnerable
to the failure to remedy any Year 2000 issues on a timely basis. Also, we cannot
be certain that our customers' credit card vendors and those organizations
responsible for maintaining and providing Internet access will rectify their
Year 2000 issues. Moreover, the costs related to Year 2000 compliance could be
significant.
PROVISIONS IN OUR CHARTER DOCUMENTS COULD DETER TAKEOVER EFFORTS WHICH COULD
DEPRESS OUR STOCK PRICE.
Provisions of our Certificate of Incorporation, Bylaws and Delaware law
could make it more difficult for a third party to acquire us, even if doing so
would be beneficial to our stockholders.
MINORITY STOCKHOLDERS MAY NOT BE ABLE TO ELECT ANY OF OUR DIRECTORS, WHICH COULD
DETER A TAKEOVER EVEN IF BENEFICIAL TO OUR STOCKHOLDERS.
Our Certificate of Incorporation does not provide for cumulative voting. As
a result, it is more difficult for minority stockholders to obtain
representation on our board of directors, which may deter takeover attempts.
RISKS RELATED TO OUR RELATIONSHIP WITH HOLLYWOOD ENTERTAINMENT
THE RIGHTS OF OUR STOCKHOLDERS COULD BE ADVERSELY AFFECTED BECAUSE WE ARE
CONTROLLED BY HOLLYWOOD ENTERTAINMENT, OUR PARENT COMPANY.
Upon completion of this offering, our parent company, Hollywood
Entertainment, will beneficially own approximately % of the outstanding shares
of our common stock. As a result, Hollywood Entertainment will have the ability
to control matters requiring the vote of the stockholders, including the
election of our directors and our corporate actions. This concentration of
ownership and other rights could impede our business development and may also
delay or deter others from initiating a potential merger, takeover or other
change in control, even if these events would benefit our stockholders and us.
Concentration of
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ownership could also adversely affect the voting and other rights of our other
stockholders, and could depress the market price of our common stock.
OVERLAPPING MANAGEMENT, BOARDS OF DIRECTORS AND STOCK INCENTIVE PLANS COULD
CAUSE CONFLICTS OF INTEREST BETWEEN OUR PARENT AND US.
Mark Wattles, our Chairman and Chief Executive Officer and Donald Ekman,
one of our directors, serve as members of the board of directors of our parent.
Service as a director or officer of Reel.com and as a director of our parent
could create or appear to create potential conflicts of interest when that
director is faced with decisions that could have different implications for
Reel.com and our parent. Such decisions may relate to corporate opportunities,
corporate strategies, potential acquisitions of businesses, the intercompany
agreements, competition, the issuance or disposition of securities, the election
of new or additional directors, the payment of dividends by Reel.com and other
matters. We have not instituted any formal plan or arrangement to address
potential conflicts of interest that may arise between our parent and us.
However, under Delaware corporate law, directors of Reel.com owe fiduciary
duties to Reel.com and its stockholders.
Mr. Wattles will be employed by both our parent and Reel.com and will spend
a substantial part of his professional time and effort on behalf of our parent.
In many instances, these efforts on behalf of our parent will involve activities
that are unrelated, and in some circumstances may be adverse, to the interests
of Reel.com. Reel.com has not established any minimum time that Mr. Wattles will
be required to spend on behalf of Reel.com.
Mr. Wattles and several other Reel.com officers and employees will continue
to hold shares of and/or options to purchase shares of common stock of our
parent acquired or granted prior to this offering. These employees may not yet
have received comparable interests under our stock incentive plans. In addition,
following the completion of this offering, employees of Reel.com may be eligible
to participate in other benefit plans of our parent that provide opportunities
to receive additional shares of common stock of our parent. These substantial
equity interests in our parent may present these employees with incentives
potentially adverse to Reel.com's stockholders.
WE DEPEND ON OUR RELATIONSHIP WITH OUR PARENT.
Our relationship with our parent provides us with access to a database of
its customers to whom we intend to cross-market. Also, we intend to enter into a
series of intercompany agreements with our parent relating to advertising,
trademark licensing, supply and other services. If these proposed agreements or
our relationship with our parent were to terminate, our ability to promote our
site would be impaired and our cost of operations could increase and thereby
adversely affect our results of operations. Additionally, these agreements may
require us to indemnify our parent with respect to a number of matters,
including this offering.
WE FACE POTENTIAL COMPETITION FROM OUR PARENT.
Any of the following events could have a material adverse effect on our
business or our stockholders:
- any competition from our parent that results in a loss of a corporate
opportunity by Reel.com;
- any engagement by our parent in any activity that is similar to the
businesses of Reel.com; or
- the early termination of the proposed services agreement.
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However, prior to completion of this offering, we anticipate that our
parent will enter into a services agreement under which it will refrain from
competing with us in the business of selling movies, movie content and/or other
entertainment products on videocassette, DVD or other fixed or streaming media
via the Internet, video-on-demand or other electronic means. Our parent is under
no other obligation to refrain from competing with us or to share with us any
future business opportunities available to it.
WE HAVE A LIMITED HISTORY AS AN INDEPENDENT COMPANY.
Prior to the completion of this offering, we operated from 1996 to October
1998 as an independent company and from October 1998 to the present as a
wholly-owned subsidiary of our parent. Our business could be adversely affected
if our parent fails to adequately provide us with certain services. Prior to the
completion of this offering, we intend to enter into a series of intercompany
agreements with our parent. Under these agreements, we will depend on our parent
to provide us with promotional services and other goods and services that are
important to our business. The termination of the intercompany agreements could
have a material adverse effect on our business. See "Certain
Transactions -- Transactions with our Parent."
The historical financial statements contained in this prospectus include
allocations for administrative and other expenses incurred by our parent for
services rendered to Reel.com. While we believe such allocations to be
reasonable, they are not necessarily indicative of, and it is not practical for
us to estimate, the levels of expenses that would have resulted had Reel.com
been operating as a separate, stand-alone company. We have also relied on our
parent to provide financing for our operations. Therefore, investors should not
rely on our cash flows to date as indicative of the cash flows that would have
resulted had Reel.com been operating as an independent company during the
periods presented.
OUR PARENT'S CREDIT AGREEMENT LIMITS US FROM CERTAIN ACTIVITIES.
In 1997, Hollywood Entertainment established a $300 million, five-year
revolving Senior Credit Facility with a syndicate of lenders. As collateral for
the credit facility, Hollywood Entertainment has pledged substantially all of
its assets, including the shares of Reel.com common stock it owns. The Senior
Credit Facility contains financial and other affirmative and restrictive
covenants, including a minimum interest coverage ratio, a maximum leverage
ratio, minimum average per store contribution requirements, minimum
shareholders' equity, and restrictions on mergers, asset sales, additional
indebtedness, guarantees, liens, investments, operating lease obligations and
acquisitions. Some of these covenants apply to Reel.com. On March 1, 1999, the
Senior Credit Facility was amended to, among other things, allow the issuance by
Reel.com of shares of Reel.com common stock in a public offering.
In connection with this offering, Hollywood Entertainment is seeking to
amend the Senior Credit Facility to release some of the restrictive covenants in
the Senior Credit Facility as they apply to Reel.com. The Senior Credit Facility
also contains a requirement that Hollywood Entertainment cause a portion of the
proceeds from any sale of any of its subsidiaries' stock to be used to pay down
obligations and, in certain circumstances, reduce the credit commitment under or
collateralize the Senior Credit Facility for investment in additional assets in
a line of business in which Hollywood Entertainment is engaged. The amendment of
the Senior Credit Facility that Hollywood Entertainment is seeking would also
include an amendment eliminating this requirement.
In the event Hollywood Entertainment is not able to amend the Senior Credit
Facility as it is seeking to do, we would continue to be subject to provisions
that, among other things,
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restrict our ability to incur additional debt, to grant liens, to conduct
certain acquisitions or mergers, to sell assets, to enter into operating leases
and to make certain investments. These restrictions would significantly and
negatively impact our business, financial condition and results of operations.
See "Description of Parent Company Indebtedness" for more information on
the Senior Credit Facility.
WE MAY BE CONTINGENTLY LIABLE FOR OUR PARENT'S TAX OBLIGATIONS.
For so long as our parent continues to own shares representing 80% of the
vote and value of our capital stock, we will be included in our parent's
consolidated group for federal income tax purposes. Federal law provides that
each member of a consolidated group is liable for the group's entire tax
obligation. Similar principles apply for state income tax purposes in many
states. Thus, if our parent or other members of its consolidated group fail to
make any federal or state income tax payments required by law, we could be
liable for the shortfall.
We intend to enter into a tax allocation agreement pursuant to which, for
so long as Reel.com is included in our parent's consolidated group, our parent
will pay the consolidated and combined federal and state income tax liabilities
of the group, and we will pay our parent an amount equal to the income taxes we
would be obligated to pay if we were a separate taxpayer (or if we were filing a
consolidated or combined return including only us and our subsidiaries). Under
the tax allocation agreement, for so long as Reel.com is included in our
parent's consolidated group, our parent will have sole authority to respond to
and conduct all tax proceedings, including tax audits, relating to us, to file
all consolidated income tax returns on our behalf and to determine the amount of
our liability to, or entitlement to payment from, our parent under the tax
allocation agreement.
OUR PARENT COULD ELECT TO SELL ALL OR A SUBSTANTIAL PORTION OF ITS EQUITY
INTEREST IN REEL.COM TO A THIRD PARTY.
In the event of a sale of our parent's interest to a third party, that
third party may be able to control Reel.com in the same manner that our parent
is able to control Reel.com. Similarly, if Hollywood Entertainment failed to pay
the indebtedness under its Senior Credit Facility or otherwise violated the
covenants under that facility, the lenders could foreclose on and sell Hollywood
Entertainment's pledged shares of Reel.com. Such a sale may adversely affect the
market price of the common stock and may harm Reel.com's business, financial
condition and results of operations.
RISKS RELATED TO THE INTERNET INDUSTRY
IF WE DO NOT RESPOND TO TECHNOLOGICAL CHANGE, OUR SERVICES COULD BECOME OBSOLETE
AND WE COULD LOSE CUSTOMERS.
To remain competitive, we must continue to enhance and improve the
responsiveness, reliability, functionality and features of our Website. The
Internet and the online commerce industry are characterized by rapid
technological change, changes in user and customer requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices. These developments could
render our Website and transaction-processing systems obsolete or require that
we
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invest significant additional capital. Our growth and operating results will
depend, in part, on our ability to:
- enhance our user experience;
- develop new features, services and technology that address the
increasingly sophisticated and varied needs of prospective customers; and
- respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
OUR GROWTH AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED IF THE INTERNET AND
ONLINE COMMERCE DO NOT CONTINUE TO GROW.
Our growth and operating results depend in part on widespread consumer
acceptance and use of the Internet as a way to buy products. This consumer
practice is at an early stage of development, and demand and continued market
acceptance is uncertain. Our future success will depend on our ability to
significantly increase revenue which will require the development and widespread
acceptance of the Internet as a medium for commerce. We cannot predict the
number of consumers that will be willing to shift their purchasing habits from
traditional to online retailers. The Internet may not become a viable commercial
marketplace due to inadequate development of network infrastructure and enabling
technologies that address consumer concerns about:
- network performance;
- security;
- reliability;
- speed of access;
- ease of use; and
- bandwidth availability.
In addition, changes in or insufficient availability of telecommunications
or other services to support the Internet also could result in slower response
times and adversely affect general usage of the Internet.
ACCEPTANCE AND EFFECTIVENESS OF THE INTERNET FOR ADVERTISING ARE UNPROVEN, WHICH
MAY DISCOURAGE SOME ADVERTISERS FROM ADVERTISING ON OUR WEBSITE.
Our strategy is to increase our focus on advertising revenue in the future.
As a result, if the Internet advertising market fails to develop or develops
more slowly than we expect, our ability to implement our strategy could be
adversely affected. The Internet advertising market is new and rapidly evolving,
and we cannot yet gauge the effectiveness of advertising on the Internet as
compared to traditional media. As a result, demand for Internet advertising is
uncertain. Many advertisers have little or no experience using the Internet for
advertising purposes. The adoption of Internet advertising, particularly by
companies that have historically relied upon traditional media for advertising,
requires the acceptance of a new way of conducting business, exchanging
information and advertising products and services. Such companies may find
advertising on the Internet to be undesirable or less effective for promoting
their products and services relative to traditional advertising media.
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IF OUR ONLINE COMMERCE SECURITY MEASURES FAIL TO PROTECT CONSUMER INFORMATION,
OUR REPUTATION AND BRAND COULD BE DAMAGED AND WE COULD LOSE CUSTOMERS AND FACE
LITIGATION.
In the online commerce business, consumers' confidence largely depends upon
the privacy of their activities and the secured transmission of confidential
information over public networks. To secure transmission of our customers'
confidential information, including their credit card numbers, we rely on
licensed encryption and authentication technology. However, our current security
measures may not be adequate. We collect information regarding our registered
users for a variety of reasons, including the collection of data derived from
the users' purchasing histories. Any reduction or limitation in the use of such
data could limit the effectiveness of our marketing and sales efforts. Moreover,
despite the display of our privacy policy on our Website, any penetration of our
network security or misappropriation of our users' personal or credit card
information could subject us to liability. We may be liable for claims based on
unauthorized purchases with credit card information, impersonation or other
similar fraud claims. Claims could also be based on other misuses of personal
information, such as for unauthorized marketing purposes. These claims could
result in litigation. In addition, the Federal Trade Commission, the European
Union and several states have investigated the use by Internet companies of
personal information.
In 1998, the U.S. Congress enacted the Children's Online Privacy Protection
Act of 1998. The Federal Trade Commission has not yet promulgated regulations
interpreting this act. We depend upon collecting personal information from our
customers and we believe that the promulgation of regulations under this act
will make it more difficult for us to collect personal information from some of
our customers. We could incur expenses if new regulations regarding the use of
personal information are introduced or if our privacy practices were
investigated.
BURDENSOME GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD ADVERSELY AFFECT
OUR RESULTS OF OPERATIONS.
It is possible that a number of laws and regulations may be adopted
concerning the Internet, relating to:
- user privacy;
- pricing;
- content;
- copyrights;
- distribution; and
- characteristics and quality of products and services.
The adoption of any additional laws or regulations may decrease the
popularity or expansion of the Internet. A decline in the growth of the Internet
could decrease demand for our products and increase our cost of doing business.
Moreover, the applicability of existing laws to the Internet is uncertain with
regard to many issues including property ownership, intellectual property,
export of encryption technology, sales tax, libel and personal privacy. Our
business, financial condition and results of operations could be seriously
harmed by any new legislation or regulation of these types. The application of
laws and regulations from jurisdictions whose laws do not currently apply to our
business, or the application of existing laws and regulations to the Internet
and other online services could also harm our business.
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<PAGE> 24
WE MAY BE LIABLE FOR SALES AND OTHER TAXES WHICH COULD HARM OUR RESULTS OF
OPERATIONS.
We currently are responsible for collecting sales or other similar taxes on
the shipment of goods shipped to addresses only in the state of California,
which accounts for approximately 20% of our revenue. Tax authorities in many
states are reviewing the appropriate tax treatment of Internet and catalog
retail companies. Any resulting state tax regulations could subject us to the
assessment of sales and income taxes in other states. Since our products are
available over the Internet in multiple states and in foreign countries, these
jurisdictions may require us to qualify to do business. If we fail to qualify in
a jurisdiction that requires us to do so, we could face expenditures for taxes
and penalties. Also, although we do not believe that our relationship with
Hollywood Entertainment would subject us to sales or use taxes in any
jurisdiction where Hollywood Entertainment operates a retail store, it is
possible that a jurisdiction may seek to impose a sales or use tax based on that
relationship. We cannot be certain that we would be successful in any challenge
to the imposition of sales or use tax.
RISKS RELATED TO THIS OFFERING
NO PRIOR PUBLIC MARKET EXISTS FOR OUR COMMON STOCK AND NO ACTIVE TRADING MARKET
MAY DEVELOP.
Prior to this offering, there has been no public market for our common
stock. We cannot be sure that an active trading market for our common stock will
develop or continue as a result of this offering.
OUR OFFERING PRICE WILL NOT NECESSARILY RELATE TO ANY ESTABLISHED CRITERIA OF
VALUE, SO OUR STOCK MAY TRADE AT MARKET PRICES BELOW THE OFFERING PRICE.
Through negotiations with the underwriters, we will determine the public
offering price of the shares of our common stock. This price will not
necessarily relate to our book value, assets, past operating results, financial
condition or other established criteria of value. As a result, the shares being
offered may trade at market prices below the initial public offering price.
STOCK PRICES OF INTERNET-RELATED COMPANIES HAVE FLUCTUATED WIDELY IN RECENT
MONTHS AND THE TRADING PRICE OF OUR COMMON STOCK IS LIKELY TO BE VOLATILE, WHICH
COULD RESULT IN SUBSTANTIAL LOSSES TO INVESTORS.
The trading price of our common stock is likely to be volatile and could
fluctuate widely in response to factors, some of which are beyond our control.
In particular, following initial public offerings, the market prices for stocks
of Internet and technology-related companies have been especially volatile and
often reach levels that bear no established relationship to the operating
performance of these companies. These market prices could vary widely. These
broad market and industry factors may significantly harm the market price of our
common stock, regardless of our actual or operating performance. In the past,
following periods of volatility in the market price of a company's security,
securities class-action litigation has often been instituted against such
companies. Such litigation, if instituted, could result in substantial costs and
a diversion of management's attention and resources.
YOU WILL FACE IMMEDIATE AND SUBSTANTIAL DILUTION IN NET TANGIBLE BOOK VALUE.
The initial public offering price of our common stock is expected to exceed
substantially the tangible net book value per share of the common stock
immediately after this offering. Based upon the estimated offering price range,
you could pay as much as $ per share and the net tangible book value per share
is expected to be, $ immediately after the offering. The net tangible book
value per share represents the amount of our total assets less total
liabilities,
23
<PAGE> 25
divided by the number of shares of common stock outstanding. Further, investors
in this offering will contribute approximately % of our net tangible assets,
but will own only approximately % of our company.
WE HAVE BROAD DISCRETION AS TO USE OF PROCEEDS AND MAY NOT USE THE PROCEEDS IN
WAYS WHICH ENHANCE OUR MARKET VALUE OR RESULTS OF OPERATIONS.
Our management can spend most of the proceeds from this offering in ways
with which our stockholders may not agree. Our management will have broad
discretion in applying the net proceeds of this offering and you will not be
able, as part of your investment decision, to assess how we apply the net
proceeds. Furthermore, our stock price could decline if the market does not view
favorably our use of the proceeds from this offering. See "Use of Proceeds."
SALES OF ADDITIONAL SHARES OF OUR COMMON STOCK INTO THE PUBLIC MARKET MAY CAUSE
OUR STOCK PRICE TO FALL.
Sales of substantial amounts of our common stock in the public market after
this offering could adversely affect the prevailing market price of our common
stock. Upon completion of this offering, we will have shares of common
stock outstanding. This includes shares we are selling in this offering,
which may be immediately resold in the public market. The holder of the
remaining shares has "demand" and "piggyback" registration rights and
these shares will become eligible for resale 180 days following the completion
of this offering, subject to Rule 144 under the Securities Act of 1933, as
amended. In addition, as soon as practicable after the date of this prospectus,
we intend to file a registration statement on Form S-8 with the SEC covering the
shares of common stock reserved for issuance under our stock incentive plans.
Sales of a large number of shares could have an adverse effect on the market
price of our common stock.
24
<PAGE> 26
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that address:
- trends in online commerce and Internet usage;
- our strategies;
- use of proceeds;
- Year 2000; and
- our financial condition or results of operations.
These forward-looking statements may be found in "Prospectus Summary,"
"Risk Factors," "Use of Proceeds," "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Business" and elsewhere in this
prospectus. In some cases you can identify forward-looking statements by
terminology, including "believes," "anticipates," "expects," "estimates," "may,"
"will," "should," "could," "plans," "predicts," "potential," "continue,"
"intends" or similar terms. Although we believe that the expectations reflected
in the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. The forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause actual results to be materially different from any future results
expressed or implied by the forward-looking statements. These factors include
those listed under "Risk Factors" and elsewhere in this prospectus. We undertake
no duty to update any of the forward-looking statements after the date of this
prospectus, even if new information becomes available or other events occur in
the future. All forward-looking statements contained in this prospectus are
expressly qualified in their entirety by this cautionary notice.
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<PAGE> 27
USE OF PROCEEDS
Our net proceeds from the sale of the shares of common stock in this
offering (assuming an initial public offering price of $ per share and after
deducting estimated underwriting discounts and commissions and estimated
offering expenses) are estimated to be $ million ($ million if
the underwriters' over-allotment option is exercised in full). We intend to use
$10 million of the net proceeds to repay indebtedness owed to our parent. We
intend to use the remainder of the net proceeds for marketing activities,
content and technology development and other general corporate purposes,
including working capital. The amounts actually used for such working capital
purposes may vary significantly and will depend on a number of factors,
including the amount of our future revenue and the other factors described under
"Risk Factors." Accordingly, we will retain broad discretion in the allocation
of the net proceeds of this offering. A portion of the net proceeds may also be
used to acquire or invest in complementary businesses, technologies, product
lines or products. We have no current agreements or commitments with respect to
any such acquisitions or investments. Pending these uses, we will invest the net
proceeds of this offering in interest-bearing, investment-grade securities.
DIVIDEND POLICY
We expect to retain any earnings to finance the expansion and development
of our business and have no plans to pay cash dividends for the foreseeable
future. The payment of dividends is within the discretion of our board of
directors and will depend on our earnings, capital requirements and operating
and financial condition, among other factors. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
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<PAGE> 28
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999
on an Actual, Pro Forma and Pro Forma as Adjusted basis. The Actual column
reflects our capitalization as of September 30, 1999 on a historical basis, with
adjustment for the subsequent stock split of our outstanding
shares of common stock. The Pro Forma column reflects our Actual capitalization
as of September 30, 1999 with adjustments for the conversion of a loan amount of
$ million from Hollywood Entertainment to additional paid-in capital,
automatically upon completion of this offering, and the Pro Forma As Adjusted
column reflects our capitalization as of September 30, 1999 with the preceding
Pro Forma adjustments and the application of the estimated net proceeds from our
sale of shares of common stock at an assumed initial public offering
price of $ per share.
The following table excludes shares of common stock reserved for
issuance under our stock incentive plans, of which were subject to
options outstanding as of , 2000 at a weighted average exercise
price of $ . It also assumes no exercise of the underwriters'
over-allotment option.
This information is qualified by, and should be read in conjunction with,
the more detailed financial statements of Reel.com and related notes appearing
at the end of this prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
---------------------------------
PRO PRO FORMA
ACTUAL FORMA AS ADJUSTED
-------- -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Short-term obligations:
Notes payable....................................... $ $ $
Current portion of long-term obligations............
-------- -------- --------
Total short-term obligations...................
Long-term obligations, net of current portion............ 42,483
Stockholders' equity:
Common stock, 1,000 shares authorized; 1,000 shares
issued and outstanding, actual; shares
issued and outstanding, as adjusted............... -- --
Additional paid-in capital............................... 96,881
Accumulated deficit...................................... (91,137)
-------- -------- --------
Total stockholders' equity..................... 5,744
-------- -------- --------
Total capitalization................... $ 48,227 $ $
======== ======== ========
</TABLE>
27
<PAGE> 29
DILUTION
As of September 30, 1999, we had a net tangible book value of approximately
$ million or $ per share. Net tangible book value per share is
equal to total tangible assets (total assets less intangible assets) less total
liabilities, divided by the number of shares of common stock then outstanding.
Without taking into account any adjustment in net tangible book value
attributable to operations after September 30, 1999, after giving effect to the
sale by us of shares in this offering at an assumed initial public
offering price of $ , our net tangible book value as of September 30, 1999
(after deduction of estimated underwriting discounts and commissions and
estimated offering expenses and the application of the net proceeds as described
under "Use of Proceeds") would have been approximately $ million or
$ per share. This represents an immediate increase in net tangible book
value of $ per share to existing stockholders and an immediate dilution of
$ per share to new investors. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $
Net tangible book value per share as of September 30,
1999................................................... $
Increase per share attributable to new investors..........
--------
Net tangible book value per share after this offering.......
-------
Dilution per share to new investors......................... $
=======
</TABLE>
The following table summarizes as of September 30, 1999 the relative
investments of all existing stockholders and new investors, giving effect to our
sale of shares in this offering at an assumed initial public offering price of
$ per share (before deduction of estimated underwriting discounts and
commissions and offering expenses payable by us):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------- ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
-------- -------- -------- -------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders........ % $ % $
New investors................
-------- -------- -------- --------
Total.............. % $ %
======== ======== ======== ========
</TABLE>
The foregoing discussion and tables assume no exercise of stock options or
warrants outstanding as of . As of September 30, 1999,
there were outstanding options to purchase shares of common stock at a
weighted average exercise price of $ per share and shares were
reserved for issuance under our stock incentive plans. To the extent that any
shares available for issuance upon exercise of outstanding options or warrants
or pursuant to our stock plans are issued, there will be further dilution to new
public investors.
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<PAGE> 30
SELECTED FINANCIAL DATA
The selected financial data presented below for the years ended December
31, 1996, 1997 and 1998 and for the nine months ended September 30, 1998 and
1999, have been derived from our audited financial statements included in this
prospectus. Operating results for the nine months ended September 30, 1999 are
not necessarily indicative of the results for the year ending December 31, 1999
or for any future period. Our independent auditors' report on our financial
statements was prepared on the assumption that we will continue as a going
concern. The report acknowledges that we have incurred losses in each of the
last three fiscal years and that we anticipate that additional funding will be
required to sustain operations. These conditions cause substantial doubt as to
our ability to continue as a going concern. The financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and related notes
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------- --------------------
1996 1997 1998(1) 1998 1999
----- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Net revenue.................................. $ -- $ 745 $ 15,040 $ 8,568 $ 21,613
Operating expenses:
Cost of net revenue................... -- 547 16,860 10,113 22,707
Marketing and sales................... 53 570 13,216 8,102 16,672
Product development................... 483 951 4,333 2,948 6,777
General and administrative............ 223 1,475 3,077 2,342 4,133
Amortization of intangible assets and
goodwill(2)........................ -- -- 12,544 -- 37,631
Write-off of purchased research and
development(2)..................... -- -- 1,900 -- --
Stock-based compensation(3)........... -- -- 605 605 --
----- ------- -------- -------- --------
Total operating expenses........ 759 3,543 52,535 24,110 87,920
----- ------- -------- -------- --------
Loss from operations.................... (759) (2,798) (37,495) (15,542) (66,307)
Non-operating income (expense).......... -- 1 (618) (460) (2,719)
----- ------- -------- -------- --------
Net loss................................ $(759) $(2,797) $(38,113) $(16,002) $(69,026)
===== ======= ======== ======== ========
</TABLE>
- ---------------
(1) The summary financial data for fiscal 1998 combines data from the nine
months ended September 30, 1998, when we operated as an independent company,
and the three months ended December 31, 1998, when we operated as a
wholly-owned subsidiary of Hollywood Entertainment.
(2) Effective October 1, 1998, Hollywood Entertainment acquired all of the
outstanding shares of Reel.com, Inc. The acquisition was accounted for using
the purchase method of accounting. Of the total purchase price, $5.3 million
was allocated to net liabilities assumed, $8.7 million to identified
intangible assets, including developed database content of $1.1 million,
in-process research and development of $1.9 million, purchased trademark and
trade name of $3.6 million, workforce of $2.1 million and the remainder of
$93.5 million to goodwill. Except for in-process research and development,
which was immediately written off, the intangible assets are being amortized
over their estimated useful lives of two years.
(3) Amount represents stock-based compensation computed for stock options issued
to employees prior to our acquisition by Hollywood Entertainment.
29
<PAGE> 31
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- SEPTEMBER 30,
1997 1998 1999
----- ------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............................................. $(951) $(4,178) $(4,960)
Total assets.............................................. 501 92,774 59,759
Long-term debt (less current portion)..................... -- 10,690 42,483
Stockholders' equity (deficit)............................ (697) 74,770 5,744
</TABLE>
30
<PAGE> 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with Reel.com's
financial statements and notes to those statements and the other financial
information appearing elsewhere in this prospectus. In addition to historical
information, the following discussion contains forward-looking statements that
involve risks and uncertainties. Our actual results may differ materially from
those anticipated in these forward-looking statements due to many factors
including, but not limited to, those set forth under "Risk Factors" and
elsewhere in this prospectus.
OVERVIEW
We were founded in January 1996 as the Knowledge Project, a sole
proprietorship, and were renamed Reel LLC, a company under common control in
September 1996. We launched our Website in January 1997. Reel.Com LLC, a
Delaware limited liability company was formed in July 1997 and became Reel.com,
Inc. in April 1998. We were reorganized as a Delaware corporation and
wholly-owned subsidiary of Hollywood Entertainment in October 1998. For the
period from our inception through April 1997 we had no sales. Operating
activities related primarily to developing our Website and network
infrastructure and establishing supplier relationships. Since launching our
Website, we have continued these operating activities and have also focused on
increasing sales, extending our product offering, establishing and improving
studio and vendor relationships, promoting our brand and establishing in-house
fulfillment and customer service capabilities. As a result, marketing and sales
expenses and product development expenses have increased significantly. In
October 1998, Hollywood Entertainment acquired Reel.com for $32.7 million in
cash and capital stock of Hollywood Entertainment valued at $64.2 million. Since
our acquisition, Hollywood Entertainment has provided funding and certain
services to us. Upon completion of this offering, Hollywood Entertainment will
continue to provide certain services to us pursuant to the terms of agreements
we will enter into with Hollywood Entertainment, including corporate services,
advertising services and space-sharing. See "Certain
Transactions -- Transactions with Our Parent -- Intercompany Services
Agreement," for a description of these services.
We have derived our revenue primarily from product sales and, to a lesser
extent, related shipping charges, sponsorships and advertising. Revenue is
recorded net of coupons, discounts and returns. Product and shipping revenue is
recognized when products are shipped to the customer either from our
distribution center or from a distribution center operated by one of our
suppliers. Advertising revenue is recognized ratably over the period in which
the advertisement is displayed. To date, advertising revenue has been
insignificant and has been primarily barter. Barter revenue and expenses are
recorded at the fair market value of the services provided or received,
whichever is more determinable in the circumstances. Revenue from barter
transactions is recognized when we deliver advertisements for other companies on
our Website. Barter expense is recognized when our advertisements are delivered
on the Websites of other companies, which is typically in the same period as our
barter revenue is recognized.
As part of our efforts to grow our customer base and revenue, we have
pursued an aggressive pricing and promotional strategy, including giving free
merchandise and discounts to our customers, which has increased our cost of
revenue and adversely impacted our gross margin. In particular, in order to
establish a leadership position in the DVD category, we have been aggressively
promoting DVDs. As part of this strategy, we have been pricing DVDs at a greater
discount to suggested retail pricing than videocassettes, contributing to a
product mix shift to DVD from videocassettes and higher cost of revenue. We have
begun to purchase a
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<PAGE> 33
greater quantity of our products directly from major and independent studios. In
addition, we plan to decrease our use of pricing promotions. Our ability to
become and remain profitable depends, in part, upon our ability to purchase our
products more efficiently and shift our promotional efforts while continuing to
increase sales. We cannot be certain that these strategies will be effective or
that we will ever become profitable.
Since inception, we have incurred significant operating losses. These
losses have resulted primarily from development costs associated with launching
our Website, marketing efforts, technology and content development, customer
service and distribution and amortization of intangible assets. Our marketing
expenses have included payments in connection with strategic alliances, as well
as payments made for advertising online, primarily in the form of banners, and
offline, primarily in the form of print, radio and direct mail. From inception
through September 30, 1999, we had accumulated net losses, excluding goodwill
amortization and other non-cash non-recurring charges, of approximately $58.6
million. We expect to experience operating losses and negative cash flow for the
foreseeable future. We anticipate that our losses will increase significantly
from current levels because we expect to incur additional costs and expenses
related to marketing and other promotional activities, content development,
technology and infrastructure development and other capital expenditures. Our
revenue will have to increase significantly to achieve and maintain
profitability. Even though revenue has grown significantly in recent quarters,
we cannot be certain that we can sustain these growth rates or that we will
achieve sufficient revenue for profitability.
From the period beginning October 1, 1998 through September 30, 1999, we
have recorded non-cash charges of approximately $52.1 million from the
amortization of intangible assets resulting from the acquisition of our company
by Hollywood Entertainment. We expect to record additional non-cash charges
associated with these intangible assets of approximately $50.2 million.
Intangible assets are primarily associated with acquired trademarks, in-place
workforce and developed database content. Intangible assets are amortized on a
straight-line basis over the estimated period of benefit, which, because of the
rapid technological changes occurring in the Internet industry and the intense
competition for qualified Internet professionals, is two years.
We have a limited operating history on which to base an evaluation of our
business and prospects. We expect to face certain risks, expenses and
difficulties frequently encountered by companies in their early stages of
development, particularly companies in new and rapidly evolving markets such as
online media and commerce. To address these risks, we must maintain and expand
our customer base, implement and successfully execute our business and marketing
strategy, continue to develop and upgrade the technology and systems that we use
to process customers' orders and payments, improve our Website, provide superior
fulfillment and customer service, respond to competitive developments and
attract, retain and motivate qualified personnel. We cannot assure you that we
will be successful in addressing these risks, and a failure to address these
risks would have a negative impact on our business, operating results and
financial condition. In view of the rapidly changing nature of our business, the
general seasonality of retail sales, including relatively higher volumes of
sales associated with the holiday gift-giving season, and our limited operating
history, we believe that period-to-period comparisons of our operating results,
including our gross profit margin and operating expenses as a percentage of net
revenue, are not necessarily meaningful and should not be relied upon as an
indication of future performance.
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<PAGE> 34
RESULTS OF OPERATIONS
The following table sets forth statement of operations data for the years
ended December 31, 1996, 1997 and 1998, and for the nine months ended September
30, 1998 and 1999. The information for all periods has been derived from audited
financial statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------------- -------------------
1996 1997 1998 1998 1999
----- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net revenue................................ $ -- $ 745 $ 15,040 $ 8,568 $ 21,613
Operating expenses:
Cost of net revenue...................... -- 547 16,860 10,113 22,707
Marketing and sales...................... 53 570 13,216 8,102 16,672
Product development...................... 483 951 4,333 2,948 6,777
General and administrative............... 223 1,475 3,077 2,342 4,133
Amortization of intangible assets and
goodwill.............................. -- -- 12,544 -- 37,631
Write-off of purchased research and
development........................... -- -- 1,900 -- --
Stock-based compensation................. -- -- 605 605 --
----- ------- -------- -------- --------
Total operating expenses......... 759 3,543 52,535 24,110 87,920
----- ------- -------- -------- --------
Loss from operations....................... (759) (2,798) (37,495) (15,542) (66,307)
Non-operating income (expense)............. -- 1 (618) (460) (2,719)
----- ------- -------- -------- --------
Net loss................................... $(759) $(2,797) $(38,113) $(16,002) $(69,026)
===== ======= ======== ======== ========
</TABLE>
The financial information included herein may not necessarily be indicative
of the financial position, results of operations and cash flows that would have
resulted had we been operating as an independent company since our inception.
Consequently, period-to-period comparisons are not necessarily meaningful.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1999
Net Revenue. Net revenue reflects sales of filmed entertainment products,
including new DVDs and videocassettes, used videocassettes and related products,
net of returns, coupons and discounts, as well as outbound shipping charges, and
revenues for sponsorships and advertising. Net revenue increased 152% to $21.6
million for the nine months ended September 30, 1999 from $8.6 million for the
nine months ended September 30, 1998. This increase was primarily attributable
to a significant increase in the number of units sold, due, in part, to the
growth of our customer base, and an increase in average selling prices resulting
from a shift in the product mix from new and used videocassettes to DVDs, as
well as, to a lesser extent, an increase in revenue derived from sponsorships
and advertising.
Operating Expenses
Cost of Net Revenue. Cost of net revenue consists primarily of the cost of
products and outbound shipping costs, as well as the cost of promotional gifts.
Cost of net revenue increased 125% to $22.7 million for the nine months ended
September 30, 1999 from $10.1 million for the nine months ended September 30,
1998. Cost of net revenue increased primarily as the result of the sale of
significantly more units. As a percentage of net revenue, cost of net revenue
decreased to 105% for the nine months ended September 30, 1999 from 118% for the
nine
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<PAGE> 35
months ended September 30, 1998 due primarily to a significant below-cost
promotion in the third quarter of 1998, partially offset by the inclusion of
promotional gifts in cost of net revenue. While, in the future, we plan to
employ more selective pricing and promotional strategies and increase our focus
on advertising revenue, we may not be able to improve our cost of net revenue as
a percentage of net revenue.
Marketing and Sales. Marketing and sales expenses consist primarily of
expenditures related to marketing and advertising, promotions and strategic
alliances and the payroll and related expenses for personnel engaged in
marketing, selling and fulfillment activities and customer service. Marketing
and sales expenses increased 106% to $16.7 million for the nine months ended
September 30, 1999 from $8.1 million for the nine months ended September 30,
1998. This increase was primarily due to our aggressive marketing and branding
campaign and increased warehousing costs. We expect marketing and sales expenses
to increase as we continue to pursue our campaign to acquire new customers and
retain our existing customers. As a percentage of net revenue, marketing and
sales expenses decreased to 77% of net revenue for the nine months ended
September 30, 1999 from 95% for the nine months ended September 30, 1998.
Product Development. Product development expenses consist primarily of
payroll and related expenses for personnel involved in engineering and software
development, creating, licensing and publishing content and related updates,
merchandising, network operations, consultants, systems and telecommunications
infrastructure, costs of licensed technology and related updates. Product
development expenses increased 130% to $6.8 million for the nine months ended
September 30, 1999 from $2.9 million for the nine months ended September 30,
1998. This increase was primarily attributable to increased staffing and costs
related to developing and launching our next-generation Website with
significantly enhanced user features, expanded content and functionality and
improved back-end transaction-processing and reporting capabilities, as well as
increased investment in corporate information systems and telecommunications
infrastructure. We expect product development expenses to increase as we seek to
enhance the Reel.com customer experience and invest in the personnel and systems
required to properly support our future growth. As a percentage of net revenue,
product development expenses decreased to 31% for the nine months ended
September 30, 1999 from 34% for the nine months ended September 30, 1998 due to
an increase in net revenue.
General and Administrative. General and administrative expenses consist
primarily of payroll and related expenses for executive, accounting, human
resources and administrative personnel, professional fees, other general
corporate expenses, depreciation and amortization and the allocation of direct
costs for services provided by Hollywood Entertainment. General and
administrative expenses increased 77% to $4.1 million for the nine months ended
September 30, 1999 from $2.3 million for the nine months ended September 30,
1998. This increase was primarily due to increased payroll and related expenses
associated with additional personnel. We expect general and administrative
expenses to continue to increase as we expand our staff and incur additional
costs to support the future growth of our business. As a percentage of net
revenue, general and administrative expenses decreased to 19% for the nine
months ended September 30, 1999 from 27% for the nine months ended September 30,
1998 due to the significant increase in net revenue during the period.
Interest Expense, Net. Net interest expense of $2.7 million, recorded for
the nine months ended September 30, 1999, was attributable to the allocation of
interest expense from our parent, Hollywood Entertainment, associated with an
intercompany loan payable. The loan is the result of funding subsequent to the
acquisition of Reel.com by Hollywood Entertainment
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on October 1, 1998. It is our intent that upon completion of this offering $
million of the outstanding loan will be contributed to additional paid-in
capital and $10 million will be repaid out of the proceeds of this offering.
YEARS ENDED DECEMBER 31, 1997 AND DECEMBER 31, 1998
Net Revenue. Net revenue increased to $15.0 million for the year ended
December 31, 1998 from $745,000 for the year ended December 31, 1997. The
increase was primarily attributable to a significant increase in the number of
units sold due, in part, to the growth of our customer base.
Operating Expenses
Cost of Net Revenue. Cost of net revenue increased to $16.9 million for
the year ended December 31, 1998 compared to $547,000 for the year ended
December 31, 1997, due to our increased sales volume. As a percentage of net
revenue, cost of net revenue increased to 112% for the year ended December 31,
1998 from 73% for the year ended December 31, 1997. Our cost of net revenue was
greater than our net revenue for the year ended December 31, 1998. The increase
in cost of net revenue as a percentage of net revenue is attributable to a
significant below-cost promotion in the third quarter of 1998 and a product mix
shift from new and used videocassettes to DVDs.
Marketing and Sales. Marketing and sales expenses increased to $13.2
million for the year ended December 31, 1998 from $570,000 for the year ended
December 31, 1997. This increase was primarily due to our marketing and branding
campaign which commenced in 1998, as well as increased personnel and related
expenses required to implement our marketing strategy and the fulfillment of the
resulting higher level of sales.
Product Development. Product development expenses increased to $4.3
million for the year ended December 31, 1998 from $951,000 for the year ended
December 31, 1997. This increase was primarily attributable to increased
staffing and related costs incurred in building and enhancing the features,
content and functionality of our Website and commerce transaction-processing and
reporting capability, as well as increased investment in corporate information
systems and telecommunications infrastructure.
General and Administrative. General and administrative expenses increased
to $3.1 million for the year ended December 31, 1998 from $1.5 million for the
year ended December 31, 1997. This increase was primarily attributable to
increased payroll and related expenses associated with recruiting, hiring and
paying additional personnel.
Interest Expense, Net. Net interest expense of $618,000, recorded for the
year ended December 31, 1998, was attributable to the allocation of interest
expense from our parent associated with an intercompany loan payable.
YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1997
Net Revenue. Net revenue was $745,000 for the year ended December 31, 1997.
There was no revenue for the year ended December 31, 1996 as we had not yet
launched our Website nor did we have any operations.
Operating Expenses
Cost of Net Revenue. Cost of net revenue was $547,000 for the year ended
December 31, 1997. There was no cost of net revenue for the year ended December
31, 1996 because we had
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no revenue. Cost of net revenue as a percentage of net revenue was 73% for the
year ended December 31, 1997.
Marketing and Sales. Marketing and sales expenses increased to $570,000 for
the year ended December 31, 1997 from $53,000 for the year ended December 31,
1996. The increase was primarily attributable to marketing and advertising,
public relations and other efforts associated with launching and promoting our
Website.
Product Development. Product development expenses increased to $951,000 for
the year ended December 31, 1997 from $483,000 for the year ended December 31,
1996. The increase was primarily attributable to higher payroll and related
costs and consulting fees associated with launching and supporting our Website.
General and Administrative. General and administrative expenses increased
to $1.5 million for the year ended December 31, 1997 from $223,000 for the year
ended December 31, 1996. The increase was primarily attributable to higher
salaries and related expenses associated with the recruiting and hiring of
personnel in order to launch and support our Website.
Interest Expense, Net. No net interest expense was recorded for the year
ended December 31, 1997 or for the year ended December 31, 1996.
SELECTED QUARTERLY OPERATING RESULTS
The following table sets forth quarterly statement of operations data for
the seven quarters ended September 30, 1999. This information was derived from
unaudited financial statements that include, in the opinion of our management,
all adjustments necessary for a fair presentation of the information for these
periods. This data should be read in conjunction with the financial statements
and the related notes included elsewhere in this prospectus. These quarterly
operating results are not necessarily indicative of the operating results for
any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
(UNAUDITED)
--------------------------------------------------------------------------
MAR. 31, JUN. 30, SEP. 30, DEC. 31, MAR. 31, JUN. 30, SEP. 30,
1998 1998 1998 1998 1999 1999 1999
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net revenue.......................... $ 938 $ 1,441 $ 6,189 $ 6,472 $ 5,520 $ 7,071 $ 9,022
Operating expenses:
Cost of net revenue................ 751 1,210 8,152 6,747 5,744 7,345 9,618
Marketing and sales................ 447 1,124 6,532 5,114 4,973 5,222 6,477
Product development................ 552 765 1,631 1,385 1,875 2,315 2,587
General and administrative......... 478 825 1,038 736 901 1,338 1,894
------- ------- -------- -------- -------- -------- --------
2,228 3,924 17,353 13,982 13,493 16,220 20,576
------- ------- -------- -------- -------- -------- --------
(1,290) (2,483) (11,164) (7,510) (7,973) (9,149) (11,554)
Non-operating income (expense)....... (27) 9 (440) (157) (566) (890) (1,263)
Amortization of intangible assets.... -- 242 365 14,444 12,544 12,544 12,543
------- ------- -------- -------- -------- -------- --------
Net loss............................. $(1,317) $(2,716) $(11,969) $(22,111) $(21,083) $(22,583) $(25,360)
======= ======= ======== ======== ======== ======== ========
</TABLE>
Net revenue increased to $6.2 million for the three months ended September
30, 1998 from $1.4 million for the three months ended June 30, 1998 primarily
due to a significant product promotion in the three months ended September 30,
1998. Cost of net revenue increased to $8.2 million for the three months ended
September 30, 1998 from $1.2 million for the three months ended June 30, 1998
primarily due to the same product promotion in the three months ended September
30, 1998. Net revenue decreased to $5.5 million for the three months ended March
31, 1999 from $6.5 million in December 31, 1998 primarily due to
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increased sales in the holiday and gift-giving season in the three months ended
December 31, 1998.
Our operating results have fluctuated significantly from quarter to quarter
in the past, and we expect these fluctuations to continue in the future. For a
discussion of factors that might cause fluctuations in our operating results,
see "Risk Factors -- Our future operating results are unpredictable and may
fluctuate. If we fail to meet the expectations of securities analysts and
investors, the market price of our common stock may decline significantly." We
believe period-to-period comparisons of our operating results are not
necessarily meaningful. You should not rely on our quarterly operating results
to predict our future performance.
INCOME TAXES
Since October 1, 1998, Reel.com, as a wholly-owned subsidiary, has been
included in Hollywood Entertainment's U.S. consolidated income tax returns. As
such, any benefit for income taxes due to losses that we generate since October
31, 1998 may be utilized by Hollywood Entertainment. Consequently, such losses
may not be available to offset any future tax liability of Reel.com. Immediately
following the offering, Hollywood Entertainment will own an approximate %
equity interest in Reel.com. Our parent is a common parent of an affiliated
group of companies within the meaning of Section 1504(a) of the Internal Revenue
Code of 1986. We are part of that affiliated group. The Internal Revenue Code
requires that our parent own at least an 80% voting and economic ownership
interest in us in order to continue to include us in its U.S. consolidated
income tax returns. Following the completion of this offering, in accordance
with the terms of the tax allocation agreement we intend to enter into with our
parent, for so long as we remain a member of our parent's affiliated group:
- our parent will pay the consolidated tax liability of the group;
- we will pay our parent amounts equal to our income tax liability computed
as if we were filing a separate return; and
- any tax loss benefits attributable to us may be used by our parent
without any compensation to us and, to the extent so utilized, will not
be available to us in the future.
See "Certain Transactions -- Transactions with our Parent -- Income Tax
Matters Agreement."
LIQUIDITY AND CAPITAL RESOURCES
Net cash flows used by operating activities were $29.6 million for the nine
months ended September 30, 1999 and $8.2 million for the nine months ended
September 30, 1998. Cash used in the first nine months of 1999 was attributable
to a net loss of $69.0 million, net of adjustment for non-cash charges and
partially offset by depreciation and goodwill amortization of $37.6 million.
Cash used in the first nine months of 1998 was attributable to a net loss of
$16.0 million, net of adjustment for non-cash charges. Cash used by operating
activities were $19.3 million for the year ended December 31, 1998 and $2.5
million for the year ended December 31, 1997. Cash used in operating activities
in 1998 was attributable to a net loss of $38.1 million, net of adjustment for
non-cash charges and partially offset by depreciation and goodwill amortization
of $12.5 million. Cash used in operating activities in 1997 was attributable to
a net loss of $2.8 million, net of adjustment for non-cash charges.
Net cash used in investing activities was $2.0 million for the nine months
ended September 30, 1999. Net cash used by investing activities were $250,000
and $1.9 million for
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the years ended December 31, 1997 and 1998, respectively. The increases in 1998
and 1999 were primarily attributable to purchases of fixed assets.
Net cash from financing activities of $31.6 million in the first nine
months of 1999 was the result of funding contributions from Hollywood
Entertainment. Since our acquisition on October 1, 1998, we have relied on
Hollywood Entertainment for financing; however, Hollywood Entertainment is
limited in the amount of additional funding it may provide to us due to
restrictive covenants in its bank credit facilities. Net cash from financing
activities of $21.1 million for the year ended December 31, 1998 and $2.8
million for the year ended December 31, 1997 resulted from increases in equity
financing and notes payable.
Our liquidity and capital requirements depend on numerous factors discussed
under the section entitled "Risk Factors." Factors such as the ability to expand
our customer base, the costs associated with enhancing our Website, the level of
expenditures for marketing and sales, the level of investment in distribution,
customer service and other capabilities would also increase our liquidity
requirements. The timing and amount of these capital requirements cannot be
accurately predicted. Additionally, we will continue to evaluate possible
investments in businesses, products and technologies, and plan to expand our
marketing and sales programs and conduct additional brand promotions. Our
independent auditors' report on our financial statements was prepared on the
assumption that we will continue as a going concern. The report acknowledges
that we have incurred losses in each of the last three fiscal years and that we
will require that additional funding to sustain our operations. These conditions
cause substantial doubt as to our ability to continue as a going concern. Our
financial statements included herein do not include any adjustments that might
result should we be unable to continue as a going concern. If we are unable to
obtain sufficient financing or achieve profitability during the remainder of
1999 or during 2000, we will, experience severe liquidity problems and our
ability to continue as a going concern would be in doubt. However, we believe
that the net proceeds from this offering, together with our operating revenue,
will be sufficient to meet anticipated cash needs for at least the next 12
months. If we need to raise additional funds by issuing equity or convertible
debt securities, the percentage ownership of our stockholders will be diluted.
Furthermore, any new securities could have rights, preferences and privileges
senior to those of our common stock. We currently do not have any commitments
for additional financing. We cannot be certain that additional financing will be
available when and to the extent required or that, if available, it will be
available on acceptable terms. If adequate funds are not available on acceptable
terms, we may not be able to fund our expansion, develop or enhance our services
or respond to competitive pressures.
YEAR 2000 COMPLIANCE DISCLOSURE
Beginning in the Year 2000, the date fields coded in some software products
and computer systems will need to accept four-digit entries in order to
distinguish 21st century dates from 20th century dates and, as a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with these Year 2000 requirements. Systems that do not properly
recognize this information could generate erroneous data or cause a system to
fail. Significant uncertainty exists in the software industry concerning the
potential effects associated with these compliance issues.
State of Readiness
We have developed a comprehensive plan for addressing the Year 2000 issue
that involves identification, assessment and testing of the equipment and
systems affected. The plan, the
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implementation of which is expected to be complete by December 15, 1999,
required an initial inventory of the following:
- information technology equipment and systems, which includes Web servers
and Web serving technology, which has been completed;
- non-information technology embedded systems such as voice mail, fire
prevention and other systems, which has been completed;
The second phase of the plan required:
- a determination of those systems that require repair or replacement,
which is 95% complete;
- repair or replacement of those systems, which is 95% complete;
- testing of those repaired or replaced systems, which is 95% complete; and
- the creation of contingency plans in the event of Year 2000 failures,
which is 50% complete.
To date, less than 5% of assessed systems have required repair or
replacement. Non-information technology systems and internally developed
programs have been reviewed, and are not considered to be date sensitive to the
Year 2000. Based on this evaluation, we do not believe that our systems and
programs present Year 2000 issues, and generally believe that they will be Year
2000 compliant.
Although we believe that we will be Year 2000 compliant, third-party
equipment and software is used that may not be Year 2000 compliant. We have
commenced an evaluation of the Year 2000 compliance of the third-party products
used in our internal systems, but we are unable to predict the extent to which
we would be vulnerable to the inability of our third-party equipment or software
providers to remediate any Year 2000 issues on a timely basis.
All vendor and supplier readiness has been assessed and tracked.
Representations from these vendors and suppliers indicate that they are Year
2000 compliant. These vendors and suppliers include merchandise suppliers such
as Baker & Taylor, Inc., and financial service suppliers such as CyberCash. The
failure of one of these vendors or suppliers to convert its systems on a timely
basis or in a manner compatible with our systems could cause us to incur
unanticipated expenses to remedy any problems and could adversely affect our
business. We have conducted and are planning to conduct additional integration
tests for Year 2000 compliance where specific dates are simulated. In addition,
the software and hardware products used by affiliate Websites, advertisers,
customers, governmental agencies, public utilities, telecommunication companies
and others may not be Year 2000 compliant. If these products are not Year 2000
compliant, customers' ability to use our Website may be disrupted.
Costs to Address Year 2000 Compliance
To date, we have incurred approximately $100,000 in expenses in connection
with identifying or evaluating Year 2000 compliance issues. These expenses are
related to outside services and software. However, the full impact of the Year
2000 issues cannot be determined at this time. The failure by certain third
parties to address their Year 2000 issues on a timely basis could adversely
affect our business.
Contingency Plan and Risks
We have not yet completed our Year 2000 contingency plans. Such plans
include, but are not limited to, using alternative suppliers and establishing
contingent supply arrangements. We
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expect to have our plans in place by the end of the fourth quarter of 1999. The
worst case scenario related to Year 2000 issues would involve a major shutdown
of the Internet, which would result in the loss of our principal revenue source
until the shutdown is resolved.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards, or SFAS, No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
the way companies report information about operating segments in annual
financial statements. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. The
disclosures prescribed by SFAS No. 131 are effective for the year ended December
31, 1998. We have determined that we do not have any separately reportable
business segments as of December 31, 1998.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position, or SOP, No. 98-1, Software for Internal Use, which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. SOP No. 98-1 is effective for financial statements
for fiscal years beginning after December 15, 1998. We do not expect that the
adoption of SOP No. 98-1 will have a material impact on our consolidated
financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
Accounting for Derivative Instruments and Hedging Activities which is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. This
statement establishes a new model for accounting for derivatives and hedging
activities. Under SFAS No. 133, all derivatives must be recognized as assets and
liabilities and measured at fair value. In July 1999, the FASB issued Statement
of Accounting Standards No. 137 Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133
which defers the effective date to all fiscal quarters of fiscal years beginning
after June 15, 2000. The adoption of SFAS No. 133 is not expected to have a
significant impact on the Company's financial position or results of operations.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximizing income we receive from investments without
significantly increased risk. Some of the securities we invest in may be subject
to market risk. This means that a change in prevailing interest rates may cause
the principal amount of the investment to fluctuate. For example, if we hold a
security that was issued with a fixed interest rate at the then-prevailing rate
and the prevailing interest rate later rises, the value of our investment will
probably decline. To minimize this risk in the future, we intend to maintain our
portfolio of cash equivalents and short-term investments in a variety of
securities, including commercial paper, money market funds, government and
non-government debt securities and certificates of deposit. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate.
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BUSINESS
OVERVIEW
Reel.com is a premier online destination for film-related content and
commerce. Through our Website, we provide consumers with an intuitive,
entertaining environment in which they can access a wide variety of film-related
information, such as news, film reviews, trivia, interviews, film clips and
editorial recommendations, and purchase a broad range of films. Our original
editorial content, coupled with our extensive selection of approximately 50,000
videocassette and DVD titles, provide a source of film exploration and
acquisition and encourage regular, active use of our Website. With our audience
of film consumers and enthusiasts, we believe we are well positioned to offer a
valuable marketing platform for film studios, advertisers and merchants. In
addition, our relationship with our parent company, Hollywood Entertainment,
which operates more than 1,500 Hollywood Video stores, provides us with
substantial opportunities for marketing to its members.
We have a strong online commerce brand, and we have experienced significant
momentum in our customer traffic and online sales. We were rated one of the top
10 most recognized Internet commerce brands by Opinion Research Corporation
International in August 1999, and we were recently named "the best place to buy
movies" by Yahoo! Internet Life. According to Media Metrix, the number of unique
visitors to our Website increased from 848,000 in January 1999 to approximately
1.4 million in September 1999. Our revenue has increased from approximately $8.6
million for the nine months ended September 30, 1998 to approximately $21.6
million for the nine months ended September 30, 1999.
INDUSTRY BACKGROUND
The Filmed Entertainment Industry
The Market for Filmed Entertainment. Filmed entertainment is an
increasingly popular pastime. According to Forrester Research, Inc., there are
over 70,000 titles in release, and Veronis, Suhler & Associates, Inc. estimates
that approximately 400 new films are released each year. Films vary by plot and
genre and feature diverse combinations of actors, producers and directors,
creating a rich and varied entertainment library that can appeal to a wide range
of film consumers. The broad appeal of films has led to substantial consumer
spending. Paul Kagan Associates, Inc. projects that domestic consumer spending
in 1999 will total $7.1 billion at the box-office, $16.5 billion for the rental
and sale of videocassettes and DVDs, and $6.0 billion for cable and satellite
subscriptions.
Production and Distribution of Films. Production of filmed entertainment
requires extensive up-front capital costs, with an average cost per film of
$52.7 million in 1998, according to the Motion Pictures Association Worldwide,
or the MPA. To recover these costs, movie studios seek to maximize revenue
within each channel of distribution, pursuing a strategy of sequential release
"windows" that allows each channel to offer new releases for a limited time
before making them available to the next channel. These distribution channels
generally include, in release date order: theaters; video stores; pay-per-view
television, including direct broadcast satellite, or DBS; premium cable; network
television and basic cable. The major studios also invest significantly in
marketing in an effort to further drive revenues within each channel. In 1998,
the average marketing cost for new feature films was $25.3 million, according to
the MPA. The majority of this spending is directed at the theatrical and video
store channels.
Influences on Consumer Spending for Filmed Entertainment. Studios promote
consumer awareness of filmed entertainment through advertising and marketing of
both upcoming
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releases and films from their libraries. For example, film trailers and
television advertising are powerful marketing tools often used by the studios to
influence consumer spending. Similarly, major studios arrange promotional
television appearances by celebrity performers, as well as timely interviews in
print and other media. In addition to studio promotion, consumer spending on
filmed entertainment can be influenced by the appeal of a particular film maker
or performer, or by the content and subject matter of a film, as well as by
television, print and Internet reviews and word-of-mouth. Retailers of home
videos draw significant promotional dollars from the studios by providing
attractive opportunities to market to qualified film consumers at the point of
sale. For example, retailers can attract promotional dollars to support direct
marketing efforts, including direct mailings and email distributions, periodic
publications and point-of-sale displays, including film trailers.
Trends in Home Distribution of Filmed Entertainment
Paul Kagan Associates, Inc. estimates that, in 1999, consumer spending on
home videos will be approximately $16.5 billion, approximately half of which
will be retail sales of videocassettes and DVDs. These formats currently offer
consumers the greatest selection and the highest degree of flexibility in
choosing the films they wish to view at home. Currently, a majority of
prerecorded films are played on videocassette recorders, or VCRs. According to
Forrester Research, Inc., over 89% of U.S. television households own VCRs. We
believe a significant number of consumers currently using VCRs will adopt and
use DVD players. Paul Kagan Associates, Inc. estimates that by the end of 2000,
the installed base of DVD players in North America will be 6.6 million and that
this number will grow to 10.1 million by the end of 2001. Moreover, many
personal computer manufacturers are offering DVD/CD-ROM drives, enabling
personal computers to play DVDs. We believe that, as the introduction of the
compact disc, or CD, player precipitated an increase in music sales in the
mid-1980's, as the installed base of DVD players and the number of available
titles increase, viewers will seek to replace their existing libraries of
videocassette titles with DVDs.
Benefits of the Internet to the Filmed Entertainment Industry
There is an extensive amount of information relating to the large number of
films in existence as well as industry news, film reviews and biographical
information on actors and directors. The distinctive functionality of the
Internet enables the aggregation and accessibility of this information and
allows film consumers to easily search for specific information. On the
Internet, informative and engaging content, such as recommendations and reviews,
can be linked to a film title, helping the online film consumer make informed
viewing decisions and, at the same time, have an interactive and enjoyable
experience. Similarly, the Internet creates an opportunity to offer products in
the context of relevant and entertaining content, enabling an online film
destination to market and drive demand for a wide range of films.
The Internet is an attractive marketplace to shop for films because an
online film destination can stock a greater number of films, provide consumers
with a wider variety of category offerings and create more innovative displays
than physical stores or catalogs, which have limitations on inventory, shelf and
catalog space. Online film consumers can find the films they want in one place,
searching either by title, actor, genre or other category, rather than searching
through different stores and catalogs. In addition, the Internet provides a
superior platform to shop for products that are information-intensive yet do not
require physical inspection, such as videocassettes and DVDs. The Internet also
enables online retailers to provide additional value-added services to consumers
more efficiently, such as notification of upcoming releases and pre-release
reservations.
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As more consumers connect to the Internet via high-speed broadband
connections, such as satellite data broadcast, cable modems and digital
subscriber line, or DSL, we believe they will demand a richer digital media
experience. For example, consumers may want to utilize film-related content,
such as interviews, reviews and trailers, delivered with full-motion video and
CD-quality audio, when making film viewing and purchase decisions. Ultimately,
as bandwidth increases, we anticipate that the functionality of the personal
computer and the television will converge, increasing the viability of the
digital distribution of full-length filmed entertainment directly to the
consumer.
Opportunity for an Online Filmed Entertainment Destination
We believe a significant opportunity exists to create an online filmed
entertainment destination that is the premier source for film consumers and
enthusiasts to discover new films, search for film-related information and
purchase films. By integrating many of the elements that influence film-viewing
decisions with a broad product selection, a filmed entertainment destination
site can provide a one-stop information-gathering and shopping experience. Such
a destination could be an attractive platform for film studios to promote new
releases and other titles to a broad range of film consumers. With a customer
base of film consumers and enthusiasts, a filmed entertainment destination can
offer film studios the opportunity to provide compelling promotions at the point
of sale as well as provide other advertisers with an attractive audience.
REEL.COM SOLUTION
We are a leading online destination for discovering new films, searching
for film-related information and purchasing films. Our extensive selection of
approximately 50,000 videocassette and DVD titles, coupled with original
editorial content, provide a source of film exploration and acquisition and
encourage regular, active use of our Website. We offer the film consumer access
to a greater selection of films than is typically available through traditional
retail outlets. We offer a compelling, interactive film experience for
consumers, attracting more than 1.4 million unique visitors to Reel.com in
September 1999, according to Media Metrix. With this audience, we believe we are
well positioned to offer a valuable marketing platform for film studios,
advertisers and merchants. Our relationship with our parent company, Hollywood
Entertainment, which operates Hollywood Video, the nation's second largest video
rental chain, provides us with inherent advantages over exclusively online film
retailers. Over the past 11 years, Hollywood Entertainment has established a
well-recognized and valuable brand name, and now has over 1,500 stores and a
large membership base. We have substantial opportunities for marketing to our
parent's customer base, and we use our parent's stores to promote and drive
traffic to the Reel.com site.
The key components of our solution include:
Engaging Content. Our Website informs and entertains visitors by offering
news, film reviews, trivia, interviews, film clips and editorial recommendations
about new and other films. We also offer games and contests targeted to the avid
film enthusiast. On our Website users can also find answers to frequently asked
questions and have the opportunity to preview almost 900 trailers as well as
other rich media content. Our editorial staff maintains and updates our Website
daily to provide our visitors with a current source of information and products.
Based on a customer's initial film selection, our Movie Matches feature allows
us to recommend films to our users based on similar film features and
characteristics. Our Movie Anatomy feature offers users a detailed, proprietary
rating system covering many aspects of a
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film's content to help them make more informed purchase decisions. We offer
original interviews and film reviews as well as news and biographies. In
addition, we have developed proprietary authoring tools that enable our editors
to easily create and publish new content for our site, allowing us to update and
refresh our site daily. Our film coverage spans all genres, including action,
comedy, drama, independent, kids and science fiction. We capitalize on our
network of relationships with the film community to gain access to information
about films in production, in theaters and already available on DVD or
videocassette.
Extensive Product Selection and a Superior Shopping Experience. We offer
approximately 50,000 titles on the videocassette format and 4,500 titles on the
DVD format. We offer our films at competitive prices and enable our customers to
order many titles up to three months in advance of the film's release. Our
Website provides customers with an easy-to-use shopping interface that is
available from the convenience of a customer's home or office. Our search
technology makes it easy for consumers to locate films efficiently based on
pre-selected criteria categorized, including title, name of actor or director,
genre, language, price range, year of movie release, rating, version, country of
origin and format. In addition, we provide sales support via live one-on-one Web
chat 24 hours per day, seven days per week and via email and telephone service.
Once orders are placed, customers are able to view the status of their orders on
our Website or contact a customer service representative. In addition, our
customer service representatives are a valuable source of feedback regarding
customer satisfaction.
Powerful Promotional Outlet. We work with film studios, including MGM,
Sony Pictures Entertainment and Warner Bros., to introduce consumers to a
variety of new films and information and to promote films. We provide studios
and other advertisers access to a highly desirable group of qualified consumers.
We collect demographic information about our users that can be used to target
advertising and commerce opportunities. In September 1999, according to Media
Metrix, our site attracted approximately 1.4 million unique visitors, who
generated approximately 22.9 million page views. Capitalizing on our platform,
studios have the opportunity to influence filmed entertainment viewing decisions
by delivering interactive promotional material directly to these targeted
consumers. For example, as part of their promotional efforts, studios have
provided us with access to original content, such as interviews with
high-profile personalities in films. In addition, we offer the major studios the
ability to create a store within our site that facilitates sales of their
titles, offer coupons for special promotions and promote their brands by linking
to their sites.
STRATEGY
Our objective is to become the leading online destination for film-related
content, commerce and community. Key elements of our strategy include:
Offer Compelling Value and Enhance the User Experience. We seek to enhance
customer loyalty by offering one of the largest selections of videocassettes and
DVDs available online. We also seek to provide fast, accurate and reliable
delivery and, to that end, have focused on adding innovative new technologies to
our commerce infrastructure and at our distribution center. To reduce
price-shopping by consumers, we offer all movies with our lowest price
guarantee. In addition, we are committed to making every aspect of browsing and
shopping on our Website an easy and pleasurable experience. We intend to
continue to improve the design, layout and navigation of all elements of our
Website, as well as to ensure that our site's performance metrics are
competitive, especially with regard to page download times and the speed of all
search functions. We intend to implement technologies that will allow
personalization of our site. We also strive to make our entire ordering and
checkout process
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easy, intuitive, fast and secure. In addition, we intend to continue to enhance
our excellent customer service.
Provide Engaging Content. We believe that continuing to develop compelling
new audio, visual and HTML content about films is critical to expanding our
audience and to our commerce and advertising efforts. We will continue to
provide informative and innovative content to visitors throughout a film's
production and distribution life cycle. Strategic alliances with TVGuide,
HarperCollins, E-Clips and others will allow us to provide our users with
additional content, such as a database of cast, crew and credit information for
films released theatrically in the U.S. since 1930, biographies of over 6,000
actors, directors and producers, online trailers, ticketing, release schedules,
film reviews and exclusive celebrity interviews. Additional features we plan to
add to our site include an online selection of streaming video programming
created specifically for Internet distribution and an interactive section that
may include daily movie trivia, moderated celebrity chat, reader reviews,
message boards, film classes and polling.
We intend to continue to develop and expand our content team, with the goal
of increasing its visibility among film consumers and film-related advertisers.
Our team currently includes industry veterans from film-related publications,
such as Cinemania and Mr. Showbiz, and film studios, such as Disney and
Twentieth Century Fox. We intend to build on the strength of our editorial team
and will seek to establish relationships with well-known industry personalities.
Continue to Build and Extend Brand Recognition. We believe that
maintaining a strong brand identity is critical to our ability to attract
customers and advertisers and build relationships with studios. Our goal is to
make the Reel.com brand synonymous with the best selection of filmed
entertainment and related original content available online. We were an early
entrant in the online film market and intend to capitalize on the lack of
established national retail brands in the online film industry. We plan to
differentiate ourselves based on the quality of our commerce and content
offerings. Our strategy is to aggressively promote and advertise to increase
awareness of our brand through a variety of techniques, including:
- engaging in targeted radio, print and other media campaigns;
- advertising on leading Websites, such as America Online, Inc.,
Entertainment Weekly.com, E! Online, LLC and the Los Angeles Times, and
in film-related publications, such as Entertainment Weekly, Home Theater
and Premiere;
- leveraging our parent's database of members and cross-marketing to these
consumers both in-store and through direct marketing;
- capitalizing on our good relationships, and those of our parent, with the
major film studios, to develop product-specific promotions, contests and
giveaways;
- sponsoring and developing strategic alliances with traditional online
traffic aggregators, such as AOL, Excite, Inc. and Yahoo! Inc., in order
to attract film consumers and buyers of DVDs; and
- conducting an ongoing public relations campaign.
Build an Online Community. We intend to create a community for users to
interact and share opinions, reviews, ideas and film-related information. We
believe our success will be, in part, a result of building customer loyalty by
joining community with content and commerce. We believe our target audience
places great value on opportunities to interact with others who share a similar
interest in films. Accordingly, we intend to offer a variety of interactive
tools,
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which may include celebrity chat, interactive Q&A, email publications and
updates, message boards, user chat rooms and targeted communities.
Increase Advertising Revenue and Diversify Revenue Streams. Our strategy
is to leverage our position as a leading online commerce brand, together with
our operating infrastructure and customer base, to broaden our market presence
and increase advertising revenue opportunities. While our primary focus has been
on selling videocassettes, DVDs and film-related merchandise, we believe that
our ability to attract and define large, demographically profiled audiences will
create a meaningful opportunity to increase advertising revenue. We intend to
increase the value of our customer base and visitor traffic to our advertisers
through enhanced collection and analysis of visitor demographic and consumer
preference data. In addition, we seek to improve the effectiveness of our
advertisers' promotions through technologies that dynamically serve-up banners
on our Website. We also plan to establish an advertising sales force to acquire
new advertisers and increase advertising revenue. In addition, we believe that
adding complementary products, such as film soundtracks, film merchandise,
entertainment magazines and other related products, such as games and music,
could be a natural extension of our commerce and brand infrastructure and offers
incremental revenue opportunities.
Capitalize on New Distribution Technologies. We intend to increase
distribution of rich content through our Website as new technologies are
developed that optimize bandwidth. We believe that online video-related content
will become increasingly compelling as bandwidth increases. We are continuing to
expand our high-bandwidth offerings through the creation and acquisition of
additional content. In addition, we believe that our support of new technologies
and formats will enable us to position ourselves as a delivery mechanism for
downloadable content, regardless of which dominant technology or delivery
formats may emerge in the future. Ultimately, we anticipate that the
functionality of the personal computer and the television will converge,
increasing the viability of the digital distribution of full-length filmed
entertainment directly to the consumer. We intend to continue to pursue
technology-related alliances, such as our current video-on-demand, or VOD,
project with Sprint/United Management Company, to facilitate our ability to
implement these new technologies as they become commercially available.
REEL.COM
One of the distinctive advantages of our Website relative to traditional
retail stores is our ability to integrate product information and editorial
content throughout our commerce offering. At our Website, customers can find
detailed product information, including reviews and recommendations of related
titles, and view movie previews on our movie overview pages. The foundation of
our site is our database, which contains information for approximately 50,000
movie titles, from the silent era through current theatrical releases.
Approximately 10,000 of the most popular titles in our database are enhanced
with a wide variety of proprietary content including the following:
- Movie Snapshot. We assist visitors to our Website in making film choices
by providing a brief, descriptive and objective summary of the film,
designed to help customers decide if the film's subject matter appeals to
them.
- Movie Anatomy. Our editors have created a rating scale of one to 10 to
evaluate 14 basic elements of the movies in our database. These 14 key
elements are action, character development, cinematography, drama depth,
family appeal, Hollywood style, humor, offbeat energy, romance, sex,
soundtrack, special effects, suspense and violence.
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- Movie Matches. We assist visitors to our Website in discovering new
films that will appeal to their individual tastes. Customers select the
title of a film and we provide a list of Movie Matches that our editors
believe cover the same subject, appeal to the same audience or provide a
similar movie-viewing experience.
Editorial Features. We believe that we attract new and repeat visitors by
creating compelling topical content and an entertaining experience for users.
Our site is maintained and updated regularly by our editorial staff to provide
users with a current source of information. This information includes:
- In Theaters. We offer our visitors exclusive reviews and summary ratings
of new films released theatrically each week, written by professional
critics, as well as previews and trailers of films that will be released
in the weeks ahead. In addition, we provide a Movie Snapshot describing
the film, a rating and editorial review of the film, a Movie Anatomy
objectively analyzing the film's key elements, and Movie Matches listing
similar films. Because films move from the theatrical to the retail
window, this content can be featured again when the films reviewed are
released on videocassette and DVD.
- Movie News. We provide original content about films and the film
industry obtained through our network of editors, columnists and
individual contributors. This content includes news and buzz about films
that are still in production, in theatrical release and available on DVD
or videocassette. Because many movie consumers are passionate about
films, the ability to provide exclusive and up-to-the-minute news allows
us to build a relationship with highly qualified customers and provides a
key competitive advantage over other online filmed entertainment sites.
- Features. Our network of relationships within the film community allows
us to interview celebrities such as Nicholas Cage and Harrison Ford, as
well as filmmakers and other behind-the-scenes industry insiders. In
addition, we offer recurring columns designed to encourage frequent
repeat visits. We also create special features based on specific film
topics and genres (such as the Star Wars Phenomenon and the 100 Scariest
Movies of All Time), creating a natural opportunity for merchandising a
wide variety of related films.
- Games and Contests. We have created a variety of film-related games and
contests for our users and affiliates, including our Oscar(R) Prediction
Game, which allowed users to create private pools, handicap Oscar(R)
favorites and calculate pool winners; our Star Wars Trivia Contest, which
allowed affiliates to place a trivia game on their sites; and our Daily
Trivia Challenge, which allows our customers to accumulate points which
can be redeemed for discounts on product purchases.
- New to VHS/DVD. In addition to providing accurate and in-depth
information about available and upcoming videocassette and DVD releases,
we supply users with the latest DVD news, original feature stories about
digital equipment trends, the latest information about DVD technology and
a weekly column that answers users' questions about DVD releases and
technology. We also feature reviews of special edition videocassettes and
DVDs that have been re-released with expanded or supplemented content.
- Screening Room. We offer almost 900 on-demand streaming video trailers
and original video programming. This content is available in both Real
Player and Microsoft Media player format and is optimized for a variety
of connection speeds.
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- Award Winners. We feature an archive of Academy Award winners as well as
festival and other award winners. Film awards are integrated into our
product database so that customers can see which awards a film has won.
- Top Ten. We help users identify what is "hot" at the box office as well
as on videocassette and DVD by offering lists of the week's top box
office and film rental performers.
- For Your Kids. We offer a section designed to help parents make educated
decisions about their children's entertainment selections.
Shopping Experience. We designed our Website to be efficient and intuitive
for customers who know what they want, while at the same time engaging,
educational and helpful for those customers who have not yet identified a
particular film to purchase. Consumers using our site can conduct targeted
searches, explore a vast array of films via our relational database, obtain film
recommendations, purchase films and check the status of their orders. The
following highlights some of the key features of our Website:
- Searching. Our Website offers visitors a variety of highlighted subject
topics and special features arranged in a simple, easy-to-use layout
intended to expedite product search and facilitate easy selection. Users
can execute sophisticated searches based on numerous pre-selected
criteria, including title, names of actor or director, genre, language,
price range, year of movie release rating, version, country of origin and
format. Many of our Website sections were designed with the particular
needs of a specific category of user in mind. For example, the Kids
Section of the Website will guide children or anyone shopping for
children to titles that are appropriate for a younger age group, and the
DVD section is tailored to meet the needs of the DVD customer.
- Browsing. We provide an extensive selection of videocassette and DVD
titles that would be economically impractical to stock in a traditional
physical store. Our Website provides us significant flexibility to
organize and present our products without having to alter the layout of a
physical store. Depending on customers' personal preferences, they can
customize the Reel.com shopping experience so that our inventory is
merchandised by actor, genre, director or other criteria. Further, the
relational nature of our database and links between various areas within
our Website allow a browsing user to explore and learn. For example, a
customer might start with a recent theatrical release, then link to a
specific actor's filmography, and then end up reading about a classic
film that features that actor. To encourage purchases, we feature various
rotating promotions, frequently updating our online recommendations and
adding content from third-party experts. For example, our Holiday Store
features three convenient ways for a customer to shop. Our Reel
Recommends section allows customers to match the tastes of their selected
gift recipients with our Gift Wishers profiles. We also offer Gift
Finder, which facilitates gift selection through short, fun and easy
questions about the gift recipient. Finally, our Gift Center features
Gifts Under $10, Gifts for Kids and other suggestions.
- Ordering. We have designed our ordering system based on comments from
our customers. Customers simply click on the "order" button to add
products to their virtual shopping carts, and can add and subtract
products while browsing in our store prior to checkout. During a shopping
session, a customer can click on a title and determine, immediately, if
the product is available. If the product is in our distribution center or
that of our fulfillment partner, our site indicates that the product
generally ships in one to two days. If the product is not in stock, our
site will indicate that the product will be
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shipped in two to three weeks or that the product is unavailable.
Customers who want to complete orders simply proceed to the checkout
page, enter their names, shipping and billing information, select
shipping and payment methods and complete the transactions. Customers
generally use credit cards or debit cards, which are authorized during
the checkout process and charged when the items are shipped. Our Website
uses an encryption technology that works with the most common Internet
browsers to prevent unauthorized parties from reading information sent by
our customers. Our system automatically confirms receipt of each order
via email within minutes and notifies customers when we ship their
orders. We keep customers' information in our database, which facilitates
repeat purchases by eliminating the need for customers to resubmit
information on future orders.
- Getting help. From every page of our Website, customers can click on a
customer service icon to go to our customer service area. In this area,
we assist customers in searching for, shopping for, ordering and
returning our products. In addition, we provide customers with
information on our policies, answer their most frequently asked questions
and request their suggestions via email. Our customer service
representatives are available to answer questions about products and the
shopping process via our one-on-one live Web chat 24 hours per day, seven
days per week. Customer service is also available via email and our
toll-free number, which is displayed in the customer service area of our
online store.
MARKETING AND SALES
The fundamental elements of our marketing and sales strategy are as
follows:
- build brand recognition;
- attract new and repeat visitors and customers to our Website;
- maximize repeat purchases; and
- build strong customer loyalty.
In order to implement our marketing strategy, we have and will employ
multiple channels, including:
Traditional Advertising. We engage in print and radio advertising programs
to acquire new customers. We regularly advertise in publications that are
attractive to our users, including Entertainment Weekly, Home Theater and
Premiere. We also periodically run radio advertising campaigns in major markets,
including Chicago, Dallas, Detroit, Los Angeles, New York and San Francisco.
Internet Advertising and Promotion. We advertise in directed areas of
major Internet search and directory providers, such as @Home, AOL, Excite, MSN
and Yahoo! We also advertise throughout film and entertainment-oriented sites,
such as Chicago Sun Times, E! Online, Film.com, Los Angeles Times, Moviefinder,
Planet Out, Turner Home Entertainment and TV Guide Entertainment Network. We
believe that this targeted strategy is more cost-effective than other methods of
advertising on the Internet. Our advertisements usually take the form of key
words or banners that are designed to encourage users to click through to our
Website.
Strategic Alliances. We have strategic relationships with several major
online portals to expand our online presence. For example, we are a tenant on
AOL and we are prominently promoted through banner and other advertisements on
AOL's online services. We are also the exclusive videocassette and DVD merchant
for Excite and Webcrawler in their Entertainment
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Channel and Shopping Channel. Additionally, our movie content is featured in
selected portions of the Excite entertainment site, and elements of our movie
content database are provided on co-branded pages to Excite users, who search
for a movie title, actor or director name. Lycos/Hotbot prominently features our
products and advertisements as well as links to our Website.
Strategic Relationship with our Parent. We intend to continue to leverage
our ability to promote our products and content in our parent's marketing
channels. We are prominently featured in our parent's retail properties through
traditional point-of-sale displays and video promotions and are regularly
included in monthly direct mailings. In addition, we intend to enter into
agreements with our parent to pursue mutually beneficial opportunities to
leverage each party's content, membership base and expertise.
Direct Marketing. We are conducting an ongoing customer email campaign
that distributes a variety of direct response pieces, including a bi-weekly
newsletter, which contains proprietary movie content and highlights current and
upcoming features and promotions on our Website. We also drive sales by offering
special discounts and promotional offers which users learn about on our site.
Our direct-to-consumer traditional mailings leverage our parent's sizable
marketing channels at little incremental cost. We intend to continue to
advertise in our parent's retail stores, in-store magazine and direct mail
pieces.
Public Relations. Our consumer public relations include press release
development and distribution, press mailings and media outreach. Our corporate
public relations program includes business and trade press outreach, speaking
engagements and industry awards. As a result, we have been featured in stories
in national newspapers, consumer and business publications and a variety of
television shows and radio programs. Our executives have been invited to
participate in industry events, and our site has won high-profile awards. This
recognition has supported our brand-building and traffic-building efforts and
has helped position Reel.com as a leading online commerce brand.
Affiliate Marketing Program. We have created the Reel.com affiliate
network, a marketing program designed to increase our exposure on the Internet
and to acquire new customers and generate additional sales at a low incremental
cost. In order to join our affiliate marketing program, prospective affiliates
complete an online application form online and create tracking links to Reel.com
through an automated link generator. Registered affiliates are paid a referral
fee, in most cases a percentage of the net sales for any revenue generated via
an affiliate's link to our site. Our affiliate program, managed by BeFree, Inc.,
had over 110,000 members as of September 30, 1999, including both companies and
individuals. Key participants in our affiliate marketing program include
Homepage.com, Homestead.com, Xoom, Inc. and Yahoo!/GeoCities. Our affiliate
program has been a proven customer acquisition and retention tool and many of
our affiliates have also become loyal customers and advocates.
Promotional Gifts and Discounts. We offer gift and discount programs to
increase awareness of our brand, acquire new customers and expand our
membership. For example, we have significantly discounted high-profile, new
releases, and we have offered consumers a chance to receive a free movie after
becoming a customer. These programs have created higher conversion rates than
our traditional advertising, convinced consumers to become Internet film
purchasers and created significant marketing benefits.
ADVERTISING SALES
As we attract more consumers to our site and build our internal advertising
sales department, we believe that our advertising sales will increase. A variety
of marketers,
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including AOL, Dell, FirstUSA Bank, N.A. and VISA U.S.A. Inc., have provided
sponsorship and have advertised on our Website. We also receive support from
studios in the form of discounts and special promotions for our Studio Specials
section. We intend to continue to expand our editorial sections to meet the
needs of prospective advertisers. Advertising sales accounted for approximately
9.4% of our revenues in the nine-month period ended September 30, 1999. We
intend to expand our marketing and sales team to better understand advertisers'
needs and to better target our users and customers.
SUPPLIER RELATIONSHIPS
We currently purchase a majority of our videocassettes and DVDs from
various suppliers based on the lowest cost available. Historically, we have not
purchased a substantial portion of our inventory directly from major or
independent film studios, but we intend to do so in the future. We do not have
long-term written supply agreements with any studio or other supplier.
PRODUCT DISTRIBUTION
We ship a majority of our customer orders from our approximately
27,000-square-foot distribution center located in San Leandro, California. The
remainder of our products are shipped by our fulfillment partner, Baker & Taylor
Inc. Between our distribution center and those of our partner, we currently
offer approximately 50,000 unique videocassette titles and 4,500 unique DVD
titles. Orders are communicated from our Website to our warehouse through an
order-processing system that controls the pick, pack and ship processes. This
system also provides our Website with real-time information about inventory
activity and status, which enables the Website to display individual product
availability. Customers can choose to have their orders shipped overnight,
second day or standard delivery. We believe that our rapid delivery contributes
substantially to the satisfaction of our customers. To ensure that our
distribution network is efficient and scaleable, we are building an automated
packaging and distribution system designed to reduce distribution costs per unit
shipped. We also intend to implement a more robust warehouse management system.
CUSTOMER SERVICE
We believe that superior customer service and support is critical to
retaining and expanding our customer base. We provide timely responses to both
telephone and email inquiries. We also recently implemented a live chat feature
on our site that allows customers to have one-on-one, real-time online
interaction with a customer service representative 24 hours per day, seven days
per week. In addition, we recently expanded our telephone and email capacity by
opening a new call center in our corporate offices, at which we employ 62
full-time customer service representatives. Our customer service team is
responsible for handling general customer inquiries, answering customer
questions about the ordering process, investigating the status of orders,
shipments and payments, as well as processing customer orders. In addition, our
customer service team uses our email system to proactively update customers on a
variety of topics, including changes in release dates, pricing changes and the
status of unique shipments. In addition to in-house resources, we use Kana
Communications, Inc. and PeopleSupport, Inc. to support our email services and
Modus Media International, Inc. to support our telephone customer service
representatives.
COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive, and we expect that competition will further intensify in the
future. Barriers to entry are not extensive, and current and new competitors can
launch new sites at a relatively low cost. We currently
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compete with a variety of online vendors who specialize in DVDs and
videocassettes, as well as general merchants, particularly those who sell books,
music and other entertainment products. Our online competitors are particularly
able to use the Internet as a marketing medium to reach significant numbers of
potential customers. Finally, new technologies and the expansion of existing
technologies, such as price comparison programs, may increase competition. Some
of our current online competitors include Amazon.com, Inc., barnesandnoble.com
inc., BigStar Entertainment, Inc., Blockbuster Entertainment Corp., Borders
Online, Inc., Buy.com, Inc. and DVD EXPRESS, Inc.
The broader retail video industry is also intensely competitive. We compete
with traditional retailers, including specialty video retailers, mass
merchandisers, department and consumer electronics stores, as well as non-store
retailers, such as mail-order video clubs. Many of these traditional retailers
also support dedicated Websites that compete with us directly. Many of our
current traditional retailer competitors, including Best Buy Co. Inc.,
Blockbuster Entertainment Corp., Hollywood Entertainment, MusicLand Stores
Corporation, Tower Records, a division of MTS, Inc., and Wherehouse
Entertainment have significantly greater experience in selling video, music,
game or software products.
The filmed entertainment information market is also rapidly evolving and
intensely competitive. Major online traffic aggregators, such as AOL, Excite,
Yahoo! and others, may continue to expand their offerings of film-related
content. Other entertainment sites, such as E! Online, Hollywood.com and Mr.
Showbiz, may choose to focus more heavily on marketing to the film consumer. In
addition, new and existing competitors may focus solely on the delivery of rich
media on-demand film content.
We believe that the principal competitive factors in our market are brand
recognition, site content, product selection, reliable and timely fulfillment,
ease of use, customer service and price. We believe that we compete favorably
with respect to these factors. Many of our current and potential competitors
have longer operating histories, larger customer bases, greater brand
recognition and significantly greater financial, marketing and other resources
than we do. Some of our competitors have adopted, and may continue to adopt,
aggressive pricing policies and devote substantially more resources to Website
and systems development than we do. Increased competition may adversely impact
our operating margins, market share and brand recognition. In addition, larger,
well-established and well-financed entities may join with current online
competitors or video, music, game and software suppliers as the use of the
Internet and other online services increases. Our competitors may also be able
to secure products from vendors on more favorable terms, fulfill customer orders
more efficiently and adopt more aggressive pricing policies than we can.
INTELLECTUAL PROPERTY
We regard our trademarks, trade secrets and similar intellectual property
as critical to our success, and we rely on trademark and trade secret protection
and confidentiality and/or license agreements with our employees, customers,
partners and others to protect our proprietary rights. We have registered our
"Reel" trademark in the United States and have applied for the registration of
over 10 trademarks, including the "Reel.com" trademark. Effective trademark and
trade secret protection may not be available in every country where our products
are available online.
GOVERNMENT REGULATION
Due to the increasing popularity and use of the Internet and other online
services, it is possible that a number of laws and regulations may be adopted
with respect to the Internet or
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other online services covering issues such as user privacy, freedom of
expression, pricing, content and quality of products and services, taxation,
advertising, intellectual property rights and information security. The nature
of this legislation and the manner in which it may be interpreted and enforced
cannot be fully determined and, therefore, this legislation could subject either
us or our customers to potential liability, which in turn could have an adverse
effect on our business, results of operations and financial condition. The
adoption of any of these laws or regulations might also decrease the rate of
growth of Internet use, which in turn could decrease the demand for our products
or increase the cost of doing business or in some other manner have an adverse
effect on our business, results of operations and financial condition. In
addition, applicability to the Internet of existing laws governing issues such
as property ownership, copyrights and other intellectual property issues,
taxation, libel, obscenity and personal privacy is uncertain. The vast majority
of these laws were adopted prior to the advent of the Internet and related
technologies and, as a result, do not contemplate or address the unique issues
of the Internet and related technologies.
The Internet is currently the subject of an increasing number of laws and
regulations. These laws and regulations may relate to liability for information
retrieved from or transmitted over the Internet, online content regulation, user
privacy, taxation and the quality of products and services. Recent laws that may
be relevant include:
- Child Online Protection Act of 1998. The first part of this act makes it
unlawful for anyone to distribute materials over the Internet to minors
that includes material that is deemed harmful to minors. It imposes
additional restrictions and obligations and establishes the Commission on
Online Protection to study and report to Congress on methods to help
reduce access to harmful information by minors. The second part of this
act makes it unlawful for an operator of a Website or online service
directed to children under 13 to collect personal information from a
child in a manner which violates regulations to be prescribed by the
Federal Trade Commission, or the FTC.
- Children's Online Privacy Protection Act of 1998. This act directs the
FTC to prescribe regulations regarding the collection and use of personal
information from children under age 16. It includes a requirement for
parental consent for the collection, use and disclosure of personal
information from children under age 13. The FTC is in the process of
issuing final regulations, has submitted proposals to the Internet
industry regarding the rights and safety of children using the Internet,
and is expected to issue additional regulations in this area.
- Protection of Children from Sexual Predators Act of 1998. This act
mandates that electronic communication service providers report facts or
circumstances from which a violation of child pornography laws is
apparent.
- Digital Millennium Copyright Act of 1998. This act establishes limited
liability for online copyright infringement by online service providers
for listing or linking to third-party Websites that include
copyright-infringing materials.
Because the courts have not yet interpreted these laws, their applicability
and reach are not defined. They may impose significant additional costs on our
business, require us to change our operating methods, or subject us to
additional liabilities. Moreover, the applicability to the Internet of existing
laws governing issues such as intellectual property ownership, copyright,
defamation, obscenity and personal privacy is uncertain and developing. We may
be subject to claims that our services violate such laws. Any new legislation or
regulation in the United States or abroad or the application of existing laws
and regulations to the Internet could damage our business and cause the price of
our common stock to decline.
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The FTC has also initiated action against at least one online service
provider regarding the manner in which information is collected from users and
provided to third parties. Changes to existing laws or the passage of new laws
intended to address these issues, including some recently proposed changes,
could create uncertainty in the marketplace that could reduce demand for our
products or increase the cost of doing business as a result of litigation costs
or increased product delivery costs, or could in some other manner have an
adverse effect on our business, results of operations and financial condition.
In addition, because our products are accessible throughout the United States,
other jurisdictions may claim that we are required to qualify to do business as
a foreign corporation in a particular state. Also, although we do not believe
that our relationship with Hollywood Entertainment would subject us to sales or
use taxes in any jurisdiction where Hollywood Entertainment operates a retail
store, it is possible that a jurisdiction may seek to impose a sales or use tax
based on that relationship. We cannot be certain that we would be successful in
any challenge to the imposition of sales or use tax. We are qualified to do
business in California, and our failure to qualify as a foreign corporation in a
jurisdiction where it is required to do so could subject us to taxes and
penalties for the failure to qualify and could result in our inability to
enforce contracts in these jurisdictions. Any new legislation or regulation, or
the application of laws or regulations of these jurisdictions whose laws do not
currently apply to our business, could have an adverse effect on our business,
results of operations and financial condition.
There are, to our knowledge, currently no investigations, inquiries,
citations, fines or allegations of violations or noncompliance of such laws
pending by government agencies. It is possible that there may be investigations
or allegations in the future. The risk that any noncompliance may be discovered
in the future is currently indeterminable. Although any potential impact on us
for noncompliance cannot currently be established, it could result in civil or
criminal penalties, including monetary fines and injunctions, for noncompliance
and negative publicity and have an adverse impact on our business, results of
operations and financial condition.
EMPLOYEES
As of September 30, 1999, we had 174 full-time employees. We vary the
number of part-time and temporary employees to respond to fluctuating market
demand for our products. Our employees are not covered by a collective
bargaining agreement. We consider our relationships with our employees to be
good.
PROPERTIES
Our principal offices are located in Emeryville, California, where we lease
approximately 19,000 square feet. This lease expires in February 2005. We also
lease approximately 27,000 square feet of space in San Leandro, California,
where we maintain our distribution center. We anticipate that we will have to
expand or relocate our distribution center within the next 12 months. We believe
additional space will be available to us on commercially reasonable terms. In
addition, we have entered into a lease in Seattle, Washington, for 3,700 square
feet of office space. As we expand, we expect that suitable additional or
alternative space will be available on commercially reasonable terms.
LEGAL PROCEEDINGS
On December 4, 1998, our former Chief Operating Officer, James C. Vicars,
filed a complaint in the Superior Court of California, alleging breach of his
employment contract, violation of the California Labor Code, employment
discrimination, breach of an implied covenant of good faith and fair dealing,
negligent misrepresentation, fraud, defamation and
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other claims. The complaint claims damages in excess of $2.1 million. Currently,
the case is in discovery, and no trial date has been set. We intend to contest
this claim vigorously.
On December 21, 1998, Excalibur Entertainment, Inc. filed a complaint in
the Superior Court of California, alleging unfair trade practices by Reel.com
relating to our sale of copies of certain films in violation of the Business and
Professions Code of the State of California. The complaint claims damages in
excess of $500,000. The case is in discovery. We intend to contest this claim
vigorously.
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MANAGEMENT
The following table sets forth information with respect to our directors,
executive officers and other key employees as of the date of this prospectus.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Mark J. Wattles.......................... 39 Chairman and Chief Executive Officer
Alex M. Bond............................. 30 Chief Financial Officer
David Rochlin............................ 36 Chief Operating Officer
Harry Bernstein.......................... 47 Vice President of Corporate Development
Jeffrey D. DeRuiter...................... 29 Vice President of Operations
Tracy Jan................................ 36 Vice President of Merchandising
Rosemary Ruley Atkins.................... 37 Vice President and Executive Producer
Jeffrey Schwager......................... 35 Vice President of Content
Michael Verhoogen........................ 32 Vice President, Legal, and Secretary
Donald J. Ekman.......................... 47 Director
</TABLE>
Mark J. Wattles has been Chairman of the board of directors of Reel.com
since October 1998 and was appointed Chief Executive Officer in November 1999.
Mr. Wattles founded Hollywood Entertainment Corporation in June 1988 and has
served as its Chairman of the board of directors and Chief Executive Officer
since that time. Mr. Wattles served as President of Hollywood Entertainment from
June 1988 to September 1997. Mr. Wattles has been an owner and operator in the
video rental industry since 1985. He currently serves as a member of the Video
Software Dealers Association board of directors.
Alex M. Bond has been the Chief Financial Officer of Reel.com since April
1999. Mr. Bond joined Hollywood Entertainment in March 1999 and served as its
Senior Vice President of Internet Development until April 1999. From January
1997 to February 1999, he was Executive Vice President of Strategic Development
for Just for Feet, Inc., a retail company. From January 1995 until January 1997,
he was employed by Hollywood Entertainment as Vice President of Strategic
Development. From February 1993 until January 1995, he was an investment banker
with Montgomery Securities, currently Banc of America Securities LLC,
specializing in growth retail.
David Rochlin has been the Chief Operating Officer of Reel.com since April
1999. Mr. Rochlin previously served as Vice President of Marketing of Reel.com
from June 1998 to April 1999. From 1996 to 1998, Mr. Rochlin was Director of
Marketing for NETCOM Online Communications, a telecommunications company. From
1994 to 1996, he was Senior Director of Market Development at DNA Plant
Technology, a consumer biotechnology company. From 1992 to 1994, he was a brand
and category Manager at Del Monte Foods. Mr. Rochlin is a regular speaker on
Internet retailing practices and is active in a variety of online commerce
industry groups, including shop.org and the GII Initiative.
Harry Bernstein has been the Vice President of Corporate Development of
Reel.com since January 1999. He previously served as Vice President of Business
Development of Reel.com from May 1997 to January 1999. From April 1996 to May
1997, Mr. Bernstein served as Vice President of Creative Development for
Film.com Inc., an Internet content company devoted to movie-related information.
Mr. Bernstein served as the Director of Entertainment Development of Starwave
Corp., a multimedia company, from March 1993 to March 1996.
Jeffrey D. DeRuiter has been the Vice President of Operations of Reel.com
since July 1999. From July 1993 until he joined Reel.com, Mr. DeRuiter was a
consultant and manager at Kurt Salmon Associates, a management consulting
company.
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Tracy Jan has been the Vice President of Merchandising of Reel.com since
April 1999. Prior to joining Reel.com, Ms. Jan was the Vice President of
Merchandise Planning and Distribution for the Duty Free Shops Group Limited (DFS
Ltd.), an international retail company, from February 1997 to April 1999. Before
joining DFS Ltd., Ms. Jan was the Director of Merchandise Planning and
Distribution for Warner Bros. Studio Stores, a media and entertainment company,
from June 1994 to January 1997.
Rosemary Ruley Atkins has been the Vice President and Executive Producer at
Reel.com since March 1999. Prior to assuming that position, Ms. Ruley Atkins was
Vice President of Merchandising of Reel.com from February 1997 to March 1999.
From October 1996 to February 1997, she served as Vice President of Products and
Operations at West Coast Entertainment, a video retail company. From March 1995
to September 1996, Ms. Ruley Atkins served as Chief Executive Officer of
Videosmith, a Boston-based video retail store before it was acquired by West
Coast Entertainment.
Jeffrey Schwager has been the Vice President of Content of Reel.com since
June 1999. From August 1994 to May 1999, Mr. Schwager served as Writer, Managing
Editor, Editorial Director and Executive Producer at Starwave Corp./Infoseek
Corp., an Internet software and services company, where he managed the operation
of Websites including Celebsite, Mr. Showbiz, Wall of Sound and the
entertainment and broadcast sections of Go.com.
Michael Verhoogen has been the Vice President, Legal, and Secretary of
Reel.com since September 1999. From April 1999 to September 1999, he was the
Director of Corporate Real Estate for Just For Feet, Inc. a retail company. From
May 1997 to April 1999, he was the Director of Real Estate for Just For Feet's
subsidiary chain.
Donald J. Ekman has been one of the directors of Reel.com since October
1998. Mr. Ekman has served on the board of directors of Hollywood Entertainment
since July 1993 and became Senior Vice President and General Counsel of
Hollywood Entertainment on March 1994. From January 1992 to March 1994, Mr.
Ekman was a partner in Ekman & Bowersox. From August 1990 until December 1991,
he practiced law with Foster, Pepper & Shefelman.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to this offering, our board of directors has not had a compensation
committee, and all compensation decisions relating to our executive officers
have been made by the full board of directors. Upon completion of this offering,
the compensation committee will make all compensation decisions regarding our
executive officers. During the year ended December 31, 1999, Mark Wattles and
Donald Ekman were both members of our parent's board of directors, and Mr.
Wattles served on its compensation committee. For a description of transactions
with Hollywood Entertainment, see "Certain Transactions."
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EXECUTIVE COMPENSATION
COMPENSATION SUMMARY. The following table sets forth compensation
information for the Chief Executive Officer and the four other most highly
compensated executive officers of Reel.com whose total annual salary and bonus
exceeded $100,000 in 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
AWARDS
ANNUAL COMPENSATION ------------
-------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITIONS SALARY($) BONUS($) COMPENSATION($) OPTIONS(#)
---------------------------- --------- -------- --------------- ------------
<S> <C> <C> <C> <C>
</TABLE>
OPTIONS GRANTED IN LAST FISCAL YEAR. The following table provides certain
information regarding stock options granted to the executive officers named in
the Summary Compensation Table during 1999. Reel.com granted to its employees
options to purchase an aggregate of shares of its stock during 1999. All
options were granted with an exercise price equal to the fair market value of
the common stock on the date of grant, as determined by the board of directors.
An option may terminate before its expiration date if the optionee is no longer
an employee of or consultant to Reel.com. We have calculated the potential
realizable value in accordance with Securities and Exchange Commission rules as
follows:
- multiplied the number of shares subject to each option by $ ,
the assumed initial public offering price per share; and
- calculated the gains or "option spreads" that would exist for the options
assuming an annual compounded stock appreciation of 5% and 10% from the
date the option was granted over the full option term of 10 years.
These assumed annual compound rates are mandated by the SEC and do not
represent Reel.com's estimate or projection of future stock prices.
OPTION GRANTS IN 1999
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------- POTENTIAL REALIZABLE
NUMBER OF VALUE AT ASSUMED
SECURITIES % OF TOTAL ANNUAL RATES OF STOCK
UNDERLYING OPTIONS EXERCISE PRICE APPRECIATION FOR
OPTIONS GRANTED TO PRICE OPTION TERM
GRANTED EMPLOYEES PER SHARE EXPIRATION -----------------------
NAME (#) IN FISCAL YEAR ($) DATE 5%($) 10%($)
---- ---------- -------------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
..................... -- -- -- -- -- --
..................... -- -- -- -- -- --
..................... -- -- -- -- -- --
</TABLE>
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AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES. The following table provides summary information regarding options held
by the executive officers named in the Summary Compensation Table as of December
31, 1999. The value of unexercised in-the-money options is based on an assumed
initial public offering price of $ per share, less the exercise price
payable for such shares.
AGGREGATED OPTION EXERCISES IN 1999
AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-
UNDERLYING UNEXERCISED THE-MONEY(1) OPTIONS AT
SHARES OPTIONS AT YEAR-END(#) YEAR-END($)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ------------ ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
............... -- -- -- -- -- --
............... -- -- -- -- -- --
............... -- -- -- -- -- --
............... -- -- -- -- -- --
............... -- -- -- -- -- --
</TABLE>
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our certificate of incorporation provides that, except to the extent
provided by Delaware law, our directors will not be personally liable to our
stockholders for monetary damages for any breach of fiduciary duty as directors,
except (a) liability for a breach of the duty of loyalty to the corporation or
its stockholders, (b) acts or omissions not in good faith or which involve
intentional misconduct or knowing violations of law, (c) unlawful payment of
dividends or unlawful stock repurchases or redemptions or (d) any transaction
from which a director derives an improper personal benefit. This provision also
does not affect the directors' responsibilities under other laws, such as the
Federal securities laws or state or Federal environmental laws and does not
limit the availability of equitable remedies, such as injunctive relief.
We have obtained liability insurance for our executive officers and
directors and have entered into indemnity agreements to indemnify our executive
officers and directors in addition to the indemnification provided for in our
certificate of incorporation and bylaws. These agreements, among other things,
indemnify our directors and executive officers for expenses, judgments and fines
and amounts paid in settlement, actually and reasonably incurred by any such
person in any action, suit or proceeding arising out of such person's services
as a director or executive officer on our behalf. We believe that these
provisions and agreements are necessary to attract and retain qualified
directors and officers.
EMPLOYEE BENEFIT PLANS
1999 Stock Incentive Plan.
Introduction. The 1999 Stock Incentive Plan is intended to serve as our
primary incentive plan. The 1999 plan was adopted by the board of directors on
and approved by the stockholders in . The 1999
plan will become effective upon completion of this offering.
Share Reserve. An aggregate of shares of our common stock
have been authorized for issuance under the 1999 plan. The share reserve under
our 1999 plan will automatically increase on the first trading day in January of
each calendar year, beginning with calendar year 2001, by an amount equal to
percent ( %) of the total number of shares of
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our common stock outstanding on the last trading day of December in the prior
calendar year, but in no event will this annual increase exceed
shares. In addition, no participant in the 1999 plan may be granted stock
options or direct stock issuances for more than shares of common
stock in total in any calendar year.
Programs. Our 1999 plan has five separate programs, each of which may be
implemented at the discretion of the board of directors:
- the discretionary option grant program, under which eligible individuals
in our employ may be granted options to purchase shares of our common
stock at an exercise price not less than the fair market value of those
shares on the grant date;
- the stock issuance program, under which eligible individuals may be
issued shares of common stock directly, upon the attainment of
performance milestones or the completion of a specified period of service
or as a bonus for past services;
- the salary investment option grant program, under which our executive
officers and other highly compensated employees may be given the
opportunity to apply a portion of their base salaries each year to the
acquisition of special below-market stock option grants;
- the automatic option grant program, under which option grants will
automatically be made at periodic intervals to eligible non-employee
directors to purchase shares of common stock at an exercise price equal
to the fair market value of those shares on the grant date; and
- the director fee option grant program, under which our non-employee
directors may be given the opportunity to apply a portion of any retainer
fees otherwise payable to them in cash each year to the acquisition of
special below-market stock option grants.
Eligibility. The individuals eligible to participate in our 1999 plan
include our officers and other employees and our board members.
Administration. The discretionary option grant and stock issuance programs
will be administered by our compensation committee. This committee will
determine which eligible individuals are to receive option grants or stock
issuances under those programs, the time or times when the grants or issuances
are to be made, the number of shares subject to each grant or issuance, the
status of any granted option as either an incentive stock option or a
nonstatutory stock option under the federal tax laws, the vesting schedule to be
in effect for the option grant or stock issuance and the maximum term for which
any granted option is to remain outstanding. The compensation committee will
also have the authority to select the executive officers and other highly
compensated employees who may participate in the salary investment option grant
program in the event that program is put into effect for one or more calendar
years.
Plan Features. Our 1999 plan will include the following features:
- The exercise price for any options granted under the plan may be paid in
cash or in shares of our common stock valued at fair market value on the
exercise date. The option may also be exercised through a same-day sale
program without any cash outlay by the optionee. The terms of options
granted under our 1999 plan may not exceed 10 years.
- The compensation committee will have the authority to cancel outstanding
options under the discretionary option grant program in return for the
grant of new options for the same or different number of option shares
with an exercise price per share based upon the fair market value of our
common stock on the new grant date.
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- Stock appreciation rights may be issued under the discretionary option
grant program. These rights will provide the holders with the election to
surrender their outstanding options for a payment from us equal to the
fair market value of the shares subject to the surrendered options less
the exercise price payable for those shares. We may make the payment in
cash or in shares of our common stock. None of the options granted under
our 1999 plan contain stock appreciation rights.
Change in Control. The 1999 plan will include certain change-in-control
provisions which may result in the accelerated vesting of outstanding option
grants and stock issuances.
Salary Investment Option Grant Program. In the event the compensation
committee decides to put this program into effect for one or more calendar
years, each of our executive officers and other highly compensated employees may
elect to reduce his or her base salary for the calendar year by an amount not
less than $10,000 nor more than $50,000. Each selected individual who makes such
an election will automatically be granted, on the first trading day in January
of the calendar year for which his or her salary reduction is to be in effect,
an option to purchase that number of shares of common stock determined by
dividing the salary reduction amount by two-thirds of the fair market value per
share of our common stock on the grant date. The option will have an exercise
price per share equal to one-third of the fair market value of the option shares
on the grant date. As a result, the option will be structured so that the fair
market value of the option shares on the grant date less the exercise price
payable for those shares will be equal to the amount of the salary reduction.
The option will become exercisable in a series of 12 equal monthly installments
over the calendar year for which the salary reduction is to be in effect.
Automatic Option Grant Program. Each individual who first becomes a
non-employee board member at any time after the effective date of this offering
will receive an option grant to purchase shares of common stock on the
date such individual joins the board. In addition, on the date of each annual
stockholders meeting held after the effective date of this offering, each
non-employee board member who is to continue to serve as a non-employee board
member, including each of our current non-employee board members, will
automatically be granted an option to purchase shares of common stock,
provided such individual has served on the board for at least six months.
Each automatic grant will have an exercise price per share equal to the
fair market value per share of our common stock on the grant date and will have
a term of 10 years, subject to earlier termination following the optionee's
cessation of board service. The option will be immediately exercisable for all
of the option shares; however, we may repurchase, at the exercise price paid per
share, any shares purchased under the option which are not vested at the time of
the optionee's cessation of board service. The shares subject to each initial
-share automatic option grant will vest in a series of ( )
successive annual installments upon the optionee's completion of each year of
board service over the ( )-year period measured from the grant
date. The shares subject to each -share annual option grant will vest upon
optionee's completion of one year of board service measured from the grant date.
The shares subject to each option will immediately vest in full upon certain
changes in control or ownership or upon the optionee's death or disability while
a board member.
Director Fee Option Grant Program. If this program is put into effect in
the future, then each non-employee board member may elect to apply all or a
portion of any cash retainer fee for the year to the acquisition of a
below-market option grant. The option grant will automatically be made on the
first trading day in January in the year for which the non-employee board member
would otherwise be paid the cash retainer fee in the absence of his or her
election. The option will have an exercise price per share equal to one-third of
the
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fair market value of the option shares on the grant date, and the number of
shares subject to the option will be determined by dividing the amount of the
retainer fee applied to the program by two-thirds of the fair market value per
share of our common stock on the grant date. As a result, the option will be
structured so that the fair market value of the option shares on the grant date
less the exercise price payable for those shares will be equal to the portion of
the retainer fee applied to that option. The option will become exercisable in a
series of 12 equal monthly installments over the calendar year for which the
election is in effect. However, the option will become immediately exercisable
for all the option shares upon the death or disability of the optionee while
serving as a board member.
Additional Program Features. Our 1999 plan will also have the following
features:
- Outstanding options under the salary investment and director fee option
grant programs will immediately vest if we are acquired by a merger or
asset sale or if there is a successful tender offer for more than 50% of
our outstanding voting stock or a change in the majority of our board
through one or more contested elections.
- Limited stock appreciation rights will automatically be included as part
of each grant made under the salary investment option grant program and
the automatic and director fee option grant programs, and these rights
may also be granted to one or more officers as part of their option
grants under the discretionary option grant program. Options with this
feature may be surrendered to us upon the successful completion of a
hostile tender offer for more than 50% of our outstanding voting stock.
In return for the surrendered option, the optionee will be entitled to a
cash distribution from us in an amount per surrendered option share based
upon the highest price per share of our common stock paid in that tender
offer.
- The board of directors may amend or modify the 1999 plan at any time,
subject to any required stockholder approval. The 1999 plan will
terminate no later than November 2009.
1999 Employee Stock Purchase Plan.
Introduction. Our 1999 Employee Stock Purchase Plan was adopted by the
board of directors on , 1999 and approved by the stockholders in
1999. The plan will become effective immediately upon the
completion of this offering. The plan is designed to allow our eligible
employees and the eligible employees of our participating subsidiaries to
purchase shares of common stock, at semi-annual intervals, with their
accumulated payroll deductions.
Share Reserve. An aggregate of shares of our common stock
will initially be reserved for issuance. The reserve will automatically increase
on the first trading day in January each calendar year, beginning in calendar
year 2001, by an amount equal to percent ( %) of the total number of
outstanding shares of our common stock on the last trading day in December in
the prior calendar year. In no event will any such annual increase exceed
shares.
Offering Periods. The plan will have a series of successive offering
periods, each with a maximum duration of 24 months. The initial offering period
will start on the date the underwriting agreement for the offering covered is
signed and will end on the last business day in January 2002. The next offering
period will start on the first business day in February 2002, and subsequent
offering periods will be set by our compensation committee.
Eligible Employees. Individuals scheduled to work more than 20 hours per
week for more than five calendar months per year may join an offering period on
the start date or any semi-
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annual entry date within that period. Semi-annual entry dates will occur on the
first business day of February and August each year. Individuals who become
eligible employees after the start date of an offering period may join the plan
on any subsequent semi-annual entry date within that offering period.
Payroll Deductions. A participant may contribute up to % of his or
her base salary through payroll deductions, and the accumulated deductions will
be applied to the purchase of shares on each semi-annual purchase date. The
purchase price per share will be equal to 85% of the fair market value per share
on the participant's entry date into the offering period or, if lower, 85% of
the fair market value per share on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of January and July each
year. However, a participant may not purchase more than shares on
any purchase date, and not more than shares may be purchased in
total by all participants on any purchase date. Our compensation committee will
have the authority to change these limitations for any subsequent offering
period.
Reset Feature. If the fair market value per share of our common stock on
any purchase date is less than the fair market value per share on the start date
of the two-year offering period, then that offering period will automatically
terminate, and a new two-year offering period will begin on the next business
day. All participants in the terminated offering will be transferred to the new
offering period.
Change in Control. The purchase price will be equal to 85% of the market
value per share on the participant's entry date into the offering period in
which an acquisition occurs or, if lower, 85% of the fair market value per share
immediately prior to the acquisition.
Plan Provisions. The following provisions will also be in effect under the
plan:
- The plan will terminate no later than the last business day of January
2010; and
- The board may at any time amend, suspend or discontinue the plan.
However, certain amendments may require stockholder approval.
Hollywood Entertainment Corporation Incentive Plans.
A number of our employees hold outstanding stock options under our parent
company stock incentive plans: the Hollywood Entertainment Corporation 1993
Stock Incentive Plan and the Hollywood Entertainment Corporation 1997 Employee
NonQualified Stock Option Plan. An aggregate of 10,000,000 shares of our parent
company's common stock is authorized for issuance under the 1993 plan, and an
additional 1,000,000 shares of our parent company's common stock is authorized
for issuance under the 1997 plan. All employees of our parent company and its
subsidiaries are eligible to participate in the 1993 plan; participation in the
1997 plan is limited to employees of our parent company and its subsidiaries who
are not otherwise officers or directors of our parent company. As of October 15,
1999, shares remained available for future issuance under the 1997
plan.
Under the 1993 plan, shares of our parent's common stock may also be issued
pursuant to stock appreciation rights, direct stock issuances, either vested or
unvested, and performance units. None of these latter securities has been issued
to our employees.
Both the 1993 plan and the 1997 plan may be administered by the Hollywood
Entertainment board of directors or by a committee of that board of directors.
The plan administrator will have complete discretion to determine which eligible
individuals are to receive option grants or other awards under the plans, the
time or times when those grants or awards are to be made, the number of shares
subject to each such grant or award, the status of
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any granted option as either an incentive stock option or a non-statutory option
under the federal tax laws, the vesting schedule (if any) to be in effect for
the option grant or other award and the maximum term for which any granted
option, stock appreciation right or performance unit is to remain outstanding.
Under the 1997 plan, however, the only type of award issuable is a non-statutory
stock option.
The exercise price of an incentive stock option will in no event be less
than 100% of the fair market value of our parent company's common stock on the
date of grant. Each non-statutory option will have an exercise price per share
determined in the sole discretion of the plan administrator. Incentive stock
options may not have a maximum term in excess of 10 years; the plan
administrator has complete discretion to determine the maximum term of each
non-statutory option granted under the plans. Each option grant will be subject
to earlier termination following the optionee's cessation of service.
The options granted under the plans generally have been structured so that
those options become exercisable for the option shares in a series of
installments over the optionee's period of service.
In the event that our parent company is acquired by merger or asset sale,
the plan administrator will have the discretion to select any of the following
alternatives for the treatment of the outstanding options under the plans:
- continue those options in full force and effect;
- provide for their assumption by the successor entity; or
- terminate those options, with or without the acceleration of any unvested
options immediately prior to such termination.
The Hollywood Entertainment board of directors may amend or modify the
plans at any time, subject to any stockholder approval required under applicable
law or regulation.
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CERTAIN TRANSACTIONS
TRANSACTIONS WITH OUR PARENT
Certain Historical Relationships
As a subsidiary of our parent, we receive various services from our parent,
including customer service, supply, marketing, human resources, finance,
accounting, administrative and legal services. Our financial statements reflect
allocations for these services rendered by our parent to us. We believe those
allocations have been made on a reasonable and consistent basis. However, they
are not necessarily indicative of, nor is it practicable for us to estimate, the
level of expenses we would have otherwise incurred had we operated as a
separate, stand-alone company. We have also relied on our parent to provide us
with financing for our cash flows. Our cash flows to date are therefore not
necessarily indicative of the cash flows that would have resulted had we been
operating as an independent company. We are currently a borrower under our
parent's bank credit facility and expect to terminate our participation in the
facility concurrent with the completion of this offering. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
We have purchased certain merchandise from Hollywood Entertainment at an
amount equal to Hollywood Entertainment's cost. These purchases amounted to
$84,983 for the three months ended December 31, 1998 and $584,000 for the nine
months ended September 30, 1999. Hollywood Entertainment charges us the costs
associated with these purchases, including cost of freight, handling and other
costs, incurred by Hollywood Entertainment in connection with selling
merchandise to us.
As a subsidiary of Hollywood Entertainment, we also receive, and are
charged our proportionate share, of various services from Hollywood
Entertainment including management and other operational services. These charges
were $237,000 for the three months ended December 31, 1998 and $1.4 million for
the nine months ended September 30, 1999.
We intend to enter into an asset transfer agreement with Hollywood
Entertainment, under which Hollywood Entertainment will acquire certain retail
assets relating to one traditional retail video store.
Since October 1, 1998, the date Hollywood Entertainment acquired us,
Hollywood Entertainment has provided all necessary funding for our operations.
This funding has been accounted for as intercompany advances. As of September
30, 1999, these funds totaled approximately $42.5 million. Hollywood
Entertainment charges us 14% interest on the net outstanding balance. Interest
expense for the three months ended December 31, 1998 was $166,000 and for the
nine months ended September 30, 1999 was $2.7 million.
Intercompany Agreements
We intend to enter into several intercompany agreements with our parent
prior to the completion of this offering. We have summarized below the
anticipated material terms of all of these agreements. These agreements will not
have been negotiated on an arms' length basis. We believe that had the
intercompany agreements been in effect during the historical periods presented
in our financial statements, they would not have had a material effect on our
results of operations. Certain of the agreements do not have fixed terms.
Initial Public Offering Agreement
GENERAL. As of the completion of this offering, we intend to enter into an
initial public offering agreement with Hollywood Entertainment, which will
govern our respective rights and
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duties with respect to this offering and will set forth certain covenants we
will agree to for various periods following this offering.
EXPENSES. Except for the fees and disbursements related to Hollywood
Entertainment's counsel, accountants and other advisers, we will generally agree
to pay any and all expenses relating to our initial public offering or any other
primary offering of our common stock.
ACCESS TO INFORMATION. Generally, we and Hollywood Entertainment will
agree to provide each other with, upon written request and subject to specified
conditions and for a specified period of time, access to information relating to
the assets, business and operations of the requesting party. We and Hollywood
Entertainment will agree to keep our books and records for a specified period of
time. Also, we and Hollywood Entertainment will agree to cooperate with each
other to allow access to each other's employees, to the extent necessary, to
discuss and explain all requested information mentioned above and with respect
to any claims brought against the other relating to the conduct of our business
prior to completion of this offering or similar transaction.
COVENANTS. We will agree that, for so long as Hollywood is required to
consolidate our results of operations and financial position, we will:
- provide Hollywood Entertainment with financial information regarding our
company and our subsidiaries;
- provide Hollywood Entertainment copies of all quarterly and annual
financial information and other reports and documents we intend to file
with the SEC prior to such filing, as well as final copies upon filing,
and to actively consult with Hollywood Entertainment with respect to any
changes made to these reports;
- consult with Hollywood Entertainment regarding the timing and content of
earnings releases and cooperate fully and cause our accountants to
cooperate fully with Hollywood in connection with any of its public
filings;
- use our reasonable best efforts to enable our auditors to complete their
audit of our financial statements such that they will date their opinion
the same date as their opinion on Hollywood Entertainment's financial
statements;
- provide to Hollywood Entertainment and its auditors all information
required for Hollywood Entertainment to meet its schedule for the filing
and distribution of its financial statements;
- make our books and records available to Hollywood Entertainment and its
auditors, so that they may conduct reasonable audits relating to our
financial statements; and
- adhere to specified accounting standards.
OTHER COVENANTS. The initial public offering agreement will also provide
that, for so long as Hollywood beneficially owns % or more of our outstanding
shares of common stock, we may not take any action or enter into any commitment
or agreement that may reasonably be anticipated to result, with or without
notice and with or without lapse of time, or otherwise, in a contravention, or
an event of default, by Hollywood Entertainment of:
- any provision of applicable law or regulation, including but not limited
to provisions pertaining to the Internal Revenue Code, or the Employee
Retirement Income Security Act of 1974, as amended; or
- any provision of Hollywood Entertainment's articles of incorporation or
bylaws.
INDEMNIFICATION PROCEDURES. The initial public offering agreement will set
forth the procedures that Hollywood Entertainment and we are to undertake if
either of us demanded to be indemnified by the other under any indemnification
right given in any of the agreements
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<PAGE> 68
between Hollywood Entertainment and us relating to this offering, other than the
tax matters agreement referred to below.
Intercompany Services Agreement
We intend to enter into an agreement with our parent pursuant to which our
parent will provide certain services to us, including advertising services,
space sharing, supply services and corporate services. In addition, we will
provide certain services to our parent, including Web hosting services, Website
development services, network operations services and advertising services. Both
parties have also agreed to provide certain services to each other, including
supply and information services. These obligations will terminate three years
from the completion of this offering unless terminated earlier by either party
as a result of any of the following:
- a material breach of the agreement;
- commencement of bankruptcy proceedings; or
- the insolvency and/or liquidation of the other party's businesses.
In addition, our parent may terminate these obligations in the event that
it or any of its affiliates ceases to beneficially own at least 20% of the
voting power of our outstanding voting stock.
For a period of two years from the completion of this offering, our parent
will refrain from competing with us in the business of selling movies, movie
content and/or other entertainment products on video, DVD or other fixed or
streaming media via the Internet, video-on-demand or other electronic means.
SERVICES PROVIDED TO US BY OUR PARENT. Our parent has agreed to provide the
following services following the completion of this offering:
Corporate Services. Our parent will provide marketing, human resources,
finance, accounting, administrative, legal and other services, as well as those
services we require by virtue of our status as an independent public company.
Our parent will provide these services to us at 100% of our parent's cost.
Space Sharing. Our parent will provide a portion of its offices that both
parties mutually agree upon. Our cost for this space will be the lesser of the
prevailing market rate for this space and the highest rate then being paid by
our parent for comparable space in the metropolitan area in which the space is
located.
Supply Services. Our parent will supply used movies and other used
entertainment products in substantially the same manner as it currently provides
these supplies to us. We will pay our parent an amount no greater than 100% of
our parent's cost for these supplies and under terms and conditions at least as
favorable as our parent provides these supplies to third parties.
Special Order Services. Our parent will exclusively promote to its retail
customers in its retail stores, our Website and the products we provide on our
Website, provided that these products are not simultaneously available to its
customers in its stores. We will pay our parent an amount no greater than 100%
of our parent's costs for these services and under terms and conditions at least
as favorable as our parent provides these services to third parties.
Advertising Services. Our parent will provide us with advertising services
in substantially the same manner it currently provides these services to us.
These advertising services will include advertising in our parent's in-store
magazines, advertising space in our parent's in-store
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video loops and other direct marketing offerings made by our parent to its
customers. The price of these advertising services will not exceed 100% of our
parent's costs of providing these services to us, and the terms and conditions
in which these services will be provided to us will be at least as favorable as
the terms on which our parent provided these services to third parties.
SERVICES WE WILL PROVIDE TO OUR PARENT. We will provide certain services to
our parent, including Web hosting and network operations services, in a manner
substantially consistent with the services we are currently providing to our
parent, pursuant to terms and conditions as both parties may mutually agree
upon. We will also provide Website development services to our parent on a
project-by-project basis pursuant to terms and conditions both parties will
mutually agree upon. In addition, we have agreed to link our Website to our
parent's Website.
JOINT SERVICES BEING PROVIDED BY US AND OUR PARENT. We have agreed with our
parent to provide certain services to each other, including supply services and
information services. Both parties will work together to acquire new movies and
entertainment products in a manner substantially similar to our current
practices. In addition, we will provide each other access to our databases that
contain information pertaining to customers and films, including, customer
mailing lists, membership customer lists, customer demographic information and
general information about films and related entertainment products and services.
Income Tax Matters Agreement
As of the completion of this offering, we will continue to be included in
the consolidated group of Hollywood Entertainment (the "consolidated group")
filing U.S. federal income tax returns and various combined or consolidated
state and local income tax returns. We will be liable for all taxes that are
either (a) imposed on us on a separate return basis or (b) imposed on a combined
or consolidated basis on a group of companies that includes only us and our
subsidiaries. Prior to the completion of this offering, we and Hollywood
Entertainment intend to enter into an income tax matters agreement. The income
tax matters agreement will require Hollywood Entertainment to pay the
consolidated and combined federal and state income tax liabilities of the
consolidated group and will require us to make payments to Hollywood
Entertainment equal to the amount of income taxes that would be due from us if
we were to file our own separate federal, state and local returns (or combined
or consolidated returns including only us and our subsidiaries). In determining
our hypothetical tax liability described in the preceding sentence, we will be
able to use net operating losses and other tax attributes to the extent such
attributes could have been used by us if we had not been included in the
consolidated or combined group except to the extent they were used by other
members of the consolidated or combined group in an earlier period. The amounts
due from us would be redetermined in cases of a redetermination of our tax
liability arising from an audit, amended return or otherwise.
Hollywood Entertainment will have all the rights of a parent of a
consolidated group filing consolidated federal income tax returns. Hollywood
Entertainment will have similar rights provided for by applicable state and
local law with respect to a parent of a consolidated or combined group.
Hollywood Entertainment will act as our agent in any and all matters relating to
income taxes of the consolidated group. Hollywood Entertainment will have
responsibility for the preparation and filing of all income tax returns or
amended returns with respect to the consolidated group. Hollywood Entertainment
will have the right to contest or compromise any asserted tax adjustment or
deficiency and to file, litigate and compromise any claim for refund on behalf
of the consolidated group. Hollywood Entertainment's authority with respect to
periods during which we are included in the consolidated group will continue to
apply even
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<PAGE> 70
with respect to tax returns that are filed after we no longer are included in
the consolidated group. For periods after we no longer are included in the
consolidated group, net operating losses and other tax attributes that otherwise
might have been available to us generally will not be available to us if the
attributes were used by the consolidated group in an earlier period. The income
tax matters agreement may result in conflicts of interest between us and
Hollywood Entertainment.
Provided that Hollywood Entertainment continues to beneficially own,
directly or indirectly, at least 80% of the total voting power and value of our
outstanding capital stock, we will be included for federal income tax purposes
in the consolidated group of which Hollywood Entertainment is the common parent.
Each member of the consolidated group for federal income tax purposes is liable
for the federal income tax liability of each other member of the consolidated
group. Similar principles apply with respect to members of the consolidated
group for state and local tax purposes. Accordingly, although the income tax
matters agreement will allocate tax liabilities between us and Hollywood
Entertainment during the period in which we are included in the consolidated
group, we could be liable for the federal, state or local income tax liability
of any other member of the consolidated group in the event any such liability is
incurred, and not discharged, by the other member.
Release and Indemnification Agreement
As of the completion of this offering, we and Hollywood Entertainment
intend to enter into a release and indemnification agreement under which we and
Hollywood Entertainment will agree to indemnify each other and we and Hollywood
Entertainment will agree to release each other with respect to some matters.
INDEMNIFICATION RELATING TO ASSETS, BUSINESSES AND OPERATIONS. We will
agree to indemnify and hold harmless Hollywood Entertainment and its affiliates
and their officers, directors, employees, agents, heirs, executors, successors
and assigns against any payments, losses, liabilities, damages, claims and
expenses and costs arising out of or relating to our past assets, businesses and
operations managed by us or persons previously associated with us.
Hollywood Entertainment will similarly agree to indemnify us and some of
our affiliates and our and their officers, directors, employees, agents, heirs,
executors, successors and assigns for Hollywood Entertainment's past assets,
businesses and operations, except for assets, businesses and operations for
which we will agree to indemnify Hollywood Entertainment. In addition, the
registration rights agreement referred to below and the income tax matters
agreement referred to above will provide for indemnification between us and
Hollywood Entertainment relating to the substance of such agreements.
INDEMNIFICATION RELATING TO THIS OFFERING. We will generally agree to
indemnify Hollywood Entertainment and some of its affiliates against all
liabilities arising out of any material untrue statements and omissions in this
prospectus and any related registration statement filed with the SEC relating to
this offering. However, our indemnification of Hollywood Entertainment does not
apply to written information provided by Hollywood Entertainment. Hollywood
Entertainment will agree to indemnify us for this information.
RELEASE RELATING TO ACTIONS BY HOLLYWOOD ENTERTAINMENT RELATED TO HOLLYWOOD
ENTERTAINMENT'S AND OUR ASSETS, BUSINESSES AND OPERATIONS. Except for the
rights and obligations of Hollywood Entertainment and us, which relate to the
agreements between Hollywood Entertainment and us relating to this offering, we
will release Hollywood Entertainment and its subsidiaries and affiliates and
their respective officers, directors, employees, agents, heirs, executors,
successors and assigns for all losses for any and all actions and failures to
take
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<PAGE> 71
actions relating to Hollywood Entertainment's and our assets, businesses and
operations. Hollywood Entertainment will similarly release us.
Registration Rights Agreement
As of the completion of this offering, we and Hollywood Entertainment
intend to enter into a registration rights agreement, which will require us,
upon the request of Hollywood Entertainment, to use our reasonable best efforts
to register, under the applicable federal and state securities laws, shares of
our equity securities owned by Hollywood Entertainment. In addition, we will
take such other actions as may be necessary to facilitate Hollywood
Entertainment's intended method of disposition and to permit the sale in other
jurisdictions, subject to specified limitations. Hollywood Entertainment will
also have the right, subject to specified limitations, to include the shares of
our equity securities it beneficially owns in other registrations we initiate.
Except for our legal and accounting and any other adviser's fees and expenses,
the registration rights agreement will provide that Hollywood Entertainment will
generally pay all or its pro rata portion of out-of-pocket costs and expenses
relating to each such registration that Hollywood Entertainment requests or in
which Hollywood Entertainment participates. The registration rights agreement
will contain indemnification and contribution provisions that are customary in
transactions similar to those contemplated by this prospectus.
OTHER TRANSACTIONS
We have entered into indemnification agreements with each of our executive
officers and directors.
------------------------
Any future transactions, including loans, between us and our officers,
directors and principal stockholders and their affiliates, will be approved by a
majority of the Board of Directors, including a majority of the independent and
disinterested directors, and will be on terms no less favorable to us than could
be obtained from unaffiliated third parties.
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<PAGE> 72
PRINCIPAL STOCKHOLDERS
Hollywood Entertainment beneficially owns all of the shares of our common
stock outstanding as of the date of this prospectus. Following the completion of
this offering, Hollywood Entertainment will continue to beneficially own % of
our common stock. If the underwriters were to fully exercise their option to
purchase up to additional shares of our common stock, our parent would
beneficially own approximately % of our common stock.
The following table sets forth information as of September 30, 1999 with
respect to the outstanding securities of Reel.com beneficially owned by:
- each person known by us to be the beneficial owner of more than 5% of the
shares of any class of such securities;
- each of our directors and director designees individually;
- each of our named executive officers individually; and
- all of our executive officers, directors and director designees as a
group.
<TABLE>
<CAPTION>
PERCENTAGE OF
COMMON STOCK
BENEFICIALLY OWNED
SHARES ----------------------
BENEFICIALLY BEFORE THE AFTER THE
NAME OF BENEFICIAL OWNER OWNED OFFERING OFFERING
------------------------ ------------ ---------- ---------
<S> <C> <C> <C>
Hollywood Entertainment.................................. -- 100% --%
Mark J. Wattles.......................................... -- * *
David Rochlin............................................ -- * *
Alex Bond................................................ -- * *
Harry Bernstein.......................................... -- * *
All directors and executive officers as a group (9
persons)............................................... -- * *
</TABLE>
- -------------------------
* Less than 1%.
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DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of shares of common stock, par
value $ and shares of preferred stock, par value $ .
COMMON STOCK
As of , shares of common stock were outstanding, held of
record by one stockholder. Upon completion of the offering, shares will
be outstanding, assuming no exercise of the underwriters' over-allotment option,
no exercise of outstanding warrants and no additional exercise of outstanding
options.
Holders of common stock are entitled to receive dividends as may from time
to time be declared by the board of directors out of funds legally available.
Holders of common stock are entitled to one vote per share on all matters on
which the holders of common stock are entitled to vote and do not have any
cumulative voting rights. Holders of common stock have no preemptive,
conversion, redemption or sinking fund rights. In the event of a liquidation,
dissolution or winding up of Reel.com, holders of common stock are entitled to
share equally and ratably in our assets, if any, remaining after the payment of
all our liabilities and the liquidation preference of any outstanding class or
series of preferred stock. The outstanding shares of common stock are, and the
shares of common stock offered by us in this offering when issued will be, fully
paid and nonassessable. The rights, preferences and privileges of holders of
common stock are subject to the rights of any series of preferred stock that we
may issue in the future, as described below.
PREFERRED STOCK
The board of directors has the authority to issue preferred stock in one or
more series and to fix the number of shares constituting any such series and the
preferences, limitations and relative rights, including dividend rights,
dividend rate, voting rights, terms of redemption, redemption price or prices,
conversion rights and liquidation preferences of the shares constituting any
series, without any further vote or action by our stockholders. The issuance of
preferred stock by the board of directors could adversely affect the rights of
holders of common stock.
STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS
The Delaware Certificate of Incorporation that will become effective
immediately prior to the completion of this offering states that stockholders
may not take action by written consent, but only at duly called annual or
special meetings of stockholders. The Delaware Certificate of Incorporation also
provides that special meetings of stockholders may be called only by the
chairman of the board of directors or by a majority of the board of directors.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR NOMINATIONS
The bylaws provide that stockholders must provide timely notice in writing
to bring business before an annual meeting of stockholders or to nominate
candidates for election as directors at an annual meeting of stockholders. To be
timely notice for an annual meeting, a stockholder's notice must be delivered to
or mailed and received at our principal executive offices at least 90 days and
no earlier than 120 days before the first anniversary of the date our notice of
the previous year's annual meeting of stockholders was provided to stockholders.
If the date of the annual meeting of stockholders has been changed to be more
than 30 calendar days before or more than 70 calendar days after that
anniversary, notice by the stockholder, to be timely, must be received at least
90 days but no earlier than 120 days before the annual
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meeting of stockholders or 10 days following the date on which notice of the
date of the meeting is made public. If, at any annual meeting, the number of
directors to be elected to the board of directors is increased and we do not
publicly announce all the nominees or specify the size of the increased board of
directors at least 100 days before the anniversary of the previous year's annual
meeting, a stockholder's notice will be considered timely, but only with respect
to nominees for the new positions created by the increase, provided the notice
is received no later than 10 days after the nominees are announced to the
public. To be timely notice for a special meetings at which one or more
directors will be elected to the board of directors, a stockholder's notice must
be delivered to us no later than 10 days after notice of the date of the meeting
and the nominees proposed to be elected are announced to the public. The bylaws
also specify requirements as to the form and content of a stockholders' notice.
These provisions may have the effect of preventing stockholders from bringing
matters before an annual meeting of stockholders or from making nominations for
directors at an annual meeting of stockholders.
Authorized But Unissued Shares
The authorized but unissued shares of common stock and preferred stock are
available for future issuances without stockholder approval. These additional
shares may be used for a variety of corporate purposes, including future public
offerings to raise additional capital, corporate acquisitions, stockholder
rights plans and employee benefit plans. The existence of authorized but
unissued shares of common stock and preferred stock could delay, deter or
prevent an attempt to obtain control of us by a proxy contest, tender offer,
merger or otherwise.
Delaware Anti-Takeover Law and Charter Provisions
We are subject to Section 203 of the Delaware General Corporation Law which
generally prohibits a Delaware corporation from engaging in any business
combination with any interested stockholder for a period of three years
following the date that the stockholder became an interested stockholder.
Section 203 applies unless:
- prior to the date the stockholder became an interested stockholder, the
board of directors of the corporation approved either the business
combination or the transaction which resulted in the stockholder becoming
an interested stockholder;
- upon consummation of the transaction which resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding certain shares; or
- on or after such date the stockholder became an interested stockholder,
the business combination is approved by the board of directors and
authorized at a meeting of stockholders by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by the
interested stockholder.
Provisions of our certificate of incorporation and Delaware law may delay,
deter or prevent a change in our control and may adversely affect the voting and
other rights of holders of common stock. In particular, our certificate of
incorporation provides for a classified board of directors and the inability of
stockholders to vote cumulatively for directors.
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TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Continental Stock
Transfer Company, New York, New York.
DESCRIPTION OF PARENT COMPANY INDEBTEDNESS
In 1997, Hollywood Entertainment established a $300 million, five-year
revolving Senior Credit Facility with a syndicate of lenders. As collateral for
the credit facility, Hollywood Entertainment has pledged substantially all of
its assets, including the shares of Reel.com common stock it owns. The Senior
Credit Facility contains financial and other affirmative and restrictive
covenants, including a minimum interest coverage ratio, a maximum leverage
ratio, minimum average per store contribution requirements, minimum
shareholders' equity, and restrictions on mergers, asset sales, additional
indebtedness, guarantees, liens, investments, operating lease obligations and
acquisitions. Some of these covenants apply to Reel.com. On March 1, 1999, the
Senior Credit Facility was amended to, among other things, allow the issuance by
Reel.com of shares of Reel.com common stock in a public or other offering and
subject to certain terms.
In connection with this offering, Hollywood Entertainment is seeking to
amend some of the covenants in the Senior Credit Facility as they apply to
subsidiaries of Hollywood Entertainment, including Reel.com. The Senior Credit
Facility also contains a requirement that Hollywood Entertainment cause a
portion of the proceeds from any sale of any of its subsidiaries' stock to be
used to pay down obligations and, in certain circumstances, reduce the credit
commitment under or collateralize the Senior Credit Facility for investment in
additional assets in a line of business in which Hollywood Entertainment is
engaged. The amendment of the Senior Credit Facility that Hollywood
Entertainment is seeking would also include an amendment eliminating this
requirement.
In the event Hollywood Entertainment is not able to amend the Senior Credit
Facility as it is seeking to do, we would continue to be subject to provisions
that, among other things, restrict our ability to incur additional debt, to
grant liens, to conduct certain acquisitions or mergers, to sell assets, to
enter into operating leases and to make certain investments. These restrictions
would significantly and negatively impact our business, financial condition and
results of operations.
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SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of our common stock in the public market after
the offering could adversely affect the market price of our common stock and our
ability to raise equity capital in the future on terms favorable to us.
After the offering, shares of our common stock will be
outstanding, assuming that the underwriters do not exercise the over-allotment
option. Of these shares, all of the shares sold in this offering
will be freely tradable without restriction or further registration under the
Securities Act, unless these shares are purchased by "affiliates" as that term
is defined in Rule 144 under the Securities Act. The remaining shares of common
stock held by existing stockholders are "restricted securities" as that term is
defined in Rule 144 under the Securities Act. Restricted securities may be sold
in the public market only if registered or if they qualify for an exemption from
registration under Rules 144 or 701 under the Securities Act, which rules are
summarized below.
The following table shows approximately when the shares of our
common stock that are not being sold in this offering but which will be
outstanding when this offering is complete will be eligible for sale in the
public market:
<TABLE>
<CAPTION>
ELIGIBILITY OF RESTRICTED SHARES
FOR SALE IN THE PUBLIC MARKET
- -------------------------------------------------------------------------
<S> <C>
180 days after the effective date
</TABLE>
Resale of most of the restricted shares that will become available for sale
in the public market starting 180 days after the effective date will be limited
by volume and other resale restrictions under Rule 144 because the holders are
our affiliates.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned shares of our
common stock for at least one year is entitled to sell, within any three-month
period, a number of shares that is not more than the greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately shares immediately after this
offering; or
- the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks before a notice of the
sale on Form 144 is filed.
Sales under Rule 144 must also comply with manner of sale provisions and
notice requirements and are subject to the availability of current public
information about us.
RULE 144(k)
Under Rule 144(k), a person who has not been one of our affiliates at any
time during the 90 days before a sale, and who has beneficially owned the
restricted shares for at least two years, is entitled to sell the shares without
complying with the manner of sale, public information, volume limitation or
notice provisions of Rule 144.
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RULE 701
In general, under Rule 701 of the Securities Act as currently in effect,
any of our employees, consultants or advisors who purchase shares from us under
a stock option plan or other written agreement can resell those shares 90 days
after the effective date of this offering in reliance on Rule 144, but without
complying with some of the restrictions, including the holding period, contained
in Rule 144.
LOCK-UP AGREEMENTS
Executive officers, directors and security holders, including our parent,
will sign lock-up agreements under which they will agree not to transfer or
dispose of, directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for shares of common stock, for
a period of 180 days after the date of this prospectus. Hambrecht & Quist LLC
may, however, in its sole discretion, at any time, without notice, release all
or any portion of the shares subject to lock-up agreements.
REGISTRATION RIGHTS
Prior to the closing of this offering, we will enter into an agreement with
our parent providing our parent with specific registration rights applicable to
shares of our common stock held by it. See "Certain Transactions -- Transactions
with our Parent -- Registration Rights Agreement.
STOCK PLANS
As soon as practicable after the completion of this offering, we intend to
file a registration statement under the Securities Act covering
shares of our common stock reserved for issuance under our 1999 Stock Incentive
Plan and the 1999 Employee Stock Purchase Plan.
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UNDERWRITING
Subject to the terms and conditions of the underwriting agreement, the
underwriters named below, through their representatives, Hambrecht & Quist LLC,
Banc of America Securities LLC, Dain Rauscher Wessels, a division of Dain
Rauscher Incorporated, and Wit Capital Corporation, have severally agreed to
purchase from Reel.com the numbers of shares of common stock set forth opposite
their names below:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
---- ---------
<S> <C>
Hambrecht & Quist LLC.......................................
Banc of America Securities LLC..............................
Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated..............................................
Wit Capital Corporation.....................................
--------
Total..................................................
========
</TABLE>
The underwriting agreement provides that the obligations of the
underwriters are subject to certain conditions, including the absence of any
material adverse change in our business and the receipt of certain certificates,
opinions and letters from us, our counsel and the independent auditors. The
underwriters are committed to purchase all of the shares of common stock offered
by this prospectus if they purchase any shares.
The following table shows the per share and total underwriting discounts
and commissions we will pay to the underwriters. Such amounts are shown assuming
both no exercise and full exercise of the underwriters' over-allotment option to
purchase additional shares.
Underwriting Discounts and Commissions
<TABLE>
<CAPTION>
WITHOUT WITH
OVER-ALLOTMENT EXERCISE OVER-ALLOTMENT EXERCISE
----------------------- -----------------------
<S> <C> <C>
Per Share.......................... $ $
Total.............................. $ $
</TABLE>
We estimate that the total expenses of this offering, excluding
underwriting discounts and commissions, will be approximately $ .
The underwriters propose to offer the shares of common stock directly to
the public at the initial public offering price set forth on the cover page of
this prospectus and to certain dealers at that price less a concession not in
excess of $ per share. The underwriters may allow and dealers may reallow a
concession not in excess of $ per share to certain other dealers. After the
initial public offering of the shares has been completed, the offering price and
other selling terms may be changed by the representatives of the underwriters.
The representatives of the underwriters have informed us that the underwriters
do not intend to confirm discretionary sales in excess of 5% of the shares of
common stock offered by this prospectus.
We have granted to the underwriters an option, exercisable no later than 30
days after the date of this prospectus, to purchase up to
additional shares of common stock at the initial public offering
price, less the underwriting discount, set forth on the cover page of this
prospectus. To the extent that the underwriters exercise this option, each of
the underwriters will have a firm commitment to purchase approximately the same
percentage thereof which the number of shares of common stock to be purchased by
it shown in the above table bears to the total number of shares of common stock
offered by this prospectus. We will be obligated, pursuant to the option, to
sell shares to the underwriters to the extent the option is exercised. The
underwriters may exercise this option only to cover over-allotments made in
connection with the sale of shares of common stock offered by this prospectus.
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The offering of the shares is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
We and our parent have agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act, and to contribute
to payments the underwriters may be required to make in respect of these
liabilities.
We, our parent and our executive officers and directors, who will
collectively own approximately shares of common stock after this
offering, have agreed that they will not, without the prior written consent of
Hambrecht & Quist LLC, offer, sell or otherwise dispose of any shares of capital
stock, options or warrants to acquire shares of capital stock or securities
exchangeable for or convertible into shares of capital stock owned by them for a
period of 180 days following the date of this prospectus. We have agreed that we
will not, without the prior written consent of Hambrecht & Quist LLC, offer,
sell or otherwise dispose of any shares of capital stock, options or warrants to
acquire shares of capital stock or securities exchangeable for or convertible
into shares of capital stock for a period of 180 days following the date of this
prospectus, except that we may grant options under our stock option plans.
Without the prior written consent of Hambrecht & Quist LLC, any options granted
shall not be exercisable during this 180-day period.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price for the common stock will be determined
by negotiations among us and representatives of the underwriters. Among the
factors to be considered in determining the initial public offering price will
be prevailing market and economic conditions, our revenue and earnings, market
valuations of other companies engaged in activities similar to ours, estimates
of our business potential and prospects, the present state of our business
operations, our management and other factors deemed relevant. The estimated
initial public offering price range set forth on the cover of this preliminary
prospectus is subject to change as a result of market conditions or other
factors.
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the common stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids, effecting syndicate-covering
transactions or imposing penalty bids. A stabilizing bid means the placing of
any bid or effecting of any purchase for the purpose of pegging, fixing or
maintaining the price of the common stock. A syndicate-covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
the offering. A penalty bid means an arrangement that permits the underwriters
to reclaim a selling concession from a syndicate member in connection with the
offering when shares of common stock sold by the syndicate member are purchased
in syndicate-covering transactions. These transactions may be effected on the
Nasdaq National Market, in the over-the-counter market or otherwise.
Stabilizing, if commenced, may be discontinued at any time.
In addition, at our request, the underwriters have reserved up to
shares of common stock for sale at the initial public offering
price to our directors, officers, employees, business associates and related
persons. The number of shares of common stock available for sale to the general
public will be reduced to the extent these persons purchase the reserved shares.
Any reserved shares that are not so purchased will be offered by the
underwriters to the general public on the same basis as the other shares offered
by this prospectus.
78
<PAGE> 80
A prospectus in electronic format is being made available on an Internet
Website maintained by Wit Capital. In addition, pursuant to an e-Dealer
Agreement, all dealers purchasing shares from Wit Capital in the offering
similarly have agreed to make a prospectus in electronic format available on
Websites maintained by each of the e-Dealers.
Wit Capital, a member of the National Association of Securities Dealers,
Inc. will participate in the offering as one of the underwriters. The National
Association of Securities Dealers, Inc. approved the membership of Wit Capital
on September 4, 1997. Since that time, Wit Capital has acted as an underwriter,
co-manager or selected dealer in over 125 public offerings. Except for its
participation as a manager in this offering, Wit Capital has no relationship
with us or any of our founders or significant stockholders.
VALIDITY OF THE ISSUANCE OF THE COMMON STOCK
The validity of the issuance of the common stock offered in this offering
will be passed upon for us by Brobeck Phleger & Harrison, LLP, San Francisco,
California and for the underwriters by Cooley Godward LLP, San Francisco,
California.
EXPERTS
The financial statements for the years ended December 31, 1996 and 1997 and
the nine months ended September 30, 1998 and 1999 and the three months ended
December 31, 1998, and at December 31, 1997 and 1998 and at September 30, 1999
included in this prospectus have been so included in reliance on the report
(which contains an explanatory paragraph relating to the Company's ability to
continue as a going concern as described in Note 2 to the financial statements)
of PricewaterhouseCoopers LLP, independent accountants, given on the authority
of said firm as experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the SEC a Registration Statement on Form S-1 under the
Securities Act with respect to the common stock offered in this offering. This
prospectus does not contain all information set forth in the Registration
Statement and the exhibits and schedules to the Registration Statement. For
further information about us and the common stock offered in this offering, you
should read the Registration Statement, exhibits and schedules. Statements
contained in this prospectus about the contents of any contract or other
document referred to are not necessarily complete, and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement. To have a complete understanding of any
such document, you should read the entire document filed as an exhibit. You may
read and copy the Registration Statement, including the exhibits and schedules,
at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549 and at the regional offices of the SEC
located at Seven World Trade Center, Suite 1300, New York, New York 10048 and
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can obtain
copies of such materials from the Public Reference Section of the SEC, Room
1024, 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates and
from the SEC's Internet Website at http://www.sec.gov. Please call the SEC at
1-800-SEC-0330 for further information about the public reference rooms.
79
<PAGE> 81
We intend to send to our stockholders annual reports containing audited
financial statements.
Upon completion of this offering, we will become subject to the information
and periodic reporting requirements of the Securities Exchange Act of 1934 and,
in accordance with that act, we will file periodic reports, proxy statements and
other information with the SEC. These periodic reports, proxy statements and
other information will be available for inspection and copying at the SEC's
public reference rooms and the SEC's Website, which is described above.
80
<PAGE> 82
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants........................... F-2
Balance Sheets at December 31, 1997, 1998 and September 30,
1999...................................................... F-3
Statements of Operations for the years ended December 31,
1996, 1997, the nine months ended September 30, 1998, the
three months ended December 31, 1998 and the nine months
ended September 30, 1999.................................. F-4
Statements of Stockholders' Equity for the years ended
December 31, 1996, 1997, the nine months ended September
30, 1998, the three months ended December 31, 1998 and the
nine months ended September 30, 1999...................... F-5
Statements of Cash Flows for the years ended December 31,
1996, 1997, the nine months ended September 30, 1998, the
three months ended December 31, 1998 and the nine months
ended September 30, 1999.................................. F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 83
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Reel.com, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, of stockholder's equity (deficit) and of cash flows present
fairly, in all material respects, the financial position of the online business
division of Reel.com, Inc., at December 31, 1997 and 1998 and at September 30,
1999, and the results of its operations and its cash flows for the years ended
December 31, 1996 and 1997, the nine months ended September 30, 1998, the three
months ended December 31, 1998, and the nine months ended September 30, 1999, 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
audits 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.
As more fully described in Note 2, these financial statements represent the
financial activities related to the online business division of Reel.com, Inc.,
a 100% owned subsidiary of Hollywood Entertainment Corporation ("Hollywood
Entertainment").
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has generated recurring losses and negative
cash flows from operations. The Company has relied upon Hollywood Entertainment
to finance its operations; however Hollywood Entertainment is limited in the
amount of additional financing it may provide to the Company due to restrictive
covenants contained in its bank credit facilities. These circumstances raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans relating to this matter are also described in Note 2. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ PricewaterhouseCoopers LLP
December 1, 1999
San Francisco, California
F-2
<PAGE> 84
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30, 1999
-------------------------- ---------------------------
1997 1998 ACTUAL PRO FORMA
----------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash.......................................... $ 112,710 $ -- $ 15,335
Accounts receivable, net of allowance for
returns of $0, $178,535, and $88,549 in
1997, 1998 and 1999......................... 21,089 203,665 530,403
Merchandise inventory, net.................... 47,310 2,148,943 5,246,932
Prepaid expenses and other current assets..... 65,715 783,786 779,605
----------- ------------ ------------
Total current assets........................ 246,824 3,136,394 6,572,275
Videocassette rental inventory, net............. 50,544 -- --
Property and equipment, net..................... 203,886 1,721,145 3,012,101
Intangible assets and goodwill, net............. -- 87,805,753 50,174,716
Other assets, net............................... -- 111,111 --
----------- ------------ ------------
Total assets................................ $ 501,254 $ 92,774,403 $ 59,759,092
=========== ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Bank overdraft................................ $ -- $ 413,558 $ 212,707
Accounts payable.............................. 301,319 4,080,122 7,226,337
Accrued expenses.............................. 142,319 2,820,346 4,093,402
Convertible notes payable..................... 682,335 -- --
Notes payable................................. 72,091 -- --
----------- ------------ ------------
Total current liabilities................... 1,198,064 7,314,026 11,532,446
Intercompany advances from Hollywood
Entertainment (Note 3)........................ -- 10,690,367 42,482,934 32,482,934
----------- ------------ ------------ ------------
Total liabilities........................... 1,198,064 18,004,393 54,015,380
----------- ------------ ------------
Commitments and contingencies (Notes 3 and 7)
Stockholders' equity (deficit):
Members' equity............................... 2,858,447 -- --
Preferred stock: $.001 par value; none
authorized at December 31, 1997 and 1998,
and September 30, 1999, 50,000,000 shares
authorized at September 30, 1999 (pro forma
unaudited), none outstanding................ -- -- --
Common stock: $.01 par value and 1,000 shares
authorized at December 31, 1998 and
September 30, 1999; $.001 par value and
100,000,000 shares authorized at September
30, 1999 (pro forma unaudited); 0, 1,000,
1,000, and 1,000 outstanding,
respectively................................ -- 10 10 1
Additional paid-in capital.................... -- 96,880,739 96,880,739 106,880,748
Accumulated deficit........................... (3,555,257) (22,110,739) (91,137,037) (91,137,037)
----------- ------------ ------------ ------------
Total stockholders' equity (deficit)........ (696,810) 74,770,010 5,743,712 $ 15,743,712
----------- ------------ ------------ ------------
Total liabilities and stockholders' equity
(deficit)................................. $ 501,254 $ 92,774,403 $ 59,759,092
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 85
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
POST-ACQUISITION
PRE-ACQUISITION ----------------------------
--------------------------------------- ----------------------------
NINE MONTHS THREE MONTHS NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED ENDED ENDED
----------------------- SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1996 1997 1998 1998 1999
--------- ----------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Net revenue.................... $ -- $ 745,093 $ 8,567,860 $ 6,472,026 $ 21,613,082
Operating expenses:
Cost of net revenue.......... -- 546,888 10,112,894 6,746,545 22,707,621
Marketing and sales.......... 52,784 569,560 8,102,153 5,113,674 16,671,931
Product development.......... 482,697 950,954 2,947,955 1,385,220 6,776,807
General and administrative... 222,998 1,474,950 2,341,245 736,188 4,133,318
Amortization of intangible
assets and goodwill....... -- -- -- 12,543,679 37,631,037
Write-off of purchased
research and
development............... -- -- -- 1,900,000 --
Stock-based compensation..... -- -- 605,397 -- --
--------- ----------- ------------ ------------ ------------
Total operating
expenses............. 758,479 3,542,352 24,109,644 28,425,306 87,920,714
--------- ----------- ------------ ------------ ------------
Loss from operations........... (758,479) (2,797,259) (15,541,784) (21,953,280) (66,307,632)
Interest expense............... (100) (1,670) (495,241) (166,303) (2,726,985)
Interest income................ -- 2,251 35,003 8,844 8,319
--------- ----------- ------------ ------------ ------------
Loss before income
taxes................ (758,579) (2,796,678) (16,002,022) (22,110,739) (69,026,298)
Income taxes................... -- -- -- -- --
--------- ----------- ------------ ------------ ------------
Net loss..................... $(758,579) $(2,796,678) $(16,002,022) $(22,110,739) $(69,026,298)
========= =========== ============ ============ ============
Net loss per share:
Basic and diluted............ $ (22,111) $ (69,026)
============ ============
Weighted average shares-basic
and diluted............... 1,000 1,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 86
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
MEMBERS' EQUITY COMMON STOCK PREFERRED STOCK
------------------------ --------------- ------------------- ADDITIONAL
UNITS AMOUNT SHARES AMOUNT SHARES AMOUNT PAID-IN CAPITAL
---------- ----------- ------ ------ ---------- ------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Capital contributions............... 4,700,000 $ 759,089 -- $-- -- $ -- $ --
Net loss............................
---------- ----------- ----- --- ---------- ------ -----------
Balance at December 31, 1996........ 4,700,000 759,089 -- -- -- -- --
Capital contributions............... 2,099,358 2,099,358
Net loss............................
---------- ----------- ----- --- ---------- ------ -----------
Balance at December 31, 1997........ 6,799,358 2,858,447 -- -- -- -- --
Restructure to C corporation (Note
1)................................ (6,799,358) (2,858,447) 2,858,447
Conversion of debt to equity........ 2,022,712
Issuance of preferred stock......... 4,143,475 4,143 8,780,024
Net loss............................
---------- ----------- ----- --- ---------- ------ -----------
Balance at September 30, 1998....... -- $ -- -- $-- 4,143,475 $4,143 $13,661,183
========== =========== ===== === ========== ====== ===========
Balance at October 1, 1998.......... -- $ -- -- $-- -- $ -- $ --
Issuance of common stock to
Hollywood Entertainment........... 1,000 10 96,880,739
Net loss............................
---------- ----------- ----- --- ---------- ------ -----------
Balance at December 31, 1998........ 1,000 10 -- -- 96,880,739
Net loss............................
---------- ----------- ----- --- ---------- ------ -----------
Balance at September 30, 1999....... -- $ -- 1,000 $10 -- $ -- $96,880,739
========== =========== ===== === ========== ====== ===========
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY (DEFICIT)
------------ ----------------
<S> <C> <C>
Capital contributions............... $ -- $ 759,089
Net loss............................ (758,579) (758,579)
------------ ------------
Balance at December 31, 1996........ (758,579) 510
Capital contributions............... 2,099,358
Net loss............................ (2,796,678) (2,796,678)
------------ ------------
Balance at December 31, 1997........ (3,555,257) (696,810)
Restructure to C corporation (Note
1)................................ --
Conversion of debt to equity........ 2,022,712
Issuance of preferred stock......... 8,784,167
Net loss............................ (16,002,022) (16,002,022)
------------ ------------
Balance at September 30, 1998....... $(19,557,279) $ (5,891,953)
============ ============
Balance at October 1, 1998.......... $ -- $ --
Issuance of common stock to
Hollywood Entertainment........... 96,880,749
Net loss............................ (22,110,739) (22,110,739)
------------ ------------
Balance at December 31, 1998........ (22,110,739) 74,770,010
Net loss............................ (69,026,298) (69,026,298)
------------ ------------
Balance at September 30, 1999....... $(91,137,037) $ 5,743,712
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 87
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PRE-ACQUISITION POST-ACQUISITION
--------------------------------------- ----------------------------
NINE MONTHS THREE MONTHS NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED ENDED ENDED
----------------------- SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1996 1997 1998 1998 1999
--------- ----------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss................................. $(758,579) $(2,796,678) $(16,002,022) $(22,110,739) $(69,026,298)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation of property and
equipment............................ 5,843 41,366 179,304 140,911 734,358
Depreciation of videocassette rental
inventory............................ -- 12,131 55,733 82,783 --
Amortization of goodwill and other
intangible assets.................... -- -- -- 12,543,679 37,631,037
Write-off of purchased research and
development.......................... -- -- -- 1,900,000 --
Stock-based compensation............... -- -- 605,397 -- --
Allowance for sales returns............ -- -- 271,306 (92,771) (50,695)
Allowance for inventory obsolescence... -- -- 275,000 38,715 172,500
Changes in operating assets and
liabilities:
Accounts receivable.................... -- (21,089) (425,341) 64,227 (276,043)
Merchandise inventory.................. -- (47,310) (427,622) (1,987,726) (3,270,489)
Prepaid expenses and other assets...... (4,714) (61,001) (1,123,416) 294,234 115,292
Accounts payable....................... 28,505 272,814 6,980,091 (3,201,288) 3,146,215
Accrued liabilities.................... 704 141,615 1,429,935 1,248,092 1,273,056
--------- ----------- ------------ ------------ ------------
Net cash used in operating
activities......................... (728,241) (2,458,152) (8,181,635) (11,079,883) (29,551,067)
--------- ----------- ------------ ------------ ------------
Cash flows from investing activities:
Purchase of property and equipment..... (63,946) (187,149) (1,079,132) (758,342) (2,025,314)
Purchase of videocassette rental
inventory............................ -- (62,675) (87,972) -- --
--------- ----------- ------------ ------------ ------------
Net cash used in investing
activities......................... (63,946) (249,824) (1,167,104) (758,342) (2,025,314)
--------- ----------- ------------ ------------ ------------
Cash flows from financing activities:
Bank overdraft......................... -- -- -- 413,558 (200,851)
Proceeds from notes payable............ 63,849 690,577 2,022,712 -- --
Repayment of notes payable............. -- -- (836,550) -- --
Proceeds from equity financing......... 759,089 2,099,358 8,784,167 -- --
Proceeds from Hollywood Entertainment.. -- -- 1,313,874 9,376,493 31,792,567
--------- ----------- ------------ ------------ ------------
Net cash provided by financing
activities......................... 822,938 2,789,935 11,284,203 9,790,051 31,591,716
--------- ----------- ------------ ------------ ------------
Change in cash........................... 30,751 81,959 1,935,464 (2,048,174) 15,335
Cash at beginning of period.............. -- 30,751 112,710 2,048,174 --
--------- ----------- ------------ ------------ ------------
Cash at end of period.................... $ 30,751 $ 112,710 $ 2,048,174 $ -- $ 15,335
========= =========== ============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
ACTIVITIES
Cash paid during the period for
interest............................. $ -- $ -- $ -- $ -- $ --
========= =========== ============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING ACTIVITIES
Exchange of advertising for advertising
or equipment......................... $ -- $ -- $ -- $ -- $ 1,014,377
========= =========== ============ ============ ============
Conversion of debt to equity........... $ -- $ -- $ 2,022,712 $ -- $ --
========= =========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 88
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS
Reel.com, Inc. (the "Company"), is the founder of the Reel.com Website, an
online destination for film-related content and commerce. Through the Website,
the Company provides an entertaining environment in which consumers can access a
wide variety of film-related information such as news, film reviews, trivia,
interviews, film clips, and editorial recommendations, and purchase a broad
range of films.
The Company was founded on January 1, 1996, as the Knowledge Project, a
sole proprietorship. Its primary business activity was the development of the
Website. On September 15, 1996, the Knowledge Project was re-named Reel LLC, a
company under common control. During January 1997, the Website was launched. On
July 1, 1997, Reel.Com LLC, a Delaware limited liability company, was formed. On
April 30, 1998, Reel.Com LLC became Reel.com, Inc. Reel.com, Inc. was engaged in
the online sale of videocassettes and the further development of the Website and
its content. On October 1, 1998, pursuant to the Agreement and Plan of Merger
and Reorganization, Hollywood Entertainment Corporation ("Hollywood
Entertainment") acquired all of the outstanding shares of Reel.com, Inc.'s
capital stock (see Note 7). Hollywood Entertainment's basis in the acquired net
assets was pushed down to the Company's financial statements. The Company
utilizes Hollywood Entertainment's business relationships, infrastructure and
brand names and has relied on Hollywood Entertainment to provide financing for
its operations.
The Company has filed a registration statement with the Securities and
Exchange Commission for a proposed initial public offering ("IPO") of common
stock. The authorized capital stock of the Company consists of 1,000 shares of
common stock with a par value of $.01 per share. Prior to the closing of the
offering, the Company intends to amend its certificate of incorporation to
increase its authorized capital stock. The Company will be authorized to issue a
total of 150,000,000 shares of stock in two classes: 100,000,000 shares of
common stock, par value $0.001 per share, and 50,000,000 shares of preferred
stock, par value $0.001 per share. After the offering, Hollywood Entertainment
is expected to own a majority of the outstanding shares of Reel.com, Inc.'s
common stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying financial statements represent the financial activities of
the online business division of Reel.com, Inc., a wholly owned subsidiary of
Hollywood Entertainment. Assets, liabilities, operations and cash flows
associated with the Company's non-Internet-based business division are not
included in the accompanying financial statements. The financial statements have
been prepared as if the Company has operated as a stand-alone entity since
inception.
The Company's financial statements have been prepared assuming the Company
will continue as a going concern. Since inception, the Company has devoted
substantially all of its efforts to developing its business and has generated
substantial losses, negative working capital and negative operating cash flows
as reflected in these financial statements. The Company has relied primarily on
equity infusions from third parties and
F-7
<PAGE> 89
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
advances from Hollywood Entertainment to fund its operations. However, Hollywood
Entertainment is limited in the amount of additional financing it may provide to
the Company pursuant to restrictive covenants contained in a Senior Credit
Facility it maintains with a syndication of banks. These circumstances raise
significant doubt about the Company's ability to continue as a going concern.
The accompanying financial statements do not include any adjustments that may
result from the outcome of this uncertainty.
The Company will require additional funding to continue as a going concern.
Management is seeking financial resources through the parent company through a
contemplated initial public offering of its shares or through other sources.
There can be no assurance that such offering will be successful or such
resources will be available from the parent company or others.
The Company's financial statements for the periods subsequent to its
acquisition by Hollywood Entertainment include incremental corporate
administration, finance and management costs allocated to the Company from
Hollywood Entertainment based on specific identification of costs incurred on
behalf of the Company, allocations of payroll costs incurred by Hollywood
Entertainment's administrative and marketing personnel directly supporting the
Company, and the cost of promotional activities performed on the Company's
behalf. Management believes such allocations are reasonable under the
circumstances. However, these allocations and estimates are not necessarily
indicative of the costs that would have resulted if the Company had operated on
a stand-alone basis during the three months ended December 31, 1998 and the nine
months ended September 30, 1999 nor are they necessarily indicative of future
costs to support the operations of the Company.
RISKS AND USE OF ESTIMATES
The Company operates in the online media and retail industry, which is new,
rapidly evolving and intensely competitive. The Company competes primarily with
traditional retail outlets and other entities that maintain similar commercial
web sites. There can be no assurance that the Company will achieve sufficient
online traffic to realize economies of scale that justify the significant
investments by third parties.
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of temporary cash investments,
certificates of deposit, and accounts receivable. The Company deposits its
temporary cash investments with two financial institutions and these deposits
exceed insured amounts. The Company sells products to consumers on a credit
basis, and establishes allowances as necessary based on management's estimates
expected returns.
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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Such estimates include the levels of valuation allowances for doubtful
accounts receivable, deferred taxes, and inventory reserves. Actual results
could differ from those estimates, and such differences could be material.
F-8
<PAGE> 90
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
REVENUE RECOGNITION
The Company recognizes revenue from product sales, net of allowances for
coupons, discounts and estimated returns, when the product is shipped to the
customer. Outbound shipping and handling charges are included in net revenue.
Such charges amounted to $0, $168,628, $1,989,682, $1,201,614, and $2,673,471,
during the years ended December 31, 1996 and 1997, the nine months ended
September 30, 1998, the three months ended December 31, 1998, and the nine
months ended September 30, 1999, respectively. Revenue from gift certificates is
recognized upon product shipment following redemption. The Company provides an
allowance for sales returns based on historical experience.
COST OF REVENUE
Cost of revenue includes cost of merchandise inventory sold, the cost of
promotional merchandise, and shipping and handling costs.
BARTER TRANSACTIONS
The Company trades advertisements on its Website for advertisements on the
Websites of other companies. Barter revenues and expenses are recorded at the
fair market value of the services provided or received, whichever is more
determinable in the circumstances. Revenue from barter transactions is
recognized when the Company delivers advertisements for other companies on its
Website. Barter expense is recognized when the Company's advertisements are
delivered on the Websites of other companies, which is typically in the same
period as the barter revenues are recognized. No advertising barter revenues
were recorded during the years ended December 31, 1996 and 1997, the nine months
ended September 30, 1998, the three months ended December 31, 1998; barter
revenues of $1,014,377 were earned during the nine months ended September 30,
1999. The Company expects that barter revenues will represent a smaller
percentage of its revenues in the future.
PRODUCT DEVELOPMENT
Product development expenses consist primarily of payroll and related
expenses for Website development, systems and telecommunications operations
personnel and consultants, system and telecommunications infrastructure. To
date, all product development costs have been expensed as incurred.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with original
maturities of three months or less. Disbursements from bank accounts in excess
of cash deposits at the respective banks are recorded as bank overdrafts.
MERCHANDISE INVENTORY
Merchandise inventories, consisting primarily of pre-recorded movies on
DVD, videocassettes and movie soundtracks on compact discs, are stated at the
lower of cost or market. Cost is determined using the moving weighted average
method, which approximates the first-in,
F-9
<PAGE> 91
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
first-out method. The Company records an allowance to reduce the carrying
amounts of inventory to estimated net realizable value. As of December 31, 1997,
1998 and September 30, 1999, the allowance was $0, $313,715 and $486,215,
respectively.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated on a straight-line basis over the estimated useful
lives of those assets. Computer equipment is depreciated over an estimated
useful life of three years and office furniture and equipment is depreciated
over five years. Leasehold improvements are amortized over the shorter of their
estimated useful life and the term of the lease.
INTANGIBLE ASSETS
Intangible assets resulting from the acquisition of the Company by
Hollywood Entertainment (see Note 9) were estimated by Hollywood Entertainment's
management to be primarily associated with the acquired trademarks, in-place
workforce, developed online commerce infrastructure, database and content, and
goodwill. Intangible assets are amortized on a straight-line basis over the
estimated period of benefit, which, because of the rapid changes occurring in
the Internet industry including consolidation of distribution channels,
short-lived Websites and tradenames, technological developments, and the intense
competition for qualified Internet professionals, is two years.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes. Under SFAS
No. 109, deferred tax assets and liabilities are determined based on temporary
differences between the financial statement and tax bases of assets and
liabilities and net operating loss and credit carry forwards using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized.
ADVERTISING AND PROMOTIONAL EXPENSES
Advertising and promotional costs are expensed as incurred. Advertising
expense was $3,723, $242,215, $4,841,137, $2,592,761 and $9,590,358 for the
years ended December 31, 1996 and 1997, the nine months ended September 30,
1998, the three months ended December 31, 1998 and the nine months ended
September 30, 1999, respectively, and is included in marketing and sales
expenses in the accompanying statements of operations. During the nine months
ended September 30, 1999, advertising expense includes $782,853 of costs arising
from barter transactions.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") No. 25,
Accounting for Stock
F-10
<PAGE> 92
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Issued to Employees, and complies with the disclosure provisions of SFAS No.
123, Accounting for Stock-Based Compensation. Under APB No. 25, compensation
expense is recognized for the difference, if any, on the date of the grant,
between the estimated fair value of the Company's stock and the exercise price
of options to purchase that stock.
NET LOSS PER SHARE
The Company computes net loss per share in accordance with SFAS No. 128,
Earnings per Share, and SEC Staff Accounting Bulletin ("SAB") No. 98. Under the
provisions of SFAS No. 128 and SAB No. 98, basic net income per share is
computed by dividing the net income available to common stockholders for the
period by the weighted average number of vested common shares outstanding during
the period. The Company does not have any potentially dilutive common shares.
Therefore, basic net loss per share equals diluted net loss per share.
The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS THREE MONTHS NINE MONTHS
DECEMBER 31, ENDED ENDED ENDED
------------------------- SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1996 1997 1998 1998 1999
--------- ------------- ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Numerator:
Net loss........................... $(758,579) $ (2,796,678) $(16,002,022) $(22,110,739) $(69,026,298)
--------- ------------- ------------ ------------ ------------
Net loss available to common
stockholders..................... $(758,579) $ (2,796,678) $(16,002,022) $(22,110,739) $(69,026,298)
========= ============= ============ ============ ============
Denominator:
Weighted average shares............ 1,000 1,000
------------ ------------
Denominator for basic
calculation...................... 1,000 1,000
============ ============
Basic net loss per share:............ $ (22,111) $ (69,026)
============ ============
</TABLE>
UNAUDITED PRO FORMA PRESENTATION
The unaudited pro forma balance sheet as of September 30, 1999 reflects the
contribution of $10 million of intercompany advances from Hollywood
Entertainment into additional paid-in capital which is intended to occur upon
the closing of the Company's proposed initial public offering.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from non-owner sources. To date, the Company has not had any
transactions that are required to be reported in comprehensive income.
F-11
<PAGE> 93
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information. SFAS No.
131 establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The disclosures prescribed by SFAS No. 131 are effective for the year
ended December 31, 1998. The Company has determined that it does not have any
separately reportable business segments as of December 31, 1998.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, Software for Internal Use, which
provides guidance on accounting for the cost of computer software developed or
obtained for internal use. SOP No. 98-1 is effective for financial statements
for fiscal years beginning after December 15, 1998. The adoption of SOP No. 98-1
in 1999 did not have a material impact on the Company's financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
Accounting for Derivative Instruments and Hedging Activities which is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. This
statement establishes a new model for accounting for derivatives and hedging
activities. Under SFAS No. 133, all derivatives must be recognized as assets and
liabilities and measured at fair value. In July 1999, the FASB issued Statement
of Accounting Standards No. 137 Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133
which defers the effective date to all fiscal quarters of fiscal years beginning
after June 15, 2000. The adoption of SFAS No. 133 is not expected to have a
significant impact on the Company's financial position or results of operations.
3. RELATED PARTY TRANSACTIONS
Certain merchandise sold from October 1, 1998 through December 31, 1998 was
purchased from Hollywood Entertainment at Hollywood Entertainment's cost. For
the three months ended December 31, 1998 and the nine months ended September 30,
1999, such purchases amounted to $84,983 and $584,005, respectively. Hollywood
Entertainment charges the Company the costs associated with such purchases,
including cost of freight, handling and other costs, incurred by Hollywood
Entertainment in connection with providing such merchandise.
As a subsidiary of Hollywood Entertainment, the Company also receives, and
is charged its proportionate share of various services from Hollywood
Entertainment which are recorded in marketing and sales expense. Such charges
were $236,876 and $1,432,839 for the three months ended December 31, 1998, and
the nine months ended September 30, 1999, respectively. In the opinion of
management, all allocations of such costs have been made on a reasonable and
consistent basis, however, they are not necessarily indicative of nor is it
practical for management to estimate the level of expenses which might have been
incurred had the Company been operating as a separate, stand-alone company.
F-12
<PAGE> 94
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Prior to the closing of the offering, the Company and Hollywood
Entertainment intend to enter into several intercompany agreements as described
in the following three paragraphs. These agreements cover rights and obligations
regarding income taxes, trademarks and the sharing of customer lists,
competition, intercompany services, and stock registration.
- The Tax Allocation Agreement generally provides that, following the
closing of the offering, for so long as the Company remains a member of
the Hollywood Entertainment taxpayer group, the Company will pay its
proportionate share of Hollywood Entertainment tax liability computed as
if the Company were filing a separate return, provided however, that any
tax benefits attributable to the Company will be used by Hollywood
Entertainment to the extent the Company is unable to use such benefits at
that time. The Company will not be entitled to reimbursement for tax
benefits utilized by other members of the Hollywood Entertainment
taxpayer group.
- Under the Intercompany Services Agreement, Hollywood Entertainment will
continue to provide all of the services it currently provides to the
Company at no more than 100% of Hollywood Entertainment's cost. Hollywood
Entertainment will continue to supply used movies and other used
entertainment products on video, DVD, and other media formats, previously
used by Hollywood Entertainment in its retail stores, under terms and
conditions that are no less favorable than those provided by Hollywood
Entertainment to third parties. Hollywood Entertainment will continue to
provide certain advertising services to Reel.com, on terms no less
favorable than those provided by Hollywood Entertainment to third
parties. These advertising services will include advertising in Hollywood
Entertainment's in-store magazines, advertising space within in-store
video loops and other direct marketing offerings made by Hollywood
Entertainment to its customers. Hollywood Entertainment will permit the
Company to use a portion of its offices at the lesser of the prevailing
market rate for such space and the highest rate then being paid by
Hollywood Entertainment for comparable space in the metropolitan area in
which such space is located. The Company and Hollywood Entertainment will
cooperate for the purpose of acquiring new movies and other new
entertainment products on video, DVD, and other media formats from
various movie studios and provide each other access to the other party's
databases that contain information pertaining to customers and films.
- The Company and Hollywood Entertainment intend to enter into an Asset
Transfer Agreement, whereby the assets, liabilities, operations, and cash
flows associated with the Company's non-Internet-based division will be
transferred to Hollywood Entertainment.
In addition, one of the Company's officers and two of its directors also
serve as officers and directors of Hollywood Entertainment.
Since October 1, 1998, the date Hollywood Entertainment acquired the
Company, Hollywood Entertainment has provided all necessary funding for the
operations of the Company; this funding is accounted for as intercompany
advances. Through December 31, 1998 and September 30, 1999, intercompany
advances totaled $10,690,367 and $42,482,934 respectively. Beginning in March
1999, Hollywood Entertainment has charged the Company 14% interest on the net
outstanding balance. Interest expense for the three months ended
F-13
<PAGE> 95
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1998 and the nine months ended September 30, 1999 was $166,303 and
$2,726,985, respectively. In addition, Hollywood Entertainment has provided
payment guarantees for the Company's operating leases amounting to $2,609,100 as
of September 30, 1999.
In 1997, Hollywood Entertainment established a $300 million, five-year
revolving Senior Credit Facility with a syndicate of lenders. As collateral for
the credit facility, Hollywood Entertainment has pledged substantially all of
its assets, including the shares of Reel.com common stock it owns. On March 1,
1999, the Senior Credit Facility was amended to, among other things, allow the
issuance by Reel.com of shares of Reel.com common stock in a public offering.
Hollywood Entertainment has confirmed its intention to continue to fund the
operating cash needs of the Company and to not require repayment of the advances
through the earlier of the effective date of this offering or October 2000. When
the Company completes its anticipated initial public offering of common stock,
$10 million of the proceeds will be used to repay Hollywood Entertainment, and
the remaining outstanding balance will be contributed to the Company and
recorded as additional paid-in capital.
4. PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 1997 and 1998, and September 30,
1999 is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1997 1998 1999
-------- ---------- -------------
<S> <C> <C> <C>
Computer equipment................................ $230,267 $1,843,476 $ 3,537,911
Furniture and office equipment.................... 20,828 233,368 462,430
Leasehold improvements............................ -- 11,725 113,542
-------- ---------- -----------
251,095 2,088,569 4,113,883
Less accumulated depreciation..................... (47,209) (367,424) (1,101,782)
-------- ---------- -----------
Property and equipment, net....................... $203,886 $1,721,145 $ 3,012,101
======== ========== ===========
</TABLE>
Depreciation expense amounted to $5,843, $41,366, $179,304, $140,911 and
$734,358 for the years ended December 31, 1996 and 1997, the nine months ended
September 30, 1998, the three months ended December 31, 1998 and the nine months
ended September 30, 1999, respectively.
F-14
<PAGE> 96
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. ACCRUED EXPENSES
Accrued expenses as of December 31, 1997 and 1998, and September 30, 1999
comprise the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1997 1998 1999
-------- ---------- -------------
<S> <C> <C> <C>
Accrued payroll, vacation and bonuses............. $ 50,077 $ 362,357 $ 467,945
Accrued professional fees......................... 12,000 419,879 663,385
Accrued marketing costs........................... -- 662,179 1,391,548
Accrued product costs............................. -- 794,074 692,528
Accrued utilities costs........................... -- 164,499 162,489
Other accrued expenses............................ 80,242 417,358 715,507
-------- ---------- ----------
$142,319 $2,820,346 $4,093,402
-------- ---------- ----------
</TABLE>
6. CONVERTIBLE NOTES PAYABLE
The Company issued convertible promissory notes amounting to $682,335 with
detachable warrants, to several investors in December 1997. Interest accrued
from the date of the notes on the unpaid principal amount at a rate equal to
5.6% per annum, compounded semi-annually. The fair value of the warrants
amounted to $52,000 determined using the Black-Scholes valuation model.
Principal and unpaid interest were due and payable upon demand by the holders of
a majority-in-interest of the aggregate principal amount of the notes at any
time after June 30, 1998. Upon the closing of the Series C preferred stock
financing in May 1998, the convertible promissory notes and accrued interest
were automatically converted into shares of Series C preferred stock.
7. COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities and distribution center under
operating leases which expire on February 28, 2005 and February 28, 2002,
respectively. Future minimum obligations under non-cancelable operating leases
at September 30, 1999 are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
----------
<S> <C>
Three months ending December 31, 1999....................... $ 100,100
Years ending December 31:
2000................................................... 600,500
2001................................................... 613,700
2002................................................... 489,900
2003................................................... 396,500
2004 and thereafter.................................... 408,400
----------
Total minimum lease payments...................... $2,609,100
==========
</TABLE>
Rent expense under operating leases for the years ended December 31, 1996
and 1997, the nine months ended September 30, 1998, the three months ended
December 31, 1998, and the
F-15
<PAGE> 97
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
nine months ended September 30, 1999 were $29,268, $42,125, $133,363, $47,108
and $219,905, respectively.
As of September 30, 1999 the Company has entered into marketing agreements
with third parties whereby the third parties provide advertising services and
database links to the Company's Website. Fees to be paid by the Company for
these services are determined as fixed monthly payments, or are calculated on a
per "click-through" basis, or as a percentage of net revenues, as defined in the
related agreements. These agreements expire on various dates through August 2000
whereby the Company is committed to pay minimum marketing fees of $2,754,321.
In the normal course of business, the Company is at times subject to
pending and threatened legal actions and proceedings. After reviewing pending
and threatened actions and proceedings with counsel, management believes that
the outcome of such actions or proceedings is not expected to have a material
adverse effect on the financial position, cash flows, or results of operations
of the Company.
8. INCOME TAXES
The Company was formed as a limited liability company ("LLC") in September
1996, and converted to a C-corporation in April 1998. Net operating losses and
tax credits generated prior to the Company's incorporation as a C Corporation
were passed through to the owners of the LLC. Losses incurred subsequent to the
acquisition by Hollywood Entertainment on October 1, 1998 were utilized to
offset Hollywood Entertainment's taxable income.
As of September 30, 1999, the Company had net operating loss carryforwards
of approximately $12,431,000 and $12,431,000 for federal and state income tax
purposes, respectively. The federal and state net operating loss carryforwards
begin to expire in the years 2018 and 2003, respectively.
The Company's ability to utilize its net operating loss carryforwards to
offset future taxable income may be subject to restrictions as defined by the
Tax Reform Act of 1986. These restrictions may limit, on an annual basis, the
Company's future use of its net operating loss carryforwards. The amount, if
any, of such limitations has not yet been determined.
The components of the net deferred tax assets and liabilities are presented
below:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1998 1998 1999
------------- ------------ -------------
<S> <C> <C> <C>
Net operating loss carryforwards................. $ 4,952,000 $ 5,076,310 $ 5,076,310
Tax credit carryforwards......................... -- -- --
Property and equipment........................... 85,000 85,000 85,000
Accruals and reserves............................ 295,000 382,000 382,000
----------- ----------- -----------
5,332,000 5,543,310 5,543,310
Less valuation allowance......................... (5,332,000) (5,543,310) (5,543,310)
----------- ----------- -----------
Net deferred tax asset........................... $ -- $ -- $ --
=========== =========== ===========
</TABLE>
F-16
<PAGE> 98
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Due to the uncertainty surrounding the realization of the favorable tax
attributes in future tax returns, the Company has placed a valuation allowance
against its net deferred tax asset. The valuation allowance recorded for the
periods ended December 31, 1998 and September 30, 1999 increased by $87,000 and
$0, respectively.
The difference between the income tax benefit at the federal statutory rate
of 34% and the Company's effective tax rate is due primarily to the valuation
allowance established to offset the deferred tax assets. The provision for
income taxes is different than the amount computed using the applicable
statutory federal income tax rate with the difference for each year summarized
below:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1998 1998 1999
------------- ------------ -------------
<S> <C> <C> <C>
Federal tax benefit at statutory rate............ (34)% (35)% (35)%
State taxes, net of federal tax benefit.......... (6) (6) (6)
Nondeductible goodwill........................... -- 26 23
Benefit utilized by parent in consolidated
return......................................... -- 15 18
Adjustment due to the increase in valuation
allowance...................................... 40 -- --
--- --- ---
Provision for income taxes....................... --% --% --%
=== === ===
</TABLE>
9. ACQUISITION BY HOLLYWOOD ENTERTAINMENT
Effective October 1, 1998, Hollywood Entertainment agreed to acquire all
the outstanding shares of Reel.com, Inc. The acquisition has been accounted for
using the purchase method of accounting and accordingly, the purchase price has
been allocated to the tangible and intangible assets acquired and liabilities
assumed on the basis of their relative fair values on the acquisition date. The
fair value of intangible assets was determined using a combination of the income
approach and the cost approach.
The total purchase price of approximately $96.9 million consisted of $32.7
million in cash and 4,000,000 shares of Hollywood Entertainment's common stock
and 1,000,000 shares of Hollywood Entertainment Series A redeemable preferred
stock. Outstanding stock options of the acquired company were exchanged for
stock options of Hollywood Entertainment and have been included in the purchase
price based on their fair value. The fair value of the stock options was
estimated using the Black-Scholes model with the following weighted average
assumptions: deemed fair value of the underlying common stock of $11.18 to
$11.39, risk-free interest rate of 4.2%, expected life of four years, expected
dividend rate of 0%, and volatility rate of 72.5%. Of the total purchase price,
$5.3 million was allocated to net liabilities assumed and $8.7 million to
identified intangible assets, including developed database content of $1.1
million, in-process research and development of $1.9 million, purchased
trademark and trade name of $3.6 million, workforce of $2.1 million and the
remainder of $93.5 million to goodwill. Except for in-process research and
development which was immediately written off, the intangible assets are being
amortized over their estimated useful lives of two years.
F-17
<PAGE> 99
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following unaudited pro forma financial information reflects the
results of operations for the years ended December 31, 1997 and 1998, as if the
acquisition had occurred on January 1, 1997, after giving effect to purchase
accounting adjustments. These pro forma results have been prepared for
comparative purposes only, do not purport to be indicative of what operating
results would have been had the acquisition actually taken place on January 1,
1997, and may not be indicative of future operating results (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Net revenue................................................. $ 745 $ 15,040
======== ========
Operating loss.............................................. $(54,872) $(75,126)
======== ========
Net loss.................................................... $(54,871) $(75,744)
======== ========
Net loss per share:
Basic and diluted......................................... $(54,871) $(75,744)
======== ========
Weighted average shares -- basic and diluted.............. 1,000 1,000
======== ========
</TABLE>
<TABLE>
<S> <C>
Fair value of tangible assets acquired by Hollywood
Entertainment............................................. $ 3,634
Goodwill and fair value of intangible assets................ 100,349
Purchased research and development.......................... 1,900
Fair value of stock issued.................................. (53,450)
Fair value of stock options issued.......................... (10,840)
Fair value of liabilities assumed........................... (8,934)
--------
Cash paid, including transaction costs, net of cash
received.................................................. $ 32,659
========
</TABLE>
10. SHAREHOLDERS' EQUITY
COMMON STOCK
The Company is authorized to issue one class of stock designated as common
stock. The total number of shares of common stock which the Company is
authorized to issue is 1,000 shares, par value $0.01 per share.
STOCK OPTIONS
On April 30, 1998, the Company's Board of Directors adopted the 1998 Stock
Option Plan (the "Plan"), which provided for the grant of incentive stock
options, and non-qualified stock options. On October 1, 1998, in conjunction
with the acquisition by Hollywood Entertainment, this plan was terminated and
all outstanding options were exchanged for options to purchase shares of
Hollywood Entertainment's stock.
F-18
<PAGE> 100
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following tables summarize stock option activity during the period
through September 30, 1998 and from October 1, 1998 (date of acquisition)
through September 30, 1999:
<TABLE>
<CAPTION>
WEIGHTED
AGGREGATE AVERAGE
OPTIONS EXERCISE PRICE EXERCISE EXERCISE
OUTSTANDING PER SHARE PRICE PRICE
----------- -------------- ----------- --------
<S> <C> <C> <C> <C>
Balances at December 31, 1997............ -- -- -- --
Options granted.......................... 2,732,661 $ 0.30 - 0.40 $ 983,758 $ 0.36
---------- -----------
Balances at September 30, 1998........... 2,732,661 983,758
Options canceled on October 1, 1998 as
part of the Hollywood Entertainment
acquisition............................ (2,732,661) $ (0.30 - 0.40) (983,758) $(0.36)
Hollywood Entertainment options granted
to Reel.com, Inc. employees in
replacement of canceled options........ 1,066,069 $ 0.56 - 11.88 831,534 $ 0.78
Hollywood Entertainment options granted
to Reel.com, Inc. employees............ 49,250 $10.63 - 25.06 996,328 $20.23
---------- -----------
Balances at December 31, 1998............ 1,115,319 1,827,862
Hollywood Entertainment options granted
to Reel.com, Inc. employees............ 561,150 $ 0.80 - 33.50 7,945,884 $14.16
---------- -----------
Hollywood Entertainment options canceled
or exercised........................... (1,004,821) $ 0.56 - 33.50 (4,099,670) $ 4.08
Balances at September 30, 1999........... 671,648 $ 5,674,076
---------- -----------
</TABLE>
Options outstanding and exercisable by price range at September 30, 1999,
are as follows:
<TABLE>
<CAPTION>
WEIGHTED
RANGE OF AVERAGE
EXERCISE NUMBER CONTRACTUAL NUMBER
PRICE OUTSTANDING REMAINING LIFE EXERCISABLE
- --------------- ----------- -------------- -----------
<S> <C> <C> <C>
$ 0.56 - 0.80 276,748 8.0 76,744
$10.63 - 19.88 394,900 8.7 2,646
------- ------
671,648 79,390
======= ======
</TABLE>
In connection with the granting of certain stock options to employees
during the nine months ended September 30, 1998, the Company recorded deferred
compensation of $4,523,882. This deferred compensation was determined as the
amount that the estimated value of the Company's stock exceeded the exercise
price of options on the date of grant and was being amortized over the expected
service periods of the grantees, generally four years. Amortization of deferred
compensation for the nine months ended September 30, 1998, was $605,397. This
plan was terminated when Hollywood Entertainment acquired the Company on October
1, 1998.
The following information concerning the employee stock options is provided
in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. The
Company
F-19
<PAGE> 101
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
accounts for the Plan in accordance with Accounting Principles Board (APB)
Opinion No. 25 and related interpretations, and has adopted the disclosure-only
provisions of SFAS 123.
The value of each employee stock option grant has been estimated on the
date of grant using the minimum value method. The weighted average minimum
values for the periods ended September 30, 1998, December 31, 1998 and September
30, 1999 were $0.06, $3.65 and $2.27, respectively. The following assumptions
were used in determining the fair value of options granted:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1998 1998 1999
------------- ------------ -------------
<S> <C> <C> <C>
Risk-free interest rate..... 5.15% 5.50% 4.75%
Expected life............... 4 years 4 years 4 years
Dividends................... 0% 0% 0%
Volatility.................. 0% 0% 0%
</TABLE>
The following comprises the pro forma net loss information pursuant to the
provisions of SFAS No. 123:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1998 1998 1999
------------- ------------ -------------
<S> <C> <C> <C>
Net loss -- Actual.......... $(16,002,022) $(22,110,739) $(69,026,298)
Net loss -- Pro Forma....... $(16,015,719) $(22,132,299) $(69,059,586)
</TABLE>
F-20
<PAGE> 102
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
UNAUDITED PRO FORMA FINANCIAL INFORMATION
OVERVIEW
On October 1, 1998, Hollywood Entertainment Corporation ("Hollywood
Entertainment") completed the merger of Reel.com, Inc. ("Reel.com") with and
into Hollywood Entertainment. As a result, Hollywood Entertainment acquired all
the outstanding shares of Reel.com for approximately $32.7 million in cash,
4,000,000 shares of Hollywood Entertainment common stock and 1,000,000 shares of
Hollywood Entertainment Series A redeemable preferred stock.
The pro forma financial information has been prepared as if the acquisition
of Reel.com had taken place at January 1, 1998 for the pro forma statements of
operations for the year ended December 31, 1998.
The acquisition of Reel.com has been accounted for as a purchase, whereby
the assets and liabilities have been recorded based upon their estimated fair
values at the date of the acquisition.
These pro forma financial statements are provided for illustrative purposes
only and are not necessarily indicative of the operations that would have
resulted if the acquisition had occurred on the dates indicated or which may be
obtained in the future.
F-21
<PAGE> 103
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
PRO FORMA STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
YEAR ENDED DECEMBER 31, 1998 1999
-------------------------------------------- -------------
ACTUAL ADJUSTMENTS PROFORMA ACTUAL
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net revenue................... $ 15,039,886 $ -- $ 15,039,886 $ 21,613,082
Operating expenses:
Cost of net revenue......... 16,859,439 -- 16,859,439 22,707,621
Marketing and sales......... 13,215,827 -- 13,215,827 16,671,931
Product development......... 4,333,175 -- 4,333,175 6,776,807
General and
administrative........... 3,077,433 -- 3,077,433 4,133,318
Amortization of intangible
assets and goodwill...... 12,543,679 37,631,037(1) 50,174,716 37,631,037
Write-off of purchased
research and
development.............. 1,900,000 -- 1,900,000 --
Stock based compensation.... 605,397 605,397 --
------------ ------------ ------------ ------------
Total operating
expenses............... 52,534,950 37,631,037 90,165,987 87,920,714
------------ ------------ ------------ ------------
Loss from operations.......... (37,495,064) (37,631,037) (75,126,101) (66,307,632)
Interest expense (net)........ (617,697) -- (617,697) (2,718,666)
------------ ------------ ------------ ------------
Loss before income taxes...... (38,112,761) (37,631,037) (75,743,798) (69,026,298)
Income taxes.................. -- -- -- --
------------ ------------ ------------ ------------
Net loss...................... $(38,112,761) $(37,631,037) $(75,743,798) $(69,026,298)
============ ============ ============ ============
Net loss per share:
Basic and diluted........... $ (38,113) $ (75,744) $ (69,026)
============ ============ ============
Weighted average
shares-basic and
diluted.................. 1,000 1,000 1,000
============ ============ ============
</TABLE>
F-22
<PAGE> 104
REEL.COM, INC.
(A WHOLLY-OWNED SUBSIDIARY OF
HOLLYWOOD ENTERTAINMENT CORPORATION)
NOTES TO PRO FORMA STATEMENT OF OPERATIONS
(UNAUDITED)
1. PROFORMA ADJUSTMENTS
The following adjustments were applied to the Company's historical
financial statements to arrive at the proforma financial information.
(1) To record amortization of intangible assets and goodwill on a
straight-line basis over the estimated useful life of two years.
2. NET LOSS PER SHARE
Basic net loss per share for the year ended December 31, 1998 is computed
using the weighted average number of common shares outstanding during the year.
The Company does not have any potentially dilutive common shares. Therefore,
basic net loss per share equals diluted net loss per share.
F-23
<PAGE> 105
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SHARES
[LOGO]
COMMON STOCK
-------------------------
PROSPECTUS
-------------------------
HAMBRECHT & QUIST
BANC OF AMERICA SECURITIES LLC
DAIN RAUSCHER WESSELS
WIT CAPITAL CORPORATION
-------------------------
, 2000
-------------------------
You should rely only on information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or any sale of our common stock.
No action is being taken in any jurisdiction outside of the United States
to permit a public offering of the common stock or possession or distribution of
this prospectus in any such jurisdiction. Persons who come into possession of
this prospectus in jurisdictions outside the United States are required to
inform themselves about and to observe any restrictions as to this offering and
the distribution of this prospectus applicable to that jurisdiction.
Until , 2000, all dealers that buy, sell or trade the common
stock, whether or not participating in this offering, may be required to deliver
a prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their allotments or
subscriptions.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 106
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses, other than
underwriting discounts, payable by the Registrant in connection with the offer
and sale of the common stock being registered. All amounts are estimates except
the registration fee, the NASD filing fee and the Nasdaq National Market entry
fee.
<TABLE>
<S> <C>
Registration fee............................................ 15,840
NASD filing fee............................................. 6,500
Blue Sky fees and expenses (including legal fees)........... 5,000
Nasdaq National Market entry fee............................ 5,000
*Accounting fees and expenses...............................
*Other legal fees and expenses..............................
*Transfer agent and registrar fee...........................
*Printing and engraving.....................................
*Miscellaneous..............................................
--------
*Total............................................
========
</TABLE>
- ---------------
* to be completed by amendment
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
certain circumstances for liabilities (including reimbursement for expenses
incurred) arising under the Securities Act of 1933, as amended (the "Securities
Act"). As permitted by the Delaware General Corporation Law, the Registrant's
Amended and Restated Certificate of Incorporation includes a provision that
eliminates the personal liability of its directors for monetary damages for
breach of fiduciary duty as a director, except for liability (i) for any breach
of the director's duty of loyalty to the Registrant or its stockholders, (ii)
for acts or omissions not in good faith or that involve intentional misconduct
or a knowing violation of law, (iii) under section 174 of the Delaware General
Corporation Law (regarding unlawful dividends and stock purchases) or (iv) for
any transaction from which the director derived an improper personal benefit. As
permitted by the Delaware General Corporation Law, the Bylaws of the Registrant
provide that (i) the Registrant is required to indemnify its directors and
officers to the fullest extent permitted by the Delaware General Corporation
Law, subject to certain very limited exceptions, (ii) the Registrant may
indemnify its other employees and agents as set forth in the Delaware General
Corporation Law, (iii) the Registrant is required to advance expenses, as
incurred, to its directors and executive officers in connection with a legal
proceeding to the fullest extent permitted by the Delaware General Corporation
Law, subject to certain very limited exceptions and (iv) the rights conferred in
the Bylaws are not exclusive. At present, there is no pending litigation or
proceeding involving a director, officer or employee of the Registrant regarding
which indemnification is sought, nor is the Registrant aware of any threatened
litigation that may result in claims for indemnification. Reference is also made
to Section 7 of the Underwriting Agreement, which provides for the
indemnification of officers, directors and controlling persons of the Registrant
against certain liabilities. In addition, certain of the intercompany agreements
provide for the indemnification of officers, directors and controlling
II-1
<PAGE> 107
persons of the Registrant against certain liabilities. The indemnification
provisions in the Registrant's Restated Certificate of Incorporation and in its
Bylaws may be sufficiently broad to permit indemnification of the Registrant's
directors and executive officers for liabilities arising under the Securities
Act. The Registrant, with approval by the Registrant's Board of Directors,
expects to obtain directors' and officers' liability insurance. Reference is
made to the following documents filed as exhibits to this registration statement
regarding relevant indemnification provisions described above and elsewhere
herein:
<TABLE>
<CAPTION>
DOCUMENT EXHIBIT NUMBER
-------- --------------
<S> <C>
Form of Underwriting Agreement.............................. 1.1
Form of Restated Certificate of Incorporation of
Registrant................................................ 3.3
Form of Bylaws of Registrant................................ 3.4
Form of Indemnification Agreement........................... 10.7
</TABLE>
The Company has entered into indemnification agreements with each of the
Company's directors, a form of which is attached as an exhibit hereto and is
incorporated herein by reference.
The Registrant may obtain insurance for the protection of its directors and
officers against any liability asserted against them in their official
capacities. The rights of indemnification described above are not exclusive of
any other rights of indemnification to which the persons indemnified may be
entitled under any bylaw, agreement, vote of stockholders or directors or
otherwise.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
All shares issued prior to the completion of the offering described herein
were issued to Hollywood Entertainment Corporation in October 1998 in connection
with the acquisition of Reel.com, a transaction exempt from Section 5 of the
Securities Act pursuant to Section 4(2) thereof.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
A. EXHIBITS
<TABLE>
<C> <S>
*1.1 Form of Underwriting Agreement
3.1 Certificate of Incorporation
3.2 Certificate of Amendment to the Certificate of Incorporation
*3.3 Bylaws
*3.4 Form of Amended and Restated Certificate of Incorporation to
be filed and become effective prior to effectiveness of this
Registration Statement
*3.5 Form of Bylaws to become effective prior to effectiveness of
this Registration Statement
*3.6 Form of Amended and Restated Certificate of Incorporation to
be filed and become effective upon the closing of this
offering
4.1 See Article II of Exhibit 3.1 and Article I of Exhibit 3.2
*4.2 Specimen Stock Certificate of Registration
*5.1 Opinion of Brobeck Phleger & Harrison, LLP
*10.1 1999 Stock Incentive Plan
*10.2 1999 Employee Stock Purchase Plan
*10.3 Form of Incentive Stock Option Agreement
*10.4 Notice of Grant of Stock Option
*10.5 Form of Employment Agreement by and between Reel.com and
David Rochlin
</TABLE>
II-2
<PAGE> 108
<TABLE>
<C> <S>
10.6 Office Lease between the Company and BEP-Emeryville, L.P.
10.7 Form of Indemnification Agreement entered into between
Reel.com and its directors and officers
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Brobeck Phleger & Harrison LLP (included in
Exhibit 5.1)
24.1 Power of Attorney (included on signature page)
27.1 Financial Data Schedule
</TABLE>
- -------------------------
* To be filed by amendment.
B. FINANCIAL STATEMENT SCHEDULES
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described in Item 14, or otherwise, the
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question of whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes to provide to the underwriters
at the closing specified in the Underwriting Agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-3
<PAGE> 109
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Amendment to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Emeryville, State of
California, on December 2, 1999.
REEL.COM, INC.
By /s/ MARK WATTLES
------------------------------------
Mark Wattles
Chairman and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Alex Bond as his true and lawful
attorney-in-fact and agent, with full power of substitution and re-substitution,
for him in his name, place and stead, in any and all capacities, in connection
with this Registration Statement, including to sign and file in the name and on
behalf of the undersigned as director or officer of the Registrant (i) any and
all amendments or supplements (including any and all stickers and post-effective
amendments) to this Registration Statement, with all exhibits thereto, and other
documents in connection therewith, and (ii) any and all additional registration
statements, and any and all amendments thereto, relating to the same offering of
securities as those that are covered by this Registration Statement that are
filed pursuant to Rule 462(b) promulgated under the Securities Act of 1933, with
the Securities and Exchange Commission and any applicable securities exchange or
securities self-regulatory body, granting unto said attorney-in-fact and agent
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in and about the premises, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, or his substitute, may
lawfully do or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON DECEMBER 2,
1999 IN THE CAPACITIES INDICATED:
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
Principal Executive Officer:
/s/ MARK WATTLES Chairman of the Board of Directors and
- ------------------------------------------- Chief Executive Officer
Mark Wattles
Principal Financial and Accounting Officer:
/s/ ALEX M. BOND Chief Financial Officer
- -------------------------------------------
Alex M. Bond
/s/ DONALD J. EKMAN Director
- -------------------------------------------
Donald J. Ekman
</TABLE>
II-4
<PAGE> 110
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NUMBER DESCRIPTION PAGE NO.
- ------- ----------- ----------
<C> <S> <C>
*1.1 Form of Underwriting Agreement..............................
3.1 Certificate of Incorporation................................
3.2 Certificate of Amendment to the Certificate of
Incorporation...............................................
*3.3 Bylaws......................................................
*3.4 Form of Amended and Restated Certificate of Incorporation to
be filed and become effective prior to effectiveness of this
Registration Statement......................................
*3.5 Form of Bylaws to become effective prior to effectiveness of
this Registration Statement.................................
*3.6 Form of Amended and Restated Certificate of Incorporation to
be filed and become effective upon the closing of this
offering....................................................
4.1 See Article II of Exhibit 3.1 and Article I of Exhibit
3.2.........................................................
*4.2 Specimen Stock Certificate of Registration..................
*5.1 Opinion of Brobeck Phleger & Harrison, LLP..................
*10.1 1999 Stock Incentive Plan...................................
*10.2 1999 Employee Stock Purchase Plan...........................
*10.3 Form of Incentive Stock Option Agreement....................
*10.4 Notice of Grant of Stock Option.............................
*10.5 Form of Employment Agreement by and between Reel.com and
David Rochlin...............................................
10.6 Office Lease between the Company and BEP-Emeryville, L.P....
10.7 Form of Indemnification Agreement entered into between
Reel.com and its directors and officers.....................
23.1 Consent of PricewaterhouseCoopers LLP.......................
23.2 Consent of Brobeck Phleger & Harrison LLP (included in
Exhibit 5.1)................................................
24.1 Power of Attorney (included on signature page)..............
27.1 Financial Data Schedule.....................................
</TABLE>
- -------------------------
* To be filed by amendment.
<PAGE> 1
EXHIBIT 3.1
CERTIFICATE OF INCORPORATION
OF
R ACQUISITION, INC
ARTICLE I.
The name of this Corporation is R Acquisition, Inc.
ARTICLE II.
The address of the registered office of the Corporation in the State of
Delaware is 9 East Lookerman Street Suite 214, Dover, DE, 19901 and the name of
the registered agent at that address is Capitol Services, Inc. .
ARTICLE III.
The purpose of the Corporation is to engage in any lawful act or
activity for which corporations may be organized under the General Corporation
Law of Delaware.
ARTICLE IV.
The name of the Corporation's incorporator is Helen M. Powers and the
incorporator's mailing address is Brobeck, Phleger & Harrison, One Market, Spear
Street Tower, San Francisco, CA 94105.
ARTICLE V.
This Corporation is authorized to issue one class of stock, to be
designated "Common Stock." The total number of shares of Common Stock which the
Corporation is authorized to issue is One Thousand (1,000) shares, par value
$0.01 per share.
ARTICLE VI.
The liability of the directors of this corporation for monetary damages
shall be eliminated to the fullest extent permissible under Delaware law.
To the fullest extent permitted by applicable law, the Corporation is
authorized to provide indemnification of (and advancement of expenses to)
directors, officers, employees and other agents of this corporation (and any
other persons to which the Delaware law permits this corporation to provide
indemnification), through Bylaw provision, agreements with any such director,
officer, employee or other agent or other
<PAGE> 2
person, vote of stockholders or disinterested directors, or otherwise, in excess
of the indemnification and advancement otherwise permitted by Section 145 of the
Delaware General Corporation Law, subject only to limits created by applicable
Delaware law (statutory or nonstatutory), with respect to actions for breach of
duty to a corporation, its stockholders and others.
ARTICLE VII.
The Corporation reserves the right to amend, alter, change or repeal any
provision contained in this Certificate of Incorporation, in the manner now or
hereafter prescribed by statute, and all rights conferred on stockholders herein
are granted subject to this reservation.
ARTICLE VIII.
Election of directors need not be by written ballot unless the Bylaws of
the Corporation shall so provide.
ARTICLE IX.
The number of directors which shall constitute the whole Board of
Directors shall be fixed from time to time by, or in the manner provided in, the
Bylaws or in an amendment thereof duly adopted by the Board of Directors or by
the stockholders.
ARTICLE X.
Meetings of stockholders may be held within or without the State of
Delaware, as the Bylaws may provide. The books of the Corporation may be kept
(subject to any provision contained in the statutes) outside the State of
Delaware at such place or places as may be designated from time to time by the
Board of Directors or in the Bylaws of the Corporation.
ARTICLE XI.
Except as otherwise provided in this Certificate of Incorporation, in
furtherance and not in limitation of the powers conferred by statute, the Board
of Directors is expressly authorized to make, repeal, alter, amend and rescind
any or all of the Bylaws of the Corporation.
ARTICLE XII.
The Corporation expressly elects not to be governed by Section 203 of
the Delaware General Corporation Law.
2
<PAGE> 3
IN WITNESS WHEREOF, the undersigned has signed this Certificate of
Incorporation this 27th day of July, 1998.
/s/ HELEN M. POWERS
-----------------------------------
Helen M. Powers,
Incorporator
<PAGE> 1
EXHIBIT 3.2
CERTIFICATE OF AMENDMENT
TO THE
CERTIFICATE OF INCORPORATION
OF
R ACQUISITION, INC.
R ACQUISITION, INC., a Delaware corporation, HEREBY CERTIFIES AS
FOLLOWS:
1. The name of the corporation is R Acquisition, Inc. (the
"Corporation").
2. The certificate of incorporation of the Corporation is hereby amended
by striking out Article I thereof and by substituting in lieu of said Article
the following new Article:
"ARTICLE I
Name
"The name of the corporation is Reel.com, Inc. (the "Corporation")."
3. The amendment of the certificate of incorporation herein certified
has been duly adopted in accordance with the provisions of Sections 228 and 242
of the General Corporation Law of the State of Delaware.
IN WITNESS WHEREOF, R ACQUISITION, INC. has caused this certificate to
be signed by Donald J. Ekman, its Secretary, this 1st day of October, 1998.
R ACQUISITION
By: /s/ DONALD J. EKMAN
-------------------------------
Secretary
<PAGE> 1
EXHIBIT 10.6
* 1400 65th STREET, EMERYVILLE, CALIFORNIA *
* OFFICE BUILDING NET LEASE *
BASIC LEASE INFORMATION
DATE OF LEASE: May 20, 1999
LANDLORD: BEP-EMERYVILLE, L.P.
LANDLORD'S ADDRESS: c/o Ellis Partners, Inc.
433 California Street, Suite 610
San Francisco, California 94104
Attention: James F. Ellis
TENANT: REEL.COM, INC.
TENANT'S ADDRESS: 1400 65th Street
Emeryville, California 94608
Attn: Jeff Jordan, President
BUILDING: 1400 65th Street, Emeryville, California
LEASED PREMISES: Approximately 19,361 rentable square feet on the
second (2nd) floor of the Building.
RENTABLE AREA: Approximately 19,361 rentable square feet
SCHEDULED TERM
COMMENCEMENT DATE: October 1, 1999
SCHEDULED TERM
EXPIRATION DATE: February 28, 2005
OPTION TO EXTEND:
Number of Extension Periods: One(1)
Years per Extension Period: Five(5)
BASE RENT(NNN): For months 1 and 2 - none. For months 3 - $0.775 per
rentable square foot of Rentable Area. For months
4 - 12 $1.55 per rentable square foot of
<PAGE> 2
Rentable Area per month. Beginning in the second (2nd)
year of the Lease, Base Rent shall increase three
percent (3%) annually (such increase shall include any
extension of the term of this Lease).
TENANT'S PROPORTIONATE
SHARE: approximately 12.91%
PARKING SPACES: Sixty (60) spaces
SECURITY DEPOSIT: None
GUARANTOR: Hollywood Entertainment Corporation, an Oregon
corporation
LANDLORD'S BROKER: CB Richard Ellis
TENANT'S BROKER: CB Richard Ellis
<PAGE> 3
OFFICE BUILDING NET LEASE
THIS LEASE, made as of the date specified in the BASIC LEASE INFORMATION
sheet, by and between the landlord specified in the BASIC LEASE INFORMATION
sheet ("Landlord") and the tenant specified in the BASIC LEASE INFORMATION
sheet ("Tenant").
ARTICLE 1.
DEFINITIONS
1.01. DEFINITIONS: Terms used herein shall have the following meanings:
1.02. "ADDITIONAL RENT" shall mean all monetary obligations of Tenant
under this Lease other than the obligation for payment of Net Rent.
1.03. "BASE RENT" shall mean the sums due from time to time as rental
for the Leased Premises as set forth in the Basic Lease Provisions.
1.04. "BASIC OPERATING COST" shall have the meaning given in Section
3.05.
1.05. "BUILDING" shall mean the building and other improvements
associated therewith identified on the Basic Lease Information sheet.
1.06. "BUILDING STANDARD IMPROVEMENTS" shall mean the standard
materials ordinarily used by Landlord in the improvement of the Leased Premises.
1.07. "COMMON AREAS" shall mean (a) the areas on individual floors of
the Building devoted to non-exclusive uses such as common corridors, lobbies,
fire vestibules, elevator foyers, stairways, elevators, electric and telephone
closets, restrooms, mechanical closets, janitor closets and other similar
facilities for the benefit of all tenants (and invitees) on the particular
floor and other floors and (b) other areas of the Project available for the use
and benefit of all tenants (and invitees).
1.08. "COMPUTATION YEAR" shall mean a fiscal year consisting of the
calendar year commencing January 1st of each year during the Term, commencing
in the Base Year and continuing through the Term with a short or stub fiscal
year in (i) the Base Year for the period between the Term Commencement Date and
December 31 of such year and (ii) any partial fiscal year in which the Lease
expires or is terminated for the period between January 1 of such year and the
date of lease termination or expiration.
1.09. "LANDLORD'S BROKER" shall mean the individual or corporate
broker identified on the Basic Lease Information sheet as the broker for
Landlord.
1.10. "LANDLORD'S CONTRIBUTION" shall have the meaning given in
EXHIBIT B.
1.11. "LANDLORD'S IMPROVEMENTS" shall mean the improvements to the
Leased Premises to be installed at Landlord's expense and paid for with
Landlord's Contribution pursuant to EXHIBIT B attached hereto.
1
<PAGE> 4
1.12. "LEASED PREMISES" shall mean the floor area more particularly
shown on the floor plan attached hereto as EXHIBIT A, containing the Rentable
Area (as such term is defined in Section 1.18 below) specified on the Basic
Lease Information sheet.
1.13. "NET RENT" shall mean the total of Base Rent and Tenant's
Proportionate Share of Basic Operating Cost.
1.14. "PERMITTED USE" shall mean general office, and any other related
lawful use; provided, however, that Permitted Use shall not include (a) offices
or agencies of any foreign government or political subdivision thereof; (b)
offices of any agency or bureau of any state, county or city government; (c)
offices of any health care professionals; (d) schools or other training
facilities which are not ancillary to corporate, executive or professional
office use; or (e) retail or restaurant uses.
1.15. "PROJECT" shall mean the Building situated at 1400 65th Street,
Emeryville California, the parking areas affiliated therewith, and the real
property on which the Building and the parking areas are located.
1.16. "RENT" shall mean Net Rent plus Additional Rent.
1.17. "RENTABLE AREA" shall mean the area or areas of space in the
Building determined in accordance with the Standard Method for Measuring Floor
Area in Office Buildings as most recently published by the Building Owners and
Managers Association International and including a proportionate allocation of
the square footage of the Building's elevator and mechanical equipment areas,
telephone and electrical rooms, janitorial service areas, public lobbies and
corridors, which method of measurement shall be subject to reasonable revision
by Landlord from time to time. The Rentable Area of the Leased Premises has
been calculated on the basis of the foregoing definition and is agreed for all
purposes of this Lease to be the amount stated on the Basic Lease Information
sheet, subject to remeasurement by Landlord only in the event of a change in
method of measurement for the Building or the Project as hereinabove provided.
1.18. "SECURITY DEPOSIT" shall mean the amount specified on the Basic
Lease Information sheet to be paid by Tenant to Landlord and held and applied
pursuant to Section 5.14.
1.19. "SUBSTANTIAL COMPLETION" shall mean (and the Leased Premises
shall be deemed "Substantially Complete") when (i) installation of Landlord's
Improvements (and any Tenant Extra Improvements installed by Landlord's
contractor, or, if permitted by Landlord, any Tenant Extra Improvements
installed by Tenant's contractor within the time schedule established by
Landlord's contractor or consultant for performance of such work) has occurred;
(ii) Tenant has direct access from the street to the elevator lobby on the
floor (or floors) where the Leased Premises are located; (iii) basic services
(as described in Section 4.01) are available to the Leased Premises; (iv)
Landlord's architect has issued a certificate of Substantial Completion with
respect to the Leased Premises; and (v) a certificate of occupancy or its
equivalent or a temporary occupancy permit for the Leased Premises has been
issued by appropriate governmental authorities. Substantial Completion shall be
deemed to have occurred notwithstanding a requirement to complete "punchlist"
items or similar corrective work unless such punchlist items materially
adversely interfere with Tenant's operation of its business in the Leased
Premises.
1.20. "TENANT EXTRA IMPROVEMENTS" shall mean the improvements to the
Leased Premises approved by Landlord and to be installed at Tenant's expense
pursuant to EXHIBIT B, if any.
1.21. "TENANT IMPROVEMENTS" shall mean the Landlord's Improvements and
the Tenant Extra Improvements (if any) installed or to be installed for Tenant
pursuant to EXHIBIT B.
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1.22. "TENANT'S BROKER" shall mean the individual or corporate broker
identified on the Basic Lease Information sheet as the broker for Tenant.
1.23. "TENANT'S PHYSICAL POSSESSION DATE" shall mean September 1, 1999 or
thirty (30) days prior to the Term Commencement Date, whichever is later.
1.24. "TENANT'S PROPORTIONATE SHARE" is specified on the Basic Lease
Information sheet and is based on the percentage which the Rentable Area of the
Leased Premises bears to the total Rentable Area of the Project, subject to
adjustment in the event of the remeasurement of the Building or the Project as
permitted under Section 1.17 above.
1.25. "TERM" shall mean the period commencing with the Term Commencement
Date and ending at midnight on the Term Expiration Date.
1.26. "TERM COMMENCEMENT DATE" shall mean the date when the Term
commences as determined pursuant to Section 3.01 hereof.
1.27. "TERM EXPIRATION DATE" shall mean the date when the Term shall end
as determined pursuant to Section 3.01 hereof, unless sooner terminated
pursuant to the terms of this Lease or unless extended pursuant to the
provisions of Section 8.01.
1.28. OTHER TERMS. Other terms used in this Lease and on the Basic Lease
Information sheet shall have the meanings given to them herein and thereon.
ARTICLE 2.
LEASED PREMISES
2.01. LEASE. Landlord hereby leases to Tenant and Tenant hereby leases
from Landlord the Leased Premises upon all of the terms, covenants and
conditions set forth in this Lease.
2.02. ACCEPTANCE OF LEASED PREMISES. Tenant acknowledges that: (a) it has
been advised by Landlord, Landlord's Broker and Tenant's Broker, if any, to
satisfy itself with respect to the condition of the Leased Premises (including,
without limitation, the HVAC, electrical, plumbing and other mechanical
installations, fire sprinkler systems, security, environmental aspects, and
compliance with applicable laws, ordinances, rules and regulations) and the
present and future suitability of the Leased Premises for Tenant's intended
use; (b) prior to Tenant's Physical Possession Date Tenant shall make such
inspection and investigation as it deems necessary with reference to such
matters and assumes all responsibility therefor as the same relate to Tenant's
occupancy of the Leased Premises and the term of this Lease; and (c) neither
Landlord nor Landlord's Broker nor any of Landlord's agents has made any oral
or written representations or warranties with respect to the condition,
suitability or fitness of the Leased Premises other than as may be specifically
set forth in this Lease. Tenant accepts the Leased Premises in its AS IS
condition existing on Tenant's Physical Possession Date, subject to all matters
of record and applicable laws, ordinances, rules and regulations. Tenant
acknowledges that neither Landlord nor Landlord's Broker nor any of Landlord's
agents has agreed to undertake any alterations or additions or to perform any
maintenance or repair of the Leased Premises except for the routine maintenance
and janitorial work specified herein and except as may be expressly set forth
in EXHIBIT B.
2.03. RIGHT TO RELOCATE LEASED PREMISES. [Intentionally Deleted].
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2.04. RESERVATION OF RIGHTS. Landlord reserves the right from time to
time, so long as reasonable access and basic services to the Leased Premises
remain available and Landlord does not unreasonably interfere with Tenant's
business, to install, use, maintain, repair, relocate and/or replace pipes,
conduits, wires and equipment within and around the Building and to do and
perform such other acts and make such other changes in, to or with respect to
the Building or the Project (including without limitation with respect to the
driveways, parking areas, walkways and entrances to the Project) as Landlord
may, in the exercise of sound business judgment, deem to be appropriate
provided such acts or changes do not materially adversely affect Tenant's
parking or access to the Project. In connection therewith, Landlord shall have
the right to close temporarily any of the Common Areas so long as reasonable
access to the Leased Premises remains available.
ARTICLE 3.
TERM, USE AND RENT
3.01. TERM. Except as otherwise provided in this Lease, the Term shall
commence on the Scheduled Term Commencement Date, and shall continue in full
force for the Term. If the Leased Premises are not Substantially Complete by
the Scheduled Term Commencement Date for any reason, Landlord shall not be
subject to any claims, damages or liabilities by reason thereof, but (i) the
Term Commencement Date shall become January 1, 2000 and (ii) the Term
Expiration Date shall be May 31, 2005. Notwithstanding any other provision of
this Lease to the contrary, if possession of the Leased Premises is not
delivered to Tenant within one hundred fifty (150) days after the Scheduled
Term Commencement Date, excluding from such tally (x) each day of Tenant Delay
and (y) each day of delay caused by factors entirely beyond the reasonable
control of Landlord, then Tenant may, at its option, by notice in writing to
Landlord within ten (10) days thereafter, cancel this Lease in which event
neither Landlord nor Tenant shall have any further obligations hereunder. If
written notice of cancellation is not received by Landlord within such ten
(10)-day period, Tenant's right to cancel this Lease shall terminate and be of
no further force or effect. When the Term Commencement Date and the Term
Expiration Date have been ascertained, the parties shall promptly execute a
Confirmation of Term of Lease substantially in the form attached as EXHIBIT C.
Tenant shall be given physical possession of the Leased Premises on the
Tenant's Physical Possession Date in order for Tenant to install furniture,
equipment, cabling and fixtures, and to otherwise prepare the Leased Premises
for occupancy. From the Tenant's Physical Possession Date through the Term
Commencement Date, Tenant shall be subject to all of the covenants in this
Lease, except that Tenant shall not be obligated to pay Rent. Tenant's
obligation to pay Rent shall commence in accordance with Section 3.03 below.
Notwithstanding any other provision of this Lease to the contrary, if the
Leased Premises are not Substantially Complete by the Scheduled Term
Commencement Date, and if Tenant is required to pay Hold-Over Fees (as defined
below), the amount of such Hold-Over Fees shall be credited against Tenant's
obligation to pay Rent and Rent shall be abated to the extent of the Hold-Over
Fees. "Hold-Over Fees" shall mean the amount of monthly base rent paid by Tenant
at 1250 45th Street, Emeryville, California (the "Current Premises") which
exceeds the amount of monthly base rent paid by Tenant during September 1999 at
the Current Premises, if any, from the Scheduled Term Commencement Date until
the Term Commencement Date (for example, if Tenant's base rent at the Current
Premises for September 1999 is $100.00 and because of its hold-over, its base
rent for October 1999 increases to $150.00, the Hold-Over Fee shall be $50.00
for October 1999 and each month thereafter until the Term Commencement Date).
3.02. USE. Tenant shall use the Leased Premises solely for the Permitted
Use and for no other use or purpose, except as permitted by Landlord pursuant
to Landlord's written consent, which consent will not be unreasonably withheld.
It shall not be deemed unreasonable for Landlord to withhold its consent to a
proposed change of use if the proposed use is one set forth in Section 1.14(a)
through (e).
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The foregoing BASIC LEASE INFORMATION is incorporated herein and made a part of
the LEASE to which it is attached. If there is any conflict between the BASIC
LEASE INFORMATION and the LEASE, the BASIC LEASE INFORMATION shall control.
"LANDLORD"
BEP-EMERYVILLE, L.P.,
a Delaware limited partnership
By: EPI Investors 103 LLC,
a California limited liability company
Its: General Partner
By: Ellis Partners, Inc.,
a California corporation
Its: Managing Member
By: /s/ JAMES F. ELLIS
--------------------------------------
Typed Name: JAMES E. ELLIS
------------------------------
Title: Vice President
-----------------------------------
"TENANT":
REEL.COM, INC., a Delaware corporation
By: /s/ [Signature Illegible]
--------------------------------------
Typed Name: [Name Illegible]
------------------------------
Title: [Illegible]
-----------------------------------
<PAGE> 8
3.03. BASE RENT.
(a) Tenant shall pay the Base Rent to Landlord in accordance with
the Basic Lease Information sheet and in the manner described below. Tenant
shall pay the Base Rent for the fourth (4th) month of the Term upon execution
of this Lease which shall be credited towards Tenant's Base Rent for the fourth
(4th) month of the Term. Commencing with the first day of the third (3rd)
calendar month of the Term, Tenant shall pay the Net Rent (consisting of Base
Rent plus, when applicable in accordance with Section 3.04 below, Tenant's
Proportionate Share of Basic Operating Cost) in monthly installments on or
before the first day of each calendar month during the Term and any extensions
or renewals thereof, in advance without demand and without any reduction,
abatement, counterclaim or setoff, in lawful money of the United States at
Landlord's address specified on the Basic Lease Information sheet or at such
other address as may be designated by Landlord in the manner provided for
giving notice under Section 9.11 hereof. Tenant shall not have to pay (i) Base
Rent for the first (1st) and second (2nd) months of the Term, and (ii) Tenant's
Proportionate Share of Basic Operating Cost for the first (1st) month of the
Term.
(b) If the Term commences on other than the first day of a month,
then the Base Rent provided for such partial month shall be prorated based upon
a thirty (30)-day month and the prorated installment shall be paid on the first
day of the calendar month next succeeding the Term Commencement Date together
with the other amounts payable on that day. If the Term terminates on other
than the last day of a calendar month, then the Net Rent provided for such
partial month shall be prorated based upon a thirty (30)-day month and the
prorated installment shall be paid on the first day of the calendar month in
which the date of termination occurs.
3.04. TENANT'S PROPORTIONATE SHARE OF BASIC OPERATING COST.
(a) Commencing on the second (2nd) month of the Term and
continuing through the remainder of the Term, Tenant shall pay to Landlord
Tenant's Proportionate Share of the Basic Operating Cost attributable to each
Computation Year. For the 2000 Computation Year through the remainder of the
Term, if Tenant's Proportionate Share of Basic Operating Cost increases by more
than four percent (4%) from the previous Computation Year, then the following
provisions shall apply: (i) Tenant shall pay Tenant's Proportionate Share of
all Basic Operating Costs increases for items that increased due to conditions
beyond Landlord's reasonable control; and (ii) Tenant shall pay Tenant's
Proportionate Share of all other Basic Operating Costs increases up to the four
percent (4%) ceiling. As used in clause (i) of the proceeding sentence,
conditions beyond Landlord's reasonable control shall include, but are not
limited to, increases in or due to the costs of utilities, insurance, damages
caused by weather or acts of God, and governmental action (including increases
to real property taxes). Attached hereto as EXHIBIT E is Landlord's estimated
budget for Basic Operating Costs for the 1999 Computation Year (the "Estimated
Budget"). The Estimated Budget has been developed by Landlord in consultation
with Landlord's consultants for the Project (including Landlord's property
manager). Landlord does not represent, warrant or guarantee to Tenant that the
Basic Operating Costs will be in the amounts set forth in the Estimated Budget.
The Estimated Budget is merely intended to be Landlord's reasonable estimate,
based upon the information presently available to Landlord, of the Basic
Operating Costs for the Project. Landlord recently acquired ownership of the
Project and, accordingly, Landlord has limited operating history with respect
to the Project and the development of the Estimated Budget. Tenant acknowledges
and agrees to the foregoing limitations with respect to the Estimated Budget.
(b) During the first Computation Year, commencing on the second
(2nd) month of the Term, on or before the first day of each month thereafter,
during such Computation Year, Tenant shall pay to Landlord one-twelfth (1/12th)
of Landlord's estimate of the amount payable by Tenant under Section 3.04(a) as
set forth in Landlord's written notice to Tenant delivered on or before the
Term Commencement Date. During the last month of each Computation Year (or as
soon thereafter as practicable), Landlord shall
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give Tenant notice of Landlord's estimate of the amount payable by Tenant under
Section 3.04(a) for the following Computation Year. Subject to Section 3.04(a),
on or before the first day of each month during the following Computation Year,
Tenant shall pay to Landlord one-twelfth (1/12) of such estimated amount,
provided that if Landlord fails to give notice in the last month of the prior
year, then Tenant shall continue to pay on the basis of the prior year's
estimate until the first day of the calendar month next succeeding the date such
notice is given by Landlord; and from the first day of the calendar month
following the date such notice is given, Tenant's payments shall be adjusted so
that the estimated amount for that Computation Year will be fully paid by the
end of that Computation Year. If at any time or times Landlord determines that
the amount payable under Section 3.04(a) for the current Computation Year will
vary from its estimate given to Tenant, Landlord, by not less than ten (10)
business days' notice to Tenant, may revise its estimate for such Computation
Year, and subsequent payments by Tenant for such Computation Year shall be
based upon such revised estimate.
(c) Following the end of each Computation Year, Landlord shall
deliver to Tenant a statement of amounts payable under Section 3.04(a) for such
Computation Year prepared by Landlord's agent. If such statement shows an
amount owing by Tenant that is less than the payments for such Computation Year
previously made by Tenant, and if no event of default (as defined below) is
outstanding at the time such statement is delivered, Landlord shall credit such
amount to the next payment(s) of Net Rent falling due under this lease. If such
statement shows an amount owing by Tenant that is more than the estimated
payments for such Computation Year previously made by Tenant, Tenant shall pay
the deficiency to Landlord within thirty (30) days after delivery of such
statement. If, within sixty (60) days of Tenant's receipt of Landlord's
statement, Tenant notifies Landlord that Tenant desires to audit or review
Landlord's statement, Landlord shall cooperate with Tenant to permit such audit
or review during normal business hours. Landlord shall make available in the
San Francisco Bay Area at Landlord's, or at Landlord's election at Landlord's
property manager's, place of business, such books and records as are
reasonably necessary for Tenant to conduct and complete such audit. Tenant
shall have the right to make copies of such books and records at Tenant's sole
cost and expense. Tenant shall bear all other costs and expenses associated
with Tenant's audit (including fees of Tenant's auditor). Within five (5)
business days of completion of the audit, if Tenant desires to challenge
Landlord's statement, then Tenant shall provide Landlord with a copy of
Tenant's auditor's report. Within thirty (30) days of Landlord's receipt of
Tenant's auditor's report, Landlord shall notify Tenant as to whether Landlord
agrees or disagrees with the conclusions reached in Tenant's auditor's report.
Landlord's failure to respond shall be deemed to constitute a disagreement with
the Tenant's auditor's report. After Landlord's notice, Landlord and Tenant
shall endeavor to resolve any disagreements regarding Tenant's auditor's
report. In the event such audit reveals a discrepancy in Tenant's favor, and
Landlord agrees with the conclusions of Tenant's auditor, then Landlord shall
credit the amount of such discrepancy to the next payment(s) of Net Rent
falling due under this Lease. In the event such audit reveals a discrepancy in
Landlord's favor, Tenant shall pay the amount of the discrepancy to Landlord
within ten (10) business days of completion of the audit. If the discrepancy in
Tenant's favor, as agreed to by Landlord, or determined by the arbitrator, is
greater than five percent (5%) of Tenant's Proportionate Share of Basic
Operating Cost paid by Tenant for the Computation Year being audited, Landlord
shall reimburse Tenant for all reasonable costs and expenses associated with
Tenant's audit (including fees of Tenant's auditor). Any such audit may only
be conducted by an independent nationally recognized accounting firm or a
nationally recognized real estate management or consulting firm. The failure of
Tenant to notify Landlord that Tenant desires an audit within sixty (60) days
of Tenant's receipt of Landlord's statement under this Section 3.04(c) shall
constitute an acceptance by Tenant of Landlord's statement and a waiver by
Tenant of its right to audit for such Computation Year. If Tenant commences an
audit in accordance with this Section 3.04(c), then such audit and the Tenant's
auditor's report must be completed within thirty (30) days of Tenant's notice
to Landlord of Tenant's desire to audit. Failure of Tenant to complete the
audit within such thirty (30) day period shall constitute an acceptance by
Tenant of Landlord's statement for such Computation Year. The respective
obligations of Landlord and Tenant under this Section 3.04(c) shall survive the
Term Expiration
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Date, and, if the Term Expiration Date is a day other than the last day of a
Computation Year, the adjustment in Tenant's Proportionate Share of Basic
Operating Cost pursuant to this Section 3.04(c) for the Computation Year in
which the Term Expiration Date occurs shall be prorated in the proportion that
the number of days in such Computation Year preceding the Term Expiration Date
bears to three hundred sixty-five (365).
(d) Landlord shall have the same remedies for a default in the payment of
Tenant's Proportionate Share of Basic Operating Cost as for a default in the
payment of Base Rent.
(e) If the parties cannot agree on the results of Tenant's audit within
sixty (60) days following delivery of Tenant's auditors report to Landlord, then
either party may commence arbitration with respect to the matters disputed in
Tenant's audit by notice to the other party ("Arbitration Notice"). The failure
of Tenant to provide an Arbitration Notice within one hundred twenty (120) days
of Tenant's delivery of the Tenant's auditor's report to Landlord shall
constitute a waiver by Tenant of its right to arbitrate hereunder, and except
for such adjustments as have been agreed to by Landlord, Landlord's statement
provided under Section 3.04(c) shall be conclusive and binding to Tenant. Within
thirty (30) days of the Arbitration Notice, Landlord and Tenant shall jointly
select an arbitrator, who shall be unaffiliated in any manner with either
Landlord or Tenant and shall have been active over the five (5) year period
ending on the date of such appointment in the leasing of comparable commercial
properties in the vicinity of the Building. Neither Landlord nor Tenant shall
consult with such arbitrator as to his or her opinion as to the disputed matters
prior to the appointment. The determination of the arbitrator shall be limited
solely to issues raised by Tenant's auditor's report or by Landlord's response
to Tenant's auditor's report. Such arbitrator may hold hearings and require such
briefs as the arbitrator, in his or her sole discretion, determines is
necessary. In addition, Landlord or Tenant may submit to the arbitrator with a
copy to the other party within five (5) business days after the appointment of
the arbitrator any data and additional information that such party deems
relevant to the determination by the arbitrator and the other party may submit a
reply in writing within five (5) business days after receipt of such data and
additional information. The arbitrator shall conduct such evidentiary hearings
as the arbitrator deems necessary or appropriate.
(1) The arbitrator shall, within thirty (30) days of his or her
appointment, reach a decision as to the disputed matters in Tenant's auditor's
report, and shall notify Landlord and Tenant of such determination.
(2) The decision of the arbitrator shall be binding upon Landlord
and Tenant.
(3) If Landlord and Tenant fail to agree upon and appoint such
arbitrator, then the appointment of the arbitrator shall be made by the American
Arbitration Association.
(4) If Landlord and Tenant fail to agree upon other matters relating
to the arbitration, then the rules of the American Arbitration Association
shall govern such arbitration.
(5) The cost of arbitration shall be paid by the substantially
unsuccessful party. As used herein, Landlord shall only be deemed to be the
substantially unsuccessful party if the discrepancy in Tenant's favor is greater
than five percent (5%) of Tenant's Proportionate Share of Basic Operating Cost
paid by Tenant for the Computation Year being audited.
(6) [intentionally deleted]
(7) Judgment upon the award rendered by the arbitrator may be
entered by either party into any court having jurisdiction, or application may
be made to such court for a judicial recognition of the award or an order of
enforcement thereof, as the case may be.
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3.05. BASIC OPERATING COST.
(a) Basic Operating Cost shall mean all expenses and costs
(but not specific costs which are separately billed to and paid by particular
tenants of the Project of every kind and nature which Landlord shall pay or
become obligated to pay because of or in connection with the management,
ownership, maintenance, repair, preservation and operation of the Project and
its supporting facilities directly servicing the Project (determined in
accordance with generally accepted accounting principles, consistently applied)
including, but not limited to, the following:
(1) Wages, salaries and related expenses and benefits of
all on-site and off-site employees and personnel engaged in the operation,
maintenance, repair and security of the Project, to the extent such charges
are directly allocable to services rendered by the employees and personnel for
the benefit of the Project (but specifically excluding any administrative
position above Property Manager).
(2) Costs of Landlord's office (including the property
management office) and office operation in the Project, as well as the costs of
operation of a room for delivery and distribution of mail to tenants of the
Building not to exceed 10% of the Basic Operating Costs.
(3) All supplies, materials, equipment and equipment
rental used in the operation, maintenance, repair and preservation of the
Project.
(4) Utilities, including water, sewer and power,
telephone, communication and cable television facilities, lighting, heating, air
conditioning and ventilating the entire Project.
(5) All maintenance, janitorial and service agreements for
the Project and the equipment therein, including, without limitation, alarm
and/or security service, window cleaning, elevator maintenance, sidewalks,
landscaping, Building exterior and service areas.
(6) A management cost recovery in an amount not to exceed
five percent (5%) of all Rent (excluding such management cost recovery) derived
from the Project.
(7) Legal and accounting services for the Project,
including the costs of audits by certified public accountants; provided,
however, that legal expenses shall not include the cost of lease negotiations,
termination of leases, extension of leases or legal costs incurred in
proceedings by or against any specific tenant.
(8) All insurance costs, including, but not limited to,
the cost of all risk property and liability coverage and rental income and
earthquake insurance applicable to the Project and Landlord's personal property
used in connection therewith, as well as commercially reasonable deductible
amounts applicable to such insurance; provided, however, that Landlord may, but
shall not be obligated to, carry earthquake insurance.
(9) Repairs, replacements and general maintenance (except
for repairs paid by proceeds of insurance or by Tenant or other tenants of the
Project or third parties, and alterations attributable solely to tenants of the
Project other than Tenant).
(10) All real estate of personal property taxes, possessory
interest taxes, business or license taxes or fees, service payments in lieu of
such taxes or fees, annual or periodic license or use fees, excises, transit
charges, housing fund assessments, open space charges, assessments, bonds,
levies, fees or charges, general and special, ordinary and extraordinary,
unforeseen as well as foreseen, of any kind which
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are assessed, levied, charged, confirmed or imposed by any public authority
upon the Project (or any portion or component thereof), its operations, this
Lease, or the Rent due hereunder (or any portion or component thereof), except;
(i) inheritance or estate taxes imposed upon or assessed against the Project, or
any part thereof or interest therein, and (ii) Landlord's personal or corporate
income, gift or franchise taxes.
(11) Amortization (together with reasonable financing charges)
of capital improvements made to the Project subsequent to the Term Commencement
Date which are designed to improve the operating efficiency of the Project, or
which may be required by governmental authorities, including those improvements
required for energy conservation and for the benefit of individuals with
disabilities ("ADA Improvements") or for energy conservation.
(b) With respect to subsection 3.05(a)(11) above, to the best of
Landlord's knowledge, the Project is in compliance with the Americans with
Disabilities Act ("ADA"). ADA Improvements, as defined in subsection
3.05(a)(11) above, includes ADA compliance work in any part of the Project
required by governmental authorities due to changes in law, rules or
regulations after the date of this Lease. ADA Improvements, for the purposes of
Section 3.05(a)(11), shall not include any ADA compliance work in other
tenant's spaces in the Project which is triggered by virtue of tenant
improvement work in such space. Tenant shall not be responsible for the cost of
improvements for ADA compliance work triggered by multi-tenanting of the
Building. Tenant shall be responsible for one hundred percent (100%) of the
cost of ADA compliance work triggered by the Tenant Improvements (or any
subsequent alterations or additions made by Tenant). Tenant shall promptly
reimburse Landlord for any costs incurred by Landlord with respect thereto.
(c) In the event any of the Basic Operating Costs are not allocable
solely to the Building, or are not provided on a uniform basis, Landlord shall
make an appropriate and equitable adjustment, in Landlord's reasonable
discretion, to the relevant cost allocations to the Building and Tenant shall
pay its proportionate share of such Basic Operating Costs allocable solely to
the Building and 100% of such Basic Operating Costs allocable solely to the
Leased Premises.
(d) Notwithstanding any other provision of this Lease to the
contrary, in the event that the Project is not fully occupied during any year of
the Term, an adjustment shall be made in computing Basic Operating Cost for such
year so that Basic Operating Cost shall be computed as though the Project had
been 95% occupied during such year provided however in no event shall Tenant be
obligated to pay more than its share of actual Basic Operating Costs.
(e) The following items shall be excluded from Basic Operating Costs:
(i) depreciation on the Building and the Project; (ii) debt service; (iii)
rental under any ground or underlying lease; (iv) attorneys' fees and expenses
incurred in connection with lease negotiations with prospective Project tenants
or alleged defaults with other Project tenants; (v) the cost of any improvements
or equipment which would be properly classified as capital expenditures (except
for any capital expenditures expressly included in Section 3.05(a), including,
without limitation, Section 3.05(a)(11)); the cost of decorating, improving for
tenant occupancy, painting or redecorating portions of the Building or Project
to be demised to tenants; (vii) advertising expenses relating to vacant space;
(viii) real estate brokers' or other leasing commissions; (ix) costs due to
Landlord's default under this Lease, and/or costs due to the negligence or
willful misconduct of Landlord, its employees, agents, contractors, and assigns;
or (x) costs or expenses of a partnership, or other entity, which constitutes
Landlord not directly related to the Project (such as accounting fees, tax
returns and income taxes of such entity), expenses incurred by Landlord not
directly related to the land, the Project, and/or its operations including,
without limitation, compensation paid to officers, executives or partners of
Landlord.
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ARTICLE 4.
LANDLORD'S COVENANTS
4.01. BASIC SERVICES. Landlord shall operate the Project to a standard of
quality consistent with that of other similar-class office projects in the
immediate geographical areas, and, subject to Tenant's obligation to pay
Tenant's Proportionate Share of Basic Operating Cost, Landlord shall:
(a) Administer improvement of the Leased Premises in accordance with
EXHIBIT B (if any).
(b) Furnish Tenant during Tenant's occupancy of the Leased Premises the
following basic services:
(i) Hot and cold water at those points of supply provided for
general use of other tenants in the Project; central heat and air
conditioning in season, during the Building hours of operation specified in
the rules and regulations for the Project adopted pursuant to Section 5.17
and at such temperatures and in such amounts as are considered by Landlord
to be standard for the comfortable use and occupancy of the Leased Premises
or, in all events, as may be permitted or controlled by applicable laws,
ordinances, rules and regulations.
(ii) Structural and exterior maintenance (including exterior glass
and glazing) and routine maintenance, repairs and electric lighting service
for all public areas and service areas of the Project in the manner and to
the extent reasonably deemed by Landlord to be standard.
(iii) Janitorial service on a five (5) day per week basis, excluding
holidays.
(iv) Electric lighting service throughout the Leased Premises and
electrical facilities to provide sufficient power for standard size personal
computers and other standard office machines of similar low electrical
consumption, but not including electricity required for electronic data
processing equipment, special lighting in excess of Building Standard
Improvements, and any other item of electrical equipment which consumes
electricity in amounts in excess of standard office equipment. Electric
power shall be separately metered at Tenant's expense (or as a cost deducted
from the Landlord's Contribution for Tenant Improvements).
(v) Building Standard lamps, bulbs, starters and ballasts used in
the Leased Premises.
(iv) Public and handicap elevator service serving the floors on which
the Leased Premises are situated, including freight elevator service when
prearranged with Landlord, subject to such rules and regulations as
Landlord shall promulgate from time to time.
(c) Landlord shall not be liable for damages to either person or
property, nor shall Landlord be deemed to have evicted Tenant, nor shall there
be any abatement of Rent, nor shall Tenant be relieved from performance of any
covenant on its part to be performed under this Lease by reason of any (i)
deficiency in the provision of basic services; (ii) breakdown of equipment or
machinery utilized in supplying services; or (iii) curtailment or cessation of
services due to causes or circumstances beyond the reasonable control of
Landlord or by the making of the necessary repairs or improvements, unless such
deficiency, breakdown, curtailment or cessation is due to the active gross
negligence or willful misconduct of Landlord. Landlord shall use reasonable
diligence to make such repairs as may be required to machinery or equipment
within the Project to provide restoration of services and, where the cessation
or interruption
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of service has occurred due to circumstances or conditions beyond Project
boundaries, to cause the same to be restored, by diligent application or
request to the provider thereof. In no event shall any mortgagee or the
beneficiary under any deed of trust referred to in Section 5.12 be or become
liable for any default of Landlord under this Section 4.01(c).
4.02. EXTRA SERVICES. Landlord shall provide to Tenant at Tenant's
sole cost and expense (and subject to the limitations hereinafter set forth)
the following extra services:
(a) Such extra cleaning and janitorial services required if
Tenant Improvements necessitate extra cleaning efforts or are not consistent in
quality and quantity with Building Standard Improvements;
(b) Additional air conditioning and ventilating capacity
required by reason of any electrical, data processing or other equipment,
facilities or services required to support the same, in excess of that which
would be required for Building Standard Improvements, when prearranged with
Landlord;
(c) Heating, ventilation, air conditioning or extra electrical
service provided by Landlord to Tenant (i) during hours other than the Building
hours of operation specified in the rules and regulations for the Project
adopted pursuant to Section 5.17, which shall provide for Building hours of
operation of 7:00 A.M. to 6:00 P.M., Monday through Friday (excluding holidays)
and from 8:00 A.M. to 1:00 P.M. on Saturday, or (ii) on Saturdays after 1:00
P.M., Sundays, or holidays, all said heating, ventilation and air conditioning
or extra electrical service to be furnished solely upon the prior written
request of Tenant submitted during business hours to Landlord at least 24 hours
in advance of the time such service is needed, or pursuant to such other
procedures as may be established from time to time by Landlord for the Building
or the Project;
(d) Maintaining and replacing non-Building Standard lamps,
bulbs, starters and ballasts (whether or not the light fixtures were installed
by Landlord as part of the Tenant Improvements);
(e) Repair and maintenance service which is the obligation of
Tenant under this Lease;
(f) Repair, maintenance or janitorial service to the Leased
Premises, the Common Areas or the Project parking area which is required as a
result of the acts or omissions of Tenant, its agents, employees, contractors,
invitees or licensees; and
(g) Any basic service in amounts determined by Landlord to
exceed the amounts required to be provided under Section 4.01(b), but only if
Landlord elects to provide such additional or excess service.
For the purposes of this Section 4.02, if, in Landlord's
reasonable opinion, Tenant's use of electrical and/or water service at the
Leased Premises is excessive, Landlord may install a separate meter(s) at the
Leased Premises to measure the amount of electricity and/or water consumed by
Tenant therein. The cost of such installation and of such excess electricity
and/or water (at the rates charged for such services by the local public
utility) shall be paid by Tenant to Landlord upon receipt by Tenant of a bill
therefor.
The cost chargeable to Tenant for all extra services shall
constitute Additional Rent and shall include a management fee payable to
Landlord of ten percent (10%). Additional Rent shall be paid monthly by Tenant
to Landlord concurrently with the payment of Base Rent.
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4.03. WINDOW COVERINGS. All window coverings for the Leased Premises
shall be those provided by Landlord as Building Standard Improvements. Tenant
shall not place or maintain any window coverings, blinds, curtains or drapes
other than those supplied by Landlord on any exterior window without Landlord's
prior written approval, which Landlord shall have the right to grant or
withhold in its absolute and sole discretion.
4.04. GRAPHICS AND SIGNAGE. Landlord shall provide identification of
Tenant's name and suite numerals (i) on a building directory in the Building
lobby and (ii) at the main entrance door to the Leased Premises. Landlord
reserves the right to exclude any other names from the building directory. All
signs, notices, advertisements and graphics of every kind or character, visible
in or from the Common Areas or the exterior of the Leased Premises shall be
subject to Landlord's prior written approval, which landlord shall have the
right to withhold in its absolute and sole discretion. Landlord may remove,
without notice to and at the expense of Tenant, any sign, notice, advertisement
or graphic of any kind inscribed, displayed or affixed in violation of the
foregoing requirement. All approved signs, notices, advertisements or graphics
shall be printed, affixed or inscribed at Tenant's expense by a person selected
by Landlord. Landlord shall be entitled to revise the Project graphics and
signage standards at any time.
4.05. TENANT EXTRA IMPROVEMENTS. All Tenant Extra Improvements (if any)
shall be installed at Tenant's cost, such installation to be made and paid for
pursuant to the provisions of EXHIBIT B. For purposes hereof, "costs" shall
include, without limitation, all building permit fees for Tenant Extra
Improvements (not already included in the permit fees paid with respect to the
Landlord's Improvements); payments to architects, engineers and other design
consultants for services and disbursements; and such inspection fees as
landlord may incur. Landlord shall not seek the benefits of depreciation
deductions or income tax credit allowances for federal or state income tax
reporting purposes with respect to any Tenant Extra Improvements for which
Tenant has fully reimbursed Landlord under this Section 4.05.
4.06. REPAIR OBLIGATION. Subject to Tenant's obligations under Section
3.04 to pay Tenant's Proportionate Share of Basic Operating Cost, Landlord's
obligation with respect to maintenance and repair shall be limited to (i) the
structural portions of the Building; (ii) the exterior walls of the Building,
including exterior glass and glazing; (iii) the roof; (iv) mechanical (including
the HVAC system), electrical, plumbing and life safety systems; (v) the Common
Areas; (vi) the Project parking area; and (vii) landscaped areas (if any).
However, Landlord shall not have any obligation to repair damage caused by
Tenant, its agents, employees, contractors, invitees or licensees. Landlord
shall have the right, but not the obligation, to undertake work of repair which
Tenant is required to perform under this Lease and which Tenant fails or
refuses to perform in a timely and efficient manner after ten (10) days prior
written notice from Landlord. Tenant shall reimburse Landlord upon demand, as
Additional Rent, for all costs incurred by Landlord in performing any such
repair for the account of Tenant, together with an amount equal to ten percent
(10%) of such costs to reimburse Landlord for its administration and managerial
effort. Except as specifically set forth in this Lease, Landlord shall have no
obligation whatsoever to maintain or repair the Leased Premises or the Project.
The parties intend that the terms of this Lease govern their respective
maintenance and repair obligations. Tenant expressly waives the benefit of any
statute now or hereafter in effect other extent it is inconsistent with the
terms of this Lease with respect to such obligations or which affords Tenant
the right to make repairs at the expense of Landlord or terminate this Lease by
reason of the condition of the Leased Premises or any needed repairs.
4.07. PEACEFUL ENJOYMENT. Landlord covenants with Tenant that upon Tenant
paying the Rent and all other charges required under this Lease and performing
all of Tenant's covenants and agreements herein contained, Tenant shall
peacefully have, hold and enjoy the Leased Premises subject to all of the terms
of this Lease and to any deed of trust, mortgage, ground lease or other
agreement to which this Lease may be subordinate. This covenant and other
covenants of Landlord contained in this Lease shall be binding
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upon Landlord and its successors only with respect to breaches occurring during
its or their respective ownerships of Landlord's interest hereunder.
ARTICLE 5.
TENANT'S COVENANTS
5.01. PAYMENTS BY TENANT. Tenant shall pay Rent at the times and in the
manner provided in this Lease. All obligations of Tenant hereunder to make
payments to Landlord shall constitute Rent and failure to pay the same when due
shall give rise to the rights and remedies provided for in Section 7.08. If
there is more than one Tenant, the obligations imposed under this Lease upon
Tenant shall be joint and several.
5.02. TENANT IMPROVEMENTS. The Tenant Improvements shall be installed and
constructed by Landlord pursuant to EXHIBIT B. All Landlord's Improvements shall
become the property of Landlord upon installation and shall be surrendered to
Landlord without compensation to Tenant upon termination of this Lease by lapse
of time or otherwise. All Tenant Extra Improvements installed pursuant to
Section 4.05 (if any) shall become the property of Landlord upon installation
and shall be surrendered to Landlord without compensation to Tenant upon
termination of this Lease by lapse of time or otherwise, subject to Landlord's
right to require their removal in the same manner as provided in Section 5.07.
5.03. TAXES ON PERSONAL PROPERTY AND TENANT EXTRA IMPROVEMENTS. In addition
to, and wholly apart from its obligation to pay Tenant's Proportionate Share of
Basic Operating Costs, Tenant shall be responsible for, and shall pay prior to
delinquency, all taxes or governmental service fees, possessory interest taxes,
fees or charges in lieu of any such taxes, capital levies, and any other charges
imposed upon, levied with respect to, or assessed against Tenant's personal
property, on the value of its Tenant Extra Improvements (if any) and on its
interest pursuant to this Lease. To the extent that any such taxes are not
separately assessed or billed to Tenant, Tenant shall pay the amount thereof as
invoiced to Tenant by Landlord.
5.04. REPAIRS BY TENANT. Subject to Landlord's repair obligations set forth
in Section 4.06, Tenant shall be obligated to maintain and repair the interior,
non-structural Leased Premises, to keep the same at all times in good order,
condition and repair, and upon expiration of the Term, to surrender the same to
Landlord in the same condition as on the Term Commencement Date, reasonable wear
and tear, and taking by condemnation excepted. Tenant's obligations shall
include, without limitation, the obligation to maintain and repair all walls,
floor coverings, ceilings and fixtures and to repair all damage caused by
Tenant, its agents, employees, contractors, invitees and others using the Leased
Premises with Tenant's expressed or implied permission. At the request of
Tenant, Landlord shall perform the work of maintenance and repair constituting
Tenant's obligation under this Section 5.04 at Tenant's sole cost and expense
and as an extra service to be rendered pursuant to Section 4.02(e). Any work of
repair and maintenance performed by or for the account of Tenant by persons
other than Landlord shall be performed by contractors reasonably approved by
Landlord and in accordance with procedures Landlord shall from time to time
establish. Tenant shall give Landlord prompt notice of any damage to or
defective condition in any part of the Building's mechanical, electrical,
plumbing, life safety or other system servicing, located in or passing through
the Leased Premises.
5.05. WASTE. Tenant shall not commit or allow any waste or damage to be
committed in any portion of the Leased Premises or the Project.
5.06. ASSIGNMENT OR SUBLEASE.
(a) Tenant shall not voluntarily or by operation of law assign,
transfer or encumber (collectively "Assign") or sublet all or any part of
Tenant's interest in this Lease or in the Leased Premises without Landlord's
prior written consent given under and subject to the terms of this Section 5.06.
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(b) If Tenant desires to Assign this Lease or any interest herein or
sublet the Leased Premises or any part thereof, Tenant shall give Landlord
written notice of such intent. Tenant's notice shall specify the date the
proposed assignment or sublease would be effective and be accompanied by
information pertinent to Landlord's determination as to the financial and
operational responsibility and appropriateness of the proposed assignee or
subtenant, including, without limitation, its name, business and financial
condition, financial details of the proposed transfer, the intended use
(including any modification) of the Leased Premises, and exact copies of all of
the proposed agreement(s) between Tenant and the proposed assignee or
subtenant. Tenant shall promptly provide Landlord with (i) such other or
additional information or documents reasonably requested (within ten (10) days
after receiving Tenant's notice) by Landlord, and (ii) an opportunity to meet
and interview the proposed assignee or subtenant, if requested by Landlord.
(c) Landlord shall have a period of twenty (20) days following such
interview and receipt of such additional information (or thirty (30) days from
the date of Tenant's original notice if Landlord does not request additional
information or an interview) within which to notify Tenant in writing that
Landlord elects either to permit Tenant to Assign this Lease or sublet such
space, subject, however, to prior written approval of the proposed assignee or
sublessee by Landlord, such consent not to be unreasonably withheld so long as
the use of the Leased Premises by such proposed assignee or sublessee would be
a Permitted Use, the proposed assignee or sublessee is of sound financial
condition as determined by Landlord in its absolute and sole discretion, the
proposed assignee or sublessee executes such reasonable assumption
documentation as Landlord shall require, and the proposed assignee or sublessee
is not (x) already a tenant in the Building or (y) a party with whom Landlord
has been discussing the leasing of space in the Building.
(d) In the event Tenant shall request the consent of Landlord to any
assignment or subletting hereunder, Tenant shall pay Landlord a processing fee
of $250.00 and shall reimburse Landlord for Landlord's reasonable attorneys'
fees (not to exceed $750.00) incurred in connection therewith. All such fees
shall be deemed Additional Rent under this Lease.
(e) Any rent realized by Tenant under any such sublease or assignment
in excess of the Rent payable hereunder, after amortization of the reasonable
cost of Tenant Extra Improvements for which Tenant has paid and reasonable
subletting and assignment costs, shall be divided and paid as follows: fifty
percent (50%) to Tenant and fifty percent (50%) to Landlord; provided, however,
that if Tenant is in default hereunder beyond any applicable cure period,
Landlord shall be entitled to all such excess rent. Notwithstanding anything
herein to the contrary, Tenant shall not be required to pay Landlord any
consideration received by Tenant for the sale or transfer of Tenant's business,
assets, and/or stock.
(f) In any subletting undertaken by Tenant, Tenant shall diligently
seek to obtain not less than fair market rent for the space to sublet. In any
assignment of this Lease in whole or in part, Tenant shall seek to obtain from
the assignee consideration reflecting a value of not less than fair market rent
for the space subject to such assignment.
(g) The consent of Landlord to any assignment or subletting shall not
constitute a consent to any subsequent assignment or subletting by Tenant or to
any subsequent or successive assignment or subletting by the assignee or
subtenant.
(h) No assignment or subletting by Tenant shall relieve Tenant of any
obligation under this Lease. In the event of default by an assignee or
subtenant of Tenant or any successor of Tenant in the performance of any of the
terms hereof, Landlord may proceed directly against Tenant without the
necessity of exhausting remedies against such assignee, subtenant or successor.
Any assignment or subletting which
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conflicts with the provisions hereof shall be void and, at Landlord's option,
shall constitute a default under this Lease.
(i) The sale or exchange of Tenant's stock in a public offering and
the subsequent sale of Tenant's stock on a nationally recognized or in NASDAQ, a
change in ownership of Tenant as a result of a merger, consolidation,
reorganization, joint venture, the exchange of stock between Tenant's parent
company and a subsidiary or between subsidiaries or the ale of all or
substantially all of Tenant's stock or the sale of all or substantially all of
Tenant's assets shall not be considered an Assignment under this Section. Tenant
shall not be required to obtain Landlord's consent and Landlord shall have no
right to delay, alter or impede any of the foregoing transactions or
combinations thereof.
5.07. ALTERATIONS, ADDITIONS AND IMPROVEMENTS.
(a) Tenant shall not make or allow to be made any alterations or
additions in or to the Leased Premises without first obtaining the written
consent of Landlord. Landlord's consent will not be unreasonably withheld with
respect to proposed alterations and additions which (i) comply with all
applicable laws, ordinances, rules and regulations; (ii) are compatible with and
does not adversely affect the Building and its mechanical, electrical, HVAC and
life safety systems; (iii) will not affect the structural portions of the
Building; (iv) will not interfere with the use and occupancy of any other
portion of the Building by any other tenant, its employees or invitees; and (v)
will not trigger any additional costs to Landlord. Specifically, but without
limiting the generality of the foregoing, Landlord's right of consent shall
encompass plans and specifications for the proposed alterations or additions,
construction means and methods, the identity of any contractor or subcontractor
to be employed on the work or alterations or additions, and the time for
performance of such work. Tenant shall supply to Landlord any reasonable
additional documents and information requested by Landlord in connection with
Tenant's request for consent hereunder.
(b) Any consent given by Landlord under this Section 5.07 shall be
deemed conditioned upon: (i) Tenant's acquiring all applicable permits required
by governmental authorities; (ii) Tenant's furnishing to Landlord copies of such
permits, together with copies of the approved plans and specifications, prior to
commencement of the work thereon; and (iii) the compliance by Tenant with the
conditions of all applicable permits and approvals in a prompt and expeditions
manner.
(c) Tenant shall provide Landlord with not less than fifteen (15)
days prior written notice of commencement of the work so as to enable Landlord
to post and record appropriate notices of non-responsibility. All alterations
and additions permitted hereunder shall be made and performed by Tenant without
cost or expense to Landlord. Tenant shall pay the contractors and suppliers all
amounts due to them when due and keep the Leased Premises and the Project free
from any and all mechanics' materialmen's and other liens and claims arising out
of any work performed, materials furnished or obligations incurred by or for
Tenant. In the event any alterations or additions to the Leased Premises are
performed by Landlord hereunder, whether by prearrangement or otherwise,
Landlord shall be entitled to charge Tenant a fifteen percent (15%)
administration fee in addition to the actual cost of labor and materials
provided. Such costs and fees shall be deemed Additional Rent under this Lease,
and may be charged and payable prior to commencement of the work.
(d) Any and all alterations, additions or improvements made to the
Leased Premises by Tenant shall become the property of Landlord upon
installation and shall be surrendered to Landlord without compensation to
Tenant upon the termination of this Lease by lapse of time or otherwise unless
(i) Landlord conditioned its approval of such alterations, additions or
improvements on Tenant's agreement to remove them, or (ii) Landlord notifies
Tenant prior to (or promptly after) the Term Expiration Date that the
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alterations, additions and/or improvements performed after the initial Tenant
Improvements or Tenant's Extra Improvements must be removed, in which case
Tenant shall, by the Term Expiration Date (or promptly thereafter), remove such
alterations, additions and improvements, repair any damage resulting from such
removal and restore the Leased Premises to their condition existing prior to
the date of installation of such alterations, additions and improvements normal
wear and tear excepted. Notwithstanding anything to the contrary set forth
above, this clause shall not apply to movable equipment or furniture owned by
Tenant. Tenant shall repair at its sole cost and expense all damage caused to
the Leased Premises and the Project by removal of Tenant's movable equipment or
furniture and such other alterations, additions and improvements as Tenant
shall be required or allowed by Landlord to remove from the Leased Premises.
(e) All alterations and improvements permitted under this
Section 5.07 shall be constructed diligently, in a good and workmanlike manner
with new, good and sufficient materials and in compliance with all applicable
laws, ordinances, rules and regulations (including, without limitation,
building codes and those related to accessibility and use by individuals with
disabilities). Tenant shall, promptly upon completion of the work, furnish
Landlord with working drawings for any alterations, additions or improvements
performed under this Section 5.07.
5.08. COMPLIANCE WITH LAWS AND INSURANCE STANDARDS. Tenant shall not
occupy or use, or permit any portion of the Leased Premises to be occupied or
used in a manner that violates any applicable law, ordinance, rule, regulation,
order, permit, covenant, easement or restriction of record, or the
recommendations of Landlord's engineers or consultants, relating in any manner
to the Project, or for any business or purpose which is disreputable,
objectionable or productive of fire hazard. Tenant shall not do or permit
anything to be done which would result in the cancellation, or in any way
increase the cost, of the all risk property insurance coverage on the Project
and/or its contents. If Tenant does or permits anything to be done which
increases the cost of any insurance covering or affecting the Project, then
Tenant shall reimburse Landlord, upon demand, as Additional Rent, for such
additional costs. Landlord shall deliver to Tenant a written statement setting
forth the amount of any such insurance cost increase and showing in reasonable
detail the manner in which it has been computed. Tenant shall, at Tenant's sole
cost and expense, comply with all laws, ordinance, rules, regulations and
orders (state, federal, municipal or promulgated by other agencies or bodies
having or claiming jurisdiction) related to the use, condition or occupancy of
the Leased Premises now in effect or which may hereafter come into effect
including, but not limited to, (a) accessibility and use by individuals with
disabilities, and (b) environmental conditions in, on or about the Leased
Premises. If anything done by Tenant in its unique use or occupancy of the
Leased Premises shall create, require or cause imposition of any requirement by
any public authority for structural or other upgrading of or alteration or
improvement to the Project, Tenant shall, at Landlord's option, either perform
the upgrade, alteration or improvement at Tenant's sole cost and expense or
reimburse Landlord upon demand, as Additional Rent, for the cost to Landlord of
performing such work. The judgment of any court of competent jurisdiction or
the admission by Tenant in any action against Tenant, whether Landlord is a
party thereto or not, that Tenant has violated any law, ordinance, rule,
regulation, order, permit, covenant, easement or restriction shall be
conclusive of that fact as between Landlord and Tenant.
5.09. NO NUISANCE; NO OVERLOADING. Tenant shall use and occupy the
Leased Premises, and control its agents, employees, contractors, invitees and
visitors in such manner so as not to create any nuisance, or interfere with,
annoy or disturb (whether by noise, odor, vibration or otherwise) any other
tenant or occupant of the Project or Landlord in its operation of the Project.
Tenant shall not place or permit to be placed any loads upon the floors, walls
or ceilings in excess of the maximum designed load specified by Landlord or
which might damage the Leased Premises, the Building, or any portion thereof.
5.10. FURNISHING OF FINANCIAL STATEMENTS; TENANT'S REPRESENTATIONS. In
the event Tenant is not a publicly traded company, Tenant agrees that it shall
promptly furnish Landlord, from time to time,
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within ten (10) business days of receipt of Landlord's written request
therefor, with financial statements in form and substance reasonably
satisfactory to Landlord reflecting Tenant's current financial condition.
Tenant represents and warrants that all financial statements, records and
information furnished by Tenant to Landlord in connection with this Lease
fairly represent the results of operations shown.
5.11. ENTRY BY LANDLORD. Landlord, its employees, agents and
consultants, shall have the right to enter the Leased Premises at any time, in
cases of an emergency, and otherwise at reasonable times to inspect the same,
to clean, to perform such work as may be permitted or required under this
Lease, to make repairs to or alterations of the Leased Premises or other
portions of the Project or other tenant spaces therein, to deal with
emergencies, to post such notices as may be permitted or required by law to
prevent the perfection of liens against Landlord's interest in the Project or
to show the Leased Premised to prospective tenants (however, not earlier than
180 days prior to the Term Expiration Date), purchasers, encumbrancers or
others, or for any other purpose as Landlord may deem necessary or desirable;
provided, however, that Landlord shall use its best efforts to minimize
interference with Tenant's business operations in the Leased Premises. Tenant
shall not be entitled to any abatement of Rent or damages by reason of the
exercise of any such right of entry.
5.12. NONDISTURBANCE AND ATTORNMENT.
(a) This Lease and the rights of Tenant hereunder shall be
subject and subordinate to the lien of any deed of trust, mortgage or other
hypothecation or security instrument (collectively, "Security Device") now or
hereafter placed upon, affecting or encumbering the Project or any part thereof
or interest therein, and to any and all advances made thereunder, interest
thereon or costs incurred and any modifications, renewals, supplements,
consolidations, replacements and extensions thereof provided Landlord agrees to
use its best efforts to obtain assurance (a "nondisturbance agreement") from the
holder of or beneficiary under such encumbrance that Tenant's possession will
not be disturbed so long as Tenant is not in default under this Lease and
attorns to the record owner of the Leased Premises. Without the consent of
Tenant, the holder of any such Security Device or the beneficiary thereunder
shall have the right to elect to be subject and subordinate to this Lease, such
subordination to be effective upon such terms and conditions as such holder or
beneficiary may direct which are not inconsistent with the provisions hereof and
do not impose further obligations on Tenant. Tenant agrees to attorn to and
recognize as the Landlord under this Lease the holder or beneficiary under a
Security Device or any other party that acquires ownership of the Leased
Premises by reason of a foreclosure or sale under any Security Device (or deed
in lieu thereof). The new owner following such foreclosure, sale or deed shall
not be (i) liable for any act or omission of any prior landlord or with respect
to events occuring prior to acquisition of ownership; (ii) subject to any
offsets or defenses which Tenant might have against any prior landlord; (iii)
bound by prepayment of more than one (1) month's Rent; or (iv) liable to Tenant
for any security deposit not actually received by such new owner.
(b) Tenant shall not unreasonably withhold its consent to
changes or amendments to this Lease requested by the holder of a Security
Device so long as these changes do not alter the basic business terms of this
Lease or otherwise materially diminish any rights or materially increase any
obligations of Tenant hereunder. If, within ten (10) business days after notice
from Landlord, Tenant fails or refused to execute with Landlord the reasonable
amendment(s) to this Lease accomplishing the change(s) or amendment(s) which
are requested by such holder, Tenant shall be in default hereunder.
5.13. ESTOPPEL CERTIFICATE. Within ten (10) business days following
Landlord's request, Tenant shall execute, acknowledge and deliver written
estoppel certificates addressed to (i) any mortgagee or prospective mortgagee
of Landlord, or (ii) any purchaser or prospective purchaser of all or any
portion of, or interest in, the Project, on a form specified by Landlord,
certifying as to such facts (if true) and agreeing
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to such notice provisions and other matters as such mortgagee(s) or
purchaser(s) may reasonably require, including, without limitation, the
following: (a) that this Lease is unmodified and in full force and effect (or
in full force and effect as modified, and stating the modifications); (b) the
amount of, and date to which Rent and other charges have been paid in advance;
(c) the amount of any Security Deposit; and (d) acknowledging that Landlord is
not in default under this Lease (or, if Landlord is claimed to be in default,
stating the nature of the alleged default). However, in no event shall any such
estoppel certificate require an amendment of the provisions of this Lease or
otherwise affect or abridge Tenant's rights hereunder. Any such estoppel
certificate may be relied upon by any such mortgagee or purchaser. Failure by
Tenant to execute and deliver any such estoppel certificate within the time
requested shall, at Landlord's election, constitute a default hereunder and
shall be conclusive upon Tenant that (1) this Lease is in full force and effect
and has not been modified except as represented by Landlord; (2) not more than
one month's Rent has been paid in advance; and (3) Landlord is not in default
under this Lease.
5.14. SECURITY DEPOSIT. [Intentionally deleted]
5.15. SURRENDER. Subject to the provisions of Section 5.07 hereof, on
the Term Expiration Date (or earlier termination of this Lease), Tenant shall
quit and surrender possession of the Leased Premises to Landlord in as good
order and condition as they were in on the Term Commencement Date, reasonable
wear and tear, taking by condemnation and repairs which are Landlord's
responsibility excepted. Reasonable wear and tear shall not include any damage
or deterioration that would have been prevented by good maintenance practice or
by Tenant performing all of its obligations under this Lease. Tenant shall,
without cost to Landlord, remove all furniture, equipment, trade fixtures,
debris and articles of personal property owned by Tenant in the Leased
Premises, and shall repair any damage to the Project resulting from such
removal. Any such property not removed by Tenant by the Term Expiration Date
(or earlier termination of this Lease) shall be considered abandoned, and
Landlord may remove any or all of such items and dispose of same in any lawful
manner or store same in a public warehouse or elsewhere for the account and at
the expense and risk of Tenant. If Tenant shall fail to pay the cost of storing
any such property after storage for thirty (30) days or more, Landlord may sell
any or all of such property at public or private sale, in such manner and at
such times and places as Landlord may deem proper, without notice to or demand
upon Tenant. Landlord shall apply the proceeds of any such sale as follows:
first, to the costs of such sale; second, to the costs of storing any such
property; third, to the payment of any other sums of money which may then or
thereafter be due to Landlord from Tenant under any of the terms of this Lease;
and fourth, the balance, if any, to Tenant.
5.16. TENANT'S REMEDIES. Landlord shall not be deemed in breach of
this Lease unless Landlord fails within a reasonable time to perform an
obligation required to be performed by Landlord. For purposes of this Section
5.16, a reasonable time shall in no event, be less than thirty (30) days
(except in the case of an emergency when such reasonable time shall be five (5)
days) after receipt by Landlord, and by the holders of any ground lease, deed
of trust or mortgage covering the Leased Premises whose name and address shall
have been furnished Tenant in writing for such purpose, of written notice
specifying wherein such obligation of Landlord has not been performed;
provided, however, that if the nature of Landlord's obligation is such that
more than thirty (30) days after such notice are reasonably required for its
performance, then Landlord shall not be in breach of this Lease if performance
is commenced within said thirty (30) day period and thereafter diligently
pursued to completion. If Landlord fails to cure such default within the time
provided for in this Lease, the holder of any such ground lease, deed of trust
or mortgage shall have an additional thirty (30) days to cure such default;
provided that if such default cannot reasonably be cured within that thirty
(30) day period, then such holder shall have such additional time to cure the
default as is reasonably necessary under the circumstances. Tenant shall look
solely to Landlord's interest in the Project for recovery of any judgment from
Landlord. Neither Landlord nor any of its trustees, directors, officers,
agents, employees or representatives (or, if Landlord is a partnership, its
partners, whether general or limited) shall ever be
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personally liable for any such judgment. Any lien obtained to enforce any such
judgment and any levy of execution thereon shall be subject and subordinate to
any lien, deed of trust or mortgage to which Section 5.12 applies or may apply.
Tenant shall not have the right to terminate this Lease or withhold, reduce or
offset any amount against any payments of Rent due and payable under this Lease
by reason of a breach of this Lease by Landlord; provided, however, if Landlord
fails to repair within the time frame required in this Section 5.16, Tenant may
undertake such repairs and send Landlord a written demand for payment of
Tenant's reasonable costs incurred in taking such action on Landlord's behalf
(including a reasonably particularized statement). If within thirty (30) days
after Landlord's receipt of Tenant's written demand Landlord has not paid the
invoice or delivered to Tenant a detailed written objection to it, Tenant may
deduct from Rent payable by Tenant under this Lease the amount set forth in the
invoice. Tenant shall not be entitled to this deduction from Rent, however, if,
within thirty (30) days after receipt of Tenant's invoice, Landlord in good
faith delivers to Tenant a written objection to its payment, setting forth with
reasonable particularity Landlord's reasons for its claim that Landlord did not
have to take this action under the terms of this Lease or that the charges are
excessive (in which case Landlord shall pay the amount it contends would not
have been excessive). If Landlord and Tenant are unable to resolve this
disagreement, Tenant's sole remedy shall be to institute legal proceedings (or
binding arbitration, if agreed to by Landlord and Tenant) against Landlord to
collect the amount set forth in Tenant's invoice.
5.17. RULES AND REGULATIONS. Tenant shall comply with the rules and
regulations for the Project attached as EXHIBIT D and such reasonable
amendments thereto as Landlord may adopt from time to time with prior notice to
Tenant.
ARTICLE 6.
ENVIRONMENTAL MATTERS
6.01. HAZARDOUS MATERIALS PROHIBITED.
(a) Tenant shall not cause or permit any Hazardous Material (as
defined in Section 6.01(c) below) to be brought, kept, used, generated,
released or disposed in, on, under or about the Leased Premises or the Project
by Tenant, its agents, employees, contractors or invitees; provided, however,
that Tenant may use, store and dispose of, in accordance with applicable Laws,
limited quantities of standard office and janitorial supplies, but only to the
extent reasonably necessary for Tenant's operations in the Leased Premises.
Tenant hereby indemnifies Landlord from and against (i) any breach by Tenant of
the obligations stated in the preceding sentence, (ii) any breach of the
obligations stated in Section 6.01(b) below, or (iii) any claims or liability
resulting from Tenant's use of Hazardous Materials. Tenant hereby agrees to
defend and hold Landlord harmless from and against any and all claims,
liability, losses, damages, costs and/or expenses (including, without
limitation, diminution in value of the Project, or any portion thereof, damages
for the loss or restriction on use of rentable or usable space or of any
amenity of the Project, damages arising from any adverse impact on marketing of
space in the Project, and sums paid in settlement of claims, fines, penalties,
attorneys' fees, consultants' fees and experts' fees) which arise during or
after the Term as a result of any breach of the obligations stated in Sections
6.01(a) or 6.01(b) or otherwise resulting from Tenant's use of Hazardous
Materials. This indemnification of Landlord by Tenant includes, without
limitation, death of or injury to person, damage to any property or the
environment and costs incurred in connection with any investigation of site
conditions or any cleanup, remedial, removal, or restoration work required by
any federal, state or local governmental agency or political subdivision
because of any Hazardous Material present in, on, under or about the Leased
Premises or the Project (including soil and ground water contamination) which
results from such a breach. Without limiting the foregoing, if the presence of
any Hazardous Material in, on, under or about the Leased Premises or the
Project caused or permitted by Tenant results in any contamination of the
Leased Premises or the Project, Tenant shall promptly take all actions at its
sole expense as are necessary to return the same to the condition existing
prior to the introduction of such
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Hazardous Material; provided that Landlord's approval of such actions, and the
contractors to be used by Tenant in connection therewith, shall first be
obtained. This indemnification of Landlord by Tenant shall survive the
expiration or sooner termination of this Lease.
(b) Tenant covenants and agrees that Tenant shall at all times be
responsible and liable for, and be in compliance with, all federal, state, local
and regional laws, ordinances, rules, codes and regulations, as amended from
time to time ("Governmental Requirements"), relating to health and safety and
environmental matters, arising, directly or indirectly, out of Tenant's use of
Hazardous Materials (as defined in Section 6.01(c) below) in the Project. Health
and safety and environmental matters in connection with Tenant's use of
Hazardous Materials for which Tenant is responsible under this paragraph
include, without limitation (i) notification and reporting to governmental
agencies, (ii) the provision of warnings of potential exposure to Hazardous
Materials to Landlord and Tenant's agents, employees, licensees, contractors and
others, (iii) the payment of taxes and fees, (iv) the proper off-site
transportation and disposal of Hazardous Materials, and (v) all requirements,
including training, relating to the use of equipment. Immediately upon discovery
of a release of Hazardous Materials caused by Tenant's activities, Tenant shall
give written notice to Landlord, whether or not such release is subject to
reporting under Governmental Requirements. The notice shall include information
on the nature and conditions of the release and Tenant's planned response.
Tenant shall be liable for the cost of any clean-up of the release of any
Hazardous Materials by Tenant on the Project.
(c) As used in this Lease, the term "Hazardous Material" means any
hazardous or toxic substance, material or waste which is or becomes regulated
by any local governmental authority, the State of California of the United
States Government. The term "Hazardous Material" includes, without limitation,
any substance, material or waste which is (i) defined as a "hazardous waste" or
similar term under the laws of the jurisdiction where the Project is located;
(ii) designated as a "hazardous substance" pursuant to Section 311 of the
Federal Water Pollution Control Act (33 U.S.C. Section 1317); (iii) defined as
a "hazardous waste" pursuant to Section 1004 of the Federal Resource,
Conservation and Recovery Act, 42 U.S.C. Section 6901 et seq. (42 U.S.C.
Section 6903); (iv) defined as a "hazardous substance" pursuant to Section 101
of the Comprehensive Environmental Response, Compensation and Liability Act, 42
U.S.C. Section 9601 et seq. (42 U.S.C. Section 9601); (v) hydrocarbons,
petroleum, gasoline, crude oil or any products, by-products or fractions
thereof; or (vi) asbestos in any form or condition.
(d) As used in this Article 6, the term "Laws" means any applicable
federal, state or local laws, ordinances, rules or regulations relating to any
Hazardous Materials affecting the Project, including, without limitation, the
specific laws, ordinances and regulations referred to in Section 6.01(c) above.
References to specific Laws shall also be references to any amendments thereto
and to any applicable successor Laws.
(e) To the best of Landlord's knowledge, except as disclosed in the
environmental reports (the "Environmental Reports") provided to Tenant (i) there
are no Hazardous Materials, PCB transformers or underground storage tanks on the
Project, and (ii) the Project is in compliance with all Laws relating to any
Hazardous Material. Landlord's knowledge is limited to the matters contained in
the Environmental Reports. Tenant acknowledges its receipt and review of the
Environmental Reports prior to entering into this Lease. Landlord represents and
warrants that (i) during the period of its ownership of the Project prior to
entering in to this Lease, it has not released any Hazardous Materials on the
Project, and (ii) after entering into this Lease, Landlord will not release any
Hazardous Materials on the Project. Landlord hereby agrees to indemnify Tenant
from any breach by Landlord of its representations and warranties in this
Section 6.01(e) and Landlord shall be liable for the cost of any clean-up of the
release of any Hazardous Materials by Landlord on the Project. If Landlord is
unable to remove the Hazardous Materials described in the preceding sentence
within sixty (60) days, and if the existence of the Hazardous Materials
materially
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affects Tenant's use of the Leased Premises because of a threat to the safety
of Tenant employees, contractors or invitees, Tenant may, at its option, by
notice in writing to Landlord, terminate this Lease.
6.02. LIMITATIONS ON ASSIGNMENT AND SUBLETTING. It shall not be
unreasonable for Landlord to withhold its consent to any proposed assignment or
subletting of the Leased Premises if (i) the proposed transferee's anticipated
use of the Leased Premises involves the generation, storage, use, treatment, or
disposal of Hazardous Material (excluding standard office and janitorial
supplies; in limited quantities as hereinabove provided); (ii) the proposed
transferee has been required by any prior landlord, lender or governmental
authority to take remedial action in connection with Hazardous Material
contaminating a property if the contamination resulted from such transferee's
actions or use of the property in question; or (iii) the proposed transferee is
subject to an enforcement order issued by any governmental authority in
connection with the generation, storage, use, treatment or disposal of a
Hazardous Material.
6.03. RIGHT OF ENTRY. Landlord, its employees, agents and consultants,
shall have the right to enter the Leased Premises at any time, in case of an
emergency, and otherwise during reasonable hours and upon reasonable notice to
Tenant provided that Landlord shall not materially interfere with Tenant's
business, in order to conduct periodic environmental inspections and tests to
determine whether any Hazardous Materials are present. The costs and expenses of
such inspections shall be paid by Landlord unless a default or breach of this
Lease, violation of Laws or contamination caused or permitted by Tenant is found
to exist. In such event, Tenant shall reimburse Landlord upon demand, as
Additional Rent, for the costs and expenses of such inspections.
6.04. NOTICE TO LANDLORD. Tenant shall immediately notify Landlord in
writing of: (i) any enforcement, clean-up, removal or other governmental or
regulatory action instituted or threatened against Tenant regarding the Leased
Premises or the Project pursuant to any Laws; (ii) any claim made or threatened
by any person against Tenant or the Leased Premises relating to damage,
contribution, cost recovery, compensation, loss or injury resulting from or
claimed to result from any Hazardous Material; and (iii) any reports made by
Tenant to or received by Tenant from any governmental agency arising out of or
in connection with any Hazardous Material in or removed from the Leased Premises
or the Project, including any complaints, notices, warnings or asserted
violations in connection therewith. Tenant shall also supply to Landlord as
promptly as possible, and in any event within three (3) business days after
Tenant first receives or sends the same, copies of all claims, reports,
complaints, notices, warnings, asserted violations or other communications
relating in any way to the Leased Premises or Tenant's use thereof.
ARTICLE 7.
INSURANCE, INDEMNITY, CONDEMNATION, DAMAGE AND DEFAULT
7.01. LANDLORD'S INSURANCE. Subject to Tenant's obligations under Section
3.04 to pay Tenant's Proportionate Share of Basic Operating Cost, Landlord shall
secure and maintain policies of insurance for the Project (including the Leased
Premises) covering loss of or damage to the Project, including the Tenant
Improvements (as shown on the working plans provided to Landlord after
completion of construction of the Tenant Improvements), but excluding all
subsequent alterations, additions and improvements to the Leased Premises, with
loss payable to Landlord and to the holders of any deeds of trust, mortgages or
ground leases on the Project. Landlord shall not be obligated to obtain
insurance for Tenant's trade fixtures, equipment, furnishings, machinery or
other property. Such policies shall provide protection against fire and extended
coverage perils and such additional perils as Landlord deems suitable, and with
such deductible(s) as Landlord shall deem reasonably appropriate. Landlord shall
further secure and maintain commercial general liability insurance with respect
to the Project in such amount as Landlord shall determine, such insurance to be
in addition to, and not in lieu of, the liability insurance required to be
maintained by Tenant. In addition, Landlord may secure and maintain rental
income insurance not to exceed twelve (12) months.
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Landlord may elect to self-insure for the coverages required under this Section
7.01. If the annual cost to Landlord for any such insurance exceeds the
standard rates because of the nature of Tenant's operations, Tenant shall, upon
receipt of appropriate invoices, reimburse Landlord for such increases in cost,
which amounts shall be deemed Additional Rent hereunder. Tenant shall not be
named as an additional insured on any policy of insurance maintained by
Landlord.
7.02. TENANT'S LIABILITY INSURANCE.
(a) Tenant (with respect to both the Leased Premises and the
Common Areas) shall secure and maintain, at its own expense, at all times
during the Term, a policy or policies of commercial general liability insurance
with the premiums thereon fully paid in advance, protecting Tenant and naming
Landlord, the holders of any deeds of trust, mortgages or ground leases on the
Project, and Landlord's representatives (which term, whenever used in this
Article 7, shall be deemed to include Landlord's partners, trustees, ancillary
trustees, officers, directors, shareholders, beneficiaries, agents, employees
and independent contractors) as additional insureds against claims for bodily
injury, personal injury, advertising injury and property damage (including
attorneys' fees) based upon, involving or arising out of Tenant's operations,
assumed liabilities or Tenant's use, occupancy or maintenance of the Leased
Premises and the Common Areas of the Project. Such insurance shall provide for
a minimum amount of Two Million Dollars ($2,000,000.00) for property damage or
injury to or death of one or more than one person in any one accident or
occurrence, with an annual aggregate limit of at least Four Million Dollars
($4,000,000.00). The coverage required to be carried shall include fire legal
liability, blanket contractual liability, personal injury liability (libel,
slander, false arrest and wrongful eviction), broad form property damage
liability, products liability and completed operations coverage (as well as
owned, non-owned and hired automobile liability if an exposure exists) and the
policy shall contain an exception to any pollution exclusion which insures
damage or injury arising out of heat, smoke or fumes from a hostile fire. Such
insurance shall be written on an occurrence basis and contain a separation of
insureds provision or cross-liability endorsement acceptable to Landlord.
Tenant shall provide Landlord with a certificate evidencing such insurance
coverage. The certificate shall indicate that the insurance provided
specifically recognizes the liability assumed by Tenant under this Lease
(including without limitation performance by Tenant under Section 7.04 to the
extent insurable) and that Tenant's insurance is primary to and not
contributory with any other insurance maintained by Landlord, whose insurance
shall be considered excess insurance only. Not more frequently than every two
(2) years, if, in the reasonable opinion of any mortgagee of Landlord or of
the insurance broker retained by Landlord, the amount of liability insurance
coverage at that time is not adequate, then Tenant shall increase its liability
insurance coverage as required by either any mortgagee of Landlord or
Landlord's insurance broker.
(b) Tenant shall, at Tenant's expense, comply with (i) all
insurance company requirements pertaining to the use of the Leased Premises and
(ii) all rules, orders, regulations or requirements of the American Insurance
Association (formerly the National Board of Fire Underwriters) and with any
similar body.
7.03 TENANT'S ADDITIONAL INSURANCE REQUIREMENTS.
(a) Tenant shall secure and maintain, at Tenant's expense, at all
time during the Term, a policy of physical damage insurance on all of Tenant's
fixtures, furnishings, equipment, machinery, merchandise and personal property
in the Leased Premises and on any Tenant Extra Improvements and alterations,
additions or improvements made by or for Tenant upon the Leased Premises, all
for the full replacement cost thereof without deduction for depreciation of the
covered items and in amounts that meet any co-insurance clauses of the policies
of insurance. Such insurance shall insure against those risks customarily
covered in an "all risk" policy of insurance covering physical loss or damage.
Tenant shall use
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the proceeds from such insurance for the replacement of fixtures, furnishings,
equipment and personal property and for the restoration of Tenant Extra
Improvements and alterations, additions or improvements to the Leased Premises.
Landlord shall be named as loss payee to the extent of the value of any Tenant
Extra Improvements. In addition, Tenant shall secure and maintain, at all times
during the Term, loss of income, business interruption and extra expense
insurance in such amounts as will reimburse Tenant for direct or indirect loss
of earnings and incurred costs attributable to all perils commonly insured
against by prudent tenants or attributable to prevention of access to the
Leased Premises or to the Building as a result of such perils; such insurance
shall be maintained with Tenant's property insurance carrier. Further, Tenant
shall secure and maintain at all times during the Term workers' compensation
insurance in such amounts as are required by law, employer's liability
insurance in the amount of One Million Dollars ($1,000,000.00) per occurrence,
and all such other insurance as may be required by applicable law or as may be
reasonably required by Landlord. In the event Tenant makes any alterations,
additions or improvements to the Leased Premises, prior to commencing any work
in the Leased Premises, Tenant shall secure "builder's all risk" insurance
which shall be maintained throughout the course of the constructions, such
policy being an all risk builder's risk completed value form, in an amount
approved by Landlord, but not less than the total contract price for the
construction of such alterations, additions or improvements and covering the
construction of such alterations, additions or improvements, and such other
insurance as Landlord may require, it being understood and agreed that all of
such alterations, additions or improvements shall be insured by Tenant pursuant
to this Section 7.03 immediately upon completion thereof. Tenant shall provide
Landlord with certificates of all such insurance. The property insurance
certificate shall confirm that the waiver of subrogation required to be
obtained pursuant to Section 7.05 is permitted by the insurer. Tenant shall, at
least thirty (30) days prior to the expiration of any policy of insurance
required to be maintained by Tenant under this Lease, furnish Landlord with an
"insurance binder" or other satisfactory evidence of renewal thereof.
(b) All policies required to be carried by Tenant under this Lease
shall be issued by and binding upon a reputable insurance company of good
financial standing licensed to do business in the State of California with a
rating of at least A-VII, or such other rating as may be required by a lender
having a lien on the Project, as set forth in the most current issue of "Best's
Insurance Reports." Tenant shall not do or permit anything to be done that
would invalidate the insurance policies referred to in this Article 7. Evidence
of insurance provided to Landlord shall include an endorsement showing that
Landlord, its representatives and the holders of any deeds of trust, mortgages
or ground leases on the Project are included as additional insureds on general
liability insurance, and as loss payees for property insurance, to the extent
required hereunder, and an endorsement whereby the insurer agrees not to
cancel, non-renew or materially alter the policy without at least thirty (30)
days prior written notice to Landlord, its representatives and any mortgagee of
Landlord except cancellation for non-payment by Tenant in which case only ten
(10) days notice is required.
(c) In the event that Tenant fails to provide evidence of insurance
required to be provided by Tenant under this Lease, prior to commencement of
the Term, and thereafter during the Term, within ten (10) business days
following Landlord's written request therefor, and thirty (30) days prior to
the expiration date of any such coverage, Landlord shall be authorized (but not
required) to procure such coverage in the amounts stated with all costs thereof
(plus a fifteen percent (15%) administrative fee) to be chargeable to Tenant
and payable upon written invoice therefor, which amounts shall be deemed
Additional Rent hereunder.
(d) The minimum limits of insurance required by this Lease, or as
carried by Tenant, shall not limit the liability of Tenant nor relieve Tenant
of any obligation hereunder.
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7.04. INDEMNITY AND EXONERATION.
(a) To the extent not prohibited by law, Landlord and Landlord's
representatives shall not be liable for any loss, injury or damage to person or
property of Tenant, Tenant's agents, employees, contractors, invitees or any
other person, whether caused by theft, fire, act of God, acts of the public
enemy, riot, strike, insurrection, war, court order, requisition or order of
governmental body or authority or which may arise through repair, alteration or
maintenance of any part of the Project or failure to make any such repair or
from any other cause whatsoever, except as expressly otherwise provided in
Sections 7.06 and 7.07. Landlord shall not be liable for any loss, injury or
damage arising from any act or omission of any other tenant or occupant of the
Project, nor shall Landlord be liable under any circumstances for damage or
inconvenience to Tenant's business or for any loss of income or profit
therefrom. Nothing herein shall limit Landlord's obligations to repair and
maintain the Project as set forth in Section 4.06.
(b) Tenant shall indemnity, protect, defend and hold the Project,
Landlord and its representatives, harmless of and from any and all claims,
liability, costs, penalties, fines, damages, injury, judgments, forfeiture,
losses (including without limitation diminution in the value of the Leased
Premises) or expenses (including without limitation attorneys' fees, consultant
fees, testing and investigation fees, expert fees and court costs) arising out
of or in any way related to or resulting directly or indirectly from (i)
Tenant's use or occupancy of the Leased Premises, (ii) the activities of Tenant,
its agents, employees, contractors or invitees in or about the Leased Premises
or the Project (where not covered by Landlord's insurance), (iii) any failure to
comply with any applicable law, provided, however, that the foregoing indemnity
shall not be applicable to claims arising by reason of the negligence or willful
misconduct of Landlord.
(c) Tenant shall indemnity, protect, defend and hold the Project,
Landlord and its representatives, harmless of and from any and all claims,
liability, costs, penalties, fines, damages, injury, judgments, forfeiture,
losses (including without limitation diminution in the value of the Leased
Premises) or expenses (including without limitation attorneys' fees, consultant
fees, testing and investigation fees, expert fees and court costs) arising out
of or in any way related to or resulting directly or indirectly from work or
labor performed, materials or supplies furnished to or at the request of Tenant
or in connection with obligations incurred by or performance of any work done
for the account of Tenant in the Leased Premises or the Project.
(d) The provisions of this Section 7.04 shall survive the expiration
or sooner termination of this Lease. BY SIGNING ITS INITIALS BELOW, TENANT
ACKNOWLEDGES THAT IT HAS READ AND UNDERSTANDS THE MEANING AND RAMIFICATIONS OF
THE PROVISIONS SET FORTH IN THIS SECTION 7.04 AND FURTHER ACKNOWLEDGES THAT SUCH
PROVISIONS WERE SPECIFICALLY NEGOTIATED.
/s/ [Initials illegible]
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TENANT'S INITIALS
(e) To the extent not prohibited by law or not inconsistent with
Sections 7.04(a) and (b), Tenant shall not be liable for any loss, injury or
damage in or about the Project, nor shall Tenant be liable for any damage or
inconvenience to Landlord or Landlord's business or for any loss of income or
profit therefrom to the extent such loss, injury or damage arises from any
negligence or willful misconduct of Landlord.
(f) To the extent not prohibited by law or not inconsistent with
Sections 7.04(a) and (b), Landlord shall indemnify, protect, defend and hold
Tenant and its representatives, harmless of and from any
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and all claims, liability, costs, penalties, fines, damages, injury, judgments,
forfeiture, losses or expenses (including without limitation reasonable
attorneys' fees, consultant fees, testing and investigation fees, expert fees
and court costs) by reason of (i) any damage or injury occurring on the Project
to the extent that such damage or injury shall be caused by or arise from any
negligence or willful misconduct by Landlord, or (ii) Landlord's failure to
comply with any governmental laws, ordinances and regulations applicable to the
Project; provided however, that the foregoing indemnity shall not be applicable
to claims to the extent arising by reason of any negligence or willful
misconduct of Tenant. Tenant shall look solely first to Landlord's insurance
and second to Landlord's interest in the Project for recovery of any judgment
against Landlord.
7.05. WAIVER OF SUBROGATION. Anything in this Lease to the contrary
notwithstanding, Landlord and Tenant each waives all rights of recovery, claim,
action or cause of action against the other, its agents (including partners,
both general and limited), trustees, officers, directors, and employees, for
any loss or damage that may occur to the Leased Premises, or any improvements
thereto, or the Project or any personal property of such party therein, by
reason of any cause required to be insured against under this Lease to the
extent of the coverage required, regardless of cause or origin, including
negligence of the other party hereto, provided that such party's insurance is
not invalidated thereby; and each party covenants that, to the fullest extent
permitted by law, no insurer shall hold any right of subrogation against such
other party. Tenant shall advise its insurers of the foregoing and such waiver
shall be a part of each policy maintained by Tenant which applies to the Leased
Premises, any part of the Project or Tenant's use and occupancy of any part
thereof.
7.06. CONDEMNATION.
(a) If the Leased Premises are taken under the power of eminent
domain or sold under the threat of the exercise of such power (all of which are
referred to herein as "condemnation"), this Lease shall terminate as to the
part so taken as of the date the condemning authority takes title or
possession, whichever first occurs (the "date of taking"). If the Leased
Premises or any portion of the Project is taken by condemnation to such an
extent as to render the Leased Premises untenantable as reasonably determined
by Landlord and Tenant, this Lease shall, at the option of either party to be
exercised in writing within thirty (30) days after receipt of written notice of
such taking, forthwith cease and terminate as of the date of taking. All
proceeds from any condemnation of the Leased Premises shall belong and be paid
to Landlord, subject to the rights of any mortgagee of Landlord's interest in
the Project or the beneficiary of any deed of trust which constitutes an
encumbrance thereon; provided that Tenant shall be entitled to any compensation
separately awarded to Tenant for Tenant's relocation expenses or, loss of
Tenant's trade fixtures. If this Lease continues in effect after the date of
taking pursuant to the provisions of this Section 7.06(a), Landlord shall
proceed with reasonable diligence to repair, at its expense, the remaining
parts of the Project and the Leased Premises (other than any Tenant Extra
Improvements, except to the extent that there are proceeds adequate for such
repair and for all other restoration purposes) to substantially their former
condition to the extent that the same is feasible (subject to reasonable
changes which Landlord shall deem desirable) and so as to constitute a complete
and tenantable Project and Leased Premises. Net Rent shall abate to the extent
the Leased Premises are untenantable during the period of restoration, and Net
Rent shall thereafter be equitably adjusted according to the remaining Rentable
Area of the Leased Premises and the Building.
(b) In the event of a temporary taking of all or a portion of the
Leased Premises, there shall be no abatement of Rent and Tenant shall remain
fully obligated for performance of all of the covenants and obligations on
its part to be performed pursuant to the terms of this Lease. All proceeds
awarded or paid with respect thereto shall belong to Tenant.
7.07. DAMAGE OR DESTRUCTION. In the event of a fire or other casualty in
the Leased Premises, Tenant shall immediately give notice thereof to Landlord.
The following provisions shall then apply:
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(a) If the damage is limited solely to the Leased Premises and the
Leased Premises can, in Landlord's opinion, be made tenantable with all damage
repaired within six (6) months from the date of damage, then Landlord shall be
obligated to rebuild the same to substantially their former condition to the
extent that the same is feasible (subject to reasonable changes which Landlord
shall deem desirable and such changes as may be required by applicable law) and
shall proceed with reasonable diligence to do so and this Lease shall remain in
full force and effect; provided, however, that Landlord shall have no obligation
to repair or restore any Tenant Extra Improvements except to the extent that
Landlord realizes insurance proceeds, if any, sufficient for such purpose and
for all other restoration and repair purposes.
(b) If portions of the Project outside the boundaries of the Leased
Premises are damaged or destroyed (whether or not the Leased Premises are also
damaged or destroyed) and the Leased Premises and the Project can, in Landlord's
opinion, both be made tenantable with all damage repaired within six (6) months
from the date of damage or destruction, and provided that Landlord determines
that it is economically feasible, then Landlord shall be obligated to rebuild
the same to substantially their former condition to the extent that the same is
feasible (subject to reasonable changes which Landlord shall deem desirable and
such changes as may be required by applicable law) and shall proceed with
reasonable diligence to do so and this Lease shall remain in full force and
effect; provided, however, that Landlord shall have no obligation to repair or
restore any Tenant Extra Improvements except to the extent that Landlord
realizes insurance proceeds, if any, sufficient for such purpose and for all
other restoration and repair purposes.
(c) Notwithstanding anything to the contrary contained in Sections
7.07(a) or 7.07(b) above, Landlord shall not have any obligation whatsoever to
repair, reconstruct or restore the Leased Premises when any damage thereto or to
the Project occurs during the last eighteen (18) months of the Term and Tenant
has not effectively exercised any option granted to Tenant to extend the Term.
Under such circumstances, Landlord shall promptly notify Tenant of its decision
not to rebuild, whereupon the Lease shall terminate as of the date of such
notice.
(d) If neither Section 7.07(a) nor 7.07(b) above applies, Landlord
shall so notify Tenant within sixty (60) days after the date of the damage or
destruction and either Tenant or Landlord may terminate this Lease within thirty
(30) days after the date of such notice, such termination notice to be
immediately effective; provided, however, that Landlord shall have the right to
elect to reconstruct the Project and the Leased Premises, in which event (i)
Landlord shall notify Tenant of such election within said sixty (60) day period
and Tenant shall thereupon have no right to terminate this Lease, and (ii)
Landlord shall proceed with reasonable diligence to rebuild the Project and the
Leased Premises to substantially their former condition to the extent that the
same is feasible (subject to reasonable changes which Landlord shall deem
desirable and such changes as may be required by applicable law); provided
further, however, that Landlord shall have no obligation to repair or restore
any Tenant Extra Improvements except to the extent that Landlord realizes
insurance proceeds, if any, sufficient for such purpose and for all other
restoration and repair purposes.
(e) During any period when Tenant's use of the Leased Premises is
significantly impaired by damage or destruction, Net Rent shall abate in
proportion to the degree to which Tenant's use of the Leased Premises is
impaired until such time as the Leased Premises are made tenantable as
reasonably determined by Landlord; provided that no such rental abatement shall
be permitted if the casualty is the result of the negligence or willful
misconduct of Tenant or Tenant's employees, agents, contractors or invitees,
except to the extent such casualty is covered by Landlord's rental income
insurance.
(f) The proceeds from any insurance paid by reason of damage to or
destruction of the Project or any part thereof insured by Landlord shall belong
to and be paid to Landlord, subject to the rights of any mortgagee of
Landlord's interest in the Project or the beneficiary of any deed of trust which
constitutes
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an encumbrance thereon. Tenant shall be responsible at its sole cost and
expense for the repair, restoration and replacement of (i) its fixtures,
furnishings, equipment, machinery, merchandise and personal property in the
Leased Premises, (ii) its alteration, additions and improvements, and (iii)
subject to Sections 7.07(a), (b) and (d) above, its Tenant Extra Improvements;
provided, however, that Landlord shall have the option of requiring Tenant to
assign to Landlord (or any party designated by Landlord) some or all of the
proceeds payable to Tenant under this Article 7, whereupon Landlord shall be
responsible for the repair or restoration of such insured property.
(g) Landlord's repair and restoration obligations under this Section
7.07 shall not impair or otherwise affect the rights and obligations of the
parties set forth elsewhere in this Lease. Subject to Section 7.07(e), Landlord
shall not be liable for any inconvenience or annoyance to Tenant, its employees,
agents, contractors or invitees, or injury to Tenant's business resulting in
any way from such damage or the repair thereof. Landlord and Tenant agree that
the terms of this Lease shall govern the effect of any damage to or destruction
of the Leased Premises or the Project with respect to the termination of this
Lease and hereby waive the provisions of any present or future statute or law
to the extent inconsistent therewith.
7.08. DEFAULT BY TENANT.
(a) Events of Default. The occurrence of any of the following shall
constitute an event of default on the part of Tenant:
(1) Abandonment. Vacating the Leased Premises without the intention
to reoccupy same, or abandonment of the Leased Premises for a continuous period
of fourteen (14) days;
(2) Nonpayment of Rent. Failure to pay an installment of Rent due
and payable hereunder on the date when payment is due, such failure continuing
for a period of three (3) business days after written notice of such failure;
provided, however, that Landlord shall not be required to provide such notice
more than two (2) times during the Term with respect to non-payment of Net Rent
or Additional Rent, the third such non-payment constituting default without
requirement of notice; furthermore, if Tenant shall be served with a demand for
the payment of past due Rent, any payment(s) tendered thereafter to cure any
default by Tenant shall be made only by cashier's check, wire-transfer or
direct deposit of immediately available funds;
(3) Other Obligations. Failure to perform any obligation, agreement
or covenant under this Lease other than those matters specified in subsections
7.08(a)(1) and 7.08(a)(2), such failure continuing for a period of fifteen (15)
business days after written notice of such failure (or such longer period as is
reasonably necessary to remedy such default, provided that Tenant commences the
remedy within such fifteen (15)-day period and continuously and diligently
pursues such remedy at all times until such default is cured);
(4) General Assignment. Any general arrangement or assignment by
Tenant for the benefit of creditors;
(5) Bankruptcy. The filing of any voluntary petition in bankruptcy
by Tenant, or the filing of an involuntary petition against Tenant, which
involuntary petition remains undischarged for a period of sixty (60) days. In
the event that under applicable law the trustee in bankruptcy or Tenant has the
right to affirm this Lease and continue to perform the obligations of Tenant
hereunder, such trustee or Tenant shall, within such time period as may be
permitted by the bankruptcy court having jurisdiction, cure all defaults of
Tenant hereunder outstanding as of the date of the affirmance of this Lease and
provide to Landlord such adequate assurances as may be required by the
bankruptcy court;
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(6) Receivership. The appointment of a trustee or receiver to
take possession of all or substantially all of Tenant's assets or the Leased
Premises, where possession is not restored to Tenant within ten (10) business
days;
(7) Attachment. The attachment, execution or other judicial
seizure of all or substantially all of Tenant's assets or the Leased Premises,
if such attachment or other seizure remains undismissed or undischarged for a
period of ten (10) business days after the levy thereof;
(8) Insolvency. The admission by Tenant in writing of its
inability to pay its debts as they become due; the filing by Tenant of a
petition seeking any reorganization, arrangement, composition, readjustment,
liquidation, dissolution or similar relief under any present or future statute,
law or regulation; the filing by Tenant of an answer admitting or failing timely
to contest a material allegation of a petition filed against Tenant in any such
proceeding; or, if within sixty (60) days after the commencement of any
proceeding against Tenant seeking any reorganization, arrangement, composition,
readjustment, liquidation, dissolution or similar relief under any present or
future statute, law or regulation, such proceeding shall not have been
dismissed;
(9) Guarantor. If the performance of Tenant's obligations under
this Lease is guaranteed: (i) the death of a guarantor; (ii) the termination of
a guarantor's liability with respect to this Lease other than in accordance with
the terms of such guaranty; (iii) a guarantor's becoming insolvent or the
subject of a bankruptcy filing; (iv) a guarantor's refusal to honor the
guaranty; or (v) a guarantor's breach of its guaranty obligation on an
anticipatory breach basis, and Tenant's failure, within sixty (60) days
following written notice by or on behalf of Landlord to Tenant of any such
event, to provide Landlord with written alternative assurance or security,
which, when coupled with the then existing resources of Tenant, equals or
exceeds the combined financial resources of Tenant and the guarantor(s) that
existed at the time of execution of this Lease; or
(10) Partner. If Tenant is a partnership or consists of more than
one (1) person or entity, if any partner of the partnership or any person or
entity constituting Tenant is involved in any of the events or acts described in
subsections 7.08(a)(4) through (8).
(11) Misrepresentation. The discovery by Landlord that any
representation, warranty or financial statement given to Landlord by Tenant or
any guarantor of Tenant's obligations under this Lease was materially false or
misleading.
(b) Remedies Upon Default:
(1) Termination. If an event of default occurs, Landlord shall
have the right, with or without notice or demand, immediately (after expiration
of any applicable grace period specified herein) to terminate this Lease, and at
any time thereafter recover possession of the Leased Premises or any part
thereof and expel and remove therefrom Tenant and any other person occupying the
same, by any lawful means, and again repossess and enjoy the Leased Premises
without prejudice to any of the remedies that Landlord may have under this
Lease, or at law or in equity by reason of Tenant's default or of such
termination.
(2) Continuation After Default. Even though Tenant has breached
this Lease and/or abandoned the Leased Premises, this Lease shall continue in
effect for so long as Landlord does not terminate Tenant's rights to possession
under subsection 7.08(b)(1) hereof in writing, and Landlord may enforce all of
its rights and remedies under this Lease, including (but without limitation) the
right to recover Rent as it becomes due, and Landlord, without terminating this
Lease, may exercise all of the rights and
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remedies of a landlord under Section 1951.4 of the Civil Code of the State of
California or any amended or successor code section. Acts of maintenance or
preservation, efforts to relet the Leased Premises or the appointment of a
receiver upon application of Landlord to protect Landlord's interest under this
Lease shall not constitute an election to terminate Tenant's right to
possession. If Landlord elects to relet the Leased Premises for the account of
Tenant, the rent received by Landlord from such reletting shall be applied as
follows: first, to the payment of any indebtedness other than Rent due
hereunder from Tenant to Landlord; second, to the payment of any costs of such
reletting; third, to the payment of the cost of any alterations or repairs to
the Leased Premises; fourth, to the payment of Rent due and unpaid hereunder;
and the balance, if any, shall be held by Landlord and applied in payment of
future Rent as it becomes due. If that portion of rent received from the
reletting which is applied against the Rent due hereunder is less than the
amount of the Rent due, Tenant shall pay the deficiency to Landlord promptly
upon demand by Landlord. Such deficiency shall be calculated and paid monthly.
Tenant shall also pay to Landlord, as soon as determined, any costs and
expenses incurred by Landlord in connection with such reletting or in making
alterations and repairs to the Leased Premises, which are not covered by the
rent received from the reletting.
(c) Damages Upon Termination. Should Landlord terminate this Lease
pursuant to the provisions of subsection 7.08(b)(1) hereof, Landlord shall have
all the rights and remedies of a landlord provided by Section 1951.2 of the
Civil Code of the State of California. Upon such termination, in addition to
any other rights and remedies to which Landlord may be entitled under
applicable law, Landlord shall be entitled to recover from Tenant: (i) the
worth at the time of award of the unpaid Rent and other amounts which had been
earned at the time of termination; (ii) the worth at the time of award of the
amount by which the unpaid Rent which would have been earned after termination
until the time of award exceeds the amount of such Rent loss that Tenant proves
could have been reasonably avoided; (iii) the worth at the time of award of the
amount by which the unpaid Rent for the balance of the Term after the time of
award exceeds the amount of such Rent loss that Tenant proves could be
reasonably avoided; and (iv) any other amount necessary to compensate Landlord
for all the detriment proximately caused by Tenant's failure to perform its
obligations under this Lease or which, in the ordinary course of things, would
be likely to result therefrom. The "worth at the time of award" of the amounts
referred to in clauses(i) and (ii) shall be computed with interest at the
lesser of thirteen percent (13%) per annum or the maximum rate then allowed by
law. The "worth at the time of award" of the amount referred to in clause (iii)
shall be computed by discounting such amount at the time of termination at the
discount rate of the Federal Bank of San Francisco at the time of the award
plus one percent (1%).
(d) Computation of Rent for Purposes of Default. For purposes of
computing unpaid Rent which would have accrued and become payable under this
Lease pursuant to the provisions of Section 7.08(c), unpaid Rent shall consist
of the sum of:
(1) the total Base Rent for the balance of the Term, plus
(2) a computation of Tenant's Proportionate Share of Basic Operating
Cost for the balance of the Term, the assumed amount for the Computation Year
of the default and each future Computation Year in the Term to be equal to
Tenant's Proportionate Share of Basic Operating Cost for the Computation Year
immediately prior to the year in which default occurs, compounded at a per
annum rate equal to the mean average rate of inflation for the preceding five
(5) calendar years as determined by the United States Department of Labor,
Bureau of Labor Statistics Consumer Price Index (All Urban Consumers, all
items (1982-84=100)) for the Metropolitan Area or Region in which the Project
is located. If such Index is discontinued or revised, the average rate of
inflation shall be determined by reference to the index designated as the
successor or substitute index by the government of the United States.
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(e) Late Charge. If any payment required to be made by Tenant under
this Lease is not received by Landlord on or before the date the same is due,
Tenant shall pay to Landlord an amount equal to ten percent (10%) of the
delinquency. The parties agree that Landlord would incur costs not contemplated
by this Lease by virtue of such delinquencies, including without limitation
administrative, collection, processing and account expenses, the amount of
which would be extremely difficult to compute, and the amount stated herein
represents a reasonable estimate thereof. Acceptance of such late charge by
Landlord shall in no event constitute a waiver of Tenant's breach or default
with respect to such delinquency, or prevent Landlord from exercising any of
Landlord's other rights and remedies.
(f) Interest on Past-Due Obligations. Except as expressly otherwise
provided in this Lease, any Rent due Landlord hereunder, other than late
charges, which is not received by Landlord on the date on which it was due,
shall bear interest from the day after it was due at the rate of thirteen
percent (13%), in addition to the late charge provided for in Section 7.08(e).
(g) Landlord's Right to Perform. Notwithstanding anything to the
contrary set forth elsewhere in this Lease, in the event Tenant fails to
perform any affirmative duty or obligation of Tenant under this Lease, then
within five (5) business days after written notice to Tenant (and without
notice in case of an emergency) Landlord may (but shall not be obligated to)
perform such duty or obligation on Tenant's behalf, including, without
limitation, the obtaining of insurance policies or governmental licenses,
permits or approvals. Tenant shall reimburse Landlord upon demand for the costs
and expenses of any such performance (including penalties, interest and
attorneys' fees incurred in connection therewith). Such costs and expenses
incurred by Landlord shall be deemed Additional Rent hereunder.
(h) Remedies Cumulative. All rights, privileges and elections or
remedies of Landlord are cumulative and not alternative with all other rights
and remedies at law or in equity to the fullest extent permitted by Law.
(i) Waiver. Tenant waives any right of redemption or relief from
forfeiture under California Code of Civil Procedure Sections 1174 and 1179, or
under any other present or future law in the event Tenant is evicted and
Landlord takes possession of the Leased Premises by reason of a default.
7.09. DEFAULT BY LANDLORD. If Landlord defaults under this Lease, Tenant
shall give written notice to Landlord specifying such default with
particularity, and Landlord shall have thirty (30) days after receipt of such
notice within which to cure such default; provided, however, that if the nature
of Landlord's default is such that more than thirty (30) days after such notice
are reasonably required for its performance or cure, then Landlord shall not be
in breach of this Lease if performance or cure is commenced within said thirty
(30)-day period and thereafter diligently pursued to completion. In the event
of any default by Landlord, Tenant's exclusive remedy shall be an action for
damages. Notwithstanding any other provision of this Lease, Landlord shall not
have any personal liability under this Lease. In the event of any default by
Landlord under this Lease, Tenant agrees to look solely to the equity or
interest then owned by Landlord in the Project, and in no event shall any
deficiency judgment or personal money judgment of any kind be sought or
obtained against Landlord.
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ARTICLE 8.
OPTION TO RENEW, OPTION TO EXPAND
8.01. OPTION TO RENEW.
(a) Landlord hereby grants to Tenant one (1) option (the "Option")
to extend the term of this Lease for an additional period of five (5) years
(the "Option Term"), all on the following terms and conditions:
(1) The Option must be exercised, if at all, by written notice
irrevocably exercising the Option ("Option Notice") delivered by Tenant to
Landlord not later than six (6) months prior to the Term Expiration Date.
Further, the Option shall not be deemed to be properly exercised if, as of the
date of the Option Notice or at the Term Expiration date, (i) Tenant is in
default under this Lease, or (ii) Tenant, or Tenant's affiliate or subsidiary,
is in possession of less than fifty percent (50%) of the square footage of the
Leased Premises. Provided Tenant has properly and timely exercised the Option,
the term of this Lease shall be extended for the period of the Option Term, and
all terms, covenants and conditions of this Lease shall remain unmodified and in
full force and effect, except that the Base Rent shall be modified as set forth
in subsection 8.01(a)(2) below.
(2) The Base Rent payable for the Option Term shall be the
greater of (i) the Base Rent payable on the Term Expiration Date, or (ii) the
then-current rental rate per rentable square foot (as further defined below,
"FMRR") being agreed to in new leases by the Landlord and other landlords of
buildings in the Emeryville, California area which are comparable in quality,
location and prestige to the Building ("Comparable Buildings") and tenants
leasing space in the Building or Comparable Buildings. As used herein, "FMRR"
shall mean the rental rate per rentable square foot for which Landlord and other
landlords are entering into new leases within the time period of nine (9) to six
(6) months prior to the Term Expiration Date ("Market Determination Period"),
with new tenants leasing from Landlord and/or other landlords office space in
the Building and/or Comparable Buildings ("Comparable Transactions"). Landlord
shall provide its determination of the FMRR to Tenant within twenty (2) days
after Landlord receives the Option Notice. Tenant shall have fifteen (15) days
("Tenant's Review Period") after receipt of Landlord's notice of the FMRR within
which to accept such FMRR or to reasonably object thereto in writing. In the
event Tenant objects to the FMRR submitted by Landlord, Landlord and Tenant
shall attempt to agree upon such FMRR. If Landlord and Tenant shall fail to
reach agreement on such FMRR within fifteen (15) days following Tenant's Review
Period (the "Outside Agreement Date"), then each party shall place in a separate
sealed envelope its final proposal as to FMRR and such determination shall be
submitted to arbitration in accordance with subparagraph 8.01(b) below.
(b) Landlord and Tenant shall meet with each other within five (5)
business days of the Outside Agreement Date and exchange the sealed envelopes
and then open such envelopes in each other's presence. If Landlord and Tenant do
not mutually agree upon the FMRR within one (1) business day of the exchange and
opening of envelopes, then, within ten (10) business days of the exchange and
opening of envelopes, Landlord and Tenant shall agree upon and jointly appoint
one arbitrator who shall be by profession a real estate appraiser or broker who
shall have been active over the five (5) year period ending on the date of such
appointment in the leasing of comparable commercial properties in the vicinity
of the Building. Neither Landlord nor Tenant shall consult with such broker or
appraiser as to his or her opinion as to FMRR prior to the appointment. The
determination of the arbitrator shall be limited solely to the issue of whether
Landlord's or Tenant's submitted FMRR for the Premises is the closer to the
actual rental rate per rentable square foot for new leases within the Market
Determination Period for Comparative Transactions. Such arbitrator may hold such
hearings and require such briefs as the arbitrator, in his or her sole
discretion, determines is necessary. In addition, Landlord or Tenant may submit
to the arbitrator with a copy to the other
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party within five (5) business days after the appointment of the arbitrator any
data and additional information that such party deems relevant to the
determination by the arbitrator ("Data") and the other party may submit a reply
in writing within five (5) business days after receipt of such Data.
(1) The arbitrator shall, within thirty (30) days of his or her
appointment, reach a decision as to whether the parties shall use Landlord's or
Tenant's submitted FMRR or such other amount determined by such arbitrator, and
shall notify Landlord and Tenant of such determination.
(2) The decision of the arbitrator shall be binding upon Landlord
and Tenant.
(3) If Landlord and Tenant fail to agree upon and appoint such
arbitrator, then the appointment of the arbitrator shall be made by the
American Arbitration Association.
(4) The cost of arbitration shall be paid by Landlord and Tenant
equally.
(5) The arbitration proceeding and all evidence given or discovered
pursuant thereto shall be maintained in confidence by all parties to the extent
allowed by law.
8.02. OPTION TO EXPAND. Before entering into a lease with anyone else
during the Term (including the Option Term), with respect to any previously
leased space contiguous to the Leased Premises, Landlord shall notify Tenant
in writing of the terms and conditions upon which Landlord is willing to lease
such space; provided, however, the terms shall not be greater than the terms
contained in this Lease. If Tenant wishes to exercise its option to lease such
space, Tenant, shall, within ten (10) business days after receipt of said
notice, deliver notice to Landlord of Tenant's intention to lease such space
for a term not extending beyond the expiration date of this Lease. Tenant must
elect to exercise its option, if at all, only with respect to all the space
offered by Landlord to Tenant at a particular time, and Tenant may not elect to
lease only a portion of that space. Landlord's notice may not be given more
than six (6) months prior to the date as of which said space will become
available. If Tenant fails to respond to said notice within said ten (10)
business day period, Tenant's rights under this paragraph shall be deemed to
have been waived, and Landlord shall be free to lease the space to anyone at
"at market"; provided, however, such terms shall not be less than the terms
offered to Tenant. Tenant's option to expand, is subordinate, however, to any
expansion or renewal options previously granted in leases to other tenants.
This option to expand shall be terminated during any period in which Tenant is
in default under any provisions of this Lease until said default has been
cured. The period of time within which this option to expand may be exercised
shall not be extended or enlarged by reason of Tenant's inability to exercise
such rights because of the foregoing provisions. Time is of the essence. If
Tenant fails to exercise its option to expand in any instance when such right
may arise, in writing, prior to the expiration of the applicable time period
for the exercise of such right, Tenant's right in the instance in question
shall thereafter be deemed null and void and of no further force or effect.
This option to expand shall only be exercisable by the originally named Tenant
or by any assignee (permitted under this Lease) of Tenant's entire interest
under this Lease.
ARTICLE 9.
MISCELLANEOUS MATTERS
9.01. PARKING.
(a) Provided Tenant is not in default of any term or provision of
this Lease, Landlord agrees to provide Tenant for use by the employees, agents,
customers and invitees of Tenant the number of parking spaces designated on the
Basic Lease Information sheet on an unreserved and unassigned basis on
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those portions of the Project designated by Landlord for parking. Such parking
spaces shall be free of charge until the Scheduled Term Expiration Date;
however, Landlord may charge a per-car parking fee during the Option Term at
the then-prevailing market rate for parking in the area. If parking spaces are
available, Tenant may request additional parking spaces at the monthly rate of
$55.00 per parking space during the 1999 Computation Year (such rate may be
increased three percent (3%) annually); however, Tenant's total parking spaces
shall not exceed 4 per 1,000 square feet of Rentable Area. The parking spaces
will not be separately identified and Landlord shall have no obligation to
monitor the use of the parking area, however, entrance to the Building garage
shall be through a card-key system implemented by Landlord. If a parking density
problem occurs during the Term, Landlord shall address the problem, in its
reasonable discretion, which solution may include initiating a parking permit
system or a reserved parking system and any costs associated therewith
(including, without limitation, costs of patrolling the Building garage and/or
parking area outside of the Building for compliance with the parking system)
shall constitute a Basic Operating Cost. All parking shall be subject to any
and all rules and regulations adopted by Landlord in its discretion from time
to time. Only automobiles no larger than full size passenger automobiles or
pick-up trucks or standard business use vehicles (which do not require parking
spaces larger than full size passenger automobiles) may be parked in the Project
parking area. Tenant shall not permit or allow any vehicles that belong to or
are controlled by Tenant or Tenant's employees, agents, customers or invitees
to be loaded, unloaded or parked in areas other than those designated by
Landlord for such activities. A failure by Tenant or any of its employees,
agents, customers or invitees to comply with the foregoing provisions shall
afford Landlord the right, but not the obligation, without notice, in
addition to any other rights and remedies available under this Lease, to remove
and to tow away the vehicles involved and to charge the cost to Tenant, which
cost shall be immediately due and payable upon demand by Landlord.
(b) Landlord reserves the right to charge a per-car parking fee during
the Term if such parking fees are mandated or otherwise imposed by applicable
law. Rates to be charged by Landlord or its operator for such parking shall be
the then-prevailing market rate for parking in such area as established by
Landlord or its operator from time to time. If a parking fee is charged,
Tenant's right to use of the Building garage and/or a parking area shall be
subject to timely payment of the established parking fees. In no event shall
Tenant be obligated to pay more than $55.00 for such parking fee.
9.02. BROKERS. Landlord has been represented in this transaction by
Landlord's Broker. Tenant has been represented in this transaction by Tenant's
Broker. Upon full execution of this Lease by both parties, Landlord shall pay
to Landlord's Broker a fee for brokerage services rendered by it in this
transaction if provided for in a separate written agreement between Landlord
and Landlord's Broker. Nothing contained in this Lease shall impose on Landlord
any obligation to pay a commission or fee to any party other than Landlord's
Broker and Tenant acknowledges that Landlord will not pay any commission or fee
to Tenant's Broker.
Tenant represents and warrants to Landlord that the brokers named in the
Basic Lease Information sheet are the only agents, brokers, finders or other
similar parties with whom Tenant has had any dealings in connection with the
negotiation of this Lease and the consummation of the transaction contemplated
hereby. Tenant hereby agrees to indemnify, defend and hold Landlord free and
harmless from and against liability for compensation or charges which may be
claimed by any agent, broker, finder or other similar party by reason of any
dealings with or actions of Tenant in connection with the negotiation of this
Lease and the consummation of this transaction, including any costs, expenses
and attorneys' fees incurred with respect thereto.
9.03. NO WAIVER. No waiver by either party of the default or breach of
any term, covenant or condition of this Lease by the other shall be deemed a
waiver of any other term, covenant or condition hereof, or of any subsequent
default or breach by the other of the same or of any other term, covenant or
condition
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hereof. Landlord's consent to, or approval of, any act shall not be deemed to
render unnecessary the obtaining of Landlord's consent to, or approval of, any
subsequent or similar act by Tenant, or be construed as the basis of an
estoppel to enforce the provision or provisions of this Lease requiring such
consent. Regardless of Landlord's knowledge of a default or breach at the time
of accepting Rent, the acceptance of Rent by Landlord shall not be a waiver of
any preceding default or breach by Tenant of any provision hereof, other than
the failure of Tenant to pay the particular Rent so accepted. Any payment given
Landlord by Tenant may be accepted by Landlord on account of monies or damages
due Landlord, notwithstanding any qualifying statements or conditions made by
Tenant in connection therewith, which statements and/or conditions shall be of
no force or effect whatsoever unless specifically agreed to in writing by
Landlord at or before the time of deposit of such payment.
9.04. RECORDING. Neither this Lease nor a memorandum thereof shall not be
recorded without the prior written consent of Landlord, which consent may be
withheld in Landlord's sole discretion.
9.05. HOLDING OVER. If Tenant holds over after expiration or termination
of this Lease without the written consent of Landlord, Tenant shall pay for
each month of hold-over tenancy 150% of the Net Rent which Tenant was obligated
to pay for the month immediately preceding the end of the Term for each month
or any part thereof of any such hold-over period, together with such other
amounts as may become due hereunder. No holding over by Tenant after the Term
shall operate to extend the Term. Any holding over with the consent of Landlord
in writing shall thereafter constitute this Lease a lease from month-to-month,
terminable upon thirty (30) days' notice from either party, at a monthly rental
rate of 150% of the Net Rent which Tenant was obligated to pay for the month
immediately preceding the end of the Term, together with such other amounts as
may become due hereunder.
9.06. TRANSFER BY LANDLORD. The term "Landlord" as used in this Lease
shall mean the owner(s) at the time in question of the fee title to the Leased
Premises or, if this is a sublease, of the Tenant's interest in the master
lease. If Landlord transfers, in whole or in part, its rights and obligations
under this Lease or in the Project, upon its transferee's assumption of all
Landlord's obligations hereunder accruing prior to such transfer and delivery
to such transferee of any unused Security Deposit then held by Landlord, no
further liability or obligations shall thereafter accrue against the
transferring or assigning person as Landlord hereunder. Subject to the
foregoing, the obligations and/or covenants in this Lease to be performed by
the Landlord shall be binding only upon the Landlord as defined in this Section
9.06.
9.07. ATTORNEYS' FEES. In the event either party places the enforcement
of this Lease, or any part of it, or the collection of any Rent due, or to
become due, hereunder, or recovery of the possession of the Leased Premises, in
the hands of an attorney, or files suit upon the same, the prevailing party
shall recover its reasonable attorneys' fees, costs and expenses, including
those which may be incurred on appeal. Such fees may be awarded in the same
suit or recovered in a separate suit, whether or not suit is filed or any suit
that may be filed is pursued to decision or judgment. The term "prevailing
party" shall include, without limitation, a part who substantially obtains or
defeats the relief sought, as the case may be, whether by compromise,
settlement, judgment, or the abandonment by the other party of its claim or
defense. The attorneys' fee award shall not be computed in accordance with any
court fee schedule, but shall be such as to fully reimburse all attorneys' fees
reasonably incurred.
9.08. TERMINATION; MERGER. No act or conduct of Landlord, including,
without limitation, the acceptance of keys to the Leased Premises, shall
constitute an acceptance of the surrender of the Leased Premises by Tenant
before the scheduled Term Expiration Date. Only a written notice from Landlord
to Tenant shall constitute acceptance of the surrender of the Leased Premises
and accomplish a termination of this Lease. Unless specifically stated
otherwise in writing by Landlord, the voluntary or other surrender of this
Lease by Tenant, the mutual termination or cancellation hereof, or a
termination hereof by Landlord for
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default by Tenant, shall automatically terminate any sublease or lesser estate
in the Leased Premises; provided, however, Landlord shall, in the event of any
such surrender, termination or cancellation, have the option to continue any
one or all of any existing subtenancies. Landlord's failure within thirty (30)
days following any such event to make any written election to the contrary by
written notice to the holder of any such lesser interest, shall constitute
Landlord's election to have such event constitute the termination of such
interest.
9.09. AMENDMENTS; INTERPRETATION. This Lease may not be altered,
changed or amended, except by an instrument in writing signed by the parties in
interest at the time of the modification. The captions of this Lease are for
convenience only and shall not be used to define or limit any of its provisions.
9.10. SEVERABILITY. If any term or provision of this Lease, or the
application thereof to any person or circumstances, shall to any extent be
invalid or unenforceable, the remainder of this Lease, or the application of
such provision to persons or circumstances other than those as to which it is
invalid or unenforceable, shall not be affected thereby, and each provision of
this Lease shall be valid and shall be enforceable to the fullest extent
permitted by law.
9.11. NOTICES. All notices, demands, consents and approvals which are
required or permitted by this Lease to be given by either party to the other
shall be in writing and shall be deemed to have been fully given by personal
delivery or by recognized overnight courier service or when deposited in the
United States mail, certified or registered, with postage prepaid, and
addressed to the party to be notified at the address for such party specified
on the Basic Lease Information sheet, or to such other place as the party to be
notified may from time to time designate by at least fifteen (15) days' notice
to the notifying party given in accordance with this Section 9.11. A copy of
all notices given to Landlord under this Lease shall be concurrently
transmitted to such party or parties at such addresses as Landlord may from
time to time hereafter designate by notice to Tenant.
Any notice sent by registered or certified mail, return receipt requested,
shall be deemed given on the date of delivery shown on the receipt card, or if
no delivery date is shown, the postmark thereon. Notices delivered by
recognized overnight courier shall be deemed given twenty-four (24) hours after
delivery of the same to the courier. If notice is received on a Saturday,
Sunday or legal holiday, it shall be deemed received on the next business day.
Service of any default notice or notice of commencement of unlawful detainer
proceedings shall be made to the party specified on the Basic Lease Information
sheet.
9.12. FORCE MAJEURE. Any prevention, delay or stoppage of work to be
performed by Landlord or Tenant which is due to strikes, labor disputes,
inability to obtain labor, materials, equipment or reasonable substitutes
therefor, acts of God, governmental restrictions or regulations or controls,
judicial orders, enemy or hostile government actions, civil commotion, or other
causes beyond the reasonable control of the party obligated to perform
hereunder, shall excuse performance of the work by that party for a period
equal to the duration of that prevention, delay or stoppage. Nothing in this
Section 9.12 shall excuse or delay Tenant's obligation to pay Rent or other
charges due under this Lease.
9.13. GUARANTOR. If there are to be any guarantors of this Lease, the
guarantee shall be on a form provided by Landlord and agreed to by Tenant, and
each such guarantor shall have the same obligations as Tenant under this Lease,
including, but not limited to, the obligation to provide the estoppel
certificate and information called for by Section 5.13. It shall constitute a
default of Tenant under this Lease if any such guarantor fails or refuses, upon
reasonable request by Landlord, to give: (a) evidence of the due execution of
the guarantee called for by this Lease, including the authority of the
guarantor (and of the party signing on guarantor's behalf) to obligate such
guarantor on said guarantee, and including, in the case of a corporate
guarantor, a certified copy of a resolution of the board of directors of
guarantor authorizing the making of
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<PAGE> 39
such guarantee, together with a certificate of incumbency showing the
signatures of the persons authorized to sign on its behalf; (b) current
financial statements of guarantor as may, from time to time, be requested by
Landlord unless guarantor is a publicly traded company; (c) an estoppel
certificate; or (d) written confirmation that the guarantee is still in effect.
9.14. SUCCESSORS AND ASSIGNS. This Lease shall be binding upon and inure
to the benefit of Landlord, its successors and assigns (subject to the
provisions hereof, including, without limitation, Section 5.15), and shall be
binding upon and inure to the benefit of Tenant, its successors, and to the
extent assignment or subletting, may be approved by Landlord hereunder,
Tenant's assigns or subtenants.
9.15. FURTHER ASSURANCES. Landlord and Tenant each agree to promptly sign
all documents reasonably requested to give effect to the provisions of this
Lease.
9.16. INCORPORATION OF PRIOR AGREEMENTS. This Lease, including the
exhibits and addenda attached to it, contains all agreements of Landlord and
Tenant with respect to any matter referred to herein. No prior agreement or
understanding pertaining to such matters shall be effective.
9.17. APPLICABLE LAW. This Lease shall be governed by, construed and
enforced in accordance with the laws of the State of California.
9.18. TIME OF THE ESSENCE. Time is of the essence of each and every
covenant of this Lease.
9.19. NO JOINT VENTURE. This Lease shall not be deemed or construed to
create or establish any relationship of partnership or joint venture or similar
relationship or arrangement between Landlord and Tenant hereunder.
9.20. AUTHORITY. If Tenant is a corporation, trust or general or limited
partnership, each individual executing this Lease on behalf of Tenant
represents and warrants that he or she is duly authorized to execute and
deliver this Lease on Tenant's behalf and that this Lease is binding upon
Tenant's behalf and that this Lease is binding upon Tenant in accordance with
its terms. If Tenant is a corporation, trust or partnership. Tenant shall,
within thirty (30) business days after request by Landlord, deliver to Landlord
evidence satisfactory to Landlord of such authority.
9.21. DECLARATION OF COVENANTS, CONDITIONS AND RESTRICTIONS. There are no
CC&Rs for the Project as of the date of this Lease. Tenant agrees to comply
with and be bound by all terms, conditions and provisions of any future CC&Rs
which affect the Project. Tenant further acknowledges and agrees that a default
by Tenant under any future CC&Rs shall constitute a default hereunder. All
obligations of Landlord hereunder shall be limited to the extent performance
of same is prohibited, restricted or limited under any future CC&Rs. Landlord
shall not enter into any CC&Rs which materially adversely affect Tenant without
Tenant's prior written approval which shall not be unreasonably withheld.
9.22 OFFER. Preparation of this Lease by Landlord's agent and submission
of same to Tenant shall not be deemed an offer to lease to Tenant. This Lease
is not intended to be binding and shall not be effective until fully executed
by both Landlord and Tenant.
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9.23. EXHIBITS; ADDENDA. The following Exhibits and addenda are attached
to, incorporated in and made a part of this Lease. EXHIBIT A Floor Plan of the
Leased Premises; EXHIBIT B Initial Improvement of the Leased Premises; EXHIBIT C
Confirmation of Term of Lease; EXHIBIT D Building Rules and Regulations; and
EXHIBIT E Estimated Budget.
IN WITNESS WHEREOF, the parties hereto have executed this Lease as of the
day and year first written above.
"LANDLORD":
BEP-EMERYVILLE, L.P.,
a Delaware limited partnership
By: EPI Investors 103 LLC.,
a California limited liability company
Its: General Partner
By: Ellis Partners, Inc.,
a California corporation
Its: Managing Member
By: /s/ James E. Ellis
---------------------------------------
Typed Name: James E. Ellis
-------------------------------
Title: Vice President
------------------------------------
"TENANT":
REEL.COM, INC.
a Delaware corporation
By: /s/ [signature illegible]
---------------------------------------
Typed Name: [name illegible]
-------------------------------
Title: President
------------------------------------
27
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EXHIBIT A
FLOOR PLAN
OF THE
LEASED PREMISES
1
<PAGE> 42
EXHIBIT A
[Floor Plan]
<PAGE> 43
EXHIBIT B
INITIAL IMPROVEMENT OF THE LEASED PREMISES
1. Tenant Improvements. Landlord shall construct and install the Tenant
Improvements in the Leased Premises, substantially in accordance with plans,
working drawings and specifications ("Tenant's Plans") prepared by Landlord's
architects. Tenant shall have the right to have the construction of the Tenant
Improvements competitively bid by a contractor selected by Tenant and, at
Tenant's discretion, may require Landlord to use such contractor selected by
Tenant. The costs of preparing Tenant's Plans and performing the Tenant
Improvements shall be allocated between, and paid by, Landlord and Tenant as
set forth in this EXHIBIT B.
2. Tenant's Plans.
As soon as reasonably possible Tenant and Landlord shall approve
Tenant's Plans. Tenant's Plan's shall comply with all applicable codes, laws,
ordinances, rules and regulations, shall not adversely affect the Building
shell or core or any systems, components or elements of the Building, shall be
in a form sufficient to secure the approval of all government authorities with
jurisdiction over the Building, and shall be otherwise satisfactory to Landlord
in Landlord's reasonable discretion. Tenant's Plans shall be complete plans,
working drawings and specifications for the layout, improvement and finish of
the Leased Premises consistent with the design and construction of the
Building, including mechanical and electrical drawings and decorating plans,
showing as many of the following as possible:
(a) Location and type of all partitions;
(b) Location and type of all doors, with hardware and keying schedule;
(c) Ceiling plans, including light fixtures;
(d) Location of telephone equipment room, with all special electrical
and cooling requirements;
(e) Location and type of all electrical outlets, switches, telephone
outlets, and lights;
(f) Location of all sprinklers;
(g) Location and type of all equipment requiring special electrical
requirements;
(h) Location, weight per square foot and description of any heavy
equipment or filing system exceeding fifty (50) pounds per square foot
live and dead load;
(i) Requirements for special air conditioning or ventilation;
(j) Type and color of floor covering;
(k) Location, type and color of wall covering;
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(l) Location, type and color of paint or finishes;
(m) Location and type of plumbing;
(n) Location and type of kitchen equipment;
(o) Indicate critical dimensions necessary for construction;
(p) Details showing all millwork with verified dimensions and
dimensions of all equipment to be built in, corridor entrances, bracing or
support of special walls or glass partitions, and any other items or
information requested by Landlord; and
(q) Location of all cabling.
3. Tenant's Plans shall be subject to Landlord's written approval (which
shall not be unreasonably withheld). If Landlord disapproves Tenant's Plans, or
any portion thereof, Landlord shall promptly give notice to Tenant setting forth
the reasons for disapproval. As promptly as reasonably possible thereafter, but
not later than five (5) business days after Landlord's notice, Tenant shall
submit to Landlord revised Tenant's Plans. Such revisions shall be subject to
Landlord's written approval within five (5) business days (which approval shall
not be unreasonably withheld). Landlord's review and approval of Tenant's Plans
shall not constitute, and Landlord shall not be deemed to have made, any
representation or warranty as to the compliance of the Tenant Improvements with
any laws or as to the suitability of the Leased Premises or the Tenant
Improvements for Tenant's needs.
4. Construction. Landlord, at its sole cost and expense and with no
deduction from Landlord's Contribution (as defined below), shall provide the
"warm shell" of the Leased Premises as further shown on EXHIBIT B-1, which shall
include the following: (i) windows, side walls and an entry door; (ii) the
restroom core; (iii) HVAC on the roof, but not distributed; (iv) insulation; (v)
line for plumbing, but not distributed; and (vi) main sprinkler lines, but not
distributed. Landlord shall complete the Tenant Improvements in the Leased
Premises substantially in accordance with Tenant's Plans and in a good and
workmanlike manner. Landlord shall be entitled to charge Tenant a ten percent
(10%) administration fee based on the total costs of the Tenant Improvements.
Such administration fee shall be deducted from Landlord's Contribution. Tenant
shall promptly pay when due the entire cost of all of the Tenant Improvements
(including the cost of all utilities, permits, fees, taxes, and property and
liability insurance in connection therewith) required by Tenant's Plans.
Landlord shall have no liability to Tenant if the Leased Premises is not
suitable for Tenant's occupancy or if Tenant has not obtained all the necessary
permits to occupy the Leased Premises by the Term Commencement Date.
5. Landlord's and Tenant's Contributions. (a) As Landlord's contribution
for the costs of Tenant Improvements (Landlord is to pay for Landlord's Work,
defined as either improvements constructed or paid for by Landlord), Landlord
shall give Tenant an allowance in the maximum amount of $25.00 per square foot
of Rentable Area, which equals $484,025.00 based upon 19,361 rentable square
feet ("Landlord's Contribution"). Landlord's Contribution may be used only for
direct hard and soft costs, including construction costs, architect fees, and
consultant fees. Any costs of preparing Tenant's Plans and constructing the
Tenant Improvements in excess of Landlord's Contribution shall be paid by Tenant
and shall constitute Tenant's Extra Improvements.
6. Changes. Except for minor and immaterial changes, if Tenant requests
any change in Tenant's Plans, Tenant shall request such change in a written
notice to Landlord. Each such request shall be accompanied by proper plans and
specifications prepared by Tenant, at Tenant's expense, necessary to show
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<PAGE> 45
and explain such change from the previously approved Tenant's Plans. All
changes in Tenant's Plans (except for minor and immaterial changes) shall be
subject to the prior written approval of Landlord which shall be given within
five (5) business days (which shall not be unreasonably withheld).
7. Other Work by Tenant. All work not within the scope of the normal
construction trades employed on the Building, such as the furnishing and
installing of furniture, telephone equipment, office equipment and wiring,
shall be furnished and installed by Tenant at Tenant's expense.
8. Requirements for Work Performed by Tenant. All work performed at the
Building or in the Project by Tenant or Tenant's contractor or subcontractors
shall be subject to the following additional requirements:
a. Such work shall not proceed until Landlord has approved in writing:
(i) Tenant's contractor, (ii) the amount and coverage of public liability
and property damage insurance, with Landlord named as an additional insured,
carried by Tenant's contractor, (iii) complete and detailed plans and
specifications for such work, and (iv) a schedule for work.
b. All work shall be done in conformity with a valid permit when
required, a copy of which shall be furnished to Landlord before such work is
commenced. In any case, all such work shall be performed in accordance with
all applicable laws. Notwithstanding any failure by Landlord to object to
any such work, Landlord shall have no responsibility for Tenant's failure to
comply with applicable laws.
c. Tenant or Tenant's contractor shall arrange for necessary utility,
hoisting and elevator service, on a nonexclusive basis, with Landlord.
Landlord shall have the right to require any necessary movement of materials
by the elevator to be done after regular working hours.
d. Tenant shall be responsible for cleaning the Leased Premises, the
Building and the Project and removing all debris in connection with the Tenant
Improvements and its other work. All completed work shall be subject to
inspection and acceptance by Landlord. Tenant shall reimburse Landlord for the
cost of third party supervision of construction of the Tenant Improvements
(which may be deducted by Landlord from Landlord's Contribution) upon demand
and for all extra expense incurred by Landlord by reason of faulty work done by
Tenant or Tenant's contractor or by reason of inadequate cleanup by Tenant or
Tenant's contractor. Landlord will provide Tenant with copies of third party
consultant invoices within five (5) business days of Tenant's request for such
invoices.
e. Tenant shall be responsible for the cost of separately metering
electrical utilities to the Leased Premises (or such cost may be paid and
deducted from Landlord's Contribution as part of Landlord's Improvements).
9. Tenant Delay. If the completion of the Tenant Improvements is delayed
(i) at the request of Tenant, (ii) by Tenant's failure to comply with the
foregoing provisions (including failure to pay any sums payable by Tenant
within the time periods specified herein), (iii) by changes in the Tenant's
Plans ordered by Tenant or by extra work ordered by Tenant, (iv) because Tenant
chooses to have additional work performed by Landlord, or (v) because of any
other act or omission of Tenant (collectively, "Tenant Delay"), then Tenant
shall be responsible for all costs and any expenses occasioned by such Tenant
Delay including, without limitation, any costs and expenses attributable to
increases in labor or materials; and, if such delay actually delays the Term
Commencement Date, then tenant shall pay Lessor the Base Rent for the entire
period of such delay.
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<PAGE> 46
EXHIBIT C
CONFIRMATION OF TERM OF LEASE
This Confirmation of Term of Lease is made by and between BEP-EMERYVILLE,
L.P., a Delaware limited partnership, as Landlord, and ______________________,
a _____________________, as Tenant, who agree as follows:
1. Landlord and Tenant entered into a Lease dated _____________, 19___
(the "Lease"), in which Landlord leased to Tenant and Tenant leased from
Landlord the Leased Premises described in the Basic Lease Information sheet of
the Lease (the "Leased Premises").
2. Pursuant to Section 3.01 of the Lease, Landlord and Tenant agree to
confirm the commencement date and expiration date of the Term of the Lease as
follows:
a. ______________________, 19___, is the Term Commencement Date;
b. ______________________, 19___, is the Term Expiration Date;
c. ______________________, 19___, is the commencement date of Rent
under the Lease.
3. Tenant hereby confirms that the Lease is in full force and effect and:
a. It has accepted possession of the Leased Premises as provided in
the Lease;
b. The improvements and space required to be furnished by Landlord
under the Lease have been furnished;
c. Landlord has fulfilled all its duties of an inducement nature;
d. The Lease has not been modified, altered or amended, except as
follows:______________________________________________________
___________; and
e. There are no setoffs or credits against Rent and no security
deposit has been paid except as expressly provided by the Lease.
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4. The provisions of this Confirmation of Term of Lease shall inure to
the benefit of, or bind, as the case may require, the parties and their
respective successors, subject to the restrictions on assignment and subleasing
contained in the Lease.
DATED: ____________________, 19__
"LANDLORD": "TENANT":
BEP-EMERYVILLE, L.P., ------------------------------
a Delaware limited partnership a
-----------------------------
By: EPI Investors 103 LLC, By:
a California limited liability company ---------------------------
Its: General Partner Name:
-------------------------
By: Ellis Partners, Inc., Title:
a California corporation ------------------------
Its: Managing Member
By:
----------------------------
Typed Name:
--------------------
Title:
-------------------------
By:
----------------------------
Typed Name:
--------------------
Title:
-------------------------
2
<PAGE> 48
EXHIBIT D
BUILDING RULES AND REGULATIONS
1. The sidewalks, doorways, halls, stairways, vestibules and other
similar areas shall not be obstructed by Tenant or used by it for any purpose
other than ingress to and egress from the Leased Premises, and for going from
one part of the Building to another part. Corridor doors, when not in use,
shall be kept closed. Before leaving the Building, Tenant shall ensure that all
doors to the Leased Premises are securely locked and all water faucets and
electricity are shut off.
2. Plumbing fixtures shall be used only for their designated purpose,
and no foreign substances of any kind shall be deposited therein. Damage to any
such fixtures resulting from misuse by Tenant or any employee or invitee of
Tenant shall be repaired at the expense of Tenant.
3. Nails, screws and other attachments to the Building require prior
written consent from Landlord, except for the routine hanging of pictures and
diplomas or certifications. Tenant shall not mar or deface the Leased Premises
in any way. Tenant shall not place anything on or near the glass of any window,
door or wall which may appear unsightly from outside the Leased Premises.
4. All contractors and technicians rendering any installation service to
Tenant shall be subject to Landlord's approval and supervision prior to
performing services. This applies to all work performed in the Building,
including, but not limited to, installation of telephones, telegraph equipment,
wiring of any kind, and electrical devices, as well as all installations
affecting floors, walls, woodwork, windows, ceilings and any other physical
portions of the Building.
5. Movement in or out of the Building of furniture, office equipment,
safes or other bulky material which requires the use of elevators, stairways,
or the Building entrance and lobby shall be restricted to hours established by
Landlord. All such movement shall be under Landlord's supervision, and the use
of an elevator for such movements shall be restricted to the Building's
freight elevator. Arrangements shall be made at least 24 hours in advance with
Landlord regarding the time, method, and routing of such movements. Tenant
shall pay for the services of the employees of the elevator service company
employed when safes and other heavy articles are moved into or from the
Building, and Tenant shall assume all risks of damage and pay the cost of
repairing or providing compensation for damage to the Building, to articles
moved and injury to persons or property resulting from such moves. Landlord
shall not be liable for any acts or damages resulting from any such activity.
6. Landlord shall have the right to limit the weight and size of, and to
designate the location of, all safes and other heavy property brought into the
Building.
7. Tenant shall cooperate with the Landlord in maintaining the Leased
Premises. Tenant shall not employ any person for the purpose of cleaning the
Leased Premises other than the Building's cleaning and maintenance personnel.
Window cleaning shall be done only by Landlord's agents at such times and
during such hours as Landlord shall elect. Janitorial services will not be
furnished on nights when rooms are occupied after 7:00 P.M.
8. Deliveries of water, soft drinks, newspapers or other such items to
the Leased Premises shall be restricted to hours established by Landlord and
made by use of the freight elevator if Landlord so directs.
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9. Nothing shall be swept or thrown into the corridors, halls, elevator
shafts or stairways. No birds, fish or animals of any kind shall be brought
into or kept in, on or about the Leased Premises, with the exception of guide
dogs where necessary.
10. No cooking shall be done in the Leased Premises except in connection
with a convenience lunch room for the sole use of employees and guests (on a
non-commercial basis) in a manner which complies with all of the provisions of
the Lease and which does not produce fumes or odors.
11. Food, soft drink or other vending machines shall not be placed within
the Leased Premises without Landlord's prior written consent.
12. Tenant shall not install or operate on the Leased Premises any
electric heater, stove or similar equipment without Landlord's prior written
consent. Tenant shall not use or keep on the Leased Premises any kerosene,
gasoline, or inflammable or combustible fluid or material other than limited
quantities reasonably necessary for the operation and maintenance of office
equipment utilized at the Leased Premises. No explosives shall be brought onto
the Project at any time.
13. Tenant shall not waste electricity, water or air conditioning and
agrees to cooperate fully with Landlord to assure the most effective operation
of the Building's heating and air conditioning and to comply with any
governmental energy-saving rules, laws or regulations of which Tenant has
actual notice. Tenant shall not tamper with or attempt to adjust temperature
control thermostats in the Leased Premises; Landlord shall make reasonable
adjustments in thermostats upon request from Tenant.
14. The Building air-conditioning system is designed for operation only
with all outside Building windows closed; accordingly, Tenant shall not open or
allow any outside window to be opened at any time.
15. Tenant, its employees, agents and invitees shall each comply with all
requirements necessary for the security of the Leased Premises, including, if
implemented by Landlord, the use of service passes issued by Landlord for
after-hours movement of office equipment/packages, and the signing of a
security register in the Building lobby after hours. Landlord reserves the
right to refuse entry to the Building after normal business hours to Tenant,
its employees, agents or invitees, or any other person without satisfactory
identification showing his or her right of access to the Building at such time.
Landlord shall not be liable for any damages resulting from any error in regard
to any such identification or from such admission to or exclusion from the
Building. Landlord shall not be liable to Tenant for losses due to theft or
burglary, or for damage by unauthorized persons in, on or about the Project,
and Tenant assumes full responsibility for protecting the Leased Premises from
theft, robbery and pilferage, which includes keeping doors locked and
other means of entry closed.
16. Landlord will furnish Tenant with a reasonable number of initial keys
for entrance doors into the Leased Premises, and may charge Tenant for
additional keys thereafter. All such keys shall remain the property of
Landlord. No additional locks are allowed on any door of the Leased Premises
without Landlord's prior written consent and Tenant shall not make any
duplicate keys. Upon termination of this Lease, Tenant shall surrender to
Landlord all keys to the Leased Premises, and give to Landlord the combination
of all locks for safes and vault doors, if any, in the Leased Premises.
17. Tenant shall not bring into (or permit to be brought into) the
Building any bicycle or other type of vehicle.
18. Landlord retains the right at any time, without liability to Tenant,
to change the name and street address of the Building, except as otherwise
expressly provided in the Lease with respect to signage.
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19. Canvassing, peddling, soliciting, and distribution of handbills in or
at the Project are prohibited and Tenant will cooperate to prevent these
activities.
20. The Building hours of operation are 7:00 A.M. to 6:00 P.M., Monday
through Friday, excluding holidays. Landlord reserves the right to close and
keep locked all entrance and exit doors of the Building on Saturdays, Sundays
and legal holidays, and between the hours of 6:00 P.M. of any day and 7:00 A.M.
of the following day, and during such other hours as Landlord may deem
advisable for the protection of the Building and the tenants thereof.
21. The requirements of Tenant will be attended to only upon application
to the Project manager. Employees will not perform any work or do anything
outside of their regular duties unless under specific instruction from the
Project manager.
22. Tenant shall cooperate fully with the life safety program of the
Building as established and administered by Landlord. This shall include
participation by Tenant and its employees in exit drills, fire inspections,
life safety orientations and other programs relating to fire and life safety
that may be established by Landlord.
23. No smoking shall be permitted in the Building.
24. Landlord reserves the right to rescind any of these rules and
regulations and to make future rules and regulations required for the safety,
protection and maintenance of the Project, the operation and preservation of
the good order thereof, and the protection and comfort of the tenants and their
employees and visitors. Such rules and regulations, when made and written
notice thereof given to Tenant, shall be binding as if originally included
herein. Landlord shall not be responsible to Tenant for the non-observance or
violation of these rules and regulations by any other tenant of the Building.
Landlord reserves the right to exclude or expel from the Project any person
who, in Landlord's judgment, is under the influence of liquor or drugs, or who
shall in any manner do any act in violation of any of these rules and
regulations.
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<PAGE> 51
EXHIBIT E
ESTIMATED BUDGET
1
<PAGE> 52
EXHIBIT E
EmeryTech
1989 Estimated Operating Expense Budget
(Based on 147,000 Rentable Square Feet)
<TABLE>
<CAPTION>
psf-yr Total
------ -----
<S> <C> <C>
Taxes $1.47 $216,090.00
Insurance $0.14 $ 20,580.00
Tenant Utilities $1.72 $252,840.00
Tenant Janitorial Service $0.78 $111,850.00
Common Area Maintenance
Repairs - Maintenance $0.10 $ 14,700.00
Landscape Maintenance $0.14 $ 20,580.00
Utilities $0.04 $ 5,880.00
Garage O & M $0.54 $ 79,380.00
Trash Removal $0.10 $ 14,700.00
Janitorial $0.09 $ 13,671.00
Elevator Maintenance $0.05 $ 7,350.00
Security $0.10 $ 14,700.00
General $0.20 $ 29,400.00
Management Fee (3%) $0.72 $105,840.00
Total Yearly Costs $6.19 $910,371.00
Total Monthly Cost $0.52 $ 75,854.25
</TABLE>
Lessor: BEP-EMERYVILLE, L.P.
By: __________________________
Date: __________________________
<PAGE> 1
EXHIBIT 10.7
REEL.COM, INC.
INDEMNIFICATION AGREEMENT
THIS AGREEMENT is made and entered into this _______ day of
__________, 1999 by and between Reel.com, Inc., a Delaware corporation (the
"Company"), and __________ ("Indemnitee").
RECITALS:
A. The Company and Indemnitee recognize the continued difficulty
in obtaining liability insurance for corporate directors, officers, employees,
controlling persons, agents and fiduciaries, the significant increases in the
cost of such insurance and the general reductions in the coverage of such
insurance.
B. The Company and Indemnitee further recognize the substantial
increase in corporate litigation in general, subjecting directors, officers,
employees, controlling persons, agents and fiduciaries to expensive litigation
risks at the same time as the availability and coverage of liability insurance
has been severely limited.
C. The stockholders of the Company have adopted Bylaws (the
"Bylaws") providing for the indemnification of the officers, directors, agents
and employees of the Company to the maximum extent authorized by Section 145 of
the Delaware Corporations Code, as amended ("Code").
D. Indemnitee does not regard the current protection available
for the Company's directors, officers, employees, controlling persons, agents
and fiduciaries as adequate under the present circumstances, and Indemnitee and
other directors, officers, employees, controlling persons, agents and
fiduciaries of the Company may not be willing to serve or continue to serve in
such capacities without additional protection.
E. The Bylaws and the Code, by their non-exclusive nature, permit
contracts between the Company and the members of its Board of Directors with
respect to indemnification of such directors.
F. The Company (i) desires to attract and retain the involvement
of highly qualified individuals, such as Indemnitee, to serve the Company and,
in part, in order to induce Indemnitee to be involved with the Company and (ii)
wishes to provide for the indemnification and advancing of expenses to
Indemnitee to the maximum extent permitted by law.
G. In view of the considerations set forth above, the Company
desires that Indemnitee be indemnified by the Company as set forth herein.
<PAGE> 2
NOW, THEREFORE, the Company and Indemnitee hereby agree as
follows:
1. Indemnification of Indemnitee.
The Company hereby agrees to indemnify Indemnitee to the fullest
extent permitted by law, even if such indemnification is not specifically
authorized by the other provisions of this Agreement, the Company's Certificate
of Incorporation (the "Certificate"), the Company's Bylaws or by statute. In the
event of any change after the date of this Agreement in any applicable law,
statute or rule which expands the right of a Delaware corporation to indemnify a
member of its Board of Directors or an officer, employee, controlling person,
agent or fiduciary, it is the intent of the parties hereto that Indemnitee shall
enjoy by this Agreement the greater benefits afforded by such change. In the
event of any change in any applicable law, statute or rule which narrows the
right of a Delaware corporation to indemnify a member of its Board of Directors
or an officer, employee, agent or fiduciary, such change, to the extent not
otherwise required by such law, statute or rule to be applied to this Agreement,
shall have no effect on this Agreement or the parties' rights and obligations
hereunder except as set forth in Section 10(a) hereof.
2. Additional Indemnity. The Company hereby agrees to hold
harmless and indemnify the Indemnitee:
a. against any and all expenses incurred by Indemnitee, as
set forth in Section 3(a) below; and
b. otherwise to the fullest extent not prohibited by the
Certificate, the Bylaws or the Code.
3. Indemnification Rights.
a. Indemnification of Expenses. The Company shall
indemnify and hold harmless Indemnitee, together with Indemnitee's partners,
affiliates, employees, agents and spouse and each person who controls any of
them or who may be liable within the meaning of Section 15 of the Securities Act
of 1933, as amended (the "Securities Act"), or Section 20 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), to the fullest extent
permitted by law if Indemnitee was or is or becomes a party to or witness or
other participant in, or is threatened to be made a party to or witness or other
participant in, any threatened, pending or completed action, suit, proceeding or
alternative dispute resolution mechanism, or any hearing, inquiry or
investigation that Indemnitee and the Company believe might lead to the
institution of any such action, suit, proceeding or alternative dispute
resolution mechanism, whether civil, criminal, administrative, investigative or
other (hereinafter a "Claim") against any and all expenses (including attorneys'
fees and all other costs, expenses and obligations incurred in connection with
investigating, defending, being a witness in or participating in (including on
appeal), or preparing to defend, be a witness in or participate in, any such
action, suit, proceeding, alternative dispute resolution mechanism, hearing,
inquiry or investigation, judgments, fines, penalties and amounts paid in
settlement (if such settlement is approved in advance by the Company, which
approval shall not be unreasonably withheld) of such Claim and any federal,
state, local or foreign taxes imposed on Indemnitee as a result of the actual or
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<PAGE> 3
deemed receipt of any payments under this Agreement (collectively, hereinafter
"Expenses"), including all interest, assessments and other charges paid or
payable in connection with or in respect of such Expenses, incurred by
Indemnitee by reason of (or arising in part out of) any event or occurrence
related to the fact that Indemnitee is or was a director, officer, employee,
controlling person, agent or fiduciary of the Company, or any subsidiary of the
Company, or is or was serving at the request of the Company as a director,
officer, employee, controlling person, agent or fiduciary of another
corporation, partnership, joint venture, trust or other enterprise, or by reason
of any action or inaction on the part of Indemnitee while serving in such
capacity including, without limitation, any and all losses, claims, damages,
expenses and liabilities, joint or several (including any investigation, legal
and other expenses incurred in connection with, and any amount paid in
settlement of, any action, suit, proceeding or any claim asserted) under the
Securities Act, the Exchange Act or other federal or state statutory law or
regulation, at common law or otherwise, which relate directly or indirectly to
the registration, purchase, sale or ownership of any securities of the Company
or to any fiduciary obligation owed with respect thereto (hereinafter an
"Indemnification Event"). Such payment of Expenses shall be made by the Company
as soon as practicable but in any event no later than twenty-five (25) days
after written demand by Indemnitee therefor is presented to the Company.
b. Reviewing Party. Notwithstanding the foregoing, (i) the
obligations of the Company under Section 2 shall be subject to the condition
that the Reviewing Party (as described in Section 12(e) hereof) shall not have
determined (in a written opinion, in any case in which the Independent Legal
Counsel referred to in Section 3(c) hereof is involved) that Indemnitee would
not be permitted to be indemnified under applicable law, and (ii) and Indemnitee
acknowledges and agrees that the obligation of the Company to make an advance
payment of Expenses to Indemnitee pursuant to Section 4(a) (an "Expense
Advance") shall be subject to the condition that, if, when and to the extent
that the Reviewing Party determines that Indemnitee would not be permitted to be
so indemnified under applicable law, the Company shall be entitled to be
reimbursed by Indemnitee (who hereby agrees to reimburse the Company) for all
such amounts theretofore paid; provided, however, that if Indemnitee has
commenced or thereafter commences legal proceedings in a court of competent
jurisdiction to secure a determination that Indemnitee should be indemnified
under applicable law, any determination made by the Reviewing Party that
Indemnitee would not be permitted to be indemnified under applicable law shall
not be binding and Indemnitee shall not be required to reimburse the Company for
any Expense Advance until a final judicial determination is made with respect
thereto (as to which all rights of appeal therefrom have been exhausted or
lapsed). Indemnitee's obligation to reimburse the Company for any Expense
Advance shall be unsecured and no interest shall be charged thereon. If there
has not been a Change in Control (as defined in Section 12(c) hereof), the
Reviewing Party shall be selected by the Board of Directors, and if there has
been such a Change in Control (other than a Change in Control which has been
approved by a majority of the Company's Board of Directors who were directors
immediately prior to such Change in Control), the Reviewing Party shall be the
Independent Legal Counsel referred to in Section 3(e) hereof. If there has been
no determination by the Reviewing Party or if the Reviewing Party determines
that Indemnitee substantively would not be permitted to be indemnified in whole
or in part under applicable law, Indemnitee shall have the right to commence
litigation seeking an initial determination by the court or challenging any such
determination by the Reviewing Party or any aspect thereof, including the legal
or factual bases therefor, and the Company hereby consents to service of process
and to appear in any such
3
<PAGE> 4
proceeding. Any determination by the Reviewing Party otherwise shall be
conclusive and binding on the Company and Indemnitee.
c. Contribution. If the indemnification provided for in
Section 3(a) above for any reason is held by a court of competent jurisdiction
to be unavailable to an Indemnitee in respect of any losses, claims, damages,
expenses or liabilities referred to therein, then the Company, in lieu of
indemnifying Indemnitee thereunder, shall contribute to the amount paid or
payable by Indemnitee as a result of such losses, claims, damages, expenses or
liabilities (i) in such proportion as is appropriate to reflect the relative
benefits received by the Company and Indemnitee, or (ii) if the allocation
provided by clause (i) above is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (i) above but also the relative fault of the Company and Indemnitee
in connection with the action or inaction which resulted in such losses, claims,
damages, expenses or liabilities, as well as any other relevant equitable
considerations. In connection with the registration of the Company's securities,
the relative benefits received by the Company and Indemnitee shall be deemed to
be in the same respective proportions that the net proceeds from the offering
(before deducting expenses) received by the Company and the Indemnitee, in each
case as set forth in the table on the cover page of the applicable prospectus,
bear to the aggregate public offering price of the securities so offered. The
relative fault of the Company and Indemnitee shall be determined by reference
to, among other things, whether the untrue or alleged untrue statement of a
material fact or the omission or alleged omission to state a material fact
relates to information supplied by the Company or Indemnitee and the parties'
relative intent, knowledge, access to information and opportunity to correct or
prevent such statement or omission.
The Company and Indemnitee agree that it would not be just and
equitable if contribution pursuant to this Section 3(c) were determined by pro
rata or per capita allocation or by any other method of allocation which does
not take account of the equitable considerations referred to in the immediately
preceding paragraph. In connection with the registration of the Company's
securities, in no event shall an Indemnitee be required to contribute any amount
under this Section 3(c) in excess of the lesser of (i) that proportion of the
total of such losses, claims, damages or liabilities indemnified against equal
to the proportion of the total securities sold under such registration statement
which is being sold by Indemnitee or (ii) the proceeds received by Indemnitee
from its sale of securities under such registration statement. No person found
guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of
the Securities Act) shall be entitled to contribution from any person who was
not found guilty of such fraudulent misrepresentation.
d. Survival Regardless of Investigation. The
indemnification and contribution provided for herein will remain in full force
and effect regardless of any investigation made by or on behalf of Indemnitee or
any officer, director, employee, agent or controlling person of Indemnitee.
e. Change in Control. After the date hereof, the Company
agrees that if there is a Change in Control of the Company (other than a Change
in Control which has been approved by a majority of the Company's Board of
Directors who were directors immediately prior to such Change in Control) then,
with respect to all matters thereafter arising concerning
4
<PAGE> 5
the rights of Indemnitee to payments of Expenses under this Agreement or any
other agreement or under the Company's Certificate or Bylaws as now or hereafter
in effect, Independent Legal Counsel (as defined in Section 12(d) hereof) shall
be selected by Indemnitee and approved by the Company (which approval shall not
be unreasonably withheld). Such counsel, among other things, shall render its
written opinion to the Company and Indemnitee as to whether and to what extent
Indemnitee would be permitted to be indemnified under applicable law. The
Company agrees to abide by such opinion and to pay the reasonable fees of the
Independent Legal Counsel referred to above and to fully indemnify such counsel
against any and all reasonable expenses (including attorneys' fees), claims,
liabilities and damages arising out of or relating to this Agreement or its
engagement pursuant hereto.
f. Mandatory Payment of Expenses. Notwithstanding any
other provision of this Agreement, to the extent that Indemnitee has been
successful on the merits or otherwise, including, without limitation, the
dismissal of an action without prejudice, in the defense of any action, suit,
proceeding, inquiry or investigation referred to in Section 3(a) hereof or in
the defense of any claim, issue or matter therein, Indemnitee shall be
indemnified against all Expenses incurred by Indemnitee in connection herewith.
4. Expenses; Indemnification Procedure.
a. Advancement of Expenses. The Company shall advance all
Expenses incurred by Indemnitee. The advances to be made hereunder shall be paid
by the Company to Indemnitee as soon as practicable but in any event no later
than ten (10) days after written demand by Indemnitee therefor to the Company.
b. Notice/Cooperation by Indemnitee. Indemnitee shall give
the Company notice in writing as soon as practicable of any Claim made against
Indemnitee for which indemnification will or could be sought under this
Agreement. Notice to the Company shall be directed to the Chief Executive
Officer of the Company at the address shown on the signature page of this
Agreement (or such other address as the Company shall designate in writing to
Indemnitee).
c. No Presumptions; Burden of Proof. For purposes of this
Agreement, the termination of any Claim by judgment, order, settlement (whether
with or without court approval) or conviction, or upon a plea of nolo
contendere, or its equivalent, shall not create a presumption that Indemnitee
did not meet any particular standard of conduct or have any particular belief or
that a court has determined that indemnification is not permitted by applicable
law. In addition, neither the failure of the Reviewing Party to have made a
determination as to whether Indemnitee has met any particular standard of
conduct or had any particular belief, nor an actual determination by the
Reviewing Party that Indemnitee has not met such standard of conduct or did not
have such belief, prior to the commencement of legal proceedings by Indemnitee
to secure a judicial determination that Indemnitee should be indemnified under
applicable law, shall be a defense to Indemnitee's claim or create a presumption
that Indemnitee has not met any particular standard of conduct or did not have
any particular belief. In connection with any determination by the Reviewing
Party or otherwise as to whether Indemnitee is entitled to be indemnified
hereunder, the burden of proof shall be on the Company to establish that
Indemnitee is not so entitled.
5
<PAGE> 6
d. Notice to Insurers. If, at the time of the receipt by
the Company of a notice of a Claim pursuant to Section 4(b) hereof, the Company
has liability insurance in effect which may cover such Claim, the Company shall
give prompt notice of the commencement of such Claim to the insurers in
accordance with the procedures set forth in each of the policies. The Company
shall thereafter take all necessary or desirable action to cause such insurers
to pay, on behalf of Indemnitee, all amounts payable as a result of such action,
suit, proceeding, inquiry or investigation in accordance with the terms of such
policies.
e. Selection of Counsel. In the event the Company shall be
obligated hereunder to pay the Expenses of any Claim, the Company shall be
entitled to assume the defense of such Claim, with counsel approved by the
Indemnitee, which approval shall not be unreasonably withheld, upon the delivery
to Indemnitee of written notice of its election to do so. After delivery of such
notice, approval of such counsel by Indemnitee and the retention of such counsel
by the Company, the Company will not be liable to Indemnitee under this
Agreement for any fees of counsel subsequently incurred by Indemnitee with
respect to the same Claim; provided that, (i) Indemnitee shall have the right to
employ Indemnitee's counsel in any such Claim at Indemnitee's expense and (ii)
if (A) the employment of counsel by Indemnitee has been previously authorized by
the Company, (B) Indemnitee shall have reasonably concluded that there is a
conflict of interest between the Company and Indemnitee in the conduct of any
such defense, or (C) the Company shall not continue to retain such counsel to
defend such Claim, then the fees and expenses of Indemnitee's counsel shall be
at the expense of the Company.
5. Nonexclusivity.
The indemnification provided by this Agreement shall be in
addition to any rights to which Indemnitee may be entitled under the Company's
Certificate, its Bylaws, any agreement, any vote of stockholders or
disinterested directors, the General Corporation Law of the State of Delaware,
or otherwise. The indemnification provided under this Agreement shall continue
as to Indemnitee for any action Indemnitee took or did not take while serving in
an indemnified capacity even though Indemnitee may have ceased to serve in such
capacity.
6. No Duplication of Payments.
The Company shall not be liable under this Agreement to make any
payment in connection with any Claim made against any Indemnitee to the extent
Indemnitee has otherwise actually received payment (under any insurance policy,
Certificate of Incorporation, Bylaw or otherwise) of the amounts otherwise
indemnifiable hereunder.
7. Partial Indemnification.
If any Indemnitee is entitled under any provision of this
Agreement to indemnification by the Company for any portion of Expenses incurred
in connection with any Claim, but not, however, for all of the total amount
thereof, the Company shall nevertheless indemnify Indemnitee for the portion of
such Expenses to which Indemnitee is entitled.
6
<PAGE> 7
8. Mutual Acknowledgement.
The Company and Indemnitee acknowledge that in certain instances,
Federal law or applicable public policy may prohibit the Company from
indemnifying its directors, officers, employees, controlling persons, agents or
fiduciaries under this Agreement or otherwise. Each Indemnitee understands and
acknowledges that the Company has undertaken or may be required in the future to
undertake with the Securities and Exchange Commission to submit the question of
indemnification to a court in certain circumstances for a determination of the
Company's rights under public policy to indemnify Indemnitee.
9. Liability Insurance.
To the extent the Company maintains liability insurance
applicable to directors, officers, employees, control persons, agents or
fiduciaries, each such Indemnitee shall be covered by such policies in such a
manner as to provide Indemnitee the same rights and benefits as are accorded to
the most favorably insured of the Company's directors, if Indemnitee is a
director, or of the Company's officers, if Indemnitee is not a director of the
Company but is an officer; or of the Company's key employees, controlling
persons, agents or fiduciaries, if Indemnitee is not an officer or director but
is a key employee, agent, control person, or fiduciary.
10. Exceptions.
Any other provision herein to the contrary notwithstanding, the
Company shall not be obligated pursuant to the terms of this Agreement:
a. Claims Initiated by Indemnitee. To indemnify or advance
expenses to any Indemnitee with respect to Claims initiated or brought
voluntarily by Indemnitee and not by way of defense, except (i) with respect to
actions or proceedings to establish or enforce a right to indemnify under this
Agreement or any other agreement or insurance policy or under the Company's
Certificate of Incorporation or Bylaws now or hereafter in effect relating to
Claims for Indemnifiable Events, (ii) in specific cases if the Board of
Directors has approved the initiation or bringing of such Claim, or (iii) as
otherwise required under Section 145 of the Delaware General Corporation Law,
regardless of whether Indemnitee ultimately is determined to be entitled to such
indemnification, advance expense payment or insurance recovery, as the case may
be; or
b. Claims Under Section 16(b). To indemnify any Indemnitee
for expenses and the payment of profits arising from the purchase and sale by
Indemnitee of securities in violation of Section 16(b) of the Exchange Act or
any similar successor statute; or
c. Claims Excluded Under Section 145 of the Delaware
General Corporation Law. To indemnify any Indemnitee if (i) he did not act in
good faith or in a manner reasonably believed by such Indemnitee to be in or not
opposed to the best interests of the Company, or (ii) with respect to any
criminal action or proceeding, Indemnitee had reasonable cause to believe his
conduct was unlawful, or (iii) Indemnitee shall have been adjudged to be liable
to the Company unless and only to the extent the court in which such action was
brought shall permit indemnification as provided in Section 145(b) of the
Delaware General Corporation Law.
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<PAGE> 8
11. Period of Limitations.
No legal action shall be brought and no cause of action shall be
asserted by or in the right of the Company against any Indemnitee, any
Indemnitee's estate, spouse, heirs, executors or personal or legal
representatives after the expiration of five years from the date of accrual of
such cause of action, and any claim or cause of action of the Company shall be
extinguished and deemed released unless asserted by the timely filing of a legal
action within such five-year period; provided, however, that if any shorter
period of limitations is otherwise applicable to any such cause of action, such
shorter period shall govern.
12. Construction of Certain Phrases.
a. For purposes of this Agreement, references to the
"Company" shall include, in addition to the resulting corporation, any
constituent corporation (including any constituent of a constituent) absorbed in
a consolidation or merger which, if its separate existence had continued, would
have had power and authority to indemnify its directors, officers, employees,
agents or fiduciaries, so that if Indemnitee is or was a director, officer,
employee, agent, control person, or fiduciary of such constituent corporation,
or is or was serving at the request of such constituent corporation as a
director, officer, employee, control person, agent or fiduciary of another
corporation, partnership, joint venture, employee benefit plan, trust or other
enterprise, Indemnitee shall stand in the same position under the provisions of
this Agreement with respect to the resulting or surviving corporation as
Indemnitee would have with respect to such constituent corporation if its
separate existence had continued.
b. For purposes of this Agreement, references to "other
enterprises" shall include employee benefit plans; references to "fines" shall
include any excise taxes assessed on any Indemnitee with respect to an employee
benefit plan; and references to "serving at the request of the Company" shall
include any service as a director, officer, employee, agent or fiduciary of the
Company which imposes duties on, or involves services by, such director,
officer, employee, agent or fiduciary with respect to an employee benefit plan,
its participants or its beneficiaries; and if any Indemnitee acted in good faith
and in a manner Indemnitee reasonably believed to be in the interests of the
participants and beneficiaries of an employee benefit plan, Indemnitee shall be
deemed to have acted in a manner "not opposed to the best interests of the
Company" as referred to in this Agreement.
c. For purposes of this Agreement a "Change in Control"
shall be deemed to have occurred if (i) any "person" (as such term is used in
Sections 13(d)(3) and 14(d)(2) of the Exchange Act), other than a trustee or
other fiduciary holding securities under an employee benefit plan of the Company
or a corporation owned directly or indirectly by the stockholders of the Company
in substantially the same proportions as their ownership of stock of the
Company, (A) who is or becomes the beneficial owner, directly or indirectly, of
securities of the Company representing 10% or more of the combined voting power
of the Company's then outstanding Voting Securities, increases his beneficial
ownership of such securities by 5% or more over the percentage so owned by such
person, or (B) becomes the "beneficial owner" (as defined in Rule 13d-3 under
said Exchange Act), directly or indirectly, of securities of the Company
representing more than 20% of the total voting power represented by the
Company's then outstanding Voting Securities, (ii) during any period of two
consecutive years, individuals
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<PAGE> 9
who at the beginning of such period constitute the Board of Directors of the
Company and any new director whose election by the Board of Directors or
nomination for election by the Company's stockholders was approved by a vote of
at least two-thirds of the directors then still in office who either were
directors at the beginning of the period or whose election or nomination for
election was previously so approved, cease for any reason to constitute a
majority thereof, or (iii) the stockholders of the Company approve a merger or
consolidation of the Company with any other corporation other than a merger or
consolidation which would result in the Voting Securities of the Company
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into Voting Securities of the
surviving entity) at least 80% of the total voting power represented by the
Voting Securities of the Company or such surviving entity outstanding
immediately after such merger or consolidation, or the stockholders of the
Company approve a plan of complete liquidation of the Company or an agreement
for the sale or disposition by the Company of (in one transaction or a series of
transactions) all or substantially all of the Company's assets.
d. For purposes of this Agreement, "Independent Legal
Counsel" shall mean an attorney or firm of attorneys, selected in accordance
with the provisions of Section 3(d) hereof, who shall not have otherwise
performed services for the Company or any Indemnitee within the last three years
(other than with respect to matters concerning the right of any Indemnitee under
this Agreement, or of other indemnitees under similar indemnity agreements).
e. For purposes of this Agreement, a "Reviewing Party"
shall mean any appropriate person or body consisting of a member or members of
the Company's Board of Directors or any other person or body appointed by the
Board of Directors who is not a party to the particular Claim for which
Indemnitee are seeking indemnification, or Independent Legal Counsel.
f. For purposes of this Agreement, "Voting Securities"
shall mean any securities of the Company that vote generally in the election of
directors.
13. Counterparts.
This Agreement may be executed in one or more counterparts, each
of which shall constitute an original.
14. Binding Effect; Successors and Assigns.
This Agreement shall be binding upon and inure to the benefit of
and be enforceable by the parties hereto and their respective successors,
assigns, including any direct or indirect successor by purchase, merger,
consolidation or otherwise to all or substantially all of the business and/or
assets of the Company, spouses, heirs, and personal and legal representatives.
The Company shall require and cause any successor (whether direct or indirect by
purchase, merger, consolidation or otherwise) to all, substantially all, or a
substantial part, of the business and/or assets of the Company, by written
agreement in form and substance satisfactory to Indemnitee, expressly to assume
and agree to perform this Agreement in the same manner and to the same extent
that the Company would be required to perform if no such succession had taken
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<PAGE> 10
place. This Agreement shall continue in effect with respect to Claims relating
to Indemnifiable Events regardless of whether any Indemnitee continues to serve
as a director, officer, employee, agent, controlling person, or fiduciary of the
Company or of any other enterprise, including subsidiaries of the Company, at
the Company's request.
15. Attorneys' Fees. In the event that any action is instituted
by an Indemnitee under this Agreement or under any liability insurance policies
maintained by the Company to enforce or interpret any of the terms hereof or
thereof, any Indemnitee shall be entitled to be paid all Expenses incurred by
Indemnitee with respect to such action if Indemnitee is ultimately successful in
such action, and shall be entitled to the advancement of Expenses with respect
to such action, unless, as a part of such action, a court of competent
jurisdiction over such action determines that the material assertions made by
Indemnitee as a basis for such action were not made in good faith or were
frivolous. In the event of an action instituted by or in the name of the Company
under this Agreement to enforce or interpret any of the terms of this Agreement,
Indemnitee shall be entitled to be paid all Expenses incurred by Indemnitee in
defense of such action (including costs and expenses incurred with respect to
Indemnitee counterclaims and cross-claims made in such action), and shall be
entitled to the advancement of Expenses with respect to such action, unless, as
a part of such action, a court having jurisdiction over such action determines
that the Indemnitee's material defenses to such action were made in bad faith or
were frivolous.
16. Notice. All notices and other communications required or
permitted hereunder shall be in writing, shall be effective when given, and
shall in any event be deemed to be given (a) five (5) days after deposit with
the U.S. Postal Service or other applicable postal service, if delivered by
first class mail, postage prepaid, (b) upon delivery, if delivered by hand, (c)
one business day after the business day of deposit with Federal Express or
similar overnight courier, freight prepaid, or (d) one day after the business
day of delivery by facsimile transmission, if deliverable by facsimile
transmission, with copy by first class mail, postage prepaid, and shall be
addressed if to Indemnitee, at Indemnitee's address as set forth beneath
Indemnitee's signature to this Agreement and if to the Company at the address of
its principal corporate offices (attention: President) or at such other address
as such party may designate by ten (10) days' advance written notice to the
other party hereto.
17. Consent to Jurisdiction. The Company and Indemnitee each
hereby irrevocably consent to the jurisdiction of the courts of the State of
Delaware for all purposes in connection with any action or proceeding which
arises out of or relates to this Agreement and agree that any action instituted
under this Agreement shall be commenced, prosecuted and continued only in the
Court of Chancery of the State of Delaware in and for New Castle County, which
shall be the exclusive and only proper forum for adjudicating such a claim.
18. Severability. The provisions of this Agreement shall be
severable in the event that any of the provisions hereof (including any
provision within a single section, paragraph or sentence) are held by a court of
competent jurisdiction to be invalid, void or otherwise unenforceable, and the
remaining provisions shall remain enforceable to the fullest extent permitted by
law. Furthermore, to the fullest extent possible, the provisions of this
Agreement (including, without limitations, each portion of this Agreement
containing any provision held to be invalid, void or otherwise unenforceable,
that is not itself invalid, void or
10
<PAGE> 11
unenforceable) shall be construed so as to give effect to the intent manifested
by the provision held invalid, illegal or unenforceable.
19. Choice of Law. This Agreement shall be governed by and its
provisions construed and enforced in accordance with the laws of the State of
Delaware, as applied to contracts between Delaware residents, entered into and
to be performed entirely within the State of Delaware, without regard to the
conflict of laws principles thereof.
20. Subrogation. In the event of payment under this Agreement,
the Company shall be subrogated to the extent of such payment to all of the
rights of recovery of Indemnitee who shall execute all documents required and
shall do all acts that may be necessary to secure such rights and to enable the
Company effectively to bring suit to enforce such rights.
21. Amendment and Termination. No amendment, modification,
termination or cancellation of this Agreement shall be effective unless it is in
writing signed by all parties hereto. No waiver of any of the provisions of this
Agreement shall be deemed or shall constitute a waiver of any other provisions
hereof (whether or not similar) nor shall such waiver constitute a continuing
waiver.
22. Integration and Entire Agreement. This Agreement sets forth
the entire understanding between the parties hereto and supersedes and merges
all previous written and oral negotiations, commitments, understandings and
agreements relating to the subject matter hereof between the parties hereto.
23. No Construction as Employment Agreement. Nothing contained in
this Agreement shall be construed as giving the Indemnitee any right to be
retained in the employ of the Company or any of its subsidiaries.
24. Corporate Authority. The Board of Directors of the Company
has approved the terms of this Agreement.
11
<PAGE> 12
IN WITNESS WHEREOF, the parties hereto have executed this
Agreement on and as of the day and year first above written.
COMPANY:
REEL.COM, INC.,
a Delaware corporation
By:
--------------------------------
Mark Wattles
Chief Executive Officer
INDEMNITEE
By:
--------------------------------
Address:
---------------------------
12
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this Registration Statement on Form S-1 of our
report dated December 1, 1999, relating to the financial statements and
financial statement schedules of the online business division of Reel.com, Inc.,
which appears in such Registration Statement. We also consent to the references
to us under the headings "Experts" and "Selected Financial Data" in such
Registration Statement.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
December 2, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 9-MOS YEAR
<FISCAL-YEAR-END> SEP-30-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> SEP-30-1999 DEC-31-1998
<CASH> 15,335 0
<SECURITIES> 0 0
<RECEIVABLES> 618,952 382,200
<ALLOWANCES> 88,549 178,535
<INVENTORY> 5,246,932 2,148,943
<CURRENT-ASSETS> 6,572,275 3,136,394
<PP&E> 4,113,883 2,088,569
<DEPRECIATION> 1,101,782 367,424
<TOTAL-ASSETS> 59,759,092 92,774,403
<CURRENT-LIABILITIES> 11,532,446 7,314,026
<BONDS> 0 0
0 0
0 0
<COMMON> 1 1
<OTHER-SE> 5,743,712 74,770,009
<TOTAL-LIABILITY-AND-EQUITY> 59,759,092 92,774,403
<SALES> 21,613,082 15,039,886
<TOTAL-REVENUES> 21,613,082 15,039,886
<CGS> 22,707,621 16,859,439
<TOTAL-COSTS> 87,920,714 52,534,950
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 2,726,985 661,544
<INCOME-PRETAX> (69,026,298) (38,112,761)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (69,026,298) (38,112,761)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (69,026,298) (38,112,761)
<EPS-BASIC> 0 0
<EPS-DILUTED> 0 0
</TABLE>
