<PAGE>
FILED PURSUANT TO RULE 424(b)4
REGISTRATION NO. 333-72469
8,320,000 Shares
[LOGO]
ETOYS INC.
Common Stock
------------------
This is an initial public offering of shares of common stock of eToys Inc.
All of the 8,320,000 shares of common stock are being sold by eToys.
Prior to this offering, there has been no public market for the common
stock. The common stock has been approved for quotation on the Nasdaq National
Market under the symbol "ETYS".
SEE "RISK FACTORS" BEGINNING ON PAGE 8 TO READ ABOUT FACTORS YOU SHOULD
CONSIDER BEFORE BUYING SHARES OF THE COMMON STOCK.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY
HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
<TABLE>
<CAPTION>
Per Share Total
----------- -------------
<S> <C> <C>
Initial public offering price............................... $ 20.00 $ 166,400,000
Underwriting discount....................................... $ 1.35 $ 11,232,000
Proceeds, before expenses, to eToys......................... $ 18.65 $ 155,168,000
</TABLE>
In connection with this offering, the underwriters have reserved up to
1,365,000 shares of common stock being sold by eToys for sale at the initial
public offering price to directors, officers, employees and friends of eToys.
The underwriters may, under specific circumstances, purchase up to an
additional 1,248,000 shares from eToys at the initial public offering price,
less the underwriting discount.
------------------------
GOLDMAN, SACHS & CO.
BANCBOSTON ROBERTSON STEPHENS
DONALDSON, LUFKIN & JENRETTE
MERRILL LYNCH & CO.
------------------------
Prospectus dated May 19, 1999.
<PAGE>
The gatefold includes:
A TALE OF TWO ARTHURS.
<TABLE>
<CAPTION>
[A PICTURE OF ARTHUR] [A PICTURE OF ARTHUR]
with the following text below each picture:
<S> <C>
1. BUCKLE CHILDREN INTO CAR SEATS. 1. TURN ON COMPUTER.
2. DRIVE TO TOY STORE. 2. GO TO WWW.eTOYS.COM
3. CIRCLE PARKING LOT 4 TIMES FOR 3. ORDER ARTHUR.
PARKING SPACE. 4. ARTHUR IS DELIVERED, GIFT WRAPPED, TO
4. CHANGE ONE DIAPER. YOUR DOORSTEP.
5. LOSE ONE CHILD IN THE BARBIE SECTION.
6. FINALLY FIND ARTHUR.
7. COAX CHILD OUT OF PLAY HOUSE. [PICTURE OF ETOYS HOME PAGE]
8. WAIT IN LONG CHECK-OUT LINE.
9. PUT CANDY BARS BACK ON RACK. [ETOYS LOGO]
10. PLACATE CRYING CHILDREN. WE BRING THE TOY STORE TO YOU.(SM)
11. DRIVE HOME. WWW.ETOYS.COM
12. REMEMBER YOU NEED GIFT WRAP. AOL KEYWORD: ETOYS
</TABLE>
- -TM--C-Marc Brown 1999
At the bottom of the page is the following language:
eToys-Registered Trademark- is a registered trademark of eToys. Toysearch-TM-
and "We Bring The Toy Store To You."(sm) are trademarks of eToys. All other
brand names or trademarks appearing in this prospectus are the property of their
respective holders. The inclusion of the products in this prospectus is not an
endorsement of eToys or the offering of the securities being made hereby by the
vendors of such products.
The following text is contained on this gatefold:
Across the top of the two pages: [eToys logo] and We Bring The Toy Store To
You.(sm)
[Two page screen shot of eToys home page with textual descriptions of our Web
site shopping features, surrounded by the following text flowed to both sides in
a counter-clockwise fashion]
[PICTURE OF BLUE'S CLUES]
eToys.com shoppers will find an extensive selection of competitively priced
products, with over 9,500 SKUs representing more than 750 brands. We provide a
comprehensive selection of both traditional, well-known brands, such as Mattel,
Hasbro and LEGO, and specialty brands, such as BRIO, PLAYMOBIL and Learning
Curve.
Our Web site features detailed product information and innovative merchandising
through easy-to-use Web pages. We also provide our customers with helpful and
useful shopping services such as birthday reminders and wish lists. For shoppers
who are not certain what to get the kids, we offer product reviews,
recommendations and gift suggestions. Our online store is available 24 hours a
day, seven days a week and may be reached from the shopper's home or office.
eToys.com. Why go to the store, when the toy store can come to you?
TOYSEARCH.-TM-
OUR TOYSEARCH LETS CUSTOMERS BROWSE BY ANY COMBINATION OF AGE, CATEGORY, KEYWORD
OR PRICE.
<PAGE>
[PICTURE OF MADELINE DOLL]
GOOD ADVICE.
OUR AWARD WINNER SECTION FEATURES TOYS RECOMMENDED BY PROMINENT PARENTING AND
FAMILY PUBLICATIONS AS WELL AS ORGANIZATIONS WHO REVIEW CHILDREN'S TOYS,
SOFTWARE AND BOOKS. CUSTOMERS CAN ALSO VISIT OUR BESTSELLERS SECTION TO VIEW THE
MOST POPULAR TOYS SOLD OVER THE PAST 30 DAYS OR BROWSE THROUGH OUR OWN FAVORITES
BY AGE RECOMMENDATIONS.
TOY BRANDS.
WE CARRY BOTH TRADITIONAL, WELL-KNOWN BRANDS, SUCH AS MATTEL, HASBRO AND LEGO,
AND SPECIALTY TOY BRANDS, SUCH AS BRIO, PLAYMOBIL AND LEARNING CURVE.
[PICTURE OF WRAPPED GIFT]
GIFT CENTER.
WE SIMPLIFY GIFT SHOPPING THROUGH OUR GIFT CENTER, WHERE CUSTOMERS CAN OBTAIN
GIFT CERTIFICATES, GIFT RECOMMENDATIONS BY AGE AND GET INFORMATION ON A VARIETY
OF CHILD-APPROPRIATE GIFT WRAP STYLES AND PERSONALIZED MESSAGE CARDS TO
ACCOMPANY THE GIFT.
PICKS OF THE MONTH.
IN OUR PICKS OF THE MONTH SECTION, WE RECOMMEND TOYS FOR DIFFERENT AGE RANGES.
[PICTURE OF BRIO TRAIN]
TWENTY UNDER $20.
OUR TWENTY UNDER $20 SECTION HAS RECOMMENDATIONS ON TOYS THAT WON'T STRAIN THE
BUDGET.
DETAILED PRODUCT INFORMATION.
A SIMPLE CLICK OF THE MOUSE GIVES SHOPPERS ACCESS TO DETAILED PRODUCT
INFORMATION THEY NEED TO MAKE EDUCATED BUYING DECISIONS, INCLUDING PRODUCT
DESCRIPTIONS, ETOYS' OWN AGE RECOMMENDATIONS, A LIST OF ACCESSORIES AND RELATED
PRODUCTS AND INVENTORY STATUS.
[PICTURE OF PRODUCT DESCRIPTION OF TWO-WAY BATTERY-POWERED ENGINE]
MY ETOYS.
WE PERSONALIZE THE CUSTOMER'S SHOPPING EXPERIENCE BY OFFERING BIRTHDAY
REMINDERS, CHILDREN'S WISH LISTS AND AN ADDRESS BOOK.
EXTENSIVE PRODUCT SELECTION.
OUR ONLINE STORE IS EXCLUSIVELY FOCUSED ON CHILDREN'S PRODUCTS AND OFFERS AN
EXTENSIVE SELECTION OF TOYS, VIDEO GAMES, SOFTWARE, VIDEOS AND MUSIC.
[PICTURE OF SUPER MARIO BROS. VIDEO GAME, GOODNIGHT MOON BOOK, JUMPSTART
SOFTWARE BOX AND PADDINGTON BEAR]
At the bottom right of the two page gatefold is the following:
[ETOYS LOGO]
WE BRING THE TOY STORE TO YOU.(SM)
WWW.ETOYS.COM
AOL KEYWORD: ETOYS
The following text is centered on the inside back cover:
[ETOYS LOGO]
WE BRING THE TOY STORE TO YOU.(SM)
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION REGARDING ETOYS AND THE FINANCIAL STATEMENTS AND NOTES APPEARING
ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, THIS PROSPECTUS
ASSUMES THE AUTOMATIC CONVERSION OF OUR OUTSTANDING PREFERRED STOCK INTO
58,779,267 SHARES OF COMMON STOCK, ASSUMING FULL EXERCISE OF A WARRANT TO
PURCHASE 48,387 SHARES OF PREFERRED STOCK OUTSTANDING AS OF MARCH 31, 1999,
WHICH EXPIRES UPON THE CLOSING OF THIS OFFERING AND THE THREE-FOR-ONE FORWARD
SPLIT OF OUR COMMON STOCK AND PREFERRED STOCK TO BE EFFECTED UPON THE CLOSING OF
THIS OFFERING. THIS PROSPECTUS ALSO ASSUMES NO EXERCISE OF THE UNDERWRITERS'
OVER-ALLOTMENT OPTION AND DOES NOT INCLUDE THE AGGREGATE OF 18,720,000 SHARES OF
OUR COMMON STOCK THAT WILL BE ISSUED IN EXCHANGE FOR ALL OUTSTANDING SHARES OF
BABYCENTER CAPITAL STOCK AND RESERVED FOR ISSUANCE UPON THE EXERCISE OF OPTIONS
WE ARE ASSUMING IN CONNECTION WITH THE PROPOSED BABYCENTER MERGER. SPECIFIC
STATEMENTS IN THIS PROSPECTUS ASSUME THAT THE BABYCENTER MERGER HAS BEEN
COMPLETED. HOWEVER, THE MERGER IS SUBJECT TO SPECIFIC CLOSING CONDITIONS AND, AS
A RESULT, IT MAY NOT BE COMPLETED. REFERENCES IN THIS PROSPECTUS TO "WE", "US"
OR "OUR" REFER TO ETOYS AND DO NOT INCLUDE BABYCENTER UNLESS OTHERWISE NOTED.
OUR FISCAL YEAR ENDS ON MARCH 31ST OF EACH YEAR AND IS NAMED FOR THE CALENDAR
YEAR JUST ENDED. FOR EXAMPLE, OUR FISCAL YEAR ENDED MARCH 31, 1999 IS CALLED
"FISCAL 1998".
ETOYS INC.
OUR BUSINESS
We are a leading Web-based retailer focused exclusively on children's
products, including toys, video games, software, videos and music. By combining
our expertise in children's products and our commitment to excellent customer
service with the benefits of Internet retailing, we are able to deliver a unique
shopping experience to consumers. Our online store offers an extensive selection
of competitively priced children's products, with over 9,500 SKUs representing
more than 750 brands. Our Web site features detailed product information,
helpful and useful shopping services and innovative merchandising through
easy-to-use Web pages. In addition, we offer customers the convenience and
flexibility of shopping 24 hours a day, seven days a week, with reliable and
timely product delivery and excellent customer service.
As of March 31, 1999, we have sold children's products to approximately
365,000 customers, of which approximately 75,000 were added during the quarter
ended March 31, 1999. Our net sales for the fiscal year ended March 31, 1999
totaled $30.0 million as compared to $0.7 million for the fiscal year ended
March 31, 1998.
OUR MARKET OPPORTUNITY
We believe that many consumers find the toy shopping experience, especially
at traditional mass market retail outlets, to be time-consuming, inconvenient
and unpleasant due to factors such as location, store layout, product selection,
level of customer service and the challenges of shopping with children.
Our online store was created to provide consumers with a convenient and
enjoyable shopping experience in a Web-based retail environment. Key components
of our solution include:
- - CONVENIENT SHOPPING EXPERIENCE. Our online store is available 24 hours a day,
seven days a week, may be reached from the shopper's home or office and
features sophisticated browsing and search technology.
- - EXTENSIVE PRODUCT SELECTION AND INNOVATIVE MERCHANDISING. We offer a broad
array of children's products, which we believe includes the largest selection
of toys available on the Internet. In addition, we believe that we are the
only retailer to provide a comprehensive selection
3
<PAGE>
of both traditional, well-known brands, such as Mattel, Hasbro and LEGO, and
specialty brands, such as BRIO, PLAYMOBIL and Learning Curve.
- - HELPFUL AND USEFUL SHOPPING SERVICES. To assist our customers, who are
generally adults purchasing for children, we offer product reviews,
recommendations, gift suggestions and services such as birthday reminders and
wish lists. Many of these services are also designed to inform and involve
children in the shopping experience.
- - EXCELLENT CUSTOMER SERVICE. We are committed to providing the highest level of
customer service. We offer free pre- and post-sales support via telephone and
e-mail, online order tracking and helpful online shopping hints.
OUR STRATEGY
Our objective is to be one of the world's leading retailers of children's
products. Key elements of our strategy include:
- - FOCUS ON ONLINE RETAILING OF CHILDREN'S PRODUCTS. We intend to become the
primary place for consumers to purchase children's products by enhancing our
current product offerings and expanding into additional categories.
- - BUILD STRONG BRAND RECOGNITION. We use online and offline marketing strategies
to enhance our brand recognition. We focus our efforts primarily towards
mothers, who we believe are the principal decision-makers for purchases of
children's products.
- - PURSUE WAYS TO INCREASE OUR NET SALES. We intend to pursue new opportunities
to increase our net sales by opening new departments, increasing product
selection, adding more helpful and useful shopping services, pursuing
international opportunities and acquiring complementary businesses, products
or technologies.
- - PROMOTE REPEAT PURCHASES. We intend to maximize the number of repeat purchases
by our customers by targeting existing customers through direct marketing
techniques, building features unique to each individual customer and enhancing
our customer service.
- - MAINTAIN OUR TECHNOLOGY FOCUS AND EXPERTISE. We intend to enhance our service
offerings to take advantage of the unique characteristics of online retailing.
We plan to increase the efficiency of our relationships with product vendors
and manufacturers and our distribution operations.
RECENT DEVELOPMENTS
On April 18, 1999, we entered into a merger agreement to acquire BabyCenter,
Inc. BabyCenter is a Web-based business that offers a wide variety of
information, products and interactive forums focused on and serving expectant
mothers and new parents. Visitors to the BabyCenter Web site can read health
articles and parenting news, interact online with other families and purchase a
wide selection of baby products and supplies. Upon the completion of this
merger, we will issue 16,708,886 shares of our common stock, subject to
adjustment, in exchange for all outstanding shares of BabyCenter capital stock
and will assume all outstanding BabyCenter options. We will reserve 2,011,114
shares of our common stock, subject to adjustment, for issuance upon the
exercise of assumed BabyCenter options. We anticipate that the merger will close
by the end of June 1999. However, the BabyCenter merger is subject to closing
conditions specified in the merger agreement, including government approvals,
approval of the merger by the stockholders of BabyCenter and other customary
closing conditions. As a result, the BabyCenter merger may not be completed.
4
<PAGE>
In April and May 1999, we granted under our 1999 Stock Plan options to
purchase an aggregate of 2,122,302 shares of our common stock at an exercise
price of $11.00 per share. We granted most of these options to 67 new employees.
The options granted in May 1999 have been considered to be compensatory.
Deferred compensation associated with such options is $14.7 million. This amount
will be amortized to expense on a straight-line basis over the four-year vesting
periods of the applicable options through the fiscal year ending March 31, 2004.
In May 1999, we hired Janine Bousquette as our new Senior Vice President of
Marketing. Prior to joining us, Ms. Bousquette worked with PepsiCo Inc., serving
most recently as Vice President of Marketing.
RISK FACTORS
An investment in our common stock involves a high degree of risk. Since our
inception in November 1996, we have incurred significant losses, and as of March
31, 1999, we had an accumulated deficit of $30.8 million. We expect our
operating losses and negative cash flow to continue for the foreseeable future.
In addition, we encounter a number of risks, including unpredictability of
operating results, seasonality, inventory risk, reliance on key vendors and
distributors, and intense competition. You should carefully consider these risks
and uncertainties as well as those other risks and uncertainties described in
"Risk Factors" beginning on page 8 of this prospectus before deciding whether to
invest in shares of our common stock.
CORPORATE INFORMATION
We were incorporated as Toys.com in Delaware in November 1996. In May 1997,
we changed our name to eToys.com Inc., and in June 1997, we changed our name to
eToys Inc. Our corporate offices are located at 3100 Ocean Park Blvd., Suite
300, Santa Monica, CA 90405. Our telephone number at that location is (310)
664-8100. Information contained on our Web site does not constitute part of this
prospectus.
5
<PAGE>
THE OFFERING
The following information assumes that the underwriters do not exercise the
option granted by us to purchase additional shares in the offering. The number
below includes an aggregate of 198,387 shares issuable upon the exercise of
warrants outstanding as of March 31, 1999, which expire at, and are expected to
be exercised prior to, the completion of this offering. The number below
excludes 11,412 shares issuable upon exercise of a warrant we issued to an
equipment lessor in January 1999 and 38,613,864 shares of common stock reserved
for issuance under our stock option and stock purchase plans, of which
14,927,676 shares were subject to outstanding options as of March 31, 1999 with
a weighted average exercise price of $1.595 per share. The number below further
excludes the aggregate of 18,720,000 shares of our common stock to be issued in
exchange for all outstanding shares of BabyCenter capital stock and to be
reserved for issuance upon exercise of assumed BabyCenter options in connection
with the proposed BabyCenter merger. See "Underwriting", "Management--Stock
Plans" and Notes 6 and 8 of Notes to Financial Statements.
<TABLE>
<S> <C>
Shares offered by eToys...................... 8,320,000 shares
Shares to be outstanding after the 101,784,682 shares
offering...................................
Use of proceeds.............................. For general corporate purposes, principally
working capital and capital expenditures. See
"Use of Proceeds".
Nasdaq National Market symbol................ "ETYS"
</TABLE>
6
<PAGE>
SUMMARY FINANCIAL INFORMATION
The following summary financial information is derived from our financial
statements included elsewhere in this prospectus. You should read the following
summary financial information in conjunction with those financial statements and
the related notes. For example, Note 1 to the notes to our financial statements
explains the determination of the number of shares and share equivalents used in
computing the pro forma per share amounts set forth below. You should also read
"Use of Proceeds", "Capitalization" and "Unaudited Pro Forma Condensed Combined
Financial Information".
The summary financial information below reflects that, prior to June 1997,
we had no operations or activities. Our general and administrative operating
expenses include expenses related to the amortization of deferred compensation
which is $2,000 for the fiscal year ended March 31, 1998 and $5.8 million for
the fiscal year ended March 31, 1999. The pro forma share amounts reflect the
conversion of preferred stock into common stock.
The balance sheet data displayed in the "As Adjusted" column reflect the
application of the net proceeds from the sale of 8,320,000 shares of common
stock offered by us at an initial public offering price of $20.00 per share,
after deducting the underwriting discount and estimated offering expenses.
The statement of operations data displayed in the "Pro Forma BabyCenter
Merger 1999" column gives effect to the BabyCenter merger expected to be
completed by the end of June 1999.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
MARCH 31,
----------------------------------------
PRO FORMA
BABYCENTER
MERGER
1998 1999 1999
------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE AND PER
SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales..................................................... $ 687 $ 29,959 $ 34,727
Gross profit.................................................. 119 5,713 9,500
Operating expenses:
Marketing and sales......................................... 1,290 20,719 23,180
Product development......................................... 421 3,608 7,360
General and administrative.................................. 678 10,166 16,405
Goodwill amortization....................................... -- 319 36,455
------------ ------------ ------------
Operating loss................................................ (2,270) (29,099) (73,900)
Net loss...................................................... $ (2,268) $ (28,558) $ (73,103)
Basic net loss per share...................................... $ (0.09) $ (0.85) $ (1.46)
Pro forma for conversion of preferred stock
basic net loss per share.................................... $ (0.08) $ (0.35) $ (0.74)
Shares used to compute basic net loss per share............... 25,129,888 33,427,908 50,136,794
Shares used to compute pro forma for conversion
of preferred stock basic net loss per share................. 30,232,902 81,923,187 98,632,073
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1999
-----------------------
ACTUAL AS ADJUSTED
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................................................ $ 20,173 $ 173,652
Working capital.......................................................................... 21,821 175,300
Total assets............................................................................. 30,666 184,145
Long-term capital lease obligations, less current portion................................ 477 477
Total stockholders' equity (deficit)..................................................... (24,098) 178,672
</TABLE>
7
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW
AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE DECIDING WHETHER TO INVEST
IN SHARES OF OUR COMMON STOCK. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY
KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS
OPERATIONS.
IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL
CONDITION OR OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED. IN SUCH
CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE PART
OR ALL OF YOUR INVESTMENT.
RISKS RELATED TO OUR BUSINESS
OUR LIMITED OPERATING HISTORY MAKES FUTURE FORECASTING DIFFICULT.
We were incorporated in November 1996. We began selling products on our Web
site in October 1997. As a result of our limited operating history, it is
difficult to accurately forecast our net sales and we have limited meaningful
historical financial data upon which to base planned operating expenses. We base
our current and future expense levels on our operating plans and estimates of
future net sales, and our expenses are to a large extent fixed. Sales and
operating results are difficult to forecast because they generally depend on the
volume and timing of the orders we receive. As a result, we may be unable to
adjust our spending in a timely manner to compensate for any unexpected revenue
shortfall. This inability could cause our net losses in a given quarter to be
greater than expected.
WE ANTICIPATE FUTURE LOSSES AND NEGATIVE CASH FLOW.
We expect operating losses and negative cash flow to continue for the
foreseeable future. We anticipate our losses will increase significantly from
current levels because we expect to incur additional costs and expenses related
to:
- - brand development, marketing and other promotional activities;
- - the expansion of our inventory management and distribution operations;
- - the continued development of our Web site, the systems that we use to process
customers' orders and payments, and our computer network;
- - the expansion of our product offerings and Web site content; and
- - development of relationships with strategic business partners.
As of March 31, 1999, we had an accumulated deficit of $30.8 million. We
incurred net losses of $2.3 million for the fiscal year ended March 31, 1998 and
$28.6 million for the fiscal year ended March 31, 1999.
In addition, if the BabyCenter merger is completed, we expect that our
losses will increase even more significantly because of additional costs and
expenses related to:
- - an increase in the number of employees;
- - an increase in sales and marketing activities;
- - additional facilities and infrastructure; and
- - assimilation of operations and personnel.
Also, if the BabyCenter merger is completed, we will record a significant
amount of goodwill and deferred compensation, the amortization of which will
significantly reduce our earnings and profitability for the foreseeable future.
We expect to record goodwill of approximately $180.7 million,
8
<PAGE>
to be amortized over a five-year period, and deferred compensation of
approximately $15.5 million, to be amortized over a four-year period. To the
extent we do not generate sufficient cash flow to recover the amount of the
investment recorded, the investment may be considered impaired and could be
subject to earlier write-off. In such event, our net loss in any given period
could be greater than anticipated and the market price of our stock could
decline.
Our ability to become profitable depends on our ability to generate and
sustain substantially higher net sales while maintaining reasonable expense
levels. If we do achieve profitability, we cannot be certain that we would be
able to sustain or increase profitability on a quarterly or annual basis in the
future. See "Selected Financial Data" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
OUR OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT. IF WE FAIL TO MEET
THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS, THE MARKET PRICE OF
OUR COMMON STOCK MAY DECLINE SIGNIFICANTLY.
Our annual and quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future due to a variety of factors, many of
which are outside of our control. Because our operating results are volatile and
difficult to predict, we believe that quarter-to-quarter comparisons of our
operating results are not a good indication of our future performance. It is
likely that in some future quarter our operating results may fall below the
expectations of securities analysts and investors. In this event, the trading
price of our common stock may decline significantly.
Factors that may harm our business or cause our operating results to
fluctuate include the following:
- - our inability to obtain new customers at reasonable cost, retain existing
customers, or encourage repeat purchases;
- - decreases in the number of visitors to our Web site or our inability to
convert visitors to our Web site into customers;
- - the mix of toys, video games, software, videos and music sold by us;
- - seasonality;
- - our inability to manage inventory levels or control inventory theft;
- - our inability to manage our distribution operations;
- - our inability to adequately maintain, upgrade and develop our Web site, the
systems that we use to process customers' orders and payments or our computer
network;
- - the ability of our competitors to offer new or enhanced Web sites, services or
products;
- - price competition;
- - an increase in the level of our product returns;
- - fluctuations in the demand for children's products associated with movies,
television and other entertainment events;
- - our inability to obtain popular children's toys, video games, software, videos
and music from our vendors;
- - fluctuations in the amount of consumer spending on children's toys, video
games, software, videos and music;
9
<PAGE>
- - the termination of existing or failure to develop new marketing relationships
with key business partners;
- - the extent to which we are not able to participate in advertising campaigns
such as those conducted by Visa and Intel;
- - increases in the cost of online or offline advertising;
- - the amount and timing of operating costs and capital expenditures relating to
expansion of our operations;
- - unexpected increases in shipping costs or delivery times, particularly during
the holiday season;
- - technical difficulties, system downtime or Internet brownouts;
- - government regulations related to use of the Internet for commerce or for
sales and distribution of toys, video games, software, videos and music; and
- - economic conditions specific to the Internet, online commerce and the
children's toy, video game, software, video and music industries.
A number of factors will cause our gross margins to fluctuate in future
periods, including the mix of toys, video games, software, videos and music sold
by us, inventory management, inbound and outbound shipping and handling costs,
the level of product returns and the level of discount pricing and promotional
coupon usage. Any change in one or more of these factors could reduce our gross
margins in future periods. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Quarterly Results of Operations".
BECAUSE WE EXPERIENCE SEASONAL FLUCTUATIONS IN OUR NET SALES, OUR QUARTERLY
RESULTS WILL FLUCTUATE AND OUR ANNUAL RESULTS COULD BE BELOW EXPECTATIONS.
We have historically experienced and expect to continue to experience
seasonal fluctuations in our net sales. These seasonal patterns will cause
quarterly fluctuations in our operating results. In particular, a
disproportionate amount of our net sales have been realized during the fourth
calendar quarter and we expect this trend to continue in the future.
In anticipation of increased sales activity during the fourth calendar
quarter, we hire a significant number of temporary employees to bolster our
permanent staff and we significantly increase our inventory levels. For this
reason, if our net sales were below seasonal expectations during this quarter,
our annual operating results could be below the expectations of securities
analysts and investors.
Due to our limited operating history, it is difficult to predict the
seasonal pattern of our sales and the impact of such seasonality on our business
and financial results. In the future, our seasonal sales patterns may become
more pronounced, may strain our personnel and warehousing and order shipment
activities and may cause a shortfall in net sales as compared to expenses in a
given period. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations".
WE FACE SIGNIFICANT INVENTORY RISK BECAUSE CONSUMER DEMAND CAN CHANGE FOR
PRODUCTS BETWEEN THE TIME THAT WE ORDER PRODUCTS AND THE TIME THAT WE RECEIVE
THEM.
We carry a significant level of inventory. As a result, the rapidly changing
trends in consumer tastes in the market for children's toys, video games,
software, videos and music subject us to significant inventory risks. It is
critical to our success that we accurately predict these trends and do not
overstock unpopular products. The demand for specific products can change
between the time the products are ordered and the date of receipt. We are
particularly exposed to this risk because
10
<PAGE>
we derive a majority of our net sales in the fourth calendar quarter of each
year. Our failure to sufficiently stock popular toys and other products in
advance of such fourth calendar quarter would harm our operating results for the
entire fiscal year.
In the event that one or more products do not achieve widespread consumer
acceptance, we may be required to take significant inventory markdowns, which
could reduce our net sales and gross margins. This risk may be greatest in the
first calendar quarter of each year, after we have significantly increased
inventory levels for the holiday season. We believe that this risk will increase
as we open new departments or enter new product categories due to our lack of
experience in purchasing products for these categories. In addition, to the
extent that demand for our products increases over time, we may be forced to
increase inventory levels. Any such increase would subject us to additional
inventory risks. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business".
WE FACE THE RISK OF INVENTORY THEFT.
If the security measures we use at our distribution facility do not
significantly reduce or prevent inventory theft, our gross profit margin may
significantly decrease. During the quarter ended March 31, 1999, we experienced
approximately $270,000 of inventory theft, which resulted in a 4% decrease in
our gross profit margin for the quarter ended March 31, 1999 and a 1% decrease
in our gross profit margin for fiscal 1998. We have begun undertaking a number
of measures designed to address inventory theft, including the installation of
enhanced security measures at our distribution facility. These measures may not
successfully reduce or prevent inventory theft in future periods. Our failure to
successfully improve the security measures we use at our distribution facility
may cause our gross profit margins and results of operations to be significantly
below expectations in future periods.
BECAUSE WE DO NOT HAVE LONG-TERM OR EXCLUSIVE VENDOR CONTRACTS, WE MAY NOT BE
ABLE TO GET SUFFICIENT QUANTITIES OF POPULAR CHILDREN'S PRODUCTS IN A TIMELY
MANNER. AS A RESULT, WE COULD LOSE CUSTOMERS.
If we are not able to offer our customers sufficient quantities of toys or
other products in a timely manner, we could lose customers and our net sales
could be below expectations. Our success depends on our ability to purchase
products in sufficient quantities at competitive prices, particularly for the
holiday shopping season. As is common in the industry, we do not have long-term
or exclusive arrangements with any vendor or distributor that guarantee the
availability of toys or other children's products for resale. Therefore, we do
not have a predictable or guaranteed supply of toys or other products.
IF WE ARE UNABLE TO OBTAIN SUFFICIENT QUANTITIES OF PRODUCTS FROM OUR KEY
VENDORS, OUR NET SALES WOULD DECREASE.
If we were unable to obtain sufficient quantities of products from our key
vendors, we could lose customers and our net sales could be below expectations.
We derive a significant percentage of our net sales from sales of Mattel and
Hasbro products. We also derive a significant percentage of our net sales from
the sale of video game products that are primarily supplied to us by a single
distributor. From time to time, we have experienced difficulty in obtaining
sufficient product allocations from a key vendor. In addition, our key vendors
have established, and may continue to expand, their own online retailing
efforts, which may impact our ability to get sufficient product allocations from
such vendors.
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TO MANAGE OUR GROWTH AND EXPANSION, WE NEED TO IMPROVE AND IMPLEMENT FINANCIAL
AND MANAGERIAL CONTROLS AND REPORTING SYSTEMS AND PROCEDURES. IF WE ARE UNABLE
TO DO SO SUCCESSFULLY, OUR RESULTS OF OPERATIONS WOULD BE IMPAIRED.
Our rapid growth in personnel and operations has placed, and will continue
to place, a significant strain on our management, information systems and
resources. If the BabyCenter merger is completed, we will add over 100 new
employees, including managerial, technical and operations personnel, and will
need to assimilate substantially all of BabyCenter's operations into our
operations. In order to manage this growth effectively, we need to continue to
improve our financial and managerial controls and reporting systems and
procedures. If we continue to experience a significant increase in the number of
our personnel, our existing management team may not be able to effectively
train, supervise and manage all of our personnel. In addition, our existing
information systems may not be able to handle adequately the increased volume of
information and transactions that would result from increased growth. Our
failure to successfully implement, improve and integrate these systems and
procedures would cause our results of operations to be below expectations.
IF WE ARE UNABLE TO SUCCESSFULLY IMPLEMENT OUR NEW ACCOUNTING AND FINANCIAL
REPORTING SYSTEMS, OUR STOCK PRICE COULD DECLINE.
If we fail to successfully implement and integrate our new financial
reporting and information systems with our existing systems or if we are not
able to expand these systems to accommodate our growth, we may not have
adequate, accurate or timely financial information. Our failure to have
adequate, accurate or timely financial information would harm our business and
could lead to volatility in our stock price. We recently implemented new
accounting and financial reporting software. In connection with the
implementation, we have encountered difficulties integrating this new software
with our other information systems. Additionally, we are in the process of
upgrading our other information systems and internal controls, including those
related to the purchase and receipt of inventory and control of inventory theft.
If we grow rapidly, we will face additional challenges in upgrading and
maintaining such systems.
WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE
COMPETITORS.
The online commerce market is new, rapidly evolving and intensely
competitive. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share, any of which could seriously
harm our net sales and results of operations. We expect competition to intensify
in the future because current and new competitors can enter our market with
little difficulty and can launch new Web sites at a relatively low cost. In
addition, the children's toy, video game, software, video and music retailing
industries are intensely competitive.
We currently or potentially compete with a variety of other companies,
including:
- - traditional store-based toy and children's product retailers such as Toys R
Us, FAO Schwarz, Zany Brainy and Noodle Kidoodle;
- - major discount retailers such as Wal-Mart, Kmart and Target;
- - online efforts of these traditional retailers, including the online stores
operated by Toys R Us, Wal-Mart and FAO Schwarz;
- - physical and online stores of entertainment entities that sell and license
children's products, such as The Walt Disney Company and Warner Bros.;
- - catalog retailers of children's products;
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- - vendors or manufacturers of children's products that currently sell some of
their products directly online, such as Mattel and Hasbro;
- - other online retailers that include children's products as part of their
product offerings, such as Amazon.com, Barnesandnoble.com, CDnow, Beyond.com
and Reel.com;
- - Internet portals and online service providers that feature shopping services,
such as AOL, Yahoo!, Excite and Lycos; and
- - various smaller online retailers of children's products, such as
BrainPlay.com, Red Rocket and Toysmart.com.
If the BabyCenter merger is completed, we will also compete with companies
that sell products or provide content for babies, toddlers and expectant
mothers. These companies include the competitors listed above and also include:
- - traditional store-based retailers such as BabyGap, Gymboree, The Right Start
and Babies R Us;
- - the online efforts of these traditional retailers, including the online stores
operated by BabyGap and Gymboree;
- - catalog retailers of products for babies, toddlers and expectant mothers; and
- - various online companies such as iBaby, BabyCatalog.com, iVillage and
Women.com.
Many traditional store-based and online competitors have longer operating
histories, larger customer or user bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Many
of these competitors can devote substantially more resources to Web site
development than we can. In addition, larger, well-established and well-financed
entities may join with online competitors or children's toy, video game,
software, video and music publishers or suppliers as the use of the Internet and
other online services increases.
Our competitors may be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we can. Traditional
store-based retailers also enable customers to see and feel products in a manner
that is not possible over the Internet. See "Business--Competition".
IF WE ENTER NEW BUSINESS CATEGORIES THAT DO NOT ACHIEVE MARKET ACCEPTANCE, OUR
BRAND AND REPUTATION COULD BE DAMAGED AND WE COULD FAIL TO ATTRACT NEW
CUSTOMERS.
Any new department or product category that is launched or acquired by us,
including BabyCenter, which is not favorably received by consumers could damage
our brand or reputation. This damage could impair our ability to attract new
customers, which could cause our net sales to fall below expectations. An
expansion of our business to include BabyCenter or any other new department or
product category will require significant additional expenses, and strain our
management, financial and operational resources. This type of expansion would
also subject us to increased inventory risk. We may choose to expand our
operations by developing other new departments or product categories, promoting
new or complementary products, expanding the breadth and depth of products and
services offered or expanding our market presence through relationships with
third parties. In addition, we may pursue the acquisition of other new or
complementary businesses, products or technologies, although we have no present
understandings, commitments or agreements with respect to any material
acquisitions or investments.
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IF WE DO NOT SUCCESSFULLY EXPAND OUR DISTRIBUTION OPERATIONS, OUR NET SALES MAY
FALL BELOW EXPECTATIONS.
If we do not successfully expand our distribution operations to accommodate
increases in demand, particularly during the fourth calendar quarter of each
year, we will not be able to increase our net sales in accordance with the
expectations of securities analysts and investors. Our success depends on our
ability to rapidly expand our distribution operations in order to accommodate a
significant increase in customer orders. We must also be able to rapidly grow
our distribution operations and information systems to accommodate significant
increases in demand, which may require us to automate tasks that are currently
performed manually.
Our planned expansion may cause disruptions in our business. Our current
distribution operations are not adequate to accommodate significant increases in
customer demand that may occur during the fourth calendar quarter of 1999. We
have leased a second distribution facility located in Virginia which we intend
to begin using in early 2000. In addition, we have entered into an agreement
with a third party that will provide us with warehouse and distribution services
from its facility in Utah. We are not experienced in coordinating and managing
distribution operations in geographically distant locations.
IF WE EXPERIENCE PROBLEMS IN OUR DISTRIBUTION OPERATIONS, WE COULD LOSE
CUSTOMERS.
We rely upon third-party carriers for product shipments, including shipments
to and from our distribution facility. We are therefore subject to the risks,
including employee strikes and inclement weather, associated with such carriers'
ability to provide delivery services to meet our shipping needs. In addition,
failure to deliver products to our customers in a timely manner would damage our
reputation and brand. We also depend upon temporary employees to adequately
staff our distribution facility, particularly during the holiday shopping
season. If we do not have sufficient sources of temporary employees, we could
lose customers.
IF WE DO NOT SUCCESSFULLY EXPAND OUR WEB SITE AND THE SYSTEMS THAT PROCESS
CUSTOMERS' ORDERS, WE COULD LOSE CUSTOMERS AND OUR NET SALES COULD BE REDUCED.
If we fail to rapidly upgrade our Web site in order to accommodate increased
traffic, we may lose customers, which would reduce our net sales. Furthermore,
if we fail to rapidly expand the computer systems that we use to process and
ship customer orders and process payments, we may not be able to successfully
distribute customer orders. As a result, we could lose customers and our net
sales could be reduced. In addition, our failure to rapidly upgrade our Web site
or expand these computer systems without system downtime, particularly during
the fourth calendar quarter, would further reduce our net sales. We may
experience difficulty in improving and maintaining such systems if our employees
or contractors that develop or maintain our computer systems become unavailable
to us. We have experienced periodic systems interruptions, which we believe will
continue to occur, while enhancing and expanding these computer systems.
OUR FACILITIES AND SYSTEMS ARE VULNERABLE TO NATURAL DISASTERS AND OTHER
UNEXPECTED PROBLEMS. THE OCCURRENCE OF A NATURAL DISASTER OR OTHER UNEXPECTED
PROBLEM COULD DAMAGE OUR REPUTATION AND BRAND AND REDUCE OUR NET SALES.
The occurrence of an earthquake or other natural disaster or unanticipated
problems at our leased facility in Southern California, or at the third-party
facility in Sunnyvale, California that houses substantially all of our computer
and communications hardware systems, could cause interruptions or delays in our
business, loss of data or render us unable to accept and fulfill customer
orders. Our leased facility in Southern California houses substantially all of
our product development and information systems, as well as our inventory. Any
such interruptions or delays at either of these
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facilities would reduce our net sales. In addition, our systems and operations
are vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, break-ins, earthquake and similar events. We have no
formal disaster recovery plan and our business interruption insurance may not
adequately compensate us for losses that may occur. In addition, the failure by
the third-party facility to provide the data communications capacity required by
us, as a result of human error, natural disaster or other operational
disruptions, could result in interruptions in our service. The occurrence of any
or all of these events could damage our reputation and brand and impair our
business.
OUR NET SALES COULD DECREASE IF OUR ONLINE SECURITY MEASURES FAIL.
Our relationships with our customers may be adversely affected if the
security measures that we use to protect their personal information, such as
credit card numbers, are ineffective. If, as a result, we lose many customers,
our net sales could decrease. We rely on security and authentication technology
that we license from third parties. With this technology, we perform real-time
credit card authorization and verification with our bank. We cannot predict
whether events or developments will result in a compromise or breach of the
technology we use to protect a customer's personal information.
Furthermore, our servers may be vulnerable to computer viruses, physical or
electronic break-ins and similar disruptions. We may need to expend significant
additional capital and other resources to protect against a security breach or
to alleviate problems caused by any breaches. We cannot assure that we can
prevent all security breaches.
OUR NET SALES AND GROSS MARGINS WOULD DECREASE IF WE EXPERIENCE SIGNIFICANT
CREDIT CARD FRAUD.
A failure to adequately control fraudulent credit card transactions would
reduce our net sales and our gross margins because we do not carry insurance
against this risk. We have developed technology to help us to detect the
fraudulent use of credit card information. Nonetheless, to date, we have
suffered losses as a result of orders placed with fraudulent credit card data
even though the associated financial institution approved payment of the orders.
Under current credit card practices, we are liable for fraudulent credit card
transactions because we do not obtain a cardholder's signature.
IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR SERVICES COULD BECOME
OBSOLETE AND WE COULD LOSE CUSTOMERS.
If we face material delays in introducing new services, products and
enhancements, our customers may forego the use of our services and use those of
our competitors. To remain competitive, we must continue to enhance and improve
the functionality and features of our online store. The Internet and the online
commerce industry are rapidly changing. If competitors introduce new products
and services embodying new technologies, or if new industry standards and
practices emerge, our existing Web site and proprietary technology and systems
may become obsolete.
To develop our Web site and other proprietary technology entails significant
technical and business risks. We may use new technologies ineffectively or we
may fail to adapt our Web site, systems that we use to process customers' orders
and payments and our computer network to customer requirements or emerging
industry standards.
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INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND COULD IMPAIR OUR
BUSINESS.
Other parties may assert infringement or unfair competition claims against
us. In the past, a toy distributor using a name similar to ours sent us notice
of a claim of infringement of proprietary rights, which claim was subsequently
withdrawn. We expect to receive other notices from other third parties 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 harm our business. If we are forced to defend against any such
claims, whether they are with or without merit or are determined in our favor,
then we may face costly litigation, diversion of technical and management
personnel, or product shipment delays. As a result of such a dispute, we may
have to develop non-infringing technology or enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may be
unavailable on terms acceptable to us, or at all. If there is a successful claim
of product infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology on a timely basis, it
could impair our business.
IF THE PROTECTION OF OUR TRADEMARKS AND PROPRIETARY RIGHTS IS INADEQUATE, OUR
BRAND AND REPUTATION COULD BE IMPAIRED AND WE COULD LOSE CUSTOMERS.
The steps we take to protect our proprietary rights may be inadequate. We
regard our copyrights, service marks, trademarks, trade dress, trade secrets and
similar intellectual property as critical to our success. We rely on trademark
and copyright law, trade secret protection and confidentiality or license
agreements with our employees, customers, partners and others to protect our
proprietary rights. In September 1998, the United States Patent and Trademark
Office granted us a registered trademark for "eToys" for online retail services
for toys and games. We have filed a trademark application for "eToys" for toys,
games and playthings and for sales of toys, games and playthings. Effective
trademark, service mark, copyright and trade secret protection may not be
available in every country in which we will sell our products and services
online. Furthermore, the relationship between regulations governing domain names
and laws protecting trademarks and similar proprietary rights is unclear.
Therefore, we may be unable to prevent third parties from acquiring domain names
that are similar to, infringe upon or otherwise decrease the value of our
trademarks and other proprietary rights.
THE LOSS OF THE SERVICES OF ONE OR MORE OF OUR KEY PERSONNEL, OR OUR FAILURE TO
ATTRACT, ASSIMILATE AND RETAIN OTHER HIGHLY QUALIFIED PERSONNEL IN THE FUTURE,
COULD DISRUPT OUR OPERATIONS AND RESULT IN LOSS OF NET SALES.
The loss of the services of one or more of our key personnel could seriously
interrupt our business. We depend on the continued services and performance of
our senior management and other key personnel, particularly Edward C. Lenk, our
President, Chief Executive Officer and Uncle of the Board. Our future success
also depends upon the continued service of our executive officers and other key
sales, marketing and support personnel. The majority of our senior management
joined us in the last four months, including our Chief Financial Officer, Chief
Information Officer and Senior Vice President of Operations. Our future success
depends on these officers effectively working together with our original
management team. Also, if we complete the BabyCenter merger, our success will
also depend on a successful integration of BabyCenter's management with our
senior management team. None of our officers or key employees is bound by an
employment agreement for any specific term. Our relationships with these
officers and key employees are at will. We do not have "key person" life
insurance policies covering any of our employees.
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WE MAY BE ADVERSELY IMPACTED IF THE SOFTWARE, COMPUTER TECHNOLOGY AND OTHER
SYSTEMS WE USE ARE NOT YEAR 2000 COMPLIANT.
Any failure of our material systems, our vendors' material systems or the
Internet to be year 2000 compliant would have material adverse consequences for
us. Such consequences would include difficulties in operating our Web site
effectively, taking product orders, making product deliveries or conducting
other fundamental parts of our business. We are currently assessing the year
2000 readiness of the software, computer technology and other services that we
use which may not be year 2000 compliant. At this time, we have not yet
developed a contingency plan to address situations that may result if we or our
vendors are unable to achieve year 2000 compliance. The cost of developing and
implementing such a plan, if necessary, could be material.
We also depend on the year 2000 compliance of the computer systems and
financial services used by consumers. A significant disruption in the ability of
consumers to reliably access the Internet or portions of it or to use their
credit cards would have an adverse effect on demand for our services and would
have a material adverse effect on us. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
THERE ARE RISKS ASSOCIATED WITH THE PROPOSED BABYCENTER MERGER AND OTHER
POTENTIAL ACQUISITIONS. AS A RESULT, WE MAY NOT ACHIEVE THE EXPECTED BENEFITS OF
THE PROPOSED BABYCENTER MERGER AND OTHER POTENTIAL ACQUISITIONS.
The BabyCenter merger is subject to a number of contingencies, including
approval of the merger by BabyCenter stockholders and governmental authorities
and other customary closing conditions. As a result, there can be no assurance
that the BabyCenter merger will be completed. If the merger is not completed,
the trading price of our common stock may fall.
If the BabyCenter merger is completed, we may not realize the anticipated
benefits from the merger. We may not be able to successfully assimilate the
additional personnel, operations, acquired technology and products into our
business. The proposed merger may further strain our existing financial and
managerial controls and reporting systems and procedures. In addition, key
BabyCenter personnel may decide not to work for us. These difficulties could
disrupt our ongoing business, distract our management and employees or increase
our expenses. Further, the physical expansion in facilities that would occur as
a result of this merger may result in disruptions that seriously impair our
business. In particular, if the BabyCenter merger is completed, we will have
operations in multiple facilities in geographically distant areas. We are not
experienced in managing facilities or operations in geographically distant
areas. In connection with the proposed merger, an aggregate of 18,720,000 shares
of our common stock will be issued in exchange for all outstanding shares of
BabyCenter capital stock and reserved for issuance upon the exercise of assumed
BabyCenter options in connection with the merger. The issuance of these
securities will be dilutive to our existing stockholders.
If we are presented with appropriate opportunities, we intend to make other
investments in complementary companies, products or technologies. We may not
realize the anticipated benefits of any other acquisition or investment. If we
buy a company, we will likely face the same risks, uncertainties and disruptions
as discussed above with respect to the proposed BabyCenter merger. Furthermore,
we may have to incur debt or issue equity securities to pay for any additional
future acquisitions or investments, the issuance of which could be dilutive to
us or our existing stockholders.
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EXECUTIVE OFFICERS, DIRECTORS AND ENTITIES AFFILIATED WITH THEM WILL CONTINUE TO
HAVE SUBSTANTIAL CONTROL OVER eTOYS AFTER THE OFFERING WHICH COULD DELAY OR
PREVENT A CHANGE IN OUR CORPORATE CONTROL FAVORED BY OUR OTHER STOCKHOLDERS.
Executive officers, directors and entities affiliated with them, if acting
together, would be able to significantly influence all matters requiring
approval by our stockholders, including the election of directors and the
approval of mergers or other business combination transactions. These
stockholders will, in the aggregate, beneficially own approximately 39% of our
outstanding common stock following the completion of this offering. See
"Principal Stockholders".
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE
BENEFICIAL TO OUR STOCKHOLDERS.
Provisions of our Amended and Restated Certificate of Incorporation, our
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. See
"Description of Capital Stock".
INVESTORS IN THE OFFERING WILL EXPERIENCE IMMEDIATE DILUTION.
We expect the initial public offering price to be substantially higher than
the book value per share of the outstanding common stock immediately after this
offering. Accordingly, if you purchase common stock in this offering, you will
experience immediate dilution of approximately $18.25 in the book value per
share of the common stock from the price you pay for the common stock. See
"Dilution".
RISKS RELATED TO OUR INDUSTRY
IF WE ARE UNABLE TO ACQUIRE THE NECESSARY WEB DOMAIN NAMES, OUR BRAND AND
REPUTATION COULD BE DAMAGED AND WE COULD LOSE CUSTOMERS.
We may be unable to acquire or maintain Web domain names relating to our
brand in the United States and other countries in which we may conduct business.
As a result, we may be unable to prevent third parties from acquiring and using
domain names relating to our brand. Such use could damage our brand and
reputation and take customers away from our Web site. We currently hold various
relevant domain names, including the "eToys.com" domain name. The acquisition
and maintenance of domain names generally is regulated by governmental agencies
and their designees. For example, in the United States, the National Science
Foundation has appointed Network Solutions, Inc. as the current exclusive
registrar for the ".com", ".net" and ".org" generic top-level domains. The
regulation of domain names in the United States and in foreign countries is
subject to change in the near future. Such changes in the United States are
expected to include a transition from the current system to a system which is
controlled by a non-profit corporation and the creation of additional top-level
domains. Governing bodies may establish additional top-level domains, appoint
additional domain name registrars or modify the requirements for holding domain
names.
WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF GOVERNMENT
REGULATION INCREASES.
The adoption or modification of laws or regulations relating to the Internet
could adversely affect the manner in which we currently conduct our business. In
addition, the growth and development of the market for online commerce may lead
to more stringent consumer protection laws, both in the United States and
abroad, that may impose additional burdens on us. Laws and regulations directly
applicable to communications or commerce over the Internet are becoming more
prevalent. The United States Congress recently enacted Internet laws regarding
children's
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privacy, copyrights, taxation and the transmission of sexually explicit
material. The European Union recently enacted its own privacy regulations. The
law of the Internet, however, remains largely unsettled, even in areas where
there has been some legislative action. It may take years to determine whether
and how existing laws such as those governing intellectual property, privacy,
libel and taxation apply to the Internet.
In order to comply with new or existing laws regulating online commerce, we
may need to modify the manner in which we do business, which may result in
additional expenses. For instance, we may need to spend time and money revising
the process by which we fulfill customers' orders to ensure that each shipment
complies with applicable laws. We may need to hire additional personnel to
monitor our compliance with applicable laws. We may also need to modify our
software to further protect our customers' personal information.
WE MAY BE SUBJECT TO LIABILITY FOR THE INTERNET CONTENT THAT WE PUBLISH.
As a publisher of online content, we face potential liability for
defamation, negligence, copyright, patent or trademark infringement, or other
claims based on the nature and content of materials that we publish or
distribute. If we face liability, then our reputation and our business may
suffer. In the past, plaintiffs have brought these types of claims and sometimes
successfully litigated them against online services. Although we carry general
liability insurance, our insurance currently does not cover claims of these
types. However, this insurance is available, and we intend to obtain insurance
to cover claims of these types by the end of June 1999. We do not expect the
premium for this insurance to be material. There can be no assurance that we
will be able to obtain such insurance or that it will be adequate to indemnify
us for all liability that may be imposed on us.
OUR NET SALES COULD DECREASE IF WE BECOME SUBJECT TO SALES AND OTHER TAXES.
If one or more states or any foreign country successfully asserts that we
should collect sales or other taxes on the sale of our products, our net sales
and results of operations could be harmed. We do not currently collect sales or
other similar taxes for physical shipments of goods into states other than
California. However, one or more local, state or foreign jurisdictions may seek
to impose sales tax collection obligations on us. In addition, any new operation
in states outside California could subject our shipments in such states to state
sales taxes under current or future laws. If we become obligated to collect
sales taxes, we will need to update our system that processes customers' orders
to calculate the appropriate sales tax for each customer order and to remit the
collected sales taxes to the appropriate authorities. These upgrades will
increase our operating expenses. In addition, our customers may be discouraged
from purchasing products from us because they have to pay sales tax, causing our
net sales to decrease. As a result, we may need to lower prices to retain these
customers.
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RISKS RELATED TO SECURITIES MARKETS
WE MAY BE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS.
We cannot be certain that additional financing will be available to us on
favorable terms when required, or at all. If we raise additional funds through
the issuance of equity, equity-related or debt securities, such securities may
have rights, preferences or privileges senior to those of the rights of our
common stock and our stockholders may experience additional dilution. We require
substantial working capital to fund our business. Since our inception, we have
experienced negative cash flow from operations and expect to experience
significant negative cash flow from operations for the foreseeable future. We
currently anticipate that the net proceeds of this offering, together with our
available funds, will be sufficient to meet our anticipated needs for working
capital and capital expenditures through at least the next 12 months. We may
need to raise additional funds prior to the expiration of such period.
OUR COMMON STOCK PRICE MAY BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES
FOR INDIVIDUAL STOCKHOLDERS.
The market price for our common stock is likely to be highly volatile and
subject to wide fluctuations in response to factors including the following,
some of which are beyond our control:
- - actual or anticipated variations in our quarterly operating results;
- - announcements of technological innovations or new products or services by us
or our competitors;
- - changes in financial estimates by securities analysts;
- - conditions or trends in the Internet and/or online commerce industries;
- - changes in the economic performance and/or market valuations of other
Internet, online commerce or retail companies;
- - announcements by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
- - additions or departures of key personnel;
- - release of lock-up or other transfer restrictions on our outstanding shares of
common stock or sales of additional shares of common stock; and
- - potential litigation.
IF OUR STOCK PRICE IS VOLATILE, WE COULD FACE A SECURITIES CLASS ACTION LAWSUIT.
In the past, following periods of volatility in the market price of their
stock, many companies have been the subject of securities class action
litigation. If we were sued in a securities class action, it could result in
substantial costs and a diversion of management's attention and resources and
would cause our stock price to fall.
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SUBSTANTIAL SALES OF OUR COMMON STOCK AFTER THE OFFERING COULD CAUSE OUR STOCK
PRICE TO FALL.
If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants, in the
public market following this offering, the market price of our common stock
could fall. Such sales also might make it more difficult for us to sell equity
or equity-related securities in the future at a time and price that we deem
appropriate. Upon completion of this offering, we will have outstanding
101,784,682 shares of common stock and 14,927,676 shares of common stock subject
to options, assuming no exercise of the underwriters' over-allotment option and
no exercise of outstanding options or additional option grants after March 31,
1999. Of these shares, the shares sold in this offering and 170,250 shares
subject to fully vested options will be freely tradeable beginning on the
effective date of this prospectus. This leaves 93,464,682 remaining shares and
14,927,676 shares of common stock subject to options. 91,464,684 of such shares
will be eligible for sale in the public market beginning 180 days after the date
of this prospectus and 1,999,998 of such shares will be eligible for sale in the
public market beginning 365 days after the date of this prospectus, subject to
volume and other restrictions pursuant to Rule 144 under the Securities Act. In
addition, 14,757,426 shares subject to options will be eligible for sale in the
public market beginning 180 days after the date of this prospectus, subject to
vesting restrictions.
If the BabyCenter merger is completed, approximately 1,377,152 shares of our
common stock to be issued in exchange for outstanding shares of BabyCenter
capital stock and issuable upon exercise of assumed BabyCenter options will be
immediately eligible for sale in the public market upon closing of the merger in
accordance with the restrictions of Rule 144. The remaining 17,342,848 shares of
our common stock to be issued in exchange for outstanding shares of BabyCenter
capital stock and issuable upon exercise of assumed BabyCenter options in
connection with the merger will be eligible for public sale in the public market
beginning 180 days after the date of this prospectus, subject in to volume and
other restrictions of Rule 144. See "Management--Stock Plans", "Shares Eligible
for Future Sale" and "Underwriting".
21
<PAGE>
USE OF PROCEEDS
The net proceeds to us from the sale of the shares being offered hereby are
estimated to be $153.5 million, after deducting the underwriting discount and
estimated offering expenses payable by us, or $176.7 million if the
underwriters' over-allotment option is exercised in full.
The principal purposes of this offering are to increase our working capital,
to create a public market for our common stock, to facilitate our future access
to the public capital markets, and to increase our visibility in the retail
marketplace. We expect to use up to approximately 30% of the net proceeds of
this offering for capital expenditures associated with technology and system
upgrades and the expansion of our distribution operations and corporate offices.
We have no specific plans for the remaining proceeds. The remainder of the net
proceeds will be used for general corporate purposes and working capital. This
allocation is only an estimate and we may adjust it as necessary to address our
operational needs in the future. For instance, we may also use a portion of the
net proceeds to acquire complementary technologies or businesses; however, with
the exception of the BabyCenter merger, we currently have no commitments or
agreements and are not involved in any negotiations with respect to any such
transactions. Pending use of the net proceeds of this offering, we intend to
invest the net proceeds in interest-bearing, investment grade securities.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We
currently intend to retain all available funds and any future earnings for use
in the operation and expansion of our business and do not anticipate paying any
cash dividends in the foreseeable future.
22
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of March 31, 1999 on an
actual, pro forma, as adjusted and pro forma BabyCenter merger basis. The
"actual" column reflects our capitalization as of March 31, 1999 on a historical
basis, without any adjustments to reflect subsequent events or anticipated
events. The "pro forma" column reflects our capitalization as of March 31, 1999
with adjustments for the following:
- - the filing of an amendment to our Certificate of Incorporation to provide for
authorized capital stock of 600,000,000 shares of common stock and 10,000,000
shares of undesignated preferred stock and a three-for-one forward stock split
of our common stock and preferred stock; and
- - the automatic conversion of all shares of outstanding preferred stock into
58,730,880 shares of common stock upon the closing of this offering.
The "as adjusted" column reflects our capitalization as of March 31, 1999
with the preceding "pro forma" adjustments plus:
- - the exercise of warrants outstanding as of March 31, 1999, which expire upon
this offering, resulting in the anticipated issuance of 198,387 shares of
common stock; and
- - the receipt of the estimated net proceeds from our sale of 8,320,000 shares of
common stock at an initial public offering price of $20.00 per share.
The "pro forma BabyCenter merger" column reflects our capitalization as of
March 31, 1999 with the preceding "pro forma" and "as adjusted" adjustments plus
16,708,886 shares of common stock, subject to adjustment, expected to be issued
in exchange for all outstanding shares of BabyCenter capital stock in connection
with the proposed BabyCenter merger. See "Unaudited Pro Forma Condensed Combined
Financial Information" included elsewhere in this prospectus.
None of the columns reflect the following:
- - the 11,412 shares of common stock issuable upon exercise of a warrant that we
issued to an equipment lessor in January 1999;
- - the 38,613,864 shares of common stock reserved for issuance under our stock
option plans and stock purchase plans, of which 14,927,676 shares were subject
to outstanding options as of March 31, 1999; and
- - the 2,011,114 shares of common stock, subject to adjustment, expected to be
reserved for issuance upon the exercise of assumed BabyCenter options in
connection with the proposed BabyCenter merger. See "Unaudited Pro Forma
Condensed Combined Financial Information" included elsewhere in this
prospectus.
23
<PAGE>
The table below should be read in conjunction with our balance sheet as of
March 31, 1999 and the related notes, which are included elsewhere in this
prospectus. The table below reflects that we recorded deferred compensation of
$44.7 million for the fiscal year ended March 31, 1999. You should review Notes
5 and 8 to the notes to our financial statements included elsewhere in this
prospectus for descriptions of our Series A preferred stock, Series B preferred
stock and Series C preferred stock.
<TABLE>
<CAPTION>
MARCH 31, 1999
---------------------------------------------------
PRO FORMA
BABYCENTER
ACTUAL PRO FORMA AS ADJUSTED MERGER
---------- ----------- ------------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Long-term capital lease obligations, less current portion............... $ 477 $ 477 $ 477 $ 1,041
Redeemable Convertible Preferred Stock, 19,593,089 shares authorized:
Series A Preferred Stock; $.0001 par value; 7,023,645 shares issued
and outstanding, actual; no shares authorized, issued or
outstanding, pro forma, as adjusted and pro forma BabyCenter
merger.............................................................. 4,355 -- -- --
Series B Preferred Stock; $.0001 par value; 11,886,649 shares issued
and outstanding, actual; no shares authorized, issued or
outstanding, pro forma, as adjusted and pro forma BabyCenter
merger.............................................................. 24,952 -- -- --
Series C Preferred Stock, $.0001 par value, 666,666 shares issued and
outstanding, actual; no shares authorized, issued or outstanding,
pro forma, as adjusted and pro forma BabyCenter merger.............. 19,984 -- -- --
Stockholders' equity (deficit):
Preferred Stock: $.0001 par value, 5,000,000 shares authorized, none
issued or outstanding actual, 10,000,000 shares authorized, none
issued or outstanding, pro forma, as adjusted and pro forma
BabyCenter merger................................................... -- -- -- --
Common Stock: $.0001 par value, 150,000,000 shares authorized,
34,535,415 shares issued and outstanding actual; 600,000,000 shares
authorized, 93,266,295 issued and outstanding, pro forma;
101,784,682 shares issued and outstanding, as adjusted; 118,493,568
shares issued and outstanding, pro forma BabyCenter merger.......... 3 9 10 12
Additional paid-in capital.............................................. 45,837 95,122 248,600 453,335
Receivables from stockholders........................................... (138) (138) (138) (138)
Deferred compensation................................................... (38,974) (38,974) (38,974) (54,431)
Accumulated deficit..................................................... (30,826) (30,826) (30,826) (30,826)
---------- ----------- ------------ ------------
Total stockholders' equity (deficit)................................ (24,098) 25,193 178,672 367,952
---------- ----------- ------------ ------------
Total capitalization............................................ $ 25,670 $ 25,670 $ 179,149 $ 368,993
---------- ----------- ------------ ------------
---------- ----------- ------------ ------------
</TABLE>
24
<PAGE>
DILUTION
Our pro forma net tangible book value as of March 31, 1999 was approximately
$24.2 million or $0.26 per share. Net tangible book value per share represents
the amount of our total tangible assets reduced by the amount of our total
liabilities and divided by the total number of shares of common stock
outstanding after giving effect to the automatic conversion of the preferred
stock. Dilution in net tangible book value per share represents the difference
between the amount per share paid by purchasers of shares of common stock in
this offering and the net tangible book value per share of common stock
immediately after the completion of this offering. After giving effect to the
sale of the 8,320,000 shares of common stock offered by us at an initial public
offering price of $20.00 per share, and after deducting the underwriting
discount and estimated offering expenses payable by us, our pro forma net
tangible book value at March 31, 1999 would have been approximately $177.6
million or $1.75 per share of common stock. This represents an immediate
increase in net tangible book value of $1.49 per share to existing stockholders
and an immediate dilution of $18.25 per share to new investors of common stock.
The following table illustrates this dilution on a per share basis:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................................... $ 20.00
Pro forma net tangible book value per share before the offering........... $ 0.26
Increase per share attributable to new investors.......................... 1.49
---------
Pro forma net tangible book value per share after the offering (as
adjusted)................................................................. 1.75
---------
Dilution per share to new investors......................................... $ 18.25
---------
---------
</TABLE>
The following table summarizes on an as adjusted basis after giving effect
to the offering, as of March 31, 1999, the differences between the existing
stockholders and new investors with respect to the number of shares of common
stock purchased from us, the total consideration paid to us and the average
price per share paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- --------------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
-------------- --------- ---------------- --------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders.......................... 93,464,682 91.8% $ 50,415,000 23.3% $ 0.54
New investors.................................. 8,320,000 8.2 166,400,000 76.7 20.00
-------------- --------- ---------------- ---------
Totals......................................... 101,784,682 100.0% $ 216,815,000 100.0%
-------------- --------- ---------------- ---------
-------------- --------- ---------------- ---------
</TABLE>
The preceding tables include an aggregate of 198,387 shares of common stock
issuable upon the exercise of warrants outstanding as of March 31, 1999, which
expire at, and are expected to be exercised prior to, the completion of this
offering. The preceding tables exclude 38,613,864 shares of common stock
reserved for issuance under our stock option plans and stock purchase plans, of
which 14,927,676 were subject to outstanding options as of March 31, 1999 at a
weighted average exercise price of $1.595 per share and 11,412 shares of common
stock issuable upon exercise of a warrant that we issued to an equipment lessor
in January 1999. The preceding tables also exclude the aggregate of 18,720,000
shares of common stock to be issued in exchange for all outstanding shares of
BabyCenter capital stock and reserved for issuance upon the exercise of assumed
BabyCenter options in connection with the proposed BabyCenter merger.
25
<PAGE>
SELECTED FINANCIAL DATA
You should read the selected financial and operating data set forth below
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our financial statements and the notes included
elsewhere in this prospectus. You should review Note 1 to the notes to our
financial statements included elsewhere in this prospectus for an explanation of
the determination of the number of shares and share equivalents used in
computing the pro forma per share amounts set forth below. The pro forma share
amounts reflect the conversion of preferred stock into common stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Unaudited Pro Forma Condensed Combined Financial Information".
The selected financial data reflect that prior to June 1997, we had no
operations or activities. The statement of operations data set forth below for
the fiscal years ended March 31, 1998 and 1999, and the selected balance sheet
data as of March 31, 1998 and 1999 have been derived from our audited financial
statements appearing elsewhere in this prospectus. The statement of operations
data displayed in the "Pro Forma BabyCenter Merger 1999" column and the balance
sheet data displayed in the "Pro Forma BabyCenter Merger" column give effect to
the BabyCenter merger expected to be completed by the end of June 1999. Our
general and administrative operating expenses include expenses related to the
amortization of deferred compensation which is $2,000 for the fiscal year ended
March 31, 1998 and $5.8 million for the fiscal year ended March 31, 1999.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
MARCH 31,
-----------------------------------------
PRO FORMA
BABYCENTER
1998 1999 MERGER 1999
------------ ------------ -------------
<S> <C> <C> <C>
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE
DATA)
STATEMENT OF OPERATIONS DATA:
Net sales.............................................................. $ 687 $ 29,959 $ 34,727
Cost of sales.......................................................... 568 24,246 25,227
------------ ------------ -------------
Gross profit........................................................... 119 5,713 9,500
Operating expenses:
Marketing and sales.................................................. 1,290 20,719 23,180
Product development.................................................. 421 3,608 7,360
General and administrative........................................... 678 10,166 16,405
Goodwill amortization................................................ -- 319 36,455
------------ ------------ -------------
Total operating expenses....................................... 2,389 34,812 83,400
------------ ------------ -------------
Operating loss......................................................... (2,270) (29,099) (73,900)
Interest income (expense), net......................................... 3 542 798
------------ ------------ -------------
Loss before income taxes............................................... (2,267) (28,557) (73,102)
Provision for income taxes............................................. 1 1 1
------------ ------------ -------------
Net loss............................................................... $ (2,268) $ (28,558) $ (73,103)
------------ ------------ -------------
------------ ------------ -------------
Basic net loss per share............................................... $ (0.09) $ (0.85) $ (1.46)
------------ ------------ -------------
------------ ------------ -------------
Pro forma for conversion of preferred stock basic net loss per share... $ (0.08) $ (0.35) $ (0.74)
------------ ------------ -------------
------------ ------------ -------------
Shares used to compute basic net loss per share........................ 25,129,888 33,427,908 50,136,794
------------ ------------ -------------
------------ ------------ -------------
Shares used to compute pro forma for conversion of preferred stock
basic net loss per share............................................. 30,232,902 81,923,187 98,632,073
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1999
------------------------
PRO FORMA
MARCH 31, BABYCENTER
1998 ACTUAL MERGER
----------- --------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................................................. $ 1,552 $ 20,173 $ 29,173
Working capital............................................................ 1,456 21,821 29,643
Total assets............................................................... 2,927 30,666 222,639
Long-term capital lease obligations, less current portion.................. -- 477 1,041
Total stockholders' equity (deficit)....................................... (1,345) (24,098) 165,182
</TABLE>
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EXCEPT FOR HISTORICAL INFORMATION, THE DISCUSSION IN THIS PROSPECTUS
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THESE
STATEMENTS REFER TO OUR FUTURE PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS.
THESE STATEMENTS MAY BE IDENTIFIED BY THE USE OF WORDS SUCH AS "EXPECTS",
"ANTICIPATES", "INTENDS", "PLANS" AND SIMILAR EXPRESSIONS. OUR ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CONTRIBUTE TO THESE DIFFERENCES INCLUDE, BUT ARE
NOT LIMITED TO, THE RISKS DISCUSSED IN THE SECTION TITLED "RISK FACTORS" IN THIS
PROSPECTUS.
OVERVIEW
We are a leading Web-based retailer focused exclusively on children's
products, including toys, video games, software, videos and music. We currently
offer an extensive selection of competitively priced children's products
consisting of over 9,500 SKUs representing more than 750 brands.
We were incorporated in November 1996 and began offering products for sale
on our Web site and entered into a marketing agreement with AOL on October 1,
1997. For the period from inception through October 1, 1997, we had no sales and
our operating activities related primarily to the development of the necessary
computer infrastructure and initial planning and development of our Web site and
operations. Since launching our online store, we have continued these operating
activities and have also focused on building sales momentum, expanding our
product offerings, establishing vendor relationships, promoting our brand name
and establishing distribution and customer service operations. Our cost of sales
and operating expenses have increased significantly since inception. This trend
reflects the costs associated with our formation as well as increased efforts to
promote our brand, build market awareness, attract new customers, recruit
personnel, build operating infrastructure and develop our Web site and
associated systems that we use to process customers' orders and payments.
We have grown rapidly since launching our online store in October 1997.
During the fall of 1998, we launched our redesigned Web site and added video
game, software, video and music departments to our online store. Our net sales
increased to $30.0 million for the fiscal year ended March 31, 1999 from $0.7
million for the fiscal year ended March 31, 1998. The market for children's
toys, video games, software, videos and music is highly seasonal. A
disproportionate amount of our net sales have been realized during the fourth
calendar quarter and we expect this trend to continue in future periods. In
addition, since a disproportionate amount of our net sales are realized during
the fourth calendar quarter, we significantly increase our purchases of
inventory during such quarter. Accordingly, our accounts payable are at their
highest levels during the fourth calendar quarter. Our gross margin was 19% for
the fiscal year ended March 31, 1999. Our gross margin will fluctuate in future
periods based on factors such as product mix, inventory management, inbound and
outbound shipping costs, the level of product returns, and the level of discount
pricing and promotional coupon usage.
Since 1997, we have significantly increased the depth of our management team
to help implement our growth strategy. To facilitate our growth, we have
recently expanded our senior management team to include a Chief Financial
Officer, Chief Information Officer and Senior Vice President of Operations.
On April 18, 1999, we entered into a merger agreement with BabyCenter, Inc.
pursuant to which a new subsidiary of ours will merge into BabyCenter so that
BabyCenter becomes our wholly owned subsidiary. BabyCenter is a Web-based
business that offers a wide variety of content, community and products focused
on and serving expectant mothers and new parents. Visitors to
27
<PAGE>
the BabyCenter Web site can read health articles and parenting news, interact
online with other families and purchase a wide selection of baby products and
supplies. BabyCenter derives its net sales principally from product sales and
sales of advertisement space as well as sponsorships with various companies.
BabyCenter is a Delaware corporation that is based in San Francisco, California,
with approximately 105 employees.
Upon the completion of this merger, an aggregate of 18,720,000 shares of our
common stock will be issued in exchange for all outstanding shares of BabyCenter
capital stock and reserved for issuance upon the exercise of BabyCenter options
we assume in connection with the proposed merger. In addition, if the BabyCenter
merger is completed, we will record a significant amount of goodwill and
deferred compensation that will significantly reduce our earnings and
profitability for the foreseeable future. We expect to record goodwill of
approximately $180.7 million and deferred compensation of approximately $15.5
million, to be amortized over a five-year period and four-year period,
respectively. To the extent we do not generate sufficient cash flow to recover
the amount of the investment recorded, the investment may be considered impaired
and could be subject to earlier write-off. We anticipate that the BabyCenter
merger will close by the end of June 1999. The BabyCenter merger is subject to a
number of conditions, including the receipt of governmental approvals, approval
of the merger by the stockholders of BabyCenter and other customary closing
conditions. As a result, the BabyCenter merger may not be completed.
Since inception, we have incurred significant losses and, as of March 31,
1999, had an accumulated deficit of $30.8 million. We expect operating losses
and negative cash flow to continue for the foreseeable future. We anticipate our
losses will increase significantly from current levels because we expect to
incur additional costs and expenses related to brand development, marketing and
other promotional activities; the expansion of our inventory management and
distribution operations; the continued development of our Web site, systems that
we use to process customers' orders and payments and our computer network; the
expansion of our product offerings and Web site content; and development of
relationships with strategic business partners.
We have a limited operating history on which to base an evaluation of our
business and prospects. You must consider our prospects in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving markets
such as online commerce. Such risks for us include, but are not limited to, an
evolving and unpredictable business model and management of growth. To address
these risks, we must, among other things, maintain and expand our customer base,
implement and successfully execute our business and marketing strategy, continue
to develop and upgrade our technology and systems that we use to process
customers' orders and payments, improve our Web site, provide superior customer
service, respond to competitive developments and attract, retain and motivate
qualified personnel. We cannot assure that we will be successful in addressing
such risks, and our failure to do so could have a material adverse effect on our
business, prospects, financial condition and results of operations.
In connection with this offering of shares of our common stock, options
granted in the fiscal years ended March 31, 1997, 1998 and 1999 have been
considered to be compensatory. Deferred compensation associated with such
options for the fiscal year ended March 31, 1999 amounted to $44.7 million. Of
this amount, $5.8 million was charged to operations for the fiscal year ended
March 31, 1999 and $38.9 million will be amortized over the vesting periods of
the applicable options through the fiscal year ending March 31, 2003. In April
and May 1999, we granted options to purchase an aggregate of 2,122,302 shares of
our common stock at an exercise price of $11.00 per share. We granted most of
these options to 67 new employees. The options granted in May 1999 have been
considered to be compensatory. Deferred compensation associated with such
options is $14.7 million. This amount will be amortized to expense on a
straight-line basis over the four-year vesting periods of the applicable options
through the fiscal year ending March 31, 2004.
28
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth statement of operations data as a percentage
of net sales for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
MARCH 31,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Net sales....................................................................................... 100% 100%
Cost of sales................................................................................... 83 81
--------- ---------
Gross profit.................................................................................... 17 19
Operating expenses:
Marketing and sales........................................................................... 188 69
Product development........................................................................... 61 12
General and administrative.................................................................... 99 35
--------- ---------
Total operating expenses.................................................................. 348 116
--------- ---------
Operating loss.................................................................................. (330) (97)
Interest income (expense), net.................................................................. 0 2
Provision for income taxes...................................................................... 0 --
--------- ---------
Net loss........................................................................................ (330)% (95)%
--------- ---------
--------- ---------
</TABLE>
FISCAL YEARS ENDED MARCH 31, 1998 AND 1999
Our fiscal year runs from April 1 through March 31. We commenced offering
products for sale on our Web site on October 1, 1997, and, accordingly, the
fiscal year ended March 31, 1998 only includes a period of six months during
which we were generating net sales and incurring expenses. Consequently, our net
sales and expenses for the fiscal year ended March 31, 1999 have increased due
to a full year of net sales generated and expenses incurred during such period
as compared to six months of net sales and expenses incurred during the fiscal
year ended March 31, 1998.
NET SALES
Net sales consist of product sales to customers and charges to customers for
outbound shipping and handling and gift wrapping and are net of product returns,
promotional discounts and coupons. Net sales increased to $30.0 million for the
fiscal year ended March 31, 1999 from $0.7 million for the fiscal year ended
March 31, 1998 as a result of the significant growth of our customer base and an
increase in repeat purchases from our existing customers, reflecting the
relaunch of our Web site and the addition of new departments to our online store
during the fall of 1998.
COST OF SALES
Cost of sales consists primarily of the costs of products sold to customers,
outbound and inbound shipping and handling costs, and gift wrapping costs. Cost
of sales increased to $24.2 million for the fiscal year ended March 31, 1999
from $0.6 million for the fiscal year ended March 31, 1998. This $23.6 million
increase was primarily attributable to our increased sales volume. We expect
cost of sales to increase in future periods to the extent that our sales volume
increases. Our gross profit margin increased to 19% of net sales for the fiscal
year ended March 31, 1999 from 17% of net sales for the fiscal year ended March
31, 1998. This increase was primarily due to greater sales of higher margin
products as a percentage of our overall net sales and improved purchasing. There
can be no assurance that we will continue to achieve improved purchasing in
future periods.
29
<PAGE>
OPERATING EXPENSES
MARKETING AND SALES. Marketing and sales expenses consist primarily of
advertising and promotional expenditures, distribution facility expenses,
including equipment and supplies, and payroll and related expenses for personnel
engaged in marketing, customer service and distribution activities. Marketing
and sales expenses increased to $20.7 million for the fiscal year ended March
31, 1999 from $1.3 million for the fiscal year ended March 31, 1998. This $19.4
million increase was primarily attributable to the expansion of our online and
offline advertising, including a comprehensive print and television advertising
campaign, as well as to increased personnel and related expenses required to
implement our marketing strategy. In addition, due to a significant increase in
our sales volume, we experienced higher distribution and customer service
expenses, including an increased level of temporary staffing during the holiday
season. Marketing and sales expenses as a percentage of net sales decreased to
69% for the fiscal year ended March 31, 1999 from 188% for the fiscal year ended
March 31, 1998. Such expenses decreased significantly as a percentage of net
sales during the fiscal year ended March 31, 1999 due to the significant
increase in net sales during such period. We intend to continue to pursue an
aggressive branding and marketing campaign and, therefore, expect marketing and
sales expenses to increase significantly in absolute dollars in future periods.
In addition, to the extent that our sales volume increases in future periods, we
expect marketing and sales expenses to increase in absolute dollars as we expand
our distribution facilities to accommodate such increases in sales volume.
PRODUCT DEVELOPMENT. Product development expenses consist primarily of
payroll and related expenses for merchandising, Web site development and
information technology personnel, Internet access and hosting charges and Web
content and design expenses. Product development expenses increased to $3.6
million for the fiscal year ended March 31, 1999 from $0.4 million for the
fiscal year ended March 31, 1998. This $3.2 million increase was primarily
attributable to increased staffing and associated costs related to enhancing the
features, content and functionality of our online store and increasing the
capacity of our systems that we use to process customers' orders and payments.
Product development expenses as a percentage of net sales decreased to 12% for
the fiscal year ended March 31, 1999 from 61% for the fiscal year ended March
31, 1998. Such expenses decreased significantly as a percentage of net sales
during the fiscal year ended March 31, 1999 due to the significant increase in
net sales during such period. We believe that continued investment in product
development is critical to attaining our strategic objectives and, as a result,
expect product development expenses to increase significantly in absolute
dollars.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of
payroll and related expenses for executive and administrative personnel,
facilities expenses, professional services expenses, travel and other general
corporate expenses. General and administrative expenses increased to $10.5
million for the fiscal year ended March 31, 1999 from $0.7 million for the
fiscal year ended March 31, 1998. This $9.8 million increase was primarily
attributable to increased headcount and related expenses associated with the
hiring of additional personnel, and increased professional services expenses.
General and administrative expenses as a percentage of net sales decreased to
35% for the fiscal year ended March 31, 1999 from 99% for the fiscal year ended
March 31, 1998. Such expenses decreased significantly as a percentage of net
sales during the fiscal year ended March 31, 1999 due to the significant
increase in net sales during such period. We expect general and administrative
expenses to increase in absolute dollars as we expand our staff and incur
additional costs related to the growth of our business and being a public
company. We further expect our general and administrative expenses to increase
if the BabyCenter merger is completed due to the associated increase in
personnel and expenses related to the integration of BabyCenter's operations
with our operations. We do not currently have an estimate of this expected
increase in general and administrative expenses because we have not yet
developed
30
<PAGE>
a plan for integrating BabyCenter's operations with our operations. We are
currently evaluating the potential integration opportunities as a result of the
BabyCenter merger.
In the fiscal year ended March 31, 1999, we recorded total deferred stock
compensation of $44.7 million in connection with stock options granted during
the period, including approximately $0.3 million which represents the fair value
of options granted to non-employees during this period. Such amount is amortized
to expense over the vesting periods of the applicable options, resulting in $5.8
million for the fiscal year ended March 31, 1999, which is included in general
and administrative expenses. These amounts represent the difference between the
exercise price of stock option grants and the deemed fair value of our common
stock at the time of such grants.
Amortization of deferred compensation expense for each of the next four
fiscal years is expected to be as follows:
<TABLE>
<CAPTION>
AMOUNT
YEAR ENDED (IN THOUSANDS)
- ------------------------------------------------------------------------------ --------------
<S> <C>
March 31, 2000................................................................ $ 10,806
March 31, 2001................................................................ 10,806
March 31, 2002................................................................ 10,798
March 31, 2003................................................................ 6,564
</TABLE>
GOODWILL AND INTANGIBLE ASSETS
If the BabyCenter merger is completed, we will record a significant amount
of goodwill, the amortization of which will significantly reduce our earnings
and profitability for the foreseeable future. We expect to record goodwill of
approximately $180.7 million, to be amortized over a five-year period. To the
extent the amount of this recorded goodwill is increased or we do not generate
additional sufficient cash flow to recover the amount of the investment
recorded, the investment may be considered impaired or be subject to earlier
write-off. In such event, our net loss in any given period could be greater than
anticipated and the market price of our stock could decline.
INTEREST INCOME (EXPENSE), NET
Interest income (expense), net consists of earnings on our cash and cash
equivalents, net of interest expense attributable to convertible notes in the
approximate principal amount of $895,000. These convertible notes were
subsequently converted into shares of preferred stock in December 1997. Net
interest income increased to $0.5 million for the fiscal year ended March 31,
1999 from $3,000 for the fiscal year ended March 31, 1998. This $0.5 million
increase was primarily attributable to earnings on higher average cash and cash
equivalent balances during the fiscal year ended March 31, 1999.
INCOME TAXES
As of March 31, 1999, we had $24.4 million of net operating loss
carryforwards for federal income tax purposes, which expire beginning in 2012.
We have provided a full valuation allowance on the deferred tax asset,
consisting primarily of net operating loss carryforwards, because of uncertainty
regarding its realizability. Changes in the ownership of our common stock, as
defined in the Internal Revenue Code of 1986, as amended, may restrict the
utilization of such carryforwards. See Note 3 of Notes to Financial Statements.
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QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly statement of operations
data for the six quarters ended March 31, 1999. This unaudited quarterly
information has been derived from our unaudited financial statements and, in the
opinion of management, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the information for
the periods covered. The quarterly data should be read in conjunction with our
financial statements and related notes. The operating results for any quarter
are not necessarily indicative of the operating results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------
DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1997 1998 1998 1998 1998 1999
----------- ------------ ----------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales............................... $ 530 $ 157 $ 381 $ 608 $ 22,910 $ 6,059
Cost of sales........................... 438 130 311 496 18,201 5,238
----------- ------------ ----------- ----------- ----------- -----------
Gross profit............................ 92 27 70 112 4,709 821
Operating expenses:
Marketing and sales................... 444 658 1,370 2,372 10,611 6,365
Product development................... 145 215 404 697 905 1,602
General and administrative(1)......... 234 312 462 703 3,180 6,140
----------- ------------ ----------- ----------- ----------- -----------
Total operating expenses.......... 823 1,185 2,236 3,772 14,696 14,107
----------- ------------ ----------- ----------- ----------- -----------
Operating loss.......................... (731) (1,158) (2,166) (3,660) (9,987) (13,286)
Interest income (expense), net.......... (15) 18 (5) 277 166 104
Provision for income taxes.............. -- 1 -- -- 1 --
----------- ------------ ----------- ----------- ----------- -----------
Net loss................................ $ (746) $ (1,141) $ (2,171) $ (3,383) $ (9,822) $ (13,182)
----------- ------------ ----------- ----------- ----------- -----------
----------- ------------ ----------- ----------- ----------- -----------
AS A PERCENTAGE OF NET SALES:
Net sales............................... 100 % 100 % 100 % 100 % 100 % 100 %
Cost of sales........................... 83 83 82 82 79 86
----------- ------------ ----------- ----------- ----------- -----------
Gross profit............................ 17 17 18 18 21 14
Operating expenses:
Marketing and sales................... 84 419 360 390 46 105
Product development................... 27 137 106 115 4 26
General and administrative(1)......... 44 199 121 116 14 101
----------- ------------ ----------- ----------- ----------- -----------
Total operating expenses............ 155 755 587 620 64 233
----------- ------------ ----------- ----------- ----------- -----------
Operating loss.......................... (138) (738) (569) (602) (44) (219)
Interest income (expense), net.......... (3) 12 (1) 46 1 2
Provision for income taxes.............. -- 1 -- -- -- --
----------- ------------ ----------- ----------- ----------- -----------
Net loss................................ (141)% (727)% (570)% (556)% (43)% (218)%
----------- ------------ ----------- ----------- ----------- -----------
----------- ------------ ----------- ----------- ----------- -----------
</TABLE>
- ------------------------------
(1) Included in general and administrative expenses are $2,000, $43,700,
$69,300, $1.51 million and $4.2 million related to the amortization expense
of deferred compensation for the quarters ended March 31, 1998, June 30,
1998, September 30, 1998, December 31, 1998 and March 31, 1999,
respectively.
Our quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future due to a variety of factors. For example,
during the quarter ended March 31, 1999, we experienced approximately $270,000
of inventory theft, which resulted in a 4% decrease in our gross profit margin
for the quarter ended March 31, 1999 and a 1% decrease in our gross profit
margin for fiscal 1998. We have begun undertaking a number of measures designed
to address inventory theft, including the installation of enhanced security
measures at our distribution facility. These measures may not successfully
reduce or prevent inventory theft in future periods. If these measures are not
successful, our gross profit margins and results of operations may be
significantly below expectations in future periods.
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Other factors that may harm our business or cause our operating results to
fluctuate include the following, many of which are outside of our control:
- - our inability to obtain new customers at reasonable cost, retain existing
customers, or encourage repeat purchases;
- - decreases in the number of visitors to our Web site or our inability to
convert visitors to our Web site into customers;
- - the mix of toys, video games, software, videos and music sold by us;
- - seasonality;
- - our inability to manage inventory levels or control inventory theft;
- - our inability to manage our distribution operations;
- - our inability to adequately maintain, upgrade and develop our Web site,
systems that we use to process customers' orders and payments or our computer
network;
- - the ability of our competitors to offer new or enhanced Web sites, services or
products;
- - price competition;
- - an increase in the level of our product returns;
- - fluctuations in the demand for children's products associated with movies,
television and other entertainment events;
- - our inability to obtain popular children's toys, video games, software, videos
and music from our vendors;
- - fluctuations in the amount of consumer spending on children's toys, video
games, software, videos and music;
- - the termination of existing or failure to develop new marketing relationships
with key business partners;
- - the extent to which we are not able to participate in advertising campaigns
such as those conducted by Visa and Intel;
- - increases in the cost of online or offline advertising;
- - the amount and timing of operating costs and capital expenditures relating to
expansion of our operations;
- - unexpected increases in shipping costs or delivery times, particularly during
the holiday season;
- - technical difficulties, system downtime or Internet brownouts;
- - government regulations related to use of the Internet for commerce or for
sales and distribution of toys, video games, software, videos and music; and
- - economic conditions specific to the Internet, online commerce and the
children's toy, video game, software, video and music industries.
Due to the foregoing factors, we believe that quarter-to-quarter comparisons
of our operating results are not a good indication of our future performance. It
is likely that in some future quarter our operating results may fall below the
expectations of securities analysts and investors. In this event, the trading
price of our common stock may fall significantly.
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RESULTS OF OPERATIONS--BABYCENTER
Since inception, BabyCenter has incurred significant operating losses.
During the 12 months ended March 31, 1999, BabyCenter recorded net sales of
approximately $4.8 million, primarily from sales of advertisment space and
sponsorships with various companies and the online sale of baby products and
supplies, and recorded a net loss of approximately $4.5 million. During the 12
months ended March 31, 1999, BabyCenter incurred total operating expenses of
approximately $8.6 million, which consisted primarily of marketing and sales and
technology and development expenses. At March 31, 1999, BabyCenter had working
capital of approximately $7.8 million and a total accumulated deficit of
approximately $5.6 million. It is expected that BabyCenter's marketing and sales
and technology and development expenses will continue to increase in future
periods.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through private
sales of preferred stock which through March 31, 1999, totaled $48.7 million.
Net cash used in operating activities was $23.9 million in the fiscal year
ended March 31, 1999, and $2.1 million in the fiscal year ended March 31, 1998.
Net cash used in operating activities for each of these periods primarily
consisted of net losses as well as increases in inventories and prepaid
expenses, partially offset by increases in accounts payable, accrued expenses
and depreciation and amortization. The significant increase in working capital
during the fiscal year ended March 31, 1999 was primarily due to significant
growth in our operations.
Net cash used in investing activities was $2.7 million in the fiscal year
ended March 31, 1999, and $0.4 million in the fiscal year ended March 31, 1998.
Net cash used in investing activities for each of these periods primarily
consisted of leasehold improvements and purchases of equipment and systems,
including computer equipment and fixtures and furniture.
Net cash provided by financing activities was $45.3 million in the fiscal
year ended March 31, 1999, and $4.1 million in the fiscal year ended March 31,
1998. Net cash provided by financing activities during the fiscal year ended
March 31, 1999 primarily consisted of proceeds of $44.8 million from the
issuance of preferred stock.
As of March 31, 1999 we had $20.2 million of cash and cash equivalents. As
of that date, our principal commitments consisted of obligations outstanding
under operating leases. Although we have no material commitments for capital
expenditures, we anticipate a substantial increase in our capital expenditures
and lease commitments consistent with anticipated growth in operations,
infrastructure and personnel. We plan to open an additional distribution
facility during fiscal 1999, which may require us to purchase real estate or
commit to additional lease obligations and to purchase equipment and install
leasehold improvements.
We entered into a marketing agreement with AOL, the leading Internet online
service provider, in October 1997. This agreement established us as a provider
of children's toy products featured on the AOL Network and AOL's Web site,
aol.com. In addition, AOL agreed to prominently promote and advertise eToys on a
non-exclusive basis in online areas controlled by AOL specified in the
agreement. Furthermore, under the agreement, AOL has committed that AOL users
will annually access the online areas promoting eToys a specified number of
times. Over the 26-month term of the agreement, we are obligated to make minimum
payments totaling $3.1 million to AOL, of which $1.1 million remained to be paid
as of March 31, 1999. We have also agreed to offer for sale a substantial
selection of children's products, to feature different children's products each
week, to offer special deals to AOL users through the AOL online area, to
provide children's toy products that are competitive in price and performance
and to manage, operate and support such content and children's toy products. The
agreement with AOL expires on December 31, 1999; however,
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AOL may terminate the agreement earlier in the event we materially breach the
agreement or in the event of bankruptcy or insolvency or similar adverse
financial events specified in the agreement. Although there can be no assurance,
we do not believe that there is any material risk that AOL would be able to
terminate the agreement earlier than December 31, 1999 because of insolvency or
any of the other specified adverse financial events.
During the fiscal year ended March 31, 1999, we entered into a number of
commitments for online and traditional offline advertising. As of March 31,
1999, our remaining commitments were $7.7 million, excluding amounts due under
our agreement with AOL, which will be paid by March 31, 2000.
We currently anticipate that the net proceeds of this offering, together
with our available funds, will be sufficient to meet our anticipated needs for
working capital and capital expenditures through at least the next 12 months. We
may need to raise additional funds prior to the expiration of such period if,
for example, we pursue business or technology acquisitions or experience
operating losses that exceed our current expectations. If we raise additional
funds through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders may experience additional
dilution. We cannot be certain that additional financing will be available to us
on favorable terms when required, or at all.
YEAR 2000
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 change in the century. If not corrected, many computer software
applications could fail or create erroneous results by, at or beyond the year
2000. We use software, computer technology and other services internally
developed and provided by third-party vendors that may fail due to the year 2000
phenomenon. For example, we are dependent on the financial institutions involved
in processing our customers' credit card payments for Internet services and a
third party that hosts our servers. We are also dependent on telecommunications
vendors to maintain our network and the United States Postal Service and other
third-party carriers to deliver orders to customers.
We are in the process of reviewing the year 2000 compliance of our
internally developed proprietary software. This review has included testing to
determine how our systems will function at and beyond the year 2000. We expect
to complete these tests during the summer of 1999. Since inception, we have
internally developed substantially all of the systems for the operation of our
Web site. These systems include the software used to provide our Web site's
search, customer interaction, and transaction-processing and distribution
functions, as well as monitoring and back-up capabilities. Based upon our
assessment to date, we believe that our internally developed proprietary
software is year 2000 compliant.
We are currently assessing the year 2000 readiness of our third-party
supplied software, computer technology and other services, which include
software for use in our accounting, database and security systems. The failure
of such software or systems to be year 2000 compliant could have a material
negative impact on our corporate accounting functions and the operation of our
Web site. As part of the assessment of the year 2000 compliance of these
systems, we have sought assurances from these vendors that their software,
computer technology and other services are year 2000 compliant. We have expensed
amounts incurred in connection with year 2000 assessment since our formation
through March 31, 1999. Such amounts have not been material. We expect this
assessment process to be completed during the summer of 1999. Based upon the
results of this assessment, we will develop and implement, if necessary, a
remediation plan with respect to third-party software, third-party vendors and
computer technology and services that may
35
<PAGE>
fail to be year 2000 compliant. We expect to complete any required remediation
during the summer of 1999. At this time, the expenses associated with this
assessment and potential remediation plan that may be incurred in the future
cannot be determined; therefore, we have not developed a budget for these
expenses. The failure of our software and computer systems and of our
third-party suppliers to be year 2000 complaint would have a material adverse
effect on us.
The year 2000 readiness of the general infrastructure necessary to support
our operations is difficult to assess. For instance, we depend on the integrity
and stability of the Internet to provide our services. We also depend on the
year 2000 compliance of the computer systems and financial services used by
consumers. Thus, the infrastructure necessary to support our operations consists
of a network of computers and telecommunications systems located throughout the
world and operated by numerous unrelated entities and individuals, none of which
has the ability to control or manage the potential year 2000 issues that may
impact the entire infrastructure. Our ability to assess the reliability of this
infrastructure is limited and relies solely on generally available news reports,
surveys and comparable industry data. Based on these sources, we believe most
entities and individuals that rely significantly on the Internet are carefully
reviewing and attempting to remediate issues relating to year 2000 compliance,
but it is not possible to predict whether these efforts will be successful in
reducing or eliminating the potential negative impact of year 2000 issues. A
significant disruption in the ability of consumers to reliably access the
Internet or portions of it or to use their credit cards would have an adverse
effect on demand for our services and would have a material adverse effect on
us.
At this time, we have not yet developed a contingency plan to address
situations that may result if we or our vendors are unable to achieve year 2000
compliance because we currently do not believe that such a plan is necessary.
The cost of developing and implementing such a plan, if necessary, could be
material. Any failure of our material systems, our vendors' material systems or
the Internet to be year 2000 compliant could have material adverse consequences
for us. Such consequences could include difficulties in operating our Web site
effectively, taking product orders, making product deliveries or conducting
other fundamental parts of our business.
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<PAGE>
BUSINESS
ETOYS
We are a leading Web-based retailer focused exclusively on children's
products, including toys, video games, software, videos and music. By combining
our expertise in children's products and our commitment to excellent customer
service with the benefits of Internet retailing, we are able to deliver a unique
shopping experience to consumers. Our online store offers an extensive selection
of competitively priced children's products, with over 9,500 SKUs representing
more than 750 brands. Our Web site features detailed product information,
helpful and useful shopping services and innovative merchandising through
easy-to-use Web pages. In addition, we offer customers the convenience and
flexibility of shopping 24 hours a day, seven days a week, with reliable and
timely product delivery and excellent customer service.
As of March 31, 1999, we have sold children's products to approximately
365,000 customers, of which approximately 75,000 were added during the quarter
ended March 31, 1999. Our net sales for the fiscal year ended March 31, 1999
totaled $30.0 million as compared to $0.7 million for the fiscal year ended
March 31, 1998.
INDUSTRY OVERVIEW
ELECTRONIC COMMERCE
The Internet is an increasingly significant medium for communication,
information and commerce. International Data Corporation estimates that there
were 97 million Web users worldwide at the end of 1998 and anticipates this
number will grow to approximately 320 million users by the end of 2002. We
believe that growth in Internet usage and online commerce is being fueled by a
number of factors including:
- - a large and growing installed base of personal computers in the workplace and
home;
- - advances in the performance and speed of personal computers and modems;
- - improvements in network security, infrastructure and bandwidth;
- - easier and cheaper access to the Internet; and
- - the rapidly expanding availability of online content and commerce sites.
The unique characteristics of the Internet provide a number of advantages
for online retailers. Online retailers are able to "display" a larger number of
products than traditional store-based or catalog retailers at a lower cost. In
addition, online retailers are able to frequently adjust their featured
selections, editorial content and pricing, providing significant merchandising
flexibility. Online retailers also benefit from the minimal cost to publish on
the Web, the ability to reach a large group of customers from a central
location, and the potential for low-cost customer interaction. Unlike
traditional retail channels, online retailers do not have the burdensome costs
of managing and maintaining a retail store infrastructure or the significant
printing and mailing costs of catalogs. Online retailers can also easily obtain
demographic and behavioral data about customers, increasing opportunities for
direct marketing and personalized services.
TRADITIONAL CHILDREN'S PRODUCTS RETAIL INDUSTRY
The market for children's products includes many categories, from
traditional toys and books to video games and educational software. Toy
Manufacturers of America, Inc. estimates that the domestic toy category alone
had retail sales of approximately $23 billion in 1997. We believe that product
categories such as children's video games, software, videos and music also
represent significant market opportunities.
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Traditional store-based toy retailers include mass market retailers such as
Toys R Us, Wal-Mart, Kmart and Target, as well as specialty chains such as Zany
Brainy and Noodle Kidoodle. Mass market retailers tend to carry a deep selection
of well-known brand name toys from leading vendors such as Mattel, Hasbro and
LEGO. Specialty retailers generally carry a broader selection of specialty toy
brands such as BRIO, PLAYMOBIL and Learning Curve. However, they do not
typically have a significant selection of well-known brand name toys. As a
result, we believe that no traditional store-based retailer currently offers an
extensive product selection of both popular, well-known brand name toys and
diverse, harder-to-find, specialty toys.
We believe that traditional store-based retailers face a number of
challenges in providing a satisfying shopping experience for consumers of
children's products:
- - The number of SKUs and the amount of product inventory that a traditional
store-based retailer can carry in any one store is constrained by the physical
space available in the store, thereby limiting selection for consumers.
- - Limited shelf space and store layout constraints limit the merchandising
flexibility of traditional store-based retailers. As a result, traditional
retailers generally display products by brand, category or packaging. They
cannot easily adjust or blend these merchandising strategies.
- - Due to the significant cost of carrying inventory in multiple store locations,
traditional store-based retailers focus their product selection on the most
popular products that produce the highest inventory turns, thereby further
limiting consumer selection.
- - Traditional store-based retailers can only serve those customers who have
convenient access to their stores. Traditional store-based retailers must open
new stores to serve additional geographic areas, resulting in significant
investments in inventory, leasehold improvements and the hiring and training
of store personnel.
- - Traditional store-based retailers face challenges in hiring, training and
maintaining knowledgeable sales staff. This limits the level of customer
service available to consumers.
In addition, we believe that many consumers find the toy shopping
experience, especially at traditional mass market retail outlets, to be
time-consuming, inconvenient and unpleasant due to factors such as location,
store layout, product selection, level of customer service and the challenges of
shopping with children.
THE ETOYS SOLUTION
We are a leading Web-based retailer focused exclusively on children's
products. Our online store is designed to provide consumers with a convenient
and enjoyable shopping experience in a Web-based retail environment. Our
exclusive focus on children's products and commitment to excellent customer
service enable us to uniquely address the needs and desires of our customers.
The key components of our solution include:
CONVENIENT SHOPPING EXPERIENCE. Our online store provides customers with an
easy-to-use Web site. It is available 24 hours a day, seven days a week and may
be reached from the shopper's home or office. Our online store enables us to
deliver a broad selection of products to customers in rural or other locations
that do not have convenient access to physical stores. We also make the shopping
experience convenient by categorizing our products into easy-to-shop
departments. These include toys, video games, software, videos and music. Our
advanced search technology makes it easy for consumers to locate products
efficiently based on pre-selected criteria depending upon the department. For
example, by using a quick keyword search or a sophisticated product search in
our toy department, a customer can search by any combination of age, category,
keyword or price.
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EXTENSIVE PRODUCT SELECTION AND INNOVATIVE MERCHANDISING. We offer a broad
selection of children's products that would be economically or physically
impractical to stock in a traditional store. We believe that we offer the
largest selection of toys available on the Internet. We also believe we are the
only retailer to provide a comprehensive selection of both traditional,
well-known brands, such as Mattel, Hasbro and LEGO, and specialty toy brands,
such as BRIO, PLAYMOBIL and Learning Curve. In addition we offer a broad
selection of children's video games, software, videos and music. We focus
exclusively on children's products. Many of our brand name and specialty
products are individually selected and tested to provide our customers with the
highest quality products. In addition, the unique environment of the Internet
enables us to dynamically adjust our merchandising strategy and product mix to
respond to changing customer demand.
HELPFUL AND USEFUL SHOPPING SERVICES. Through our online store, we offer
helpful and useful services to assist our customers, who are generally adults
purchasing for children. Many of these services are also designed to inform and
involve children in the shopping experience. Our services include:
- - PRODUCT REVIEWS AND RECOMMENDATIONS. To assist customers in selecting
appropriate products, we provide regularly updated product recommendations
through our PICKS OF THE MONTH, FAVORITES BY AGE, TOY BOX ESSENTIALS and our
TWENTY UNDER $20 recommended list of affordable toys. In addition, we feature
product reviews and lists of award-winning products from prominent parenting
and family publications as well as from organizations solely dedicated to
children's products, including the OPPENHEIM TOY PORTFOLIO, FAMILY FUN
magazine, PARENTING magazine and DR. TOY.
- - GIFT CENTER. We simplify gift shopping through our Gift Center. Here,
consumers can obtain gift recommendations by age and get information on a
variety of child-appropriate gift wrap styles and personalized message cards
to accompany the gift. We also sell electronic gift certificates through our
Gift Center.
- - MY ETOYS. Through My eToys, we personalize the customer's shopping experience
by offering the following services:
- BIRTHDAY REMINDERS, in which we notify shoppers of a child's birthday
three weeks in advance via e-mail and proactively offer age-appropriate
gift recommendations;
- WISH LISTS, in which parents and children can e-mail friends and family a
list of a child's most desired toys, video games, software, videos and
music; and
- ADDRESS BOOK, in which we record the addresses of people to whom our
customers send gifts so they do not need to re-enter the same addresses
multiple times.
- - IN-STOCK NOTIFICATION. If a product is out of stock, our customers can request
that we e-mail them when the product is back in stock. We believe this service
helps customers avoid extended store-to-store searches for hard-to-find
products.
- - PRODUCT NEWS. Our free monthly e-mail newsletter, THE ETOYS NEWS, delivers
updates about new products and services and special offers to our customers.
EXCELLENT CUSTOMER SERVICE. We provide free pre- and post-sales support via
both e-mail and toll-free telephone service during extended business hours. Once
an order is made, customers can view order-tracking information on our Web site
or contact our customer service department to obtain the status of their orders
and, when necessary, resolve order and product questions. Furthermore, the
customer service area of our Web site contains extensive information for
first-time and repeat visitors. These include helpful hints in searching for,
shopping for, ordering and returning our products.
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BUSINESS STRATEGY
Our objective is to be one of the world's leading retailers of children's
products. Key elements of our strategy include:
FOCUS ON ONLINE RETAILING OF CHILDREN'S PRODUCTS. We intend to become the
primary place for consumers to purchase children's products. Our online store is
exclusively focused on children's products and offers an extensive selection of
toys, video games, software, videos and music. We intend to enhance our product
offerings by expanding into additional children's product categories, which will
enable us to take advantage of our customer base, brand name, merchandising
expertise and distribution capabilities.
BUILD BRAND RECOGNITION. Through our advertising and promotional
activities, we target purchasers of children's products, with a primary focus on
mothers. We believe that mothers are the principal decision-makers for purchases
of children's products and strongly influence the purchasing decisions of family
and friends. We use offline and online marketing strategies to maximize customer
awareness and enhance our brand recognition:
- - OFFLINE ADVERTISING. We use offline advertising to promote both our brand name
and specific merchandising opportunities. Our traditional advertising efforts
have included print advertising in FAMILY FUN, FAMILY PC, PARENTING, PARENTS
and CHILD publications, and radio and television advertising in major markets.
In October 1998, we initiated television advertising, including a national
advertising campaign begun in November in which Visa co-promoted eToys in a
holiday commercial. We plan to increase our use of traditional offline
advertising in order to continue building our brand recognition.
- - ONLINE ADVERTISING. We partner with major online portals and Internet service
providers, parenting-related Web sites and children-oriented companies.
Accordingly, we have entered into relationships with AOL, Children's
Television Workshop and Moms Online. In addition, we advertise on the sites of
major online portals, including Excite, Infoseek, Microsoft Network, Yahoo!
and Lycos.
- - DIRECT ONLINE MARKETING. As our customer base grows, we continue to collect
significant data about our customers' buying preferences and habits in an
effort to increase repeat purchases by existing customers. We intend to
maximize the value of this information by delivering meaningful information
and special offers to our customers via e-mail and other means. In addition,
we use our in-house newsletter, THE ETOYS NEWS, to alert customers to
important developments and merchandising initiatives.
PURSUE WAYS TO INCREASE OUR NET SALES. We intend to pursue new
opportunities to increase our net sales by:
- - opening new departments on our Web site to expand into new children's product
categories;
- - increasing product selection in our existing departments;
- - adding more services to My eToys to further personalize the customer
experience;
- - pursuing international market opportunities; and
- - acquiring complementary businesses, products or technologies.
PROMOTE REPEAT PURCHASES. We are focused on promoting customer loyalty and
building repeat purchase relationships with our customers. To accomplish this
strategy, we intend to effectively use direct marketing techniques targeted at
existing customers, build features unique to each individual customer and
continually strive to enhance our customer service.
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MAINTAIN OUR TECHNOLOGY FOCUS AND EXPERTISE. We intend to use our commerce
platform to enhance our service offerings and take advantage of the unique
characteristics of online retailing. To date, we have developed technologies and
implemented systems to support secure and reliable online retailing. Among other
technology objectives, we intend to develop features unique to each individual
customer and to enhance the look-and-feel of our Web site. We also seek to
continuously increase the efficiency of our relationships with product vendors
and manufacturers and our distribution activities.
THE ETOYS ONLINE RETAIL STORE
We designed our online retail store to be the primary place for consumers to
purchase children's products. We believe our attractive, easy-to-use, online
store offers consumers a unique and enjoyable shopping experience as compared to
traditional store-based retailers. The look-and-feel of our Web site is playful
and entertaining, and navigation is consistent throughout. A consumer shopping
on our Web site can, in addition to ordering products, browse the different
departments of our store, conduct targeted searches, view recommended products,
visit our Gift Center, participate in promotions and check order status. In
contrast to a traditional retail store, the consumer can shop in the comfort and
convenience of his or her home or office.
OUR STORE DEPARTMENTS
We categorize products into different departments, including toys, video
games, software, videos and music. Within each department, products are
organized by brand, such as Mattel and Hasbro, by category, such as games, plush
toys and dolls, and by our recommendations, such as bestsellers and favorites.
The following is a summary of each of these departments:
TOYS. Since inception, we have focused on becoming the leading online
retailer of quality children's toys. We believe that we offer the largest
selection of toys available on the Internet. Through our toy department, we
offer an extensive selection of toys. We believe that we are the only retailer
of children's products to provide a comprehensive selection of both traditional,
well-known brands, such as Mattel, Hasbro and LEGO, and specialty toy brands,
such as BRIO, PLAYMOBIL and Learning Curve. We select and test many of our toys
before adding them to our online store collection.
VIDEO GAMES. Through our video game department, we offer an extensive
selection of game titles, including bestsellers and new releases, for the
popular Sony PlayStation, Nintendo 64 and Game Boy platforms. We provide our own
ratings for each video game with respect to content, language and level of
violence. In addition, we sell video game hardware and recommended accessories.
SOFTWARE. Through our children's software department, we offer a wide
selection of software with an emphasis on educational titles. We organize our
software into easy-to-use and understandable categories. We feature a variety of
well-known classic and currently popular brands including Broderbund, Disney
Interactive, Microsoft's Magic School Bus and Jumpstart.
VIDEOS. Through our children's video department, we offer videos for
children that are organized into easy-to-shop categories. We feature a variety
of well-known titles from popular television series, including Barney, Blue's
Clues, Dr. Seuss, Magic School Bus, Muppets, Peanuts, Rugrats, Teletubbies and
Winnie the Pooh. We also feature award-winning independent releases.
MUSIC. Through our children's music department, we offer an extensive
assortment of children's music in both cassette and CD format. Unlike most
retailers, we organize our children's music into different categories by
subject. We feature a variety of popular children's music categories, including
books on tape, Disney, educational, holiday, lullabies and bedtime, rock for
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kids, soundtracks, storytelling and Sesame Street. We also carry music from
artists associated with independent labels. We listen to many of our music
products in order to create helpful product descriptions and recommendations.
SHOPPING AT OUR STORE
We believe that the sale of children's products over the Web can offer
attractive benefits to consumers. These include enhanced selection, convenience,
ease-of-use, depth of content and information, and competitive pricing. Key
features of our online store include:
BROWSING. Our Web site offers visitors a variety of highlighted subject
areas and special features arranged in a simple, easy-to-use format intended to
enhance product search, selection and discovery. By clicking on the permanently
displayed department names, the consumer moves directly to the home page of the
desired department and can quickly view promotions and featured products.
Customers can use a quick keyword search in order to locate a specific product.
They can also execute more sophisticated searches based on pre-selected criteria
depending upon the department. In addition, customers can browse our online
store by hot-linking to specially designed pages dedicated to products from key
national and specialty brands. Customers can also hot-link to pages featuring
key product categories such as construction toys, just-for-girls software and
movie soundtrack music.
GETTING ANSWERS. One of the unique advantages of an Internet retail store
is the ability to provide product information and editorial content. On our Web
site customers can find detailed product information, including product
descriptions, manufacturers' and merchants' age recommendations, product
packaging, battery requirements, a list of accessories and related products that
are available and product awards. We also provide editorial content for our
customers through regularly updated product recommendations, including TOYBOX
ESSENTIALS, FAVORITES BY AGE, PICKS OF THE MONTH and TWENTY UNDER $20.
Furthermore, on our Web site we highlight award-winning products from prominent
parenting and family publications as well as from organizations solely dedicated
to children's products.
FINDING A GIFT. In our Gift Center, consumers can obtain gift
recommendations by age and get information on a variety of child-appropriate
gift wrap styles and personalized message cards to accompany the gift. In
addition, we offer a birthday reminder service, in which we notify shoppers of a
child's birthday three weeks in advance via e-mail and proactively offer
age-appropriate recommendations to help our busy shoppers. We also provide a
children's wish list service, in which parents and children can e-mail friends
and family a list of a child's most desired gifts. Furthermore, we sell
electronic gift certificates through our Gift Center.
SELECTING A PRODUCT AND CHECKING OUT. To purchase products, customers
simply click on the "order now" button to add products to their virtual shopping
cart. Customers can add and subtract products from their shopping cart as they
browse around our store, prior to making a final purchase decision, just as in a
physical store. Because we maintain a fully-integrated inventory system and
stock each item we sell, we are able to notify customers in real-time whether a
selected product is currently in stock. To execute orders, customers click on
the "checkout" button and, depending upon whether the customer has previously
shopped with us, are prompted to supply shipping details online. We also offer
customers a variety of gift wrapping and shipping options during the checkout
process. Prior to finalizing an order by clicking the "submit order" button,
customers are shown their total charges along with the various options chosen at
which point customers still have the ability to change their order or cancel it
entirely.
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PAYING. To pay for orders, a customer must use a credit card, which is
authorized during the checkout process, but which is charged when we ship the
customer's items from our distribution facility. Our Web site uses a security
technology that works with the most common Internet browsers and makes it
virtually impossible for unauthorized parties to read information sent by our
customers. Our system automatically confirms receipt of each order via e-mail
within minutes and notifies the customer when we ship the order, which is
typically within one to two business days for in-stock items. We also offer our
customers a money-back return policy.
GETTING HELP. From every page of our Web site, a customer can click on a
"help" button to go to our customer service area. The customer service area of
our Web site contains extensive information for first-time and repeat visitors.
In this area, we assist customers in searching for, shopping for, ordering and
returning our products as well as provide information on our low price
guarantee, shipping charges and other policies. In addition, we provide
customers with answers to the most frequently asked questions and encourage our
visitors to send us feedback and suggestions via e-mail. Furthermore, customer
service agents are available to answer questions about products and the shopping
process during extended business hours via our toll-free number, which is
displayed in the customer service area of our Web site.
MERCHANDISING
We believe that the breadth and depth of our product selection, together
with the flexibility of our online store and our range of helpful and useful
shopping services, enable us to pursue a unique merchandising strategy. We
provide an extensive selection of children's products. These include traditional
mass market toys, specialty toys and a broad selection of related children's
products, including video games, software, videos and music, that would be
economically impractical to stock in a traditional store. We focus exclusively
on children's products and we individually select and test many of the products
in our online store to ensure quality. This level of product evaluation enables
us to deliver valuable additional product information to our shoppers. For
example, we are able to develop detailed and helpful descriptions and our own
recommendations by age for many of the products in our online store.
Unlike store-based retail formats, our online store provides us significant
flexibility with regard to the organization and presentation of our product
selection. Our easy-to-use Web site allows customers to browse our product
selection by brand, age, product category and price, as well as by combinations
of these attributes. For example, a customer can easily search for
science-oriented toys designed for eight-year-old children or view all Barbie
dolls and related accessories without consulting store personnel or walking
multiple aisles within one or more traditional stores. Our online store enables
us to dynamically adjust our product mix to respond to changing customer demand.
In addition, our online store gives us flexibility in featuring or promoting
specific toys without having to alter the physical layout of a store. For
example, in connection with the new STAR WARS feature film, EPISODE I: THE
PHANTOM MENACE, we were able to offer over 100 PHANTOM MENACE toys in a total
collection of over 150 PHANTOM MENACE products. These new toys supplemented our
existing assortment of classic STAR WARS merchandise consisting of over 40
classic STAR WARS toys in a total collection of over 80 STAR WARS products.
Thus, with more than 250 new and classic STAR WARS products available, we were
able to provide a one-stop Internet commerce destination designed to meet the
needs of the most enthusiastic STAR WARS fans.
To encourage purchases, we feature various promotions on a rotating basis
throughout the store and continually update our online recommendations. We also
actively create and maintain pages that are artistically designed to highlight
the most prominent product brands we sell in our different departments. We
believe this strategy provides us with an excellent opportunity to cross-sell a
brand across our departments and promote impulse purchases by customers.
Finally, our range of helpful and useful shopping services such as our Gift
Center, our recommendations and
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our TWENTY UNDER $20 feature enable us to display and promote our product
selection in a flexible and targeted manner.
We believe that our merchandising strategy provides a unique selling
opportunity for our vendors. We are able to offer all our vendors access to
purchasers of children's products regardless of the size or influence of the
individual vendor.
MARKETING AND PROMOTION
Our marketing and promotion strategy is designed to:
- - build brand recognition;
- - increase consumer traffic to our store;
- - add new customers;
- - build strong customer loyalty;
- - maximize repeat purchases; and
- - develop additional ways to increase our net sales.
Through our advertising and promotions, we target adult purchasers of
children's products, with a focus on mothers. We believe that mothers are the
principal decision-makers in purchases of children's products and strongly
influence children's products purchases by family and friends. Our advertising
campaigns are designed to identify with a mother's toy shopping experience. We
use offline and online marketing strategies to maximize customer awareness and
enhance brand recognition. To accomplish this strategy, we have entered into
relationships with AOL, Children's Television Workshop and Moms Online. Our
marketing agreements generally provide for us to be the preferred online toy
retailer on the sites of these providers specified in the agreements. We also
generally have the right to place banner advertisements and integrated links to
our store on specified children-related or other particular pages or through
keyword searches. In addition, we advertise on the sites of major online
portals, including Excite, Infoseek, Microsoft Network, Yahoo! and Lycos.
We entered into a marketing agreement with AOL, the leading Internet online
service provider, in October 1997. This agreement established us as a preferred
AOL provider of children's toy products featured on the AOL Network and AOL's
Web site, aol.com. In addition, AOL agreed to promote and advertise eToys on a
non-exclusive basis in online areas controlled by AOL specified in the
agreement. Furthermore, under the agreement, AOL has committed that AOL users
will annually access the online areas promoting eToys a specified number of
times. Over the 26-month term of the agreement, we are obligated to make minimum
payments totaling $3.1 million to AOL, of which $1.1 million remained to be paid
as of March 31, 1999. We have also agreed to offer for sale a substantial
selection of children's products, to feature different children's products each
week, to offer special deals to AOL users through the AOL online area, to
provide children's toy products that are competitive in price and performance
and to manage, operate and support such content and children's toy products. The
agreement with AOL expires on December 31, 1999; however, AOL may terminate the
agreement earlier in the event we materially breach the agreement or in the
event of bankruptcy or insolvency or similar adverse financial events specified
in the agreement. Although there can be no assurance, we do not believe that
there is any material risk that AOL would be able to terminate the agreement
earlier than December 31, 1999, because of insolvency or any of the other
specified adverse financial events.
We use traditional offline advertising, including print advertising in
FAMILY FUN, FAMILY PC, PARENTING, PARENTS and CHILD publications, and radio and
television advertising in major markets. In October 1998, we initiated
television advertising, including a national advertising campaign begun in
November in which Visa co-promoted eToys in a holiday commercial.
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To direct traffic to our Web site, we have created inbound links that
connect directly to our Web site from other sites. Potential customers can
simply click on these links to become connected to our Web site from search
engines and community and affinity sites. In addition, in order to increase
exposure on the Internet and directly generate sales, we have an affiliates
program. Under this program, we pay one of our registered affiliates a referral
fee for any sale generated via their link to our Web site.
OPERATIONS
We obtain products from a network of large and small vendors, manufacturers
and distributors. We carry inventory of the products available for sale on our
Web site. We currently conduct our distribution operations in an approximately
60,000 square-foot facility located in Commerce, California. Both the facility
and the operations within it are operated solely by us. We send orders from our
Web site to our distribution facility over a secure connection and an internally
developed warehouse management system optimizes the pick, pack and ship process.
Our warehouse management system provides the Web site with data on inventory
receiving, shipping, inventory quantities and inventory location, which enables
us to display information about the availability of the products on our Web
site. Our warehouse management system also enables us to offer a variety of gift
wrap choices, custom gift cards and custom to/from labels for each individual
gift. In addition, we offer an order tracking service for our customers on our
Web site.
We offer three levels of shipping service: next day delivery, three-day
delivery, and ground delivery. We have developed relationships with both United
Parcel Service and the United States Postal Service to maximize our overall
service level to all 50 states. Priority orders are flagged and expedited
through our distribution processes. These capabilities are required due to the
time-sensitive nature of the gifts that we deliver to our customers.
On April 21, 1999, we entered into a warehouse and distribution agreement
with Fingerhut Business Services, Inc. The agreement has an initial term of
three years and can be renewed by us for three additional one-year terms.
Pursuant to this agreement, Fingerhut will provide us warehouse and distribution
services from its approximately 1,000,000 square foot warehouse and distribution
facility located in Utah. The scope and cost of such services are to be mutually
agreed upon by us and Fingerhut on a project by project basis. Fingerhut is not
obligated under this agreement to perform any project requested by us, and we
are not obligated to use any of Fingerhut's warehouse or distribution services.
Prior to using Fingerhut's operations, we will link Fingerhut's warehouse
management system with our Web site and management system so that we will obtain
the same data from the Fingerhut distribution facility as we do from our own
facility. We are currently developing the computer interface that will link our
computer system with Fingerhut's warehouse computer system. We expect to
complete our testing of the compatibility of these systems, including their Year
2000 readiness, by the end of September 1999.
On May 10, 1999, we entered into an agreement with East Bowles, L.L.C. to
lease an approximately 438,500 square-foot warehouse in Virginia. The lease has
an initial term of approximately five years and can be renewed by us for two
additional five-year terms. We currently plan to begin installing various
improvements in 1999 and to begin warehouse operations in this facility in the
fourth calendar quarter of 2000.
CUSTOMER SERVICE
We believe that a high level of customer service and support is critical to
retaining and expanding our customer base. Our customer service representatives
are available from 6:00 a.m. to 11:00 p.m. Pacific Time, seven days a week to
provide assistance via e-mail or telephone. We strive to answer all customer
inquiries within 24 hours. Our customer service representatives handle questions
about orders, assist customers in finding desired products and register
customers' credit card information over the telephone. Our customer service
representatives are a valuable source of
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feedback regarding user satisfaction. We also use BizRate, an online market
research company, to obtain monthly customer feedback. Our Web site also
contains a customer service page that outlines store policies and provides
answers to frequently asked questions.
OPERATIONS AND TECHNOLOGY
We have implemented a broad array of scaleable site management, search,
customer interaction, distribution services and systems that we use to process
customers' orders and payments. These services and systems use a combination of
our own technologies and commercially available, licensed technologies. The
systems that we use to process customers' orders and payments are integrated
with our accounting and financial systems. We focus our internal development
efforts on creating and enhancing specialized software that is unique to our
business. We use a set of applications for:
- - accepting and validating customer orders;
- - organizing, placing and managing orders with suppliers;
- - receiving product and assigning it to customer orders; and
- - managing shipment of products to customers based on various ordering criteria.
Our systems have been designed based on industry standard architectures and
have been designed to reduce downtime in the event of outages or catastrophic
occurrences. Our systems provide 24-hour-a-day, seven-day-a-week availability.
Our system hardware is hosted at a third-party facility in Sunnyvale,
California, which provides redundant communications lines and emergency power
backup. We have implemented load balancing systems and our own redundant servers
to provide for fault tolerance.
We incurred product development expenses of $0.4 million in the fiscal year
ended March 31, 1998 and $3.6 million in the fiscal year ended March 31, 1999.
We anticipate that we will continue to devote significant resources to product
development in the future as we add new features and functionality to our Web
site. The market in which we compete is characterized by rapidly changing
technology, evolving industry standards, frequent new service and product
announcements and enhancements and changing customer demands. Accordingly, our
future success will depend on our ability to:
- - adapt to rapidly changing technologies;
- - adapt our services to evolving industry standards;
- - continually improve the performance, features and reliability of our service
in response to competitive service and product offerings and evolving demands
of the marketplace.
Our failure to adapt to such changes would have a material adverse effect on
our business, results of operations and financial condition. In addition, the
widespread adoption of new Internet, networking or telecommunications
technologies or other technological changes could require substantial
expenditures by us to modify or adapt our services or infrastructure. This could
have a material adverse effect on our business, results of operations and
financial condition.
GOVERNMENT REGULATION
We are not currently subject to direct federal, state or local regulation
other than regulations applicable to businesses generally or directly applicable
to electronic commerce. However, the Internet is increasingly popular. As a
result, it is possible that a number of laws and regulations may be adopted with
respect to the Internet. These laws may cover issues such as user privacy,
freedom of expression, pricing, content and quality of products and services,
taxation, advertising, intellectual property rights and information security.
Furthermore, the growth of electronic commerce may prompt calls for more
stringent consumer protection laws. Several states have proposed legislation to
limit the uses of personal user information gathered online or require online
services to establish privacy policies. The Federal Trade Commission has also
initiated action against at least one online service regarding the manner in
which personal information is collected from users and provided to third
parties. We do not currently provide personal information regarding our users to
third parties. However, the adoption of such consumer protection laws could
create uncertainty in Web usage and reduce the demand for our products and
services.
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We are not certain how our business may be affected by the application of
existing laws governing issues such as property ownership, copyrights,
encryption and other intellectual property issues, taxation, libel, obscenity
and export or import matters. The vast majority of such laws were adopted prior
to the advent of the Internet. As a result, they do not contemplate or address
the unique issues of the Internet and related technologies. Changes in laws
intended to address such issues could create uncertainty in the Internet market
place. Such uncertainty could reduce demand for our services or increase the
cost of doing business as a result of litigation costs or increased service
delivery costs.
In addition, because our services are available over the Internet in
multiple states and foreign countries, other jurisdictions may claim that we are
required to qualify to do business in each such state or foreign country. We are
qualified to do business only in California. Our failure to qualify in a
jurisdiction where we are required to do so could subject us to taxes and
penalties. It could also hamper our ability to enforce contracts in such
jurisdictions. The application of laws or regulations from jurisdictions whose
laws do not currently apply to our business could have a material adverse effect
on our business, results of operations and financial condition.
COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive. We expect competition to intensify in the future. Increased
competition is likely to result in price reductions, reduced gross margins and
loss of market share, any of which could seriously harm our net sales and
results of operations. Current and new competitors can enter our market with
little difficulty and can launch new Web sites at a relatively low cost. In
addition, the children's toy, video game, software, video and music retailing
industries are intensely competitive.
We currently or potentially compete with a variety of other companies,
including:
- - traditional store-based toy and children's product retailers such as Toys R
Us, FAO Schwarz, Zany Brainy and Noodle Kidoodle;
- - major discount retailers such as Wal-Mart, Kmart and Target;
- - online efforts of these traditional retailers, including the online stores
operated by Toys R Us, Wal-Mart and FAO Schwarz;
- - physical and online stores of entertainment entities that sell and license
children's products, such as The Walt Disney Company and Warner Bros.;
- - catalog retailers of children's products;
- - vendors of children's products that currently sell some of their products
directly online, such as Mattel and Hasbro;
- - other online retailers that include children's products as part of their
product offerings, such as Amazon.com, Barnesandnoble.com, CDnow, Beyond.com
and Reel.com;
- - Internet portals and online service providers that feature shopping services,
such as AOL, Yahoo!, Excite and Lycos; and
- - various smaller online retailers of children's products, such as
BrainPlay.com, Red Rocket and Toysmart.com.
We believe that the following are principal competitive factors in our
market:
- - brand recognition;
- - selection;
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- - convenience;
- - price;
- - speed and accessibility;
- - customer service;
- - quality of site content; and
- - reliability and speed of order shipment.
Many traditional store-based and online competitors have longer operating
histories, larger customer or user bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Many
of these competitors can devote substantially more resources to Web site
development than we can. In addition, larger, well-established and well-financed
entities may join with online competitors or children's toy, video game,
software, video and music publishers or suppliers as the use of the Internet and
other online services increases.
Our competitors may be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we can. Traditional
store-based retailers also enable customers to see and feel products in a manner
that is not possible over the Internet. Some of our competitors such as Toys R
Us and Wal-Mart have significantly greater experience in selling children's
toys, video games, software, videos and music 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.
LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims
arising out of our ordinary course of business. We believe that there are no
claims or actions pending or threatened against us, the ultimate disposition of
which would have a materially adverse effect on us.
INTELLECTUAL PROPERTY
We rely on various intellectual property laws and contractual restrictions
to protect our proprietary rights in products and services. These include
confidentiality, invention assignment and nondisclosure agreements with our
employees, contractors, suppliers and strategic partners. Despite these
precautions, it may be possible for a third party to copy or otherwise obtain
and use our intellectual property without our authorization. In addition, we
pursue the registration of our trademarks and service marks in the U.S. and
internationally. However, effective intellectual property protection may not be
available in every country in which our services are made available online.
We have licensed various proprietary rights to third parties. We attempt to
ensure that these licensees maintain the quality of our brand. However, these
licensees may nevertheless take actions that materially adversely affect the
value of our proprietary rights or reputation. We also rely on technologies that
we license from third parties. These licenses may not continue to be available
to us on commercially reasonable terms in the future. As a result, we may be
required to obtain substitute technology of lower quality or at greater cost,
which could materially adversely affect our business, results of operations and
financial condition.
To date, we have not been notified that our technologies infringe the
proprietary rights of third parties. However, there can be no assurance that
third parties will not claim infringement by us with respect to our current or
future technologies. We expect that participants in our markets will be
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increasingly subject to infringement claims as the number of services and
competitors in our industry segment grows. Any such claim, with or without
merit, could be time-consuming, result in costly litigation, cause service
upgrade delays or require us to enter into royalty or licensing agreements. Such
royalty or licensing agreements might not be available on terms acceptable to us
or at all. As a result, any such claim of infringement against us could have a
material adverse effect upon our business, results of operations and financial
condition.
EMPLOYEES
As of March 31, 1999, we had 306 full-time employees. None of our employees
are represented by a labor union. We have not experienced any work stoppages and
consider our employee relations to be good.
Our future performance depends in significant part upon the continued
service of our key technical, sales and senior management personnel, none of
whom are bound by an employment agreement requiring service for any defined
period of time. The loss of services of one or more of our key employees could
have a material adverse effect on our business, financial condition and results
of operations. Our future success also depends in part upon our continued
ability to attract, hire, train and retain highly qualified technical, sales and
managerial personnel. Competition of such personnel is intense and there can be
no assurance that we can retain our key personnel in the future.
FACILITIES
Our corporate offices are located in Santa Monica, California, where we
lease approximately 60,000 square feet under a lease that expires in July 2003.
In addition, we lease approximately 60,000 square feet in Commerce, California
for our distribution operations under a lease that expires in August 2003 and
approximately 438,500 square feet in Pittsylvania County, Virginia for our
distribution operations under a lease that expires in July 2004.
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RECENT DEVELOPMENTS
THE BABYCENTER MERGER
On April 18, 1999, we entered into a merger agreement to acquire BabyCenter.
Under the merger agreement, a new subsidiary of ours will merge with BabyCenter
so that BabyCenter becomes our wholly owned subsidiary. The following
description sets forth the material terms of the merger agreement, the merger
and related transactions. The description is qualified in its entirety by the
merger agreement and related agreements, which are included as exhibits to the
registration statement of which this prospectus forms a part.
We will account for the merger using the purchase method of accounting. The
merger is intended to qualify as a tax-free reorganization under Section 368 of
the Internal Revenue Code. At the closing of the merger, we will issue
16,708,886 shares of our common stock, subject to adjustment, in exchange for
the 7,335,026 outstanding shares of BabyCenter capital stock. We will also
reserve 2,011,114 shares of our common stock, subject to adjustment, for
issuance upon exercise of the 882,858 BabyCenter options that we assume. The
exchange ratio is approximately 2.28 shares of our common stock for each share
of BabyCenter capital stock. The aggregate estimated purchase price is
approximately $205 million. The purchase price is based on $11.00 per share of
our common stock, which was the mid-point of our filing range at the
announcement of the BabyCenter merger. Upon completion of the offering, the
shares of our common stock to be issued and reserved for issuance in connection
with the merger will constitute approximately 14% of our common stock.
Each BabyCenter option we assume will continue to have, and be subject to,
the same terms and conditions as set forth in the incentive stock plan of
BabyCenter and the respective option agreements governing such option
immediately prior to the merger, except that such option will be exercisable for
shares of our common stock and the number of shares subject to the option and
the exercise price will be adjusted to reflect the exchange ratio in the merger.
As of March 31, 1999, BabyCenter had granted options with a weighted average
exercise price equal to $1.34 per share. The BabyCenter options that we will
assume generally vest at the rate of 1/4th of the total number of shares subject
to the options 12 months after the date of grant, and 1/48th of the total number
of shares each month thereafter.
Under the merger agreement, BabyCenter made customary representations and
warranties regarding such matters as its corporate good standing, capital
structure, intellectual property ownership, pending litigation, assets and
liabilities, employee relations, material contracts, tax good standing,
compliance with laws and regulations and customers. We also made customary
representations and warranties to BabyCenter regarding such matters as our
corporate good standing, our authority to enter into the merger, the disclosures
set forth in the registration statement of which this prospectus forms a part,
and our compliance with laws and regulations.
BabyCenter has agreed to indemnify us and each of our officers, directors
and affiliates with respect to breaches of any representations, warranties,
covenants or other agreements made by BabyCenter in the merger agreement. These
indemnification obligations are subject to minimum threshold limitations
specified in the merger agreement. To secure these indemnification obligations,
300,000 of the shares of our common stock to be issued to BabyCenter
stockholders will be held in escrow for a period of six months after the closing
of the merger.
Upon consummation of the merger, BabyCenter's Chief Executive Officer,
Matthew Glickman, will be appointed to our Board of Directors.
The BabyCenter merger is subject to a number of closing conditions specified
in the merger agreement, including governmental approval, approval of the merger
by BabyCenter stockholders
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and other customary closing conditions. As a result, we cannot be certain that
the BabyCenter merger will be completed.
BabyCenter has agreed that its stockholders holding at least 95% of the
shares of our common stock to be issued in the merger as well as BabyCenter
optionees holding at least 85% of the shares to be issued upon exercise of
BabyCenter options we assume in the merger will enter into lock-up agreements
similar to those entered into by our directors, officers and securityholders. As
a result, upon the closing of the merger, up to approximately 1,377,152 shares
of our common stock to be issued in exchange for outstanding shares of
BabyCenter capital stock and issuable upon exercise of BabyCenter options we
assume will be immediately eligible for sale in the public market in accordance
with the restrictions of Rule 144 under the Securities Act. The remaining
17,342,848 shares of our common stock to be issued in exchange for outstanding
shares of BabyCenter capital stock and issuable upon exercise of BabyCenter
options we assume in connection with the merger will be eligible for public sale
in the public market beginning 180 days after the date of this prospectus,
subject to the volume and other restrictions of Rule 144. See "Shares Eligible
for Future Sale".
RECENT OPTION GRANTS
In April and May 1999, we granted under our 1999 Stock Plan options to
purchase an aggregate of 2,122,302 shares of our common stock at an exercise
price of $11.00 per share. We granted most of these options to 67 new employees.
The options granted in May 1999 have been considered to be compensatory.
Deferred compensation associated with such options is $14.7 million. This amount
will be amortized to expense on a straight-line basis over the four-year vesting
periods of the applicable options through the fiscal year ending March 31, 2004.
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<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth specific information regarding our executive
officers and directors as of March 31, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- ---------------------------- --- -----------------------------------------------------
<S> <C> <C>
Edward C. Lenk.............. 37 President, Chief Executive Officer and Uncle of the
Board
Steven J. Schoch............ 40 Senior Vice President and Chief Financial Officer
John R. Hnanicek............ 35 Senior Vice President and Chief Information Officer
Frank C. Han................ 35 Senior Vice President of Product Development
Janine Bousquette........... 38 Senior Vice President of Marketing
Louis V. Zambello III....... 41 Senior Vice President of Operations
Peter C.M. Hart............. 48 Director
Tony A. Hung................ 31 Director
Michael Moritz.............. 44 Director
Daniel J. Nova.............. 37 Director
</TABLE>
EDWARD C. LENK founded eToys and has served as our President, Chief
Executive Officer and a Director since June 1997. In December 1998, he was
appointed Uncle of the Board. Prior to founding eToys, from May 1994 to July
1996 Mr. Lenk was employed as Vice President of Strategic Planning at The Walt
Disney Company, where he was responsible for strategic planning and new business
development of Worldwide Attractions and Resorts. From May 1991 to May 1994, he
was a Director of Strategic Planning at The Walt Disney Company. Mr. Lenk
received a Bachelor of Arts SUMMA CUM LAUDE from Bowdoin College and a Masters
in Business Administration, with distinction, from Harvard Business School.
STEVEN J. SCHOCH has served as our Chief Financial Officer since January
1999. Prior to joining us, from December 1995 to January 1999, Mr. Schoch was
Vice President and Treasurer of Times Mirror Company, a newspaper and magazine
publishing company. He also served as Chief Executive Officer and President of a
wholly owned subsidiary of Times Mirror Company dedicated to the reduction and
containment of costs of the parent company. From March 1991 to October 1995, Mr.
Schoch worked at The Walt Disney Company, most recently as Vice President,
Treasurer--Euro Disney S.C.A. Mr. Schoch serves as a director of VDI Media. Mr.
Schoch received a Bachelor of Science from Tufts University and a Masters in
Business Administration from the Amos Tuck School of Business Administration at
Dartmouth College.
JOHN R. HNANICEK has served as our Chief Information Officer since December
1998. Prior to joining us, from October 1996 to December 1998, he was employed
as Senior Vice President of Information Systems for Hollywood Entertainment,
Inc., a nationwide retail video chain. From January 1996 to October 1996, Mr.
Hnanicek served as Chief Information Officer for Homeplace, Inc., a home
furnishings chain. From 1990 to 1995, he served as Senior Vice President of
Information Systems and Logistics at OfficeMax, Inc., a retail office supply
outlet. Mr. Hnanicek holds a Bachelor of Science in Computer Science and
Accounting from Cleveland State University.
FRANK C. HAN has served as our Senior Vice President of Product Development
since January 1999. From February 1997 to January 1999, Mr. Han was our Chief
Operating Officer and Vice President of Finance. Prior to joining us, Mr. Han
worked at Union Bank of California, serving as Vice President of Interactive
Markets from January 1995 to February 1997 and as Director of Strategic Planning
from 1993 to 1995. Mr. Han received a Bachelor of Science CUM LAUDE from Yale
University and a Masters in Business Administration from the Stanford Graduate
School of Business.
52
<PAGE>
JANINE BOUSQUETTE has served as our Senior Vice President of Marketing since
May 1999. Prior to joining us, from 1995 to May 1999, Ms. Bousquette worked at
PepsiCo Inc., a manufacturer of soft drinks, juices and snackfoods, serving most
recently as Vice President of Marketing and also serving as Vice President of
Marketing for the Flavor Brands. From 1982 to 1995, Ms. Bousquette worked in
brand management at The Procter & Gamble Company, a manufacturer of consumer
products, serving most recently as Senior Marketing Director. Ms. Bousquette
received a Bachelor of Arts PHI BETA KAPPA from the University of Michigan.
LOUIS V. ZAMBELLO III has served as our Senior Vice President of Operations
since December 1998. Prior to joining us, from 1984 to 1998, he held a variety
of positions at L.L. Bean, Inc., an outdoor retailer. Most recently, Mr.
Zambello served as Senior Vice President of Operations and Creative from June
1998 to December 1998, as Senior Vice President of Operations from December 1993
to June 1998, as Vice President of Merchandise Services and Manufacturing from
December 1991 to August 1993 and in a variety of other positions since 1984. Mr.
Zambello received a Bachelor of Arts MAGNA CUM LAUDE from Cornell University and
a Masters in Business Administration from Harvard Business School.
PETER C.M. HART has served as a Director of eToys since October 1997. Since
January 1999, Mr. Hart has been a Managing Partner of Wildkin LLC, a distributor
of toys. Since November 1997, he has served as a business advisor to EdUsa, a
company that provides language instruction over the Internet. From 1983 to 1997,
he held a variety of positions at Ross Stores, Inc., an apparel retailer, most
recently as a Senior Vice President managing warehousing, distribution and MIS
operations. Previously, Mr. Hart was a Business Systems Analyst at Joseph Magnin
Department Store in San Francisco and at Rediffusion in Buckinghamshire,
England. Mr. Hart is a member of the Audit Committee of the Board of Directors.
TONY A. HUNG has served as a Director of eToys since December 1997. Since
1997, he has been a Vice President of DynaFund Ventures, a venture capital
partnership. Previously, Mr. Hung held a variety of positions at The Walt Disney
Company, serving as Manager of Corporate Strategic Planning from 1996 to 1997,
as Manager of Television and Telecommunications from 1995 to 1996, and as Senior
Analyst in the Corporate Treasury department from 1992 to 1995. Mr. Hung serves
on the boards of directors of a number of private companies. Mr. Hung holds a
Bachelor of Arts from Harvard University and a Masters in Business
Administration from The Anderson School at University of California at Los
Angeles. Mr. Hung is a member of the Audit Committee of the Board of Directors.
MICHAEL MORITZ has served as a Director of eToys since June 1998. He has
been a general partner of Sequoia Capital, a venture capital firm, since 1986.
Sequoia Capital provided the original venture capital financing to companies
such as Cisco Systems Inc., LSI Logic Corporation, Linear Technology
Corporation, Microchip Technology Inc. and International Network Services. Mr.
Moritz serves as a director of Yahoo! Inc. and Flextronics International Ltd.,
as well as several private companies. Mr. Moritz received a Master of Arts
degree from Oxford University and a Masters in Business Administration from the
Wharton School at the University of Pennsylvania. Mr. Moritz is a member of the
Compensation Committee of the Board of Directors.
DANIEL J. NOVA has served as a Director of eToys since June 1998. Since
August 1996, Mr. Nova has served as a general partner of Highland Capital
Partners, a venture capital firm. Previously, he was a general partner of
CMG@Ventures from January 1995 to August 1996 and a Senior Associate at Summit
Partners from June 1991 to January 1995. Mr. Nova is a director of Lycos, Inc.,
an online portal, and several private companies. Mr. Nova received a Bachelor of
Science in Computer Science and Marketing with honors from Boston College and a
Masters in Business Administration from Harvard Business School. Mr. Nova is a
member of the Audit and Compensation Committees of the Board of Directors.
53
<PAGE>
Our Board of Directors currently consists of five members with two
vacancies. Each director is elected for a period of one year at our annual
meeting of stockholders and serves until the next annual meeting or until his
successor is duly elected and qualified.
Our executive officers serve at the discretion of the Board of Directors.
There are no family relationships among any of our directors or executive
officers.
If the BabyCenter merger is completed, Matthew N. Glickman will be appointed
to our Board of Directors. Matthew N. Glickman co-founded BabyCenter and has
served as its Chief Executive Officer and its director since October 1996. Prior
to founding BabyCenter, he served as Product Manager for Intuit Inc.'s Quicken
personal finance software product and in other product management roles at
Intuit from July 1993 to October 1996. He previously served as a consultant at
Bain and Company. Mr. Glickman received a Bachelor of Arts, Phi Beta Kappa, from
Amherst College, a Master of Arts in Educational Policy from the Stanford School
of Education, and a Masters in Business Administration from the Stanford
Graduate School of Business. As of March 31, 1999, Mr. Glickman was 33 years
old.
BOARD COMMITTEES
Our Board of Directors established the Compensation Committee in December
1998 and the Audit Committee in February 1999. The Compensation Committee
reviews and recommends to the Board of Directors the compensation and benefits
of all our officers and establishes and reviews general policies relating to
compensation and benefits of our employees. The Audit Committee reviews our
internal accounting procedures and consults with and reviews the services
provided by our independent accountants.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of our Compensation Committee of the Board of Directors are
currently Mr. Moritz and Mr. Nova, neither of whom has ever been an officer or
employee of eToys. Prior to establishing the Compensation Committee in December
1998, the Board of Directors as a whole performed the functions delegated to the
Compensation Committee.
DIRECTOR COMPENSATION
Our directors do not currently receive any cash compensation from us for
their service as members of the Board of Directors, although they are reimbursed
for travel and lodging expenses in connection with attendance at Board and
Committee meetings. Under our 1997 Stock Plan, nonemployee directors are
eligible to receive stock option grants and stock purchase rights at the
discretion of the Board of Directors or other administrator of the plan. Under
our 1999 Directors' Stock Option Plan, non-employee directors are eligible to
receive automatic stock option grants upon their initial appointment and at each
of our annual stockholders meetings. See "--Stock Plans". In September 1997 the
Board of Directors granted Mr. Hart an option to purchase 300,000 shares of
common stock at $0.005 per share in connection with his appointment as a member
of the Board of Directors. 1/4th of the shares vested upon June 15, 1998 and
1/48th of the total number of shares vest monthly from and after June 15, 1998.
From January 1998 to June 1998, Mr. Hart provided us consulting services. In
connection with these services, Mr. Hart received aggregate payments of $39,000,
reimbursement of his expenses and an option to purchase 63,000 shares of common
stock at $0.033 per share. This option, which vested at the rate of 1/6th per
month commencing upon February 1, 1998, is fully vested.
54
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth the compensation received for services
rendered to eToys during the fiscal years ended March 31, 1998 and March 31,
1999 by our Chief Executive Officer and our four other executive officers who
earned more than $100,000 during the fiscal year ended March 31, 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION --------------
------------------------------------------------- SECURITIES
NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING ALL OTHER
POSITION FISCAL YEAR SALARY($) BONUS($) COMPENSATION($) OPTIONS(#) COMPENSATION($)
- ------------------------- ----------- ----------- ----------- ----------------------- -------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
Edward C. Lenk .......... 1998 105,000 -- -- 3,000,000 --
President and Chief 1997 76,250 -- -- -- --
Executive Officer
Louis V. Zambello 1998 50,000 28,750 -- 825,000 --
III(1) ................
Senior Vice President
of Operations
John R. Hnanicek(2) ..... 1998 37,500 15,000 -- 600,000 --
Senior Vice President
and Chief Information
Officer
Steven J. Schoch(3) ..... 1998 20,833 4,167 -- 750,000 --
Senior Vice President
and Chief Financial
Officer
Frank C. Han ............ 1998 93,750 10,000 -- 825,750 --
Senior Vice President 1997 65,833 -- -- -- --
of Product Development
</TABLE>
- ------------------------------
(1) Louis V. Zambello III became Senior Vice President of Operations in December
1998. On an annual basis, Mr. Zambello's salary would have been $200,000.
Mr. Zambello is entitled to a bonus of $115,000 which vests monthly over the
first year of his employment; the amount in the table reflects the portion
of his bonus that vested in fiscal 1998.
(2) John R. Hnanicek became Senior Vice President and Chief Information Officer
in December 1998. On an annual basis, Mr. Hnanicek's salary would have been
$150,000. Mr. Hnanicek was paid a bonus of $60,000 which vests monthly over
the first year of his employment; the amount in the table reflects the
portion of his bonus that vested in fiscal 1998.
(3) Steven J. Schoch became Senior Vice President and Chief Financial Officer in
January 1999. On an annual basis, Mr. Schoch's salary would have been
$125,000. Mr. Schoch is entitled to a bonus of $25,000 which vests monthly
over the first year of his employment; the amount in the table reflects the
portion of his bonus that vested in fiscal 1998.
We did not pay to our Chief Executive Officer or any named executive officer
any compensation intended to serve as incentive for performance to occur over a
period longer than one year pursuant to a long-term incentive plan in the fiscal
year ended March 31, 1998. We do not have any defined benefit or actuarial plan
with respect to our Chief Executive Officer or any named executive officer under
which benefits are determined primarily by final compensation and years of
service.
55
<PAGE>
OPTION GRANTS
The following table provides summary information regarding stock options
granted to our Chief Executive Officer and our four other highest compensated
executive officers during the fiscal year ended March 31, 1999.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------------------- POTENTIAL REALIZABLE VALUE AT
NUMBER OF PERCENT OF ASSUMED ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION FOR OPTION
UNDERLYING GRANTED IN TERM(3)
OPTIONS FISCAL 1998 EXERCISE PRICE EXPIRATION ------------------------------
NAME GRANTED(#) (%)(1) ($/SHARE)(2) DATE 5% 10%
- ------------------------ ----------- ------------- --------------- ----------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Edward C. Lenk.......... 3,000,000(4) 21.25% $ 0.143 10/21/08 $ 43,279,730 $ 68,915,737
Louis V. Zambello III... 825,000(5) 5.84 1.667 12/31/08 9,854,812 15,692,141
John R. Hnanicek........ 600,000(5) 4.25 1.667 12/31/08 7,167,136 11,412,466
Steven J. Schoch........ 750,000(6) 5.31 3.333 1/31/09 6,922,802 11,023,405
Frank C. Han............ 825,000(4) 5.84 0.143 10/21/08 11,901,925 18,951,827
750(7) 0.01 2.833 1/31/09 7,533 11,996
</TABLE>
- ------------------------------
(1) We granted options for an aggregate of 14,116,650 shares to our employees
and consultants under the 1997 Stock Plan and the 1999 Stock Plan during the
fiscal year ended March 31, 1999. See "Stock Plans".
(2) Options were granted at an exercise price equal to the fair market value of
the common stock, as determined by the Board of Directors on the date of
grant.
(3) The potential realizable value is calculated assuming the exercise price on
the date of grant appreciates at the indicated rate for the entire term of
the option and that the option is exercised at the exercise price and sold
on the last day of its term at the appreciated price. All options listed
have a term of 10 years. Stock price appreciation of 5% and 10% is assumed
pursuant to the rules of the Securities and Exchange Commission. There can
be no assurance that the actual stock price will appreciate over the 10-year
option term at the assumed 5% and 10% levels or at any other defined level.
Unless the market price of the common stock appreciates over the option
term, no value will be realized from the option grants made to the named
executive officers.
(4) The options become exercisable at the rate of 1/4th of the total number of
shares on October 21, 1999 and 1/48th of the total number of shares monthly
from and after October 21, 1999.
(5) The options are immediately exercisable. However, if exercised, the
underlying shares are subject to a right of repurchase at cost in our favor
which lapses at the rate of 1/4th of the total number of shares on December
31, 1999 and 1/48th of the total number of shares monthly from and after
December 31, 1999.
(6) The option is immediately exercisable. However, if exercised, the underlying
shares are subject to a right of repurchase at cost in our favor which
lapses at the rate of 1/4th of the total number of shares on January 31,
2000 and 1/48th of the total number of shares monthly from and after January
31, 2000.
(7) The option is immediately exercisable.
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<PAGE>
OPTION EXERCISES AND HOLDINGS
The following table provides summary information concerning the shares of
common stock represented by outstanding stock options held by our Chief
Executive Officer and our four other highest compensated executive officers as
of March 31, 1999.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
VALUE OF UNEXERCISED IN-THE-
UNDERLYING UNEXERCISED MONEY OPTIONS AT MARCH 31,
OPTIONS AT MARCH 31, 1999(1) 1999(1)(2)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------------------------- ------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Edward C. Lenk(3).................................... -- 3,000,000 -- $ 26,570,000
Louis V. Zambello III(4)............................. 825,000 -- $6,050,000 --
John R. Hnanicek(4).................................. 600,000 -- 4,400,000 --
Steven J. Schoch(5).................................. 750,000 -- 4,250,000 --
Frank C. Han(6)...................................... 750 825,000 4,625 7,306,750
</TABLE>
- ------------------------------
(1) No options were exercised as of the completion of the fiscal year ended
March 31, 1999.
(2) Based on the estimated fair market value of $9.00 for our common stock on
March 31, 1999.
(3) The option becomes exercisable at the rate of 1/4th of the total number of
shares on October 21, 1999 and 1/48th of the total number of shares monthly
from and after October 21, 1999.
(4) The options are immediately exercisable. However, if exercised, the
underlying shares are subject to a right of repurchase at cost in our favor
which lapses at the rate of 1/4th of the total number of shares on December
31, 1999 and 1/48th of the total number of shares monthly from and after
December 31, 1999.
(5) The option is immediately exercisable. However, if exercised, the underlying
shares are subject to a right of repurchase at cost in our favor which
lapses at the rate of 1/4th of the total number of shares on January 31,
2000 and 1/48th of the total number of shares monthly from and after January
31, 2000.
(6) Mr. Han holds an immediately exercisable option to purchase 750 shares. Mr.
Han holds a second option to purchase 825,000 shares which becomes
exercisable at the rate of 1/4th of the total number of shares on October
21, 1999 and 1/48th of the total number of shares monthly from and after
October 21, 1999.
STOCK PLANS
1999 STOCK PLAN. The Board of Directors adopted our 1999 Stock Plan in
February 1999 and our stockholders approved it in March 1999. We have reserved a
total of 24,800,000 shares of common stock for issuance under the 1999 Stock
Plan, plus an automatic annual increase on the first day of our fiscal years
beginning in 2000, 2001, 2002, 2003 and 2004 equal to the lesser of 5,200,000
shares, 3.0% of our outstanding common stock on the last day of the immediately
preceding fiscal year or such lesser number of shares as the Board of Directors
determines. As of March 31, 1999, options to purchase 1,536,300 shares of common
stock with a weighted average exercise price equal to $8.900 have been granted,
none of which have been exercised.
The 1999 Stock Plan provides for the granting to employees, including
officers and directors, of incentive stock options within the meaning of Section
422 of the Internal Revenue Code of 1986, as amended, and for the granting to
employees, consultants and nonemployee directors, of stock purchase rights and
nonstatutory stock options. If an optionee would have the right in any calendar
year to exercise for the first time incentive stock options for shares having an
aggregate fair market value (under all of our plans and determined for each
share as of the date the option to purchase the shares was granted) in excess of
$100,000, any such excess options shall be treated as nonstatutory stock
options. Unless terminated earlier, the 1999 Stock Plan will terminate in
February 2009.
The 1999 Stock Plan may be administered by the Board of Directors or a
committee of the Board, each known as the "administrator". The Board of
Directors currently administers the 1999 Stock Plan. The administrator
determines the terms of options and stock purchase rights granted under the 1999
Stock Plan, including the number of shares subject to an option or stock
purchase right, the exercise or purchase price, and the term and exercisability
of options. The administrator
57
<PAGE>
may grant an individual employee options or stock purchase rights under the 1999
Stock Plan during any one fiscal year to purchase a maximum of 9,000,000 shares.
The exercise price of all incentive stock options granted under the 1999 Stock
Plan generally must be at least equal to the fair market value of our common
stock on the date of grant. The administrator has the authority to grant
nonstatutory stock options and stock purchase rights at prices below fair market
value, although the exercise price of such awards granted to our Chief Executive
Officer or our four other most highly compensated officers will generally equal
at least 100% of the fair market value of the common stock on the date of grant.
Payment of the purchase price of options and stock purchase rights may be made
in cash or other consideration as determined by the administrator.
Generally, options granted under the plan have a term of ten years and are
nontransferable. The administrator may grant nonstatutory stock options with
limited transferability rights in circumstances specified in the 1999 Stock
Plan. The administrator determines the vesting terms of options and stock issued
pursuant to stock purchase rights. We expect that options and stock purchase
rights granted under the 1999 Stock Plan generally will vest at the rate of
1/4th of the total number of shares subject to the options or stock purchase
rights 12 months after the date of grant, and 1/48th of the total number of
shares each month thereafter.
In the event that we are acquired by another company, we expect that awards
outstanding under the 1999 Stock Plan will be assumed or equivalent awards
substituted by our acquiror. If an acquiror did not agree to assume or
substitute awards, the vesting of outstanding options and stock issued pursuant
to stock purchase rights will accelerate in full prior to consummation of the
transaction. If we are acquired pursuant to a transaction in which outstanding
awards are assumed or substituted by our acquiror and a participant holding an
assumed or substituted award is involuntarily terminated within 24 months
following the acquisition, the vesting of any award held by such person would
accelerate in full immediately prior to the date of his or her termination.
The Board has the authority to amend or terminate the 1999 Stock Plan as
long as such action does not materially and adversely affect any outstanding
option and provided that stockholder approval for any amendments to the 1999
Stock Plan shall be obtained to the extent required by applicable law.
1997 STOCK PLAN. The Board of Directors adopted and our stockholders
approved our 1997 Stock Plan in March 1997. We have reserved a total of
17,400,000 shares of common stock for issuance under the 1997 Stock Plan. As of
March 31, 1999, options to purchase 1,886,136 shares of common stock with a
weighted average exercise price of $0.035 had been exercised and options to
purchase a total of 13,391,376 shares at a weighted average exercise price of
$0.757 per share were outstanding. As of March 31, 1999, 2,122,488 shares
remained available for future issuance under the 1997 Stock Plan. However, the
Board has determined that all future grants to employees and consultants will
take place under our 1999 Stock Plan and therefore any shares remaining
available for issuance under the 1997 Stock Plan as of the date of this offering
will be returned to our authorized but unissued capital stock and will not be
available for future grant. Shares returning to the 1997 Stock Plan upon
cancellation of outstanding options may be made subject to future grant after
the date of this offering. Unless terminated earlier, the 1997 Stock Plan will
terminate in March 2007.
The terms of options and stock purchase rights issued under the 1997 Stock
Plan are generally the same as those which may be issued under the 1999 Stock
Plan, except with respect to the following features. The 1997 Stock Plan does
not impose an annual limitation on the number of shares subject to options or
stock purchase rights which may be issued to any individual employee.
Nonstatutory stock options or stock purchase rights granted under the 1997 Stock
Plan are nontransferable in all cases and must generally be granted with an
exercise price or purchase price equal to at least 85% of the fair market value
of the common stock on the date of grant.
In the event that we are acquired by another company, we expect that awards
outstanding under the 1997 Stock Plan will be assumed or equivalent awards
substituted by our acquiror. If an
58
<PAGE>
acquiror did not agree to assume or substitute awards, the vesting of
outstanding options and stock issued pursuant to stock purchase rights will
accelerate in full prior to consummation of the transaction. If we are acquired
pursuant to a transaction in which outstanding awards are assumed or substituted
by our acquiror and a participant holding an assumed or substituted award is
involuntarily terminated within 24 months following the acquisition, the vesting
of any award held by such person would accelerate in full immediately prior to
the date of his or her termination.
BABYCENTER, INC. 1997 STOCK PLAN. In connection with the BabyCenter merger,
we will assume the outstanding options issued under the BabyCenter, Inc. 1997
Stock Plan. We expect that options outstanding under the BabyCenter plan will,
upon closing of the merger, become options to purchase an aggregate of 2,011,114
shares of our common stock, subject to adjustment. The terms of the BabyCenter
options are similar to the terms of options issuable under our 1999 Stock Plan,
except that if we were acquired, such options would terminate if not assumed, or
equivalent options substituted, by our acquiror.
1999 DIRECTORS' STOCK OPTION PLAN. The Board of Directors adopted our 1999
Directors' Stock Option Plan in February 1999 and our stockholders approved it
in March 1999. We have reserved a total of 600,000 shares of common stock for
issuance under the 1999 Directors' Stock Option Plan. The 1999 Directors' Stock
Option Plan becomes effective upon the effective date of this offering and,
unless terminated earlier, it terminates in February 2009. As of the date of
this offering, no options to purchase shares of common stock have been issued
under the 1999 Directors' Stock Option Plan. The 1999 Directors' Stock Option
Plan is designed to work automatically without administration; however, to the
extent administration is necessary, it will be performed by the Board of
Directors. To the extent that conflicts of interest arise, we expect they will
be addressed by abstention of any interested director from both deliberations
and voting regarding matters in which such director has a personal interest.
The 1999 Directors' Stock Option Plan provides that each person who becomes
a nonemployee director after the date of this offering will be granted a
nonstatutory stock option to purchase 60,000 shares of common stock on the date
on which the optionee first becomes a nonemployee director. In addition, on the
date of each annual meeting of stockholders, each nonemployee director will
automatically be granted an additional option to purchase 15,000 shares of
common stock if, on such date, he or she has served on our Board of Directors
for at least six months. All options granted under the 1999 Directors' Stock
Option Plan shall have an exercise price equal to 100% of the fair market value
of the common stock as of the date of grant and will be vested and exercisable
in full immediately upon grant. Options granted under the 1999 Directors' Stock
Option Plan are nontransferable.
A nonemployee director who ceases to serve as a director for any reason
other than death or disability has 90 days after the date he or she ceases to be
a director to exercise options granted under the 1999 Directors' Stock Option
Plan. To the extent that he or she does not exercise an option within such 90
day period, the option will terminate. If a director's service on our Board of
Directors terminates as a result of his or her death or disability, the director
or the director's estate will have the right to exercise an option for 12 months
following such termination date. Options granted under the 1999 Directors' Stock
Option Plan have a term of ten years.
In the event that we are acquired by another company, we expect that awards
outstanding under the 1999 Directors' Stock Option Plan will be assumed or
equivalent awards substituted by our acquiror. If an acquiror did not agree to
assume or substitute awards, all outstanding awards under the 1999 Directors'
Stock Option Plan would terminate to the extent not previously exercised upon
consummation of the acquisition. The Board of Directors may amend or terminate
the 1999 Directors' Stock Option Plan at any time as long as such action does
not adversely affect any outstanding option and stockholder approval for any
amendments is obtained to the extent required by applicable law.
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<PAGE>
1999 EMPLOYEE STOCK PURCHASE PLAN. The Board of Directors adopted our 1999
Employee Stock Purchase Plan in February 1999 and our stockholders approved it
in March 1999. We have reserved a total of 1,000,000 shares of common stock for
issuance under the 1999 Employee Stock Purchase Plan, plus an automatic annual
increase on the first day of each of our fiscal years beginning in 2000, 2001,
2002, 2003 and 2004 equal to the lesser of 620,000 shares, 0.5% of our
outstanding common stock on the last day of the immediately preceding fiscal
year, or such lesser number of shares as the Board of Directors shall determine.
The 1999 Employee Stock Purchase Plan becomes effective upon the date of this
offering and, unless terminated earlier by the Board of Directors, it will
terminate in February 2019.
The 1999 Employee Stock Purchase Plan is intended to qualify under Section
423 of the Internal Revenue Code. This plan consists of a series of overlapping
offering periods of 24 months' duration. The initial offering period is expected
to commence on the date of this offering and end on April 30, 2001 and the
initial purchase period is expected to begin on the date of this offering and
end on October 31, 1999. A new 24-month offering period will begin upon the
closing of the BabyCenter merger, and additional offering periods will begin on
May 1 and November 1 of each year during the term of the plan. The Board of
Directors has the authority under the plan to set new offering or purchase
periods.
The Board of Directors or a committee appointed by the Board of Directors
will administer the 1999 Employee Stock Purchase Plan. The 1999 Employee Stock
Purchase Plan permits eligible employees to purchase common stock through
payroll deductions, which may not exceed 15% of an employee's compensation. The
purchase price is equal to the lower of 85% of the fair market value of the
common stock at the beginning of each offering period or at the end of each
purchase period. In circumstances specified in the 1999 Employee Stock Purchase
Plan, the purchase price may be adjusted during an offering period to avoid our
incurring adverse accounting charges. Our employees, including officers and
employee directors, are eligible to participate in the 1999 Employee Stock
Purchase Plan if they are employed by us for at least 20 hours per week and more
than five months per year. Employees may end their participation in the 1999
Employee Stock Purchase Plan at any time, and participation ends automatically
on termination of employment. If the fair market value of the common stock on a
purchase date is less than the fair market value at the beginning of the
offering period, each participant in the 1999 Employee Stock Purchase Plan shall
automatically be withdrawn from the offering period as of the end of the
purchase date and re-enrolled in the new 24-month offering period beginning on
the first business day following the purchase date.
The 1999 Employee Stock Purchase Plan limits the number of stock purchase
rights that can be granted to any single employee. An employee cannot be granted
rights to purchase stock under this plan if his or her rights accrue at a rate
which exceeds $25,000 worth of stock in any calendar year. In addition, no
employee may purchase more than 9,000 shares of common stock during any one
purchase period (equivalent to a maximum of 36,000 shares over a 24-month
offering period).
In the event that we are acquired by another company, the 1999 Employee
Stock Purchase Plan provides that each right to purchase stock will be assumed
or equivalent rights substituted by our acquiror. If an acquiror did not agree
to assume or substitute stock purchase rights, the offering period then in
progress would be shortened and a new exercise date occurring prior to
consummation of the acquisition would be set. The Board of Directors has the
power to amend or terminate the 1999 Employee Stock Purchase Plan and to change
or terminate offering periods as long as such action does not adversely affect
any outstanding rights to purchase stock thereunder. However, the Board of
Directors may amend or terminate the 1999 Employee Stock Purchase Plan or an
offering period even if it would adversely affect outstanding options in order
to avoid our incurring adverse accounting charges.
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<PAGE>
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
Our Certificate of Incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:
- - any breach of their duty of loyalty to the corporation or its stockholders;
- - acts or omissions not in good faith or which involve intentional misconduct or
a knowing violation of law;
- - unlawful payments of dividends or unlawful stock repurchases or redemptions;
or
- - any transaction from which the director derived an improper personal benefit.
Such limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.
Our Certificate of Incorporation and Bylaws provide that we shall indemnify
our directors and executive officers and may indemnify our other officers and
employees and other agents to the fullest extent permitted by law. We believe
that indemnification under our Bylaws covers at least negligence and gross
negligence on the part of indemnified parties. Our Bylaws also permit us to
secure insurance on behalf of any officer, director, employee or other agent for
any liability arising out of his or her actions in such capacity, regardless of
whether the Bylaws would permit indemnification.
We have entered into agreements to indemnify our directors and executive
officers in addition to indemnification provided for in our Bylaws. These
agreements, among other things, provide for indemnification of our directors and
executive officers for expenses specified in the agreements, including
attorneys' fees, judgments, fines and settlement amounts incurred by any such
person in any action or proceeding arising out of such person's services as a
director or executive officer of eToys, any subsidiary of eToys or any other
entity to which the person provides services at our request. We believe that
these provisions and agreements are necessary to attract and retain qualified
persons as directors and executive officers.
At present, we are not aware of any pending or threatened litigation or
proceeding involving a director, officer, employee or agent in which
indemnification would be required or permitted. We are not aware of any
threatened litigation or proceeding that might result in a claim for such
indemnification.
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<PAGE>
CERTAIN TRANSACTIONS
In June 1997, we sold 7,500,000 shares of common stock to Edward C. Lenk at
$0.005 per share in exchange for $18,750 in cash and a promissory note in the
principal amount of $18,750. The note is full recourse and secured by 3,750,000
of Mr. Lenk's shares. 3,750,000 of Mr. Lenk's shares are subject to a repurchase
option in our favor. In the event of the termination of his employment, our
repurchase option enables us to repurchase a specific number of Mr. Lenk's
shares at $0.005 per share. Our repurchase option lapses over four years
according to the following schedule: 1/4th of such shares were released from our
repurchase option on December 1, 1997, and 1/48th of such total are released
from our repurchase option monthly from and after December 1, 1997 until
December 1, 2000. In addition, all shares are immediately released from our
repurchase option upon a change of control. This offering will not constitute
such a change of control.
In October 1998, we issued Mr. Lenk an option to purchase 3,000,000 shares
of common stock at $0.143 per share. The option vests over four years according
to the following schedule: 1/4th of the shares vest on October 21, 1999 and
1/48th of the total number of shares vest monthly from and after October 21,
1999 until October 21, 2002. This option expires on October 21, 2008.
In June 1997, we sold 2,500,002 shares of common stock to Frank C. Han at
$0.005 per share in exchange for $6,250 in cash and a promissory note in the
principal amount of $6,250. The note is full recourse and secured by 1,250,001
of Mr. Han's shares. 1,250,001 of Mr. Han's shares are subject to a repurchase
option in our favor. In the event of the termination of his employment, our
repurchase option enables us to repurchase a specific number of Mr. Han's shares
at $0.005 per share. Our repurchase option lapses over four years according to
the following schedule: 1/4th of such shares were released from our repurchase
option on February 1, 1998, and 1/48th of such total are released from our
repurchase option monthly from and after February 1, 1998 until February 1,
2001. In addition, all shares are immediately released from our repurchase
option upon a change of control. This offering will not constitute such a change
of control.
In October 1998, we issued Mr. Han an option to purchase 825,000 shares of
common stock at $0.143 per share. The option vests over four years according to
the following schedule: 1/4th of the shares vest on October 21, 1999 and 1/48th
of the total number of shares vest monthly from and after October 21, 1999 until
October 21, 2002. This option expires on October 21, 2008. In January 1999, we
issued Mr. Han a fully vested option to purchase 750 shares of common stock at
$2.833 per share. This option expires on January 31, 2009.
In September 1997 we issued Peter C.M. Hart a stock option to purchase
300,000 shares of common stock at $0.005 per share. The option vests over four
years according to the following schedule: 1/4th of the shares subject to the
option vested on June 15, 1998 and 1/48th of the total have vested monthly from
and after June 15, 1998 until June 15, 2001. This option expires on September
29, 2007. In September 1997, we sold Mr. Hart a promissory note in the amount of
$20,000 and a warrant to purchase 48,387 shares of preferred stock at $0.207 per
share. The note converted into 98,817 shares of preferred stock in December 1997
and Mr. Hart exercised the warrant in full in March 1999. Mr. Hart was appointed
a Director in October 1997. In December 1997, we sold Mr. Hart 98,817 shares of
preferred stock at $0.207 per share. From January 1998 to June 1998, Mr. Hart
provided us part-time consulting services. In connection with these services, in
February 1998 we issued Mr. Hart a stock option to purchase 63,000 shares of
common stock at $0.033 per share. This option vested over six months according
to the following schedule: 1/6th of the shares subject to this option vested
monthly from and after February 1, 1998 until July 1, 1998. This option expires
on February 5, 2008.
In December 1998, we entered into an Offer Letter with John R. Hnanicek, our
Chief Information Officer. The agreement entitles Mr. Hnanicek to a salary of
$150,000 per year and a
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<PAGE>
signing bonus of $60,000 which vests monthly over the first year of his
employment. In December 1998, we granted Mr. Hnanicek an option to purchase
600,000 shares of common stock at $1.667 per share. The option is immediately
exercisable and, if exercised, the underlying shares are subject to a right of
repurchase in our favor. In the event of the termination of Mr. Hnanicek's
employment, our repurchase option enables us to repurchase a specific number of
his shares at $1.667 per share. Our repurchase option lapses over four years
according to the following schedule: 1/4th of the shares will be released from
our repurchase option on December 31, 1999 and 1/48th of the total number of
shares will be released from our repurchase option monthly from and after
December 31, 1999 until December 31, 2002. If Mr. Hnanicek is terminated without
cause during the first six months of his employment, an additional 1/8th of such
shares shall be released from our repurchase option. If Mr. Hnanicek is
terminated without cause during his first six to 12 months of employment, an
additional 1/48th of such shares shall be released from our repurchase option
per each month of completed employment. This option expires on December 31,
2008.
In December 1998, we entered into an Offer Letter with Louis V. Zambello
III, our Senior Vice President of Operations. The agreement entitles Mr.
Zambello to a salary of $200,000 per year, a signing bonus of $115,000 which
vests monthly over the first year of his employment and severance benefits equal
to $100,000 if he is terminated without cause during the first 12 months of his
employment with us. In December 1998, we granted Mr. Zambello an option to
purchase 825,000 shares of common stock at $1.667 per share. The option is
immediately exercisable and, if exercised, the underlying shares are subject to
a right of repurchase in our favor. In the event of the termination of Mr.
Zambello's employment, our repurchase option enables us to repurchase a specific
number of his shares at $1.667 per share. Our repurchase option lapses over four
years according to the following schedule: 1/4th of the shares will be released
from our repurchase option on December 31, 1999 and 1/48th of the total number
of shares will be released from our repurchase option monthly from and after
December 31, 1999 until December 31, 2002. If Mr. Zambello is terminated without
cause during the first six months of his employment, an additional 1/8th of such
shares shall be released from our repurchase option. If Mr. Zambello is
terminated without cause during his first six to 12 months of employment, an
additional 1/48th of such shares shall be released from our repurchase option
for each month of completed employment. Furthermore, if we experience a change
of control within two years following his commencement of employment, a total of
412,500 of such shares shall immediately be released from our repurchase option.
This offering will not constitute such a change of control. This option expires
on December 31, 2008.
In January 1999, we entered into an Offer Letter with Steven J. Schoch, our
Chief Financial Officer. The agreement entitles Mr. Schoch to a salary of
$125,000 per year, a signing bonus of $25,000 which vests monthly over the first
year of his employment and severance benefits equal to $93,750 if he is
terminated without cause during the first 12 months of his employment with us.
In January 1999, we granted Mr. Schoch an option to purchase 750,000 shares of
common stock at $3.333 per share. The option is immediately exercisable and, if
exercised, the underlying shares are subject to a right of repurchase in our
favor. In the event of the termination of Mr. Schoch's employment, our
repurchase option enables us to repurchase a specific number of his shares at
$3.333 per share. Our repurchase option lapses over four years according to the
following schedule: 1/4th of the shares will be released from our repurchase
option on January 31, 2000 and 1/48th of the total number of shares will be
released from our repurchase option monthly from and after January 31, 2000
until January 31, 2003. If Mr. Schoch is terminated without cause during the
first six months of his employment, an additional 1/8th of such shares shall be
released from our repurchase option. If Mr. Schoch is terminated without cause
during his first six to 12 months of employment, an additional 1/48th of such
shares will be released from our repurchase option for each month of completed
employment. Furthermore, if we experience a change of control within 18 months
following his commencement of employment, a total of 281,250 of such shares
shall
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<PAGE>
immediately be released from our repurchase option. This offering will not
constitute such a change of control. This option expires on January 31, 2009.
In May 1999, we entered into an Offer Letter with Janine Bousquette, our
Senior Vice President of Marketing. The agreement entitles Ms. Bousquette to a
salary of $138,462 per year, a signing bonus of $75,000 which vests monthly over
the first year of her employment and severance benefits equal to $100,000 if she
is terminated without cause during the first 12 months of her employment with
us. In May 1999, we granted to Ms. Bousquette an option to purchase 480,000
shares of common stock at $11.00 per share. The option is immediately
exercisable and, if exercised, the underlying shares are subject to a right of
repurchase in our favor. In the event of the termination of Ms. Bousquette's
employment, our repurchase option enables us to repurchase a specific number of
her shares at $11.00 per share. Our repurchase option lapses over four years
according to the following schedule: 1/4th of the shares will be released from
our repurchase option on May 17, 2000 and 1/48th of the total number of shares
will be released from our repurchase option monthly from and after May 17, 2000
until May 17, 2003. If Ms. Bousquette is terminated without cause during the
first six months of her employment, an additional 1/8th of such shares shall be
released from our repurchase option. If Ms. Bousquette is terminated without
cause during her first six to 12 months of employment, an additional 1/48th of
such shares shall be released from our repurchase option for each month of
completed employment. Furthermore, if we experience a change of control within
18 months following her commencement of employment, a total of 180,000 of such
shares shall immediately be released from our repurchase option. This offering
will not constitute such a change of control. This option expires on May 17,
2009.
In June 1997, we sold 19,400,001 shares of common stock at $0.005 per share
and issued a note in the principal amount of $100,000 to idealab!. Pursuant to a
Letter Agreement dated November 5, 1997, idealab! returned shares of common
stock to us in the form of a capital contribution such that idealab!'s ownership
was reduced to 18,320,001 shares of common stock. Pursuant to a second Letter
Agreement dated November 5, 1997, idealab! forgave our indebtedness in the
amount of $100,000 as a capital contribution.
We have entered into indemnification agreements with our officers and
directors which may require us, among other things, to indemnify our officers
and directors against liabilities that may arise by reason of their status or
service as officers or directors, other than liabilities arising from willful
misconduct of a culpable nature, and to advance their expenses incurred as a
result of any proceeding against them as to which they could be indemnified. See
"Management--Limitation of Liability and Indemnification Matters".
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<PAGE>
The following table summarizes the shares of common stock and preferred
stock purchased by our directors and 5% stockholders and persons and entities
associated with them in private placement transactions. Each share of preferred
stock automatically converts into one share of common stock upon the closing of
this offering. The shares of common stock were sold at $0.005 per share, the
shares of Series A preferred stock were sold at $0.207 per share, the shares of
Series B preferred stock were sold at $0.701 per share and the shares of Series
C preferred stock were sold at $10.00 per share. See "Principal Stockholders".
<TABLE>
<CAPTION>
COMMON SERIES A SERIES B SERIES C
ENTITIES AFFILIATED WITH DIRECTORS STOCK PREFERRED PREFERRED PREFERRED
- ---------------------------------------------------------- ------------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Entities affiliated with Highland Capital Partners (Daniel
Nova)(1)................................................ -- -- 11,411,184 999,999
Entities affiliated with Sequoia Capital (Michael
Moritz)(2).............................................. -- -- 7,131,990 999,999
Entities affiliated with DynaFund Ventures (Tony
Hung)(3)................................................ -- 4,838,709 2,852,796 --
Peter C.M. Hart........................................... -- 147,204 -- --
OTHER 5% STOCKHOLDERS
- ----------------------------------------------------------
idealab!(4)............................................... 18,320,001 -- -- --
Intel Corporation......................................... -- 4,838,709 2,852,793 --
Entities affiliated with idealab! Capital Management I,
LLC(5).................................................. -- 4,838,709 2,139,594 --
</TABLE>
- ------------------------
(1) Includes shares held by Highland Capital Partners III Limited Partnership,
Highland Entrepreneurs' Fund III Limited Partnership, Highland Capital
Partners IV Limited Partnership and Highland Entrepreneurs' Fund IV Limited
Partnership. Daniel Nova is a general partner of the general partner of the
Highland entities and is a Director of eToys. He disclaims beneficial
ownership of the shares held by the entities except to the extent of his
proportionate interest therein.
(2) Includes shares held by Sequoia Capital VIII, Sequoia International
Technology Partners VIII (Q), CMS Partners LLC, Sequoia International
Technology Partners VIII, Sequoia 1997, and Sequoia Capital Franchise Fund.
Michael Moritz is a general partner of the general partners of the Sequoia
entities and is a Director of eToys. He disclaims beneficial ownership of
the shares held by the entities except to the extent of his proportionate
interest therein.
(3) Includes shares held by DynaFund L.P. and DynaFund International L.P. Tony
Hung is a vice president of the general partner of the DynaFund entities and
is a Director of eToys. He disclaims beneficial ownership of the shares held
by the entities except to the extent of his proportionate interest therein.
(4) In November 1997, idealab! returned shares of common stock to us in the form
of a capital contribution such that idealab!'s ownership was reduced to
18,320,001 shares of common stock.
(5) Includes shares held by idealab! Capital Partners I-A, LP and idealab!
Capital Partners I-B, LP. idealab! Capital Management I, LLC is the general
partner of idealab! Capital Partners I-A, LP and idealab! Capital Partners
I-B, LP, and exercises voting and investment power over the shares held by
these entities.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of March 31, 1999, as adjusted to
reflect the sale of the common stock offered hereby under this prospectus, by:
- - each stockholder known by us to own beneficially more than 5% of the common
stock,
- - each director,
- - our Chief Executive Officer and our four other highest compensated executive
officers, and
- - all directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO OFFERING(1) AFTER OFFERING(1)
---------------------------- ----------------------------
NUMBER PERCENTAGE(2) NUMBER PERCENTAGE(2)
----------- --------------- ----------- ---------------
<S> <C> <C> <C> <C>
idealab! ...................................... 18,320,001 19.60% 18,320,001 18.00%
130 West Union Street
Pasadena, CA 91103
Entities affiliated with Highland Capital
Partners(3) ................................. 12,411,183 13.28 12,411,183 12.20
Two International Place
Boston, MA 02110
Entities affiliated with Sequoia Capital
Partners(4) ................................. 8,131,989 8.70 8,131,989 7.99
3000 Sand Hill Road, Bldg. 4, Suite 280
Menlo Park, CA 94025
Entities affiliated with DynaFund
Ventures(5) ................................. 7,691,505 8.23 7,691,505 7.56
21311 Hawthorne Blvd., Suite 300
Torrance, CA 90503
Intel Corporation ............................. 7,691,502 8.23 7,691,502 7.56
2200 Mission Blvd.
Santa Clara, CA 95052
Entities affiliated with idealab! Capital ..... 6,978,303 7.47 6,978,303 6.86
Management I, LLC(6)
130 West Union Street
Pasadena, CA 91103
Daniel J. Nova(7) ............................. 12,411,183 13.28 12,411,183 12.20
Michael Moritz(8) ............................. 8,131,989 8.70 8,131,989 7.99
Tony Hung(9) .................................. 7,691,505 8.23 7,691,505 7.56
Edward C. Lenk ................................ 7,491,000 8.01 7,491,000 7.36
Peter C.M. Hart(10) ........................... 353,952 * 353,952 *
Frank C. Han(11) .............................. 2,488,752 2.66 2,488,752 2.45
Louis V. Zambello III(12) ..................... 825,000 * 825,000 *
Steven J. Schoch(13) .......................... 750,000 * 750,000 *
John R. Hnanicek(14) .......................... 600,000 * 600,000 *
Janine Bousquette(15) ......................... 480,000 * 480,000 *
All directors and executive officers as a group
(10 persons)(16) ............................ 41,223,381 42.73% 41,223,381 39.35%
</TABLE>
- ------------------------
* Less than 1% of the outstanding shares of common stock.
(1) Assumes no exercise of the underwriters' over-allotment option and does not
include the aggregate of 18,720,000 shares of our common stock that will be
issued in exchange for all outstanding shares of BabyCenter capital stock
and reserved for issuance upon the exercise
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of options we are assuming in connection with the proposed BabyCenter
merger. Except pursuant to applicable community property laws or as
indicated in the footnotes to this table, to our knowledge, each
stockholder identified in the table possesses sole voting and investment
power with respect to all shares of common stock shown as beneficially
owned by such stockholder.
(2) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage of ownership of that
person, shares of common stock subject to options or warrants held by that
person that are currently exercisable or will become exercisable within 60
days after March 31, 1999 are deemed outstanding, while such shares are not
deemed outstanding for computing percentage ownership of any other person.
Unless otherwise indicated in the footnotes below, the persons and entities
named in the table have sole voting and investment power with respect to
all shares beneficially owned, subject to community property laws where
applicable.
(3) Includes 10,954,737 shares held by Highland Capital Partners III Limited
Partnership, 456,447 shares held by Highland Entrepreneurs' Fund III
Limited Partnership, 960,000 shares held by Highland Capital Partners IV
Limited Partnership and 39,999 shares held by Highland Entrepreneurs' Fund
IV Limited Partnership. Highland Management Partners III LLC is the general
partner of Highland Capital Partners III Limited Partnership and exercises
voting and investment power over the shares held by this entity. HEF III
LLC is the general partner of Highland Entrepreneurs' Fund III Limited
Partnership and exercises voting and investment power over the shares held
by this entity. Highland Management Partners IV LLC is the general partner
of Highland Capital Partners IV Limited Partnership and exercises voting
and investment power over the shares held by this entity. Highland
Entrepreneurs' Fund IV LLC is the general partner of Highland
Entrepreneurs' Fund IV Limited Partnership and exercises voting and
investment power over the shares held by this entity.
(4) Includes 6,463,722 shares held by Sequoia Capital VIII, 427,920 shares held
by Sequoia International Technology Partners VIII (Q), 142,641 shares held
by CMS Partners LLC, 82,017 shares held by Sequoia International Technology
Partners VIII, 15,690 shares held by Sequoia 1997, and 999,999 shares held
by Sequoia Capital Franchise Fund. SC VIII Management, LLC is the general
partner of Sequoia Capital VIII, Sequoia International Technology Partners
VIII and Sequoia International Technology Partners VIII (Q) and exercises
investment and voting power over the shares held by these entities. SC VIII
Management, LLC also exercises investment and voting power over the shares
held by CMS Partners LLC and Sequoia 1997. SCFF Management, LLC is the
general partner of Sequoia Capital Franchise Fund and exercises investment
and voting power over the shares held by this entity.
(5) Includes 4,155,894 shares held by DynaFund International L.P. and 3,535,611
shares held by DynaFund L.P. DynaFund Ventures LLC is the general partner
of DynaFund L.P. and DynaFund International L.P. and exercises investment
and voting power over the shares held by these entities.
(6) Includes 6,562,359 shares held by idealab! Capital Partners I-A, LP and
415,944 shares held by idealab! Capital Partners I-B, LP. idealab! Capital
Management I, LLC is the general partner of idealab! Capital Partners I-A,
LP and idealab! Capital Partners I-B, LP, and exercises voting and
investment power over the shares held by these entities. William S. Elkus
and William T. Gross exercise voting and investment power over idealab!
Capital Management I, LLC.
(7) Includes 10,954,737 shares held by Highland Capital Partners III Limited
Partnership, 456,447 shares held by Highland Entrepreneurs' Fund III
Limited Partnership, 960,000 shares held by Highland Capital Partners IV
Limited Partnership and 39,999 shares held by Highland Entrepreneurs' Fund
IV Limited Partnership. Highland Management Partners III LLC is the general
partner of Highland Capital Partners III Limited Partnership and exercises
voting and investment power over the shares held by this entity. HEF III
LLC is the general partner of
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Highland Entrepreneurs' Fund III Limited Partnership and exercises voting
and investment power over the shares held by this entity. Highland
Management Partners IV LLC is the general partner of Highland Capital
Partners IV Limited Partnership and exercises voting and investment power
over the shares held by this entity. Highland Entrepreneurs' Fund IV LLC is
the general partner of Highland Entrepreneurs' Fund IV Limited Partnership
and exercises voting and investment power over the shares held by this
entity. Daniel Nova is a general partner of the general partners of the
Highland entities and is a Director of eToys. He disclaims beneficial
ownership of the shares held by the entities except to the extent of his
proportionate interest therein.
(8) Includes 6,463,722 shares held by Sequoia Capital VIII, 427,920 shares held
by Sequoia International Technology Partners VIII (Q), 142,641 shares held
by CMS Partners LLC, 82,017 shares held by Sequoia International Technology
Partners VIII, 15,690 shares held by Sequoia 1997, and 999,999 shares held
by Sequoia Capital Franchise Fund. SC VIII Management, LLC is the general
partner of Sequoia Capital VIII, Sequoia International Technology Partners
VIII and Sequoia International Technology Partners VIII (Q) and exercises
investment and voting power over the shares held by these entities. SC VIII
Management, LLC also exercises investment and voting power over the shares
held by CMS Partners LLC and Sequoia 1997. SCFF Management, LLC is the
general partner of Sequoia Capital Franchise Fund and exercises investment
and voting power over the shares held by this entity. Michael Moritz is a
general partner of the general partners of the Sequoia entities and is a
Director of eToys. He disclaims beneficial ownership of the shares held by
the entities except to the extent of his proportionate interest therein.
(9) Includes 4,155,894 shares held by DynaFund International L.P. and 3,535,611
shares held by DynaFund L.P. DynaFund Ventures LLC is the general partner
of DynaFund L.P. and DynaFund International L.P. and exercises investment
and voting power over the shares held by these entities. Tony Hung is a
vice president of the general partner of the DynaFund entities and is a
Director of eToys. He disclaims beneficial ownership of the shares held by
the entities except to the extent of his proportionate interest therein.
(10) Includes 206,748 shares issuable upon exercise of options which will be
vested within 60 days of March 31, 1999.
(11) Includes 750 shares issuable upon exercise of an option which will be
vested within 60 days of March 31, 1999.
(12) Includes 825,000 shares issuable upon exercise of an option which will be
exercisable within 60 days of March 31, 1999, but which are subject to a
right of repurchase in our favor at cost in the event Mr. Zambello ceases
employment with us.
(13) Includes 750,000 shares issuable upon exercise of an option which will be
exercisable within 60 days of March 31, 1999, but which are subject to a
right of repurchase in our favor at cost in the event Mr. Schoch ceases
employment with us.
(14) Includes 600,000 shares issuable upon exercise of an option which will be
exercisable within 60 days of March 31, 1999, but which are subject to a
right of repurchase in our favor at cost in the event Mr. Hnanicek ceases
employment with us.
(15) Includes 480,000 shares issuable upon exercise of an option which will be
exercisable within 60 days of March 31, 1999, but which are subject to a
right of repurchase in our favor at cost in the event Ms. Bousquette
ceases employment with us.
(16) Includes the shares described in Notes 7 through 15.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
600,000,000 shares of common stock, $0.0001 par value, and 10,000,000 shares of
undesignated preferred stock, $0.0001 par value. The following description of
our capital stock does not purport to be complete and is subject to and
qualified in its entirety by our Certificate of Incorporation and Bylaws, which
are included as exhibits to the registration statement of which this prospectus
forms a part, and by the provisions of applicable Delaware law.
COMMON STOCK
As of March 31, 1999 there were 93,266,295 shares of common stock
outstanding, held of record by approximately 127 stockholders, which reflects
the conversion of all outstanding shares of preferred stock into common stock.
In addition, as of March 31, 1999, there were 209,799 shares subject to
outstanding warrants, 198,397 of which expire upon this offering, and 14,927,676
shares of common stock subject to outstanding options. Upon completion of this
offering, there will be 101,784,682 shares of common stock outstanding, assuming
full exercise of warrants to purchase 198,387 shares which expire at, and are
expected to be exercised upon, completion of this offering and no exercise of
the underwriter's overallotment option or additional exercise of outstanding
options and warrants.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by stockholders. Subject to preferences that may be
applicable to any outstanding preferred stock, holders of common stock are
entitled to receive ratably such dividends as may be declared by the Board of
Directors out of funds legally available for that purpose. See "Dividend
Policy". In the event of our liquidation, dissolution or winding up, the holders
of common stock are entitled to share ratably in all assets remaining after
payment of liabilities and the liquidation preference of any outstanding
preferred stock. The common stock has no preemptive or conversion rights, other
subscription rights, or redemption or sinking fund provisions. All outstanding
shares of common stock are fully paid and non-assessable, and the shares of
common stock to be issued upon completion of this offering will be fully paid
and non-assessable.
PREFERRED STOCK
As of March 31, 1999, we had three series of preferred stock: Series A
preferred stock, Series B preferred stock and Series C preferred stock. Each
series of preferred stock has the rights, preferences and privileges set forth
in our current Certificate of Incorporation, which is included as an exhibit to
the registration statement of which this prospectus forms a part. As of March
31, 1999, the number of outstanding shares for each series of our preferred
stock was:
- - 21,119,322 shares of Series A preferred stock, which number reflects the full
exercise of a warrant to purchase 48,387 shares of Series A preferred stock
outstanding as of March 31, 1999;
- - 35,659,947 shares of Series B preferred stock; and
- - 1,999,998 shares of Series C preferred stock.
Upon the closing of the offering, all outstanding shares of our preferred
stock will be converted on a share-by-share basis into 58,779,267 shares of
common stock, which reflects the full exercise of a warrant to purchase 48,387
shares of Series A preferred stock outstanding as of March 31, 1999, and
automatically retired. Thereafter, the Board of Directors will have the
authority, without further action by the stockholders, to issue up to 10,000,000
shares of preferred stock in one or more series and to designate the rights,
preferences, privileges and restrictions of each such series. The issuance of
preferred stock could have the effect of restricting dividends on the common
stock, diluting the voting power of the common stock, impairing the liquidation
rights of
69
<PAGE>
the common stock or delaying or preventing our change in control without further
action by the stockholders. We have no present plans to issue any shares of
preferred stock after the completion of this offering.
WARRANTS
As of March 31, 1999 there were warrants outstanding to purchase a total of
11,412 shares of common stock at a price of $7.01 per share. In addition, there
was a warrant to purchase a total of 48,387 shares of preferred stock at a price
of $0.207 per share, which was exercised in April 1999, and a warrant to
purchase a total of 150,000 shares of common stock at a price of $0.003 per
share, which expires upon completion of this offering.
REGISTRATION RIGHTS
The holders of 68,677,269 shares of common stock and options to purchase
3,825,750 shares of common stock (the "registrable securities") are entitled to
have their shares registered by us under the Securities Act under the terms of
an agreement between us and the holders of the registrable securities. Subject
to limitations specified in the agreement, these registration rights include the
following:
- - The holders of at least 25% of the then outstanding registrable securities may
require, on two occasions beginning 180 days after the date of this
prospectus, that we use our best efforts to register the registrable
securities for public resale.
- - If we register any common stock, either for our own account or for the account
of other security holders, the holders of registrable securities are entitled
to include their shares of common stock in such registration, subject to the
ability of the underwriters to limit the number of shares included in the
offering in view of market conditions.
- - The holders of at least 25% of the then outstanding registrable securities may
require us on three occasions to register all or a portion of their
registrable securities on Form S-3 when use of such form becomes available to
us, provided that the proposed aggregate selling price is at least $2,000,000.
We will bear all registration expenses other than underwriting discounts and
commissions. All registration rights terminate on the date five years following
the closing of this offering, or, with respect to each holder of registrable
securities, at such time as the holder is entitled to sell all of its shares in
any three-month period under Rule 144 of the Securities Act.
DELAWARE ANTI-TAKEOVER LAW AND OUR CERTIFICATE OF INCORPORATION AND BYLAW
PROVISIONS
Provisions of Delaware law and our Certificate of Incorporation and Bylaws
could make more difficult our acquisition by a third party and the removal of
our incumbent officers and directors. These provisions, summarized below, are
expected to discourage coercive takeover practices and inadequate takeover bids
and to encourage persons seeking to acquire control of eToys to first negotiate
with us. We believe that the benefits of increased protection of our ability to
negotiate with the proponent of an unfriendly or unsolicited acquisition
proposal outweigh the disadvantages of discouraging such proposals because,
among other things, negotiation could result in an improvement of their terms.
We are subject to Section 203 of the Delaware General Corporation Law, which
regulates corporate acquisitions. In general, Section 203 prohibits a publicly
held Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years following the date the
person became an interested stockholder, unless:
70
<PAGE>
- - the Board of Directors approved the transaction in which such stockholder
became an interested stockholder prior to the date the interested stockholder
attained such status;
- - upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, he or she owned at least 85% of the voting
stock of the corporation outstanding at the time the transaction commenced,
excluding shares owned by persons who are directors and also officers; or
- - on or subsequent to such date the business combination is approved by the
Board of Directors and authorized at an annual or special meeting of
stockholders.
A "business combination" generally includes a merger, asset or stock sale, or
other transaction resulting in a financial benefit to the interested
stockholder. In general, an "interested stockholder" is a person who, together
with affiliates and associates, owns, or within three years prior to the
determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock.
Our Certificate of Incorporation and Bylaws do not provide for the right of
stockholders to act by written consent without a meeting or for cumulative
voting in the election of directors. In addition, our Certificate of
Incorporation permits the Board of Directors to issue preferred stock with
voting or other rights without any stockholder action. Commencing at our first
annual meeting of stockholders following the date on which we have at least 800
stockholders, our Certificate of Incorporation provides for the Board of
Directors to be divided into three classes, with staggered three-year terms. As
a result, only one class of directors will be elected at each annual meeting of
stockholders. Each of the two other classes of directors will continue to serve
for the remainder of its respective three-year term. These provisions, which
require the vote of stockholders holding at least a majority of the outstanding
common stock to amend, may have the effect of deterring hostile takeovers or
delaying changes in our management.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services, L.L.C. The transfer agent's address is 400 South Hope
Street, 4th Floor, Los Angeles, California 90071 and telephone number is (213)
553-9730.
71
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock.
Future sales of substantial amounts of common stock in the public market could
adversely affect prevailing market prices. As described below, no shares
currently outstanding will be available for sale immediately after this offering
because of contractual restrictions on resale. Sales of substantial amounts of
our common stock in the public market after the restrictions lapse could
adversely affect the prevailing market price and impair our ability to raise
equity capital in the future.
Upon completion of the offering, we will have 101,784,682 outstanding shares
of common stock and options to purchase 14,927,676 shares of common stock,
assuming no additional option grants or exercises after March 31, 1999. Of these
shares, the 8,320,000 shares sold in the offering, plus any shares issued upon
exercise of the underwriters' over-allotment option, will be freely tradable
without restriction under the Securities Act, unless purchased by our
"affiliates" as that term is defined in Rule 144 under the Securities Act. In
general, affiliates include officers, directors or 10% stockholders.
The remaining 93,464,682 shares outstanding and 14,927,676 shares subject to
outstanding options are "restricted securities" within the meaning of Rule 144.
Restricted securities may be sold in the public market only if registered or if
they qualify for an exemption from registration under Rules 144, 144(k) or 701
promulgated under the Securities Act, which are summarized below. Sales of the
restricted securities in the public market, or the availability of such shares
for sale, could adversely affect the market price of the common stock.
Our directors, officers and securityholders have entered into lock-up
agreements in connection with this offering generally providing that they will
not offer, sell, contract to sell or grant any option to purchase or otherwise
dispose of our common stock or any securities exercisable for or convertible
into our common stock owned by them for a period of 180 days after the date of
this prospectus without the prior written consent of Goldman, Sachs & Co. In
addition, some stockholders have entered into similar lock-up agreements
covering a period of 365 days from the date of this prospectus. Notwithstanding
possible earlier eligibility for sale under the provisions of Rules 144, 144(k)
and 701, shares subject to lock-up agreements will not be salable until such
agreements expire or are waived by Goldman, Sachs & Co. Goldman Sachs & Co. has
released the holders of fully vested options to purchase 170,250 shares of
common stock from such lock-up agreements. Taking into account the lock-up
agreements, and assuming Goldman, Sachs & Co. does not further release
stockholders from these agreements, the following shares will be eligible for
sale in the public market at the following times:
- - Beginning on the effective date of this prospectus, the shares sold in the
offering and 170,250 shares subject to fully vested options will be
immediately available for sale in the public market.
- - Beginning 180 days after the effective date, approximately 7,658,202 shares
will be eligible for sale pursuant to Rule 701, approximately 1,701,000
additional shares will be eligible for sale pursuant to Rule 144(k), and
approximately 82,105,482 additional shares will be eligible for sale pursuant
to Rule 144. In addition, approximately 14,757,426 shares subject to options
will be eligible for sale pursuant to Rule 701, subject to vesting
restrictions. All but 20,113,995 of such shares and 12,636,926 of such shares
subject to options are held by affiliates.
- - Beginning 365 days after the effective date, approximately 1,999,998 shares
will be eligible for sale pursuant to Rule 144, all of which are held by
affiliates.
In connection with the BabyCenter merger, BabyCenter has agreed that its
stockholders holding at least 95% of the shares of our common stock to be issued
in the merger as well as BabyCenter optionees holding at least 85% of the shares
to be issued upon exercise of BabyCenter
72
<PAGE>
options we assume in the merger will enter into lock-up agreements similar to
those entered into by our existing directors, officers and securityholders. As a
result, upon the closing of the merger, up to approximately 1,377,152 shares of
our common stock to be issued in exchange for outstanding shares of BabyCenter
capital stock and issuable upon exercise of BabyCenter options we assume will be
immediately eligible for sale in the public market in accordance with the
restrictions of Rule 144 under the Securities Act. The remaining 17,342,848
shares of our common stock to be issued in exchange for outstanding shares of
BabyCenter capital stock and issuable upon exercise of BabyCenter options we
assume in connection with the merger will be eligible for public sale in the
public market beginning 180 days after the date of this prospectus, subject to
the volume and other restrictions of Rule 144.
In general, under Rule 144 as currently in effect, after the expiration of
the lock-up agreements, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- - one percent of the number of shares of common stock then outstanding which
will equal approximately 1,017,847 shares immediately after the offering; or
- - the average weekly trading volume of the common stock during the four calendar
weeks preceding the sale.
Sales under Rule 144 are also subject to requirements with respect to manner
of sale, notice, and the availability of current public information about us.
Under Rule 144(k), a person who is not deemed to have been our affiliate at any
time during the three months preceding a sale, and who has beneficially owned
the shares proposed to be sold for at least two years, is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares pursuant to a written compensatory plan or
contract to resell such shares in reliance upon Rule 144 but without compliance
with specific restrictions. Rule 701 provides that affiliates may sell their
Rule 701 shares under Rule 144 without complying with the holding period
requirement and that non-affiliates may sell such shares in reliance on Rule 144
without complying with the holding period, public information, volume limitation
or notice provisions of Rule 144.
In addition, we intend to file registration statements under the Securities
Act as promptly as possible after the effective date to register shares to be
issued pursuant to our employee benefit plans. As a result, any options or
rights exercised under the 1997 Stock Plan, the 1999 Stock Plan, the 1999
Employee Stock Purchase Plan, the 1999 Directors' Stock Option Plan or any other
benefit plan after the effectiveness of the registration statements will also be
freely tradable in the public market. However, such shares held by affiliates
will still be subject to the volume limitation, manner of sale, notice and
public information requirements of Rule 144 unless otherwise resalable under
Rule 701. As of March 31, 1999 there were outstanding options for the purchase
of 14,927,676 shares of common stock, of which options to purchase 535,944
shares were exercisable. See "Risk Factors--Risks Related to Securities
Markets--Substantial Sales of Our Common Stock Could Cause Our Stock Price to
Fall", "Management--Stock Plans" and "Description of Capital Stock--Registration
Rights".
73
<PAGE>
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for
eToys by Venture Law Group, A Professional Corporation, Menlo Park, California.
Glen R. Van Ligten, a director of Venture Law Group, serves as our Assistant
Secretary. Certain legal matters in connection with this offering will be passed
upon for the underwriters by Gunderson, Dettmer, Stough, Villeneuve, Franklin &
Hachigian, LLP. A director of Venture Law Group and an investment partnership
affiliated with Venture Law Group own an aggregate of 41,772 shares of common
stock and, in connection with this offering, certain directors and attorneys of
Venture Law Group will acquire an additional 8,275 shares of common stock. If
the BabyCenter merger is completed, certain directors and attorneys of Venture
Law Group and two investment partnerships affiliated with Venture Law Group will
own an aggregate of approximately 83,509 shares of common stock (including the
shares described in the preceding sentence).
EXPERTS
The financial statements of eToys Inc. as of March 31, 1998 and 1999 and for
each of the two years in the period ended March 31, 1999 and of BabyCenter, Inc.
as of September 30, 1997 and 1998 and March 31, 1999 and for the period from
inception (February 11, 1997) to September 30, 1997, the year ended September
30, 1998 and for the six months ended March 31, 1999, appearing in this
prospectus and registration statement have been audited by Ernst & Young LLP,
independent auditors, as set forth in their reports thereon appearing elsewhere
herein, and are included in reliance upon such reports given on the authority of
such firm as experts in accounting and auditing.
74
<PAGE>
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission 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 of the
information set forth in the registration statement and the exhibits and
schedule thereto. For further information with respect to eToys and the common
stock offered in this offering, we refer you to the registration statement and
to the attached exhibits and schedules. Statements made in this prospectus
concerning the contents of any document referred to in this prospectus are not
necessarily complete. With respect to each such document filed as an exhibit to
the registration statement, we refer you to the exhibit for a more complete
description of the matter involved.
You may inspect our registration statement and the attached exhibits and
schedules without charge at the public reference facilities maintained by the
Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, and at the regional offices of the Commission located at Seven World
Trade Center, 13th Floor, New York, NY 10048, and the Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may
obtain copies of all or any part of our registration statement from the
Securities and Exchange Commission upon payment of prescribed fees. You may also
inspect reports, proxy and information statements and other information
regarding registrants that file electronically with the Securities and Exchange
Commission without charge at a Web site maintained by the Securities and
Exchange Commission at http://www.sec.gov.
75
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
ETOYS INC.
Report of Independent Auditors....................................................... F-2
Balance Sheets at March 31, 1998 and 1999............................................ F-3
Statements of Operations for the years ended March 31, 1998 and 1999................. F-4
Statements of Stockholders' Equity (Deficit) for the years ended March 31, 1998 and
1999............................................................................... F-5
Statements of Cash Flows for the years ended March 31, 1998 and 1999................. F-6
Notes to Financial Statements........................................................ F-7
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Combined Statement of Operations for the year ended
March 31, 1999..................................................................... F-19
Unaudited Pro Forma Condensed Combined Balance Sheet at March 31, 1999............... F-20
Notes to Unaudited Pro Forma Condensed Combined Financial Information................ F-21
BABYCENTER, INC.
Report of Independent Auditors....................................................... F-23
Balance Sheets at September 30, 1997 and 1998 and March 31, 1999..................... F-24
Statements of Operations for the period from inception (February 11, 1997) to
September 30, 1997, the year ended September 30, 1998 and the six months ended
March 31, 1998 (unaudited) and 1999................................................ F-25
Statements of Stockholders' Equity (Deficit) for the period from inception (February
11, 1997) to September 30, 1997, the year ended September 30, 1998 and six months
ended March 31, 1999............................................................... F-26
Statements of Cash Flows for the period from inception (February 11, 1997) to
September 30, 1997, the year ended September 30, 1998 and the six months ended
March 31, 1998 (unaudited) and 1999................................................ F-27
Notes to Financial Statements........................................................ F-28
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
eToys Inc.
We have audited the accompanying balance sheets of eToys Inc. as of March
31, 1998 and 1999, and the related statements of operations, stockholders'
equity (deficit), and cash flows for the years then ended. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of eToys Inc. as of March 31,
1998 and 1999, and the results of its operations and its cash flows for the
years then ended, in conformity with generally accepted accounting principles.
Ernst & Young LLP
Los Angeles, California
May 3, 1999
F-2
<PAGE>
ETOYS INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
EQUITY AT
MARCH 31, MARCH 31, MARCH 31,
1998 1999 1999
------------ -------------- --------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 1,552,000 $ 20,173,000
Inventories....................................................... 224,000 5,067,000
Prepaid expenses and other current assets......................... 35,000 1,577,000
------------ --------------
Total current assets................................................ 1,811,000 26,817,000
Property and equipment:
Equipment......................................................... 155,000 1,393,000
Furniture and fixtures............................................ 8,000 10,000
Leasehold improvements............................................ 15,000 371,000
Assets under capital lease........................................ -- 731,000
------------ --------------
178,000 2,505,000
Accumulated depreciation and amortization......................... (18,000) (369,000)
------------ --------------
160,000 2,136,000
Goodwill (net of accumulated amortization of $319,000 at March 31,
1999)............................................................. 956,000 637,000
Other assets........................................................ -- 1,076,000
------------ --------------
Total assets........................................................ $ 2,927,000 $ 30,666,000
------------ --------------
------------ --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.................................................. $ 346,000 $ 4,236,000 $
Accrued expenses.................................................. 9,000 530,000
Current portion of capital lease obligations...................... 230,000
------------ --------------
Total current liabilities........................................... 355,000 4,996,000
Long-term capital lease obligations................................. -- 477,000
Redeemable Convertible Preferred Stock, 19,593,089 shares
authorized:
Series A Preferred Stock; $.0001 par value; 6,318,017 and
7,023,645 shares issued and outstanding at March 31, 1998 and
1999, respectively............................................ 3,917,000 4,355,000 --
Series B Preferred Stock, $.0001 par value, 11,886,649 shares
issued and outstanding........................................ -- 24,952,000 --
Series C Preferred Stock, $.0001 par value, 666,666 shares
issued and outstanding........................................ -- 19,984,000 --
Commitments and contingencies.......................................
Stockholders' equity:
Common Stock, $.0001 par value, 150,000,000 shares authorized;
32,799,276 and 34,535,415 shares issued and outstanding at March
31, 1998 and 1999, respectively................................. 3,000 3,000 9,000
Additional paid-in capital........................................ 1,003,000 45,837,000 95,122,000
Receivables from stockholders..................................... (30,000) (138,000) (138,000)
Deferred compensation............................................. (53,000) (38,974,000) (38,974,000)
Accumulated deficit............................................... (2,268,000) (30,826,000) (30,826,000)
------------ -------------- --------------
Total stockholders' equity (deficit)................................ (1,345,000) (24,098,000) $ 25,193,000
------------ -------------- --------------
--------------
Total liabilities and stockholders' equity (deficit)................ $ 2,927,000 $ 30,666,000
------------ --------------
------------ --------------
</TABLE>
See accompanying notes.
F-3
<PAGE>
ETOYS INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
--------------------------------
1998 1999
-------------- ----------------
<S> <C> <C>
Net sales...................................................................... $ 687,000 $ 29,959,000
Cost of sales.................................................................. 568,000 24,246,000
-------------- ----------------
Gross profit................................................................... 119,000 5,713,000
Operating expenses:
Marketing and sales.......................................................... 1,290,000 20,719,000
Product development.......................................................... 421,000 3,608,000
General and administrative................................................... 678,000 10,485,000
-------------- ----------------
2,389,000 34,812,000
-------------- ----------------
Operating loss................................................................. (2,270,000) (29,099,000)
Other income (expense):
Interest income.............................................................. 18,000 589,000
Interest expense............................................................. (15,000) (47,000)
-------------- ----------------
Loss before provision for income taxes......................................... (2,267,000) (28,557,000)
Provision for income taxes..................................................... 1,000 1,000
-------------- ----------------
Net loss....................................................................... $ (2,268,000) $ (28,558,000)
-------------- ----------------
-------------- ----------------
Basic net loss per equivalent share............................................ $ (0.09) $ (0.85)
-------------- ----------------
-------------- ----------------
Pro forma basic net loss per equivalent share.................................. $ (0.08) $ (0.35)
-------------- ----------------
-------------- ----------------
Shares used to compute basic net
loss per equivalent share.................................................... 25,129,888 33,427,908
-------------- ----------------
-------------- ----------------
Shares used to compute pro forma basic net loss per equivalent share........... 30,232,902 81,923,187
-------------- ----------------
-------------- ----------------
</TABLE>
See accompanying notes.
F-4
<PAGE>
ETOYS INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RECEIVABLES
----------------------- PAID-IN FROM DEFERRED ACCUMULATED
SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION DEFICIT TOTAL
---------- ----------- ----------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at April 1, 1997........ -- $ -- $ -- $ -- $ -- $ -- $ --
Issuance of Common Stock...... 26,569,275 3,000 917,000 -- -- -- 920,000
Restricted stock issued....... 6,080,001 -- 30,000 (30,000) -- -- --
Exercise of stock options..... 150,000 -- 1,000 -- -- -- 1,000
Deferred compensation......... -- -- 55,000 -- (55,000) -- --
Amortization of deferred
compensation................ -- -- -- -- 2,000 -- 2,000
Net loss...................... -- -- -- -- -- (2,268,000) (2,268,000)
---------- ----------- ----------- ------------- -------------- ------------- -------------
Balance at March 31, 1998....... 32,799,276 3,000 1,003,000 (30,000) (53,000) (2,268,000) (1,345,000)
Restricted stock issued....... 525,000 -- 35,000 (140,000) -- -- (105,000)
Exercise of stock options..... 1,211,139 -- 32,000 -- -- -- 32,000
Issuance of warrants.......... -- -- 32,000 -- -- -- 32,000
Deferred compensation......... -- -- 44,735,000 -- (44,735,000) -- --
Amortization of deferred
compensation................ -- -- -- -- 5,814,000 5,814,000
Repayment of receivables from
stockholders................ -- -- -- 32,000 -- -- 32,000
Net loss...................... -- -- -- -- -- (28,558,000) (28,558,000)
---------- ----------- ----------- ------------- -------------- ------------- -------------
Balance at March 31, 1999....... 34,535,415 $ 3,000 $45,837,000 $ (138,000) $(38,974,000) $(30,826,000) $ (24,098,000)
---------- ----------- ----------- ------------- -------------- ------------- -------------
---------- ----------- ----------- ------------- -------------- ------------- -------------
</TABLE>
See accompanying notes.
F-5
<PAGE>
ETOYS INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED
MARCH 31,
-------------------------
1998 1999
----------- ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss.................................................................. $(2,268,000) $(28,558,000)
Adjustments to reconcile net loss to net cash used in operating
activities:
Noncash interest........................................................ 15,000 70,000
Nonemployee stock compensation.......................................... 33,000 --
Amortization of deferred compensation................................... 2,000 5,814,000
Depreciation............................................................ 18,000 411,000
Amortization............................................................ -- 319,000
Loss on disposal of property and equipment.............................. -- 6,000
Changes in operating assets and liabilities:
Inventories........................................................... (198,000) (4,843,000)
Prepaid expenses and other current assets............................. (35,000) (1,542,000)
Accounts payable...................................................... 297,000 3,890,000
Accrued expenses...................................................... 9,000 503,000
----------- ------------
Net cash used in operations............................................... (2,127,000) (23,930,000)
INVESTING ACTIVITIES:
Capital expenditures for property and equipment........................... (178,000) (2,119,000)
Proceeds from sale of property and equipment.............................. -- 475,000
Acquisition of Toys.com................................................... (270,000) --
Other assets.............................................................. -- (1,076,000)
----------- ------------
Net cash used in investing activities..................................... (448,000) (2,720,000)
FINANCING ACTIVITIES:
Proceeds from bridge loan................................................. -- 5,000,000
Payments on bridge loan................................................... -- (2,238,000)
Proceeds from the issuance of Common Stock................................ 224,000 --
Exercise of stock options................................................. 1,000 32,000
Proceeds from the issuance of Redeemable Convertible Preferred Stock...... 3,007,000 42,031,000
Proceeds from the issuance of convertible
notes................................................................... 895,000 --
Payments on capital leases................................................ -- (24,000)
Proceeds from receivables from stockholders............................... -- 32,000
Proceeds from exercise of warrants........................................ -- 438,000
----------- ------------
Net cash provided by financing activities................................. 4,127,000 45,271,000
----------- ------------
Net increase in cash and cash equivalents................................. 1,552,000 18,621,000
Cash and cash equivalents at beginning of period.......................... -- 1,552,000
----------- ------------
Cash and cash equivalents at end of period................................ $ 1,552,000 $ 20,173,000
----------- ------------
----------- ------------
Supplemental disclosures:
Income taxes paid......................................................... $ 1,000 $ 1,000
Interest paid............................................................. $ -- $ 9,000
</TABLE>
See accompanying notes.
F-6
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1999
1. SIGNIFICANT ACCOUNTING POLICIES
GENERAL
eToys Inc. (the Company) was incorporated in November 1996 in the state of
Delaware. Prior to June 1997, the Company had no operations or activities. In
June 1997, initial issuances of Common Stock occurred. The Company launched its
Web site in October 1997. The Company is a Web-based retailer focused
exclusively on children's products, including toys, video games, software,
videos and music.
The accompanying financial statements have been prepared on the basis that
the Company will continue as a going concern. The Company has incurred
significant operating losses since inception of operations and has limited
working capital. Management believes that the proceeds raised through the sale
of equity securities, in addition to revenue generated from product sales, will
support the Company's operations through 1999. The financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the eventual outcome of this uncertainty.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities, and the reported amounts of
revenues and expenses. Actual results could differ materially from those
estimates.
CASH EQUIVALENTS
The Company considers those investments which are highly liquid, readily
convertible to cash and which mature within three months from the date of
purchase as cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (using the first in-first out
method) or market and consist primarily of finished goods.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is provided using the
straight-line method based upon estimated useful lives, which range from three
to five years. Leasehold improvements are recorded at cost. Amortization is
provided using the straight-line method over the shorter of the term of the
related lease or estimated useful lives of the assets.
GOODWILL
Goodwill represents the excess of the purchase price over the estimated fair
market value of net assets acquired in a business combination. Goodwill is
amortized on a straight-line basis over three years.
F-7
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG-LIVED ASSETS
The Company reviews for the impairment of long-lived assets and certain
identifiable intangibles whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. An impairment loss
would be recognized when estimated future cash flows expected to result from the
use of the asset and its eventual disposition is less than its carrying amount.
No such impairment losses have been identified by the Company.
INCOME TAXES
Income taxes are accounted for under Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Under SFAS No. 109,
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax basis of assets and liabilities, and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares
of Common Stock outstanding. Shares associated with stock options and the
Redeemable Convertible Preferred Stock are not included because they are
antidilutive.
PRO FORMA NET LOSS PER SHARE (UNAUDITED)
Pro forma net loss per share is computed using the weighted average number
of common shares outstanding, including the pro forma effects of the automatic
conversion of the Company's Redeemable Convertible Preferred Stock into shares
of the Company's Common Stock effective upon the closing of the Company's
initial public offering as if such conversion occurred on April 1, 1997, or at
the date of original issuance, if later.
F-8
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table sets forth the computation of basic and pro forma net
loss per share for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1999
-------------- ---------------
<S> <C> <C>
Numerator:
Net loss...................................................................... $ (2,268,000) $ (28,558,000)
Denominator:
Weighted average shares....................................................... 25,129,888 33,427,908
-------------- ---------------
Denominator for basic calculation............................................. 25,129,888 33,427,908
Weighted average effect of pro forma securities:
Series A Redeemable Convertible Preferred Stock............................. 5,103,014 19,195,678
Series B Redeemable Convertible Preferred Stock............................. -- 29,255,765
Series C Redeemable Convertible Preferred Stock............................. -- 43,836
-------------- ---------------
Denominator for pro forma calculation......................................... 30,232,902 81,923,187
-------------- ---------------
-------------- ---------------
Net loss per share:
Basic......................................................................... $ (0.09) $ (0.85)
-------------- ---------------
-------------- ---------------
Pro forma..................................................................... $ (0.08) $ (0.35)
-------------- ---------------
-------------- ---------------
</TABLE>
REVENUE RECOGNITION
The Company recognizes revenue from product sales, net of any discounts,
when the products are shipped to customers. Outbound shipping and handling
charges are included in net sales. The Company provides an allowance for sales
returns in the period of sale, based upon historical experience.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. For the years ended
March 31, 1998 and 1999, the Company incurred advertising costs of $917,000 and
$10,745,000, respectively.
ACCOUNTING FOR STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," requires that stock
awards granted subsequent to January 1, 1995, be recognized as compensation
expense based on their fair value at the date of grant. Alternatively, a company
may use Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock
Issued to Employees," and disclose pro forma income amounts which would have
resulted from recognizing such awards at their fair value. The Company has
elected to account for stock-based compensation expense under APB No. 25 and
make the required pro forma disclosures for compensation (see Note 6).
F-9
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SUPPLEMENTAL CASH FLOW INFORMATION
During the year ended March 31, 1998:
Convertible notes in the amount of $895,000, plus accrued interest of
$15,000, were converted into Series A Redeemable Convertible Preferred
Stock.
The Company expensed approximately $33,000 for services rendered from
several vendors in exchange for Common Stock.
The Company issued stock in return for notes receivable totaling $30,000
from employees. Such notes have been classified in the equity section of the
balance sheet.
The Company issued 2,340,000 shares of Common Stock as part of the
acquisition of Toys.com. See Note 2.
During the year ended March 31, 1999:
The Company financed the purchase of fixed assets under capital leases in
the amount $731,000.
The Company issued notes receivable for Common Stock and Series B Redeemable
Convertible Preferred Stock in the amounts of $35,000 and $105,000,
respectively.
Convertible notes in the amount of $2,762,000, plus accrued interest of
$38,000, were converted into Series B Redeemable Convertible Preferred
Stock.
2. ACQUISITION OF TOYS.COM
In March 1998, the Company acquired certain assets and assumed certain
liabilities and obligations of one of its online competitors, Toys.com,
including $25,000 in toy inventories and assumed certain advertising liabilities
in the amount of $48,000, and the assumption of future contingent advertising
contracts. The acquisition was accounted for under the purchase method of
accounting and included a cash payment of $270,000 and the issuance of 2,340,000
shares of Common Stock with an estimated deemed fair value of approximately
$663,000. Goodwill resulting from the acquisition was $956,000. Subsequent to
the acquisition, Toys.com ceased operations as a separate entity.
F-10
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. INCOME TAXES
As a result of the net operating losses, the provision for income taxes
consists solely of minimum state taxes. The following is a reconciliation of the
statutory federal income tax rate to the Company's effective income tax rate:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------
1998 1999
----- -----
<S> <C> <C>
Statutory federal income tax expense (benefit)............... (34)% (34)%
State income tax expense (benefit)........................... (6) (6)
Valuation allowance.......................................... 40 24
Non-deductible stock compensation............................ -- 15
Non-deductible goodwill amortization......................... -- 1
-- --
--% --%
-- --
-- --
</TABLE>
The components of the deferred tax assets and related valuation allowance at
March 31, 1998 and 1999, are as follows:
<TABLE>
<CAPTION>
MARCH 31,
------------------------------
1998 1999
------------ ----------------
<S> <C> <C>
Other........................................................ $ -- $ 792,000
Net operating loss carryforwards............................. 914,000 9,731,000
------------ ----------------
Deferred tax assets.......................................... 914,000 10,523,000
Valuation allowance.......................................... (914,000) (10,523,000)
------------ ----------------
$ -- $ --
------------ ----------------
------------ ----------------
</TABLE>
Due to the uncertainty surrounding the timing of realizing the benefits of
its favorable tax attributes in future tax returns, the Company has placed a
valuation allowance against its otherwise recognizable deferred tax assets.
The Company has net operating losses for both federal and state tax purposes
of approximately $24,430,000 expiring beginning in the years 2012 for federal
and 2005 for state. The net operating losses can be carried forward to offset
future taxable income. Utilization of the above carryforwards may be subject to
utilization limitations, which may inhibit the Company's ability to use
carryforwards in the future.
4. CONVERTIBLE NOTES AND BRIDGE FINANCING
During the year ended March 31, 1998, the Company received $895,000 in
proceeds from the issuance of 6.07% convertible notes. The notes were
automatically converted into Series A Redeemable Convertible Preferred Stock due
to certain conditions as specified within the initial note agreement. As a
result of the conversion, the initial proceeds from the convertible notes of
$895,000, plus $15,000 of accrued interest, were converted into 1,468,018 shares
of Series A Redeemable Convertible Preferred Stock.
In conjunction with the issuance of the 6.07% convertible notes, the Company
issued to the purchasers of the 6.07% convertible notes, 721,757 stock warrants
for the purchase of Series A
F-11
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. CONVERTIBLE NOTES AND BRIDGE FINANCING (CONTINUED)
Redeemable Convertible Preferred Stock at $.62 per share. As of March 31, 1999,
705,628 warrants have been exercised. The warrants are immediately exercisable
and expire on December 31, 2002, or on the closing date of an initial public
offering, if sooner. No value has been allocated to the warrants as the amount
is not deemed to be significant.
On May 6, 1998, the Company entered into a $5,000,000 bridge financing
agreement with a group of investors. The bridge financing was in the form of
Convertible Subordinated Promissory Notes (the Notes) which were payable on
demand after May 6, 1999 accruing interest at a rate of 8% per annum until paid
and compounded annually. In July 1998, $2.8 million of the Notes plus interest
were converted into 1,331,235 shares of Series B Redeemable Convertible
Preferred Stock. The remaining balance of the Notes of $2.2 million plus accrued
interest was repaid in cash to the investors in June 1998.
5. CAPITAL STRUCTURE
COMMON AND REDEEMABLE CONVERTIBLE PREFERRED STOCK
On March 19, 1999, the Company amended its Certificate of Incorporation to,
among other matters, increase the authorized number of shares of Preferred Stock
to 19,593,089.
In conjunction with this amendment, the Company authorized 666,666 shares of
Series C Redeemable Convertible Preferred Stock (Series C). In December 1997,
the issuance of Series A Redeemable Convertible Preferred Stock (Series A)
resulted in proceeds of $3,007,000, representing 4,849,999 shares issued and
outstanding at $0.62 per share. In conjunction with this offering, $895,000 of
convertible notes, plus related accrued interest of $15,000, were converted into
1,468,018 shares of Series A (see Note 4). In June 1998, the issuance of Series
B resulted in proceeds of $25,000,000 representing 11,886,649 shares issued and
outstanding at $2.1032 per share. In March 1999, the Company issued Series C
which resulted in proceeds of approximately $20,000,000, representing 666,666
shares issued and outstanding at $30 per share. The following summarizes the
Series A, Series B and Series C activity:
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ---------- ---------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at April 1, 1997.................. -- $ -- -- $ -- -- $ --
Issuance of Series A...................... 6,318,017 3,917,000 -- -- -- --
--------- ---------- ---------- ----------- --------- -----------
Balance at March 31, 1998................. 6,318,017 3,917,000 -- -- -- --
Issuance of Series A...................... 705,628 438,000 -- -- -- --
Issuance of Series B...................... -- -- 11,886,649 24,952,000 -- --
Issuance of Series C...................... -- -- -- -- 666,666 19,984,000
--------- ---------- ---------- ----------- --------- -----------
Balance at March 31, 1999................. 7,023,645 $4,355,000 11,886,649 $24,952,000 666,666 $19,984,000
--------- ---------- ---------- ----------- --------- -----------
--------- ---------- ---------- ----------- --------- -----------
</TABLE>
F-12
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. CAPITAL STRUCTURE (CONTINUED)
The following table is presented to summarize the Common Stock authorized at
March 31, 1999:
<TABLE>
<CAPTION>
COMMON
SHARES ISSUED
DESCRIPTION OF INSTRUMENT OR RESERVED
- ------------------------------------------------------------------------------ --------------
<S> <C>
Common Stock outstanding 34,535,415
Series A Redeemable Convertible Preferred Stock 21,070,935
Series B Redeemable Convertible Preferred Stock 35,659,947
Series C Redeemable Convertible Preferred Stock 1,999,998
1997 Employee Incentive Stock Option Plan 17,400,000
1999 Employee Incentive Stock Option Plan 21,600,000
1999 Employee Stock Purchase Plan 900,000
1999 Directors Stock Option Plan 600,000
Preferred and Common Stock warrants 209,799
--------------
Common Stock issued or reserved 133,976,094
--------------
Common Stock available 16,023,906
--------------
--------------
</TABLE>
Each share of Redeemable Convertible Preferred Stock is convertible, at the
stockholder's option, into such number of fully paid and nonassessable shares of
Common Stock as is determined by dividing $0.62 in the case of Series A, $2.1032
in the case of Series B and $30 in the case of Series C by the Conversion Price,
as defined. In the event of a public offering of the Company's equity securities
resulting in gross proceeds to the Company of $20 million or greater, all
outstanding Redeemable Convertible Preferred Stock will automatically be
converted into Common Stock.
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, the holders of Series A, Series B and Series C
are entitled to receive preference to the Common Stock holders to any
distribution of any assets of the Company in an amount per share equal to $0.62,
$2.1032 and $30 per share, respectively. After the initial distribution of
assets, the holders of Series A, Series B and Series C are entitled to
participate with the holders of the Common Stock on a pro rata basis until the
holders of Series A, Series B and Series C have received an aggregate of $1.86,
$6.31 and $90, respectively (as adjusted for any stock splits, stock dividends,
recapitalizations, or the like).
On or at any time after November 26, 2002, subject to the written consent of
66 2/3% of the then outstanding shares of Series A, Series B and Series C, the
Redeemable Convertible Preferred Stock may be redeemed for cash in whole or in
part for $0.62, $2.1032 and $30 per share (as adjusted for any stock dividends,
combinations or splits with respect to such share) plus all declared but unpaid
dividends, for Series A, Series B and Series C, respectively.
The voting rights of the Series A, Series B and Series C are equal to one
vote for each share of Common Stock into which such Redeemable Convertible
Preferred Stock may be converted. Each share of Series A, Series B and Series C
entitles the holder to receive dividends in cash at an annual rate of $0.043,
$0.1472 and $2.40 per share, respectively (as adjusted for any stock splits,
stock dividends, recapitalizations, or the like). Dividends are payable
quarterly when and if declared by the board of directors and are not cumulative.
F-13
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. CAPITAL STRUCTURE (CONTINUED)
RECEIVABLES FROM STOCKHOLDERS
Receivables from stockholders, totaling $30,000 and $138,000 at March 31,
1998 and 1999, respectively, represent interest bearing notes from certain
stockholders issued to finance the purchase of 6,605,001 and 50,000 shares of
the Company's Common and Series B, respectively. The notes bear interest rates
between 6.0% and 8.0% per year with interest due upon payment of the notes. The
notes are payable on different dates ranging from December 1, 1999 to July 27,
2002, or upon termination of employment or transfer of any of the purchased
shares.
DEFERRED COMPENSATION
The Company recorded deferred compensation of $55,000 and $44,735,000 for
the years ended March 31, 1998 and 1999, respectively. The amounts recorded
represent the difference between the grant price and the deemed fair value of
the Company's Common Stock for shares subject to options granted. The
amortization of deferred compensation will be charged to operations over the
vesting period of the options, which is typically four years. Total amortization
recognized was $2,000 and $5,814,000 for the years ended March 31, 1998 and
1999, respectively.
6. STOCK OPTION PLANS
In February 1999, the Board of Directors adopted the 1999 Stock Plan, the
1999 Directors' Stock Option Plan and the 1999 Employee Stock Purchase Plan. In
March 1999 the stockholders approved these plans. The 1999 Stock Plan provides
for 21,600,000 shares of Common Stock to be granted under terms similar to the
1997 Stock Plan. The 1999 Directors' Stock Option Plan reserves a total of
600,000 shares of Common Stock for grants of options to nonemployee directors.
The 1999 Employee Stock Purchase Plan reserves a total of 900,000 shares of
Common Stock for limited purchases by employees through payroll deductions, with
a purchase price equal to 85% of the fair market value of the Common Stock.
The Company adopted the 1997 Stock Plan, as amended June 1998 (the Plan),
which provides for the granting of options for purchases up to 17,400,000 shares
of the Company's Common Stock. Under the terms of the Plan, options may be
granted to employees, nonemployees, directors or consultants at prices not less
than the fair value at the date of grant. Options granted to nonemployees are
recorded at the value of negotiated services received. Options vest over four
years, 25% for the first year and ratably over the remaining three years and
generally expire ten years from the date of grant.
F-14
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. STOCK OPTION PLANS (CONTINUED)
The following table summarizes the Company's stock option activity:
<TABLE>
<CAPTION>
NUMBER OF PRICE WEIGHTED AVERAGE
SHARES PER SHARE EXERCISE PRICE
------------- ------------------- ------------------
<S> <C> <C> <C>
Outstanding at March 31, 1997.......... --
Granted.............................. 4,407,000 $ 0.005 to $0.033 $ 0.010
Exercised............................ (150,000) 0.005 to 0.005 0.005
Canceled............................. -- --
-------------
Outstanding at March 31, 1998.......... 4,257,000 0.005 to 0.033 0.010
Granted.............................. 14,116,650 0.033 to 9.000 1.695
Exercised............................ (1,736,136) 0.005 to 3.333 0.037
Canceled............................. (1,709,838) 0.005 to 3.333 0.053
-------------
Outstanding at March 31, 1999.......... 14,927,676 0.005 to 9.000 1.595
-------------
-------------
</TABLE>
Options granted during the years ended March 31, 1998 and 1999 resulted in a
total compensation amount of $55,000 and $44,735,000, respectively, and were
recorded as deferred compensation in stockholders' equity. The deferred
compensation amount will be recognized as compensation expense over the vesting
period. During the years ended March 31, 1998 and 1999, such compensation
expense amounted to $2,000 and $5,814,000, respectively. Options outstanding at
March 31, 1998 and 1999 were exercisable for 321,000 and 535,944 shares of
Common Stock, respectively. Common Stock available for future grants at March
31, 1998 and 1999 were 4,165,500 and 22,786,188 shares, respectively.
Additional information with respect to the outstanding options as of March
31, 1999 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------------------ OPTIONS EXERCISABLE
WEIGHTED AVERAGE -------------------------------
WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE
NUMBER OF EXERCISE CONTRACTUAL NUMBER OF EXERCISE
SHARES PRICE LIFE SHARES PRICE
------------- ------------------ ------------------- ----------- ------------------
<S> <C> <C> <C> <C> <C>
RANGE OF EXERCISE PRICES
$0.005 to $0.033....... 2,773,626 $ 0.019 8.98 305,994 $ 0.016
$0.140 to $0.140....... 702,000 0.014 9.60 -- --
$0.143 to $1.667....... 8,095,500 0.494 9.85 52,500 1.667
$2.833 to $9.000 3,356,550 5.856 10.14 177,450 2.892
------------- -----------
$0.005 to $9.000....... 14,927,676 535,944
------------- -----------
------------- -----------
</TABLE>
F-15
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. STOCK OPTION PLANS (CONTINUED)
The Company calculated the minimum fair value of each option grant on the
date of the grant using the minimum value option pricing model as prescribed by
SFAS No. 123 using the following assumptions:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------
1998 1999
----- ---------
<S> <C> <C>
Risk-free interest rates....................................................... 6.0% 5.14%
Expected lives (in years)...................................................... 5 4
Dividend yield................................................................. 0% 0%
Expected volatility............................................................ 0% 0%
</TABLE>
The compensation cost associated with the stock-based compensation plans did
not result in a material difference from the reported net loss for the years
ended March 31, 1998 or 1999.
7. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its office and warehouse facilities under long-term
noncancelable operating leases. For the years ended March 31, 1998 and 1999,
total rent expense incurred related to these leases amounted to $52,000 and
$636,000, respectively.
At March 31, 1999, future lease commitments under these agreements were as
follows:
<TABLE>
<CAPTION>
CAPITAL
OPERATING LEASES LEASES
---------------- -----------
<S> <C> <C>
2000........................................................... $ 2,404,000 $ 273,000
2001........................................................... 3,040,000 273,000
2002........................................................... 3,101,000 246,000
2003........................................................... 3,916,000 --
2004........................................................... 1,294,000 --
Thereafter..................................................... 431,000 --
---------------- -----------
14,186,000 792,000
Less amounts representing interest............................. -- (85,000)
---------------- -----------
$ 14,186,000 $ 707,000
---------------- -----------
---------------- -----------
</TABLE>
EQUIPMENT FINANCING ARRANGEMENT
During December 1998, the Company entered into a line of credit arrangement
with a leasing institution that provides for sale and leaseback transactions of
capital equipment up to a maximum of $2,000,000. Under this agreement,
$1,344,000 was available for future financing transactions at March 31, 1999. In
addition, the agreement provides the leasing institution warrants, with value
equal to approximately $112,000 with the number of shares to be determined
pursuant to a formula, as defined, at the time of issuance. Such warrants were
issued on January 31, 1999.
ADVERTISING COMMITMENTS
During 1998 and the first part of 1999, the Company entered into a number of
commitments for online, print and broadcast advertising. At March 31, 1999, the
advertising commitments amounted to approximately $8,828,000 to be incurred
through March 2000.
F-16
<PAGE>
ETOYS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
PURCHASE COMMITMENTS
At March 31, 1999, the Company had approximately $30.5 million in
outstanding orders with certain suppliers for the purchase of inventory. Such
purchase commitments are expected to be fulfilled from April to December 1999.
LEGAL MATTERS
The Company is involved in litigation and other legal matters which have
arisen in the normal course of business. Although the ultimate outcome of these
matters is not currently determinable, management does not expect that they will
have a material adverse effect on the Company's financial position, results of
operations or cash flows.
8. INITIAL PUBLIC OFFERING AND STOCK SPLIT
In February 1999, the Company's Board of Directors authorized management to
file a registration statement with the Securities and Exchange Commission to
permit the Company to sell shares of its Common Stock to the public. Upon
completion of the Company's initial public offering, the Series A, Series B and
Series C Redeemable Convertible Preferred Stock will convert into 58,730,880
shares of Common Stock. Unaudited pro forma stockholders' equity reflects the
assumed conversion of the Redeemable Convertible Preferred Stock as of March 31,
1999.
In March 1999, the Company's Board of Directors declared a stock split of 3
shares for every 1 share of Common Stock then outstanding. The stock split will
become effective at the date the Company's public offering of Common Stock is
closed. Accordingly, the accompanying financial statements and footnotes have
been restated to reflect the stock split. The par value of the shares of Common
Stock to be issued in connection with the stock split was credited to Common
Stock and a like amount charged to additional paid-in capital.
9. SUBSEQUENT EVENT
In April 1999, the Company entered into a merger agreement with BabyCenter.
In connection with this proposed merger, an aggregate of 18,720,000 shares of
the Company's Common Stock will be issued and reserved for issuance upon the
exercise of assumed BabyCenter options included in the proposed merger.
In addition, in May 1999, the Company increased the number of shares
eligible to be granted under the 1999 Stock Plan to 24,800,000 and the number of
shares available for purchase under the 1999 Employee Stock Purchase Plan to
1,000,000.
F-17
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
The following unaudited pro forma condensed combined financial information
for eToys consists of the Unaudited Pro Forma Condensed Combined Statement of
Operations for the year ended March 31, 1999, and the Unaudited Pro Forma
Condensed Combined Balance Sheet as of March 31, 1999.
On April 18, 1998, eToys entered into a merger agreement to acquire
BabyCenter in exchange for 18,720,000 shares of eToys' common stock. The
Unaudited Pro Forma Condensed Combined Statement of Operations for the year
ended March 31, 1999 gives effect to the BabyCenter acquisition as if it had
taken place on April 1, 1998. The Unaudited Pro Forma Condensed Combined Balance
Sheet gives effect to the BabyCenter acquisition as if it had taken place on
March 31, 1999.
The Unaudited Pro Forma Condensed Combined Statement of Operations combines
eToys' historical results of operations for the year ended March 31, 1999 with
BabyCenter's historical results for the year ended March 31, 1999. The pro forma
financial information is not necessarily indicative of what the actual financial
results would have been had the transaction taken place on April 1, 1998 or
March 31, 1999 and does not purport to indicate the results of future
operations.
The BabyCenter acquisition will be accounted for using the purchase method
of accounting. The pro forma financial information has been prepared on the
basis of assumptions described in the notes.
The pro forma financial information should be read in conjunction with the
related notes included in this document and the audited financial statements and
notes of eToys, and the audited financial statements and notes of BabyCenter,
included elsewhere in this prospectus.
F-18
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED MARCH 31, 1999
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
PRO FORMA
ETOYS BABYCENTER ADJUSTMENTS TOTAL
---------- ------------ ------------ ----------
<S> <C> <C> <C> <C>
Net sales................................................... $ 29,959 $ 4,768 $ -- $ 34,727
Cost of sales............................................... 24,246 981 -- 25,227
---------- ------------ ------------ ----------
Gross profit................................................ 5,713 3,787 -- 9,500
Operating expenses
Marketing and sales....................................... 20,719 2,461 -- 23,180
Product development....................................... 3,608 3,752 -- 7,360
General and administrative................................ 10,166 2,375 3,864(5) 16,405
Goodwill amortization..................................... 319 -- 36,136(6) 36,455
---------- ------------ ------------ ----------
34,812 8,588 40,000 83,400
---------- ------------ ------------ ----------
Operating loss.............................................. (29,099) (4,801) (40,000) (73,900)
Other income:
Interest income........................................... 589 280 -- 869
Interest expense.......................................... (47) (24) -- (71)
---------- ------------ ------------ ----------
Loss before provision for taxes............................. (28,557) (4,545) (40,000) (73,102)
Provision for taxes......................................... 1 -- -- 1
---------- ------------ ------------ ----------
Net loss.................................................... $ (28,558) $ (4,545) $ (40,000) $ (73,103)
---------- ------------ ------------ ----------
---------- ------------ ------------ ----------
Basic net loss per equivalent share......................... $ (0.85) $ (1.46)
---------- ----------
---------- ----------
Pro forma for conversion of preferred stock basic net loss
per equivalent share...................................... $ (0.35) $ (0.74)
---------- ----------
---------- ----------
Shares used to compute basic net loss per equivalent
share..................................................... 33,428 16,709 50,137
---------- ------------ ----------
---------- ------------ ----------
Shares used to compute pro forma for conversion of preferred
stock basic net loss per equivalent share................. 81,923 16,709 98,632
---------- ------------ ----------
---------- ------------ ----------
</TABLE>
See notes to unaudited pro forma condensed combined financial information.
F-19
<PAGE>
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
AS OF MARCH 31, 1999
(Amount in thousands)
<TABLE>
<CAPTION>
PRO FORMA
ETOYS BABYCENTER ADJUSTMENTS TOTAL
--------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 20,173 $ 9,000 $ -- $ 29,173
Inventories............................................... 5,067 201 -- 5,268
Prepaid expenses and other current assets................. 1,577 750 -- 2,327
--------- ------------ ------------ -----------
Total current assets........................................ 26,817 9,951 -- 36,768
Property and equipment...................................... 2,505 1,582 -- 4,087
Accumulated depreciation and amortization................... (369) (278) -- (647)
--------- ------------ ------------ -----------
2,136 1,304 -- 3,440
Goodwill (net of accumulated amortization).................. 637 -- 180,678(2) 181,315
Other assets................................................ 1,076 40 -- 1,116
--------- ------------ ------------ -----------
Total assets................................................ $ 30,666 $ 11,295 $ 180,678 $ 222,639
--------- ------------ ------------ -----------
--------- ------------ ------------ -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 4,236 $ 693 $ -- $ 4,929
Deferred revenues......................................... -- 713 -- 713
Accrued expenses.......................................... 760 723 -- 1,483
--------- ------------ ------------ -----------
Total current liabilities................................... 4,996 2,129 -- 7,125
Long-term capital lease obligations......................... 477 564 -- 1,041
Redeemable convertible preferred stock...................... 49,291 -- -- 49,291
Stockholders' equity (deficit).............................. (24,098) 8,602 $ (15,457)(3) 165,182
196,135(4)
--------- ------------ ------------ -----------
Total liabilities and stockholders' equity (deficit)........ $ 30,666 $ 11,295 $ 180,678 $ 222,639
--------- ------------ ------------ -----------
--------- ------------ ------------ -----------
</TABLE>
See notes to unaudited pro forma condensed combined financial information.
F-20
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
The pro forma information gives effect to eToys' acquisition of BabyCenter
through a merger and exchange of shares. The Unaudited Pro Forma Condensed
Combined Statement of Operations for the year ended March 31, 1999 reflects this
transaction as if it had taken place on April 1, 1998. The Unaudited Pro Forma
Condensed Combined Balance Sheet reflects this transaction as if it had taken
place on March 31, 1999.
The BabyCenter acquisition will be accounted for using the purchase method
of accounting. The pro forma financial information has been prepared on the
basis of assumptions described in the following notes and include assumptions
relating to the allocation of the consideration paid for the assets and
liabilities of BabyCenter based on preliminary estimates of their fair value.
The actual allocation of such consideration may differ from that reflected in
the pro forma financial information after valuations and other procedures to be
performed after the closing of the BabyCenter acquisition. eToys does not expect
that the final allocation of the purchase price will differ materially from the
preliminary allocations. In the opinion of eToys' management, all adjustments
necessary to present fairly such pro forma financial information have been based
on the proposed terms and structure of the BabyCenter merger.
The pro forma financial information is not necessarily indicative of what
the actual financial results would have been had this transaction taken place on
April 1, 1998 or March 31, 1999 and does not purport to indicate the results of
future operations.
The pro forma financial information gives effect to the following pro forma
adjustments:
1. In accordance with the reorganization agreement for the BabyCenter
merger:
The BabyCenter merger will be accounted for using the purchase method of
accounting. The purchase price was based on $11.00 per share, which is the
mid-point of eToys' filing range at the announcement of the BabyCenter merger.
The purchase price was determined as follows:
<TABLE>
<CAPTION>
BABYCENTER FAIR VALUE
SHARES ETOYS SHARES (IN THOUSANDS)
------------ ------------- --------------
<S> <C> <C> <C>
Shares.......................................... 7,335,026 16,708,886 $ 183,798
Vested stock options............................ 222,958 507,889 5,482
Unvested stock options.......................... 659,900 1,503,225 15,457
------------ ------------- --------------
Totals........................................ 8,217,884 18,720,000 $ 204,737
------------ ------------- --------------
------------ ------------- --------------
</TABLE>
The BabyCenter shares were first converted to eToys equivalent shares by
taking the number of BabyCenter shares multiplied by the exchange ratio of
approximately 2.28 eToys shares for each BabyCenter share.
The fair value of "shares" was calculated by taking the fair value of the
stock ($11.00 per share) times the number of eToys shares to be exchanged.
With respect to stock options exchanged as part of the BabyCenter merger,
all vested and unvested BabyCenter options exchanged for eToys options are
included as part of the purchase price based on their fair value.
The fair value of the stock was calculated by taking the vested and unvested
options to purchase eToys shares (2,011,114 options) times the fair value of the
stock ($11.00 per share) less the proceeds which will be received from the
optionholders upon exercise.
F-21
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
The pro forma financial information has been prepared on the basis of
assumptions described in these notes and include assumptions relating to the
allocation of the consideration paid for the assets and liabilities of
BabyCenter based on preliminary estimates of their fair value. The actual
allocation of such consideration may differ from that reflected in the pro forma
financial information after valuations and other procedures to be performed
after the closing of the BabyCenter acquisition. Below is a table of the
estimated acquisition cost, purchase price allocation and annual amortization of
the intangible assets acquired (in thousands):
<TABLE>
<CAPTION>
ANNUAL
AMORTIZATION
OF
AMORTIZATION LIFE INTANGIBLES
------------------- -------------
<S> <C> <C> <C>
ESTIMATED ACQUISITION COST:
Estimated purchase price............................. $ 204,737
-----------------
-----------------
PURCHASE PRICE ALLOCATION:
Estimated fair value of net tangible assets of
BabyCenter at March 31, 1999....................... $ 8,602
Deferred compensation on unvested stock options
assumed............................................ 15,457 4 $ 3,864
Intangible assets acquired:
Goodwill............................................. 180,678 5 36,136
-----------------
$ 204,737
-----------------
-----------------
</TABLE>
Tangible assets of BabyCenter acquired in the BabyCenter merger principally
include cash, and fixed assets. Liabilities of BabyCenter assumed in the
BabyCenter merger principally include accounts payable, accrued payroll and
other current liabilities.
2. The pro forma adjustment is for goodwill allocation of $180.7 million.
3. The pro forma adjustment is for deferred stock compensation associated
with the unvested BabyCenter stock options to acquire approximately 1,503,225
shares of common stock to be assumed by eToys.
4. The pro forma adjustment to "stockholders' equity" reflects the
elimination of BabyCenter's stockholders' equity ($8.6 million) and the impact
of the issuance of eToys' common stock ($204.7 million) in connection with the
BabyCenter merger.
5. The pro forma adjustment is for amortization of deferred stock
compensation associated with the unvested BabyCenter stock options assumed by
eToys over the remaining vesting period.
6. The pro forma adjustment is for amortization of goodwill.
F-22
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
BabyCenter, Inc.
We have audited the accompanying balance sheets of BabyCenter, Inc. as of
September 30, 1997 and 1998 and March 31, 1999, and the related statements of
operations, stockholders' equity, and cash flows for the period from inception
(February 11, 1997) to September 30, 1997, for the year ended September 30,
1998, and for the six months ended March 31, 1999. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of BabyCenter, Inc. at
September 30, 1997 and 1998 and March 31, 1999, and the results of its
operations and its cash flows for the period from inception (February 11, 1997)
to September 30, 1997, for the year ended September 30, 1998 and for the six
months ended March 31, 1999, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Palo Alto, California
April 30, 1999
F-23
<PAGE>
BABYCENTER, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------- MARCH 31,
1997 1998 1999
---------- ----------- -----------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $1,795,941 $ 1,201,786 $ 8,999,635
Short-term investments............................. 972,713 -- --
Accounts receivable, net of allowance of $30,000 at
March 31, 1999................................... 11,500 706,136 669,388
Inventories........................................ -- -- 201,286
Other current assets............................... 18,913 69,367 80,149
---------- ----------- -----------
Total current assets................................. 2,799,067 1,977,289 9,950,458
Property and equipment, net.......................... 91,538 601,867 1,304,404
Other assets......................................... 29,906 36,892 40,025
---------- ----------- -----------
$2,920,511 $ 2,616,048 $11,294,887
---------- ----------- -----------
---------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 34,004 $ 292,439 $ 693,418
Accrued liabilities................................ 6,206 25,202 604,930
Deferred revenue................................... 53,876 464,920 713,161
Current portion of capital lease obligations....... 33,421 124,135 117,659
---------- ----------- -----------
Total current liabilities............................ 127,507 906,696 2,129,168
Capital lease obligations, net of current portion.... 51,079 38,661 564,089
Commitments
Stockholders' equity:
Preferred stock, $0.001 par value, 5,700,000 shares
authorized, issuable in series: 2,862,717,
2,895,930, and 4,895,930 convertible shares
issued and outstanding at September 30, 1997 and
1998 and March 31, 1999, respectively (aggregate
liquidation preference of $13,331,330 at March
31, 1999)........................................ 3,260,981 3,310,981 13,245,642
Common stock, $0.001 par value, 11,000,000 shares
authorized, 1,759,138 and 2,297,096 shares issued
and outstanding at September 30, 1997 and 1998
and March 31, 1999, respectively................. 1,759 1,759 1,104,606
Additional paid-in capital......................... -- -- 9,874,296
Notes receivable from officers..................... -- -- (1,102,000)
Deferred compensation.............................. -- -- (8,896,144)
Accumulated deficit................................ (520,815) (1,642,049) (5,624,770)
---------- ----------- -----------
Total stockholders' equity........................... 2,741,925 1,670,691 8,601,630
---------- ----------- -----------
$2,920,511 $ 2,616,048 $11,294,887
---------- ----------- -----------
---------- ----------- -----------
</TABLE>
See accompanying notes.
F-24
<PAGE>
BABYCENTER, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(FEBRUARY 11, SIX MONTHS ENDED
1997) TO YEAR ENDED MARCH 31,
SEPTEMBER 30, SEPTEMBER 30, ----------------------------
1997 1998 1999
-------------- -------------- 1998 --------------
------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues.......................................... $ 7,624 $ 1,935,668 $ 250,869 $ 3,083,355
Costs and expenses:
Cost of revenues................................ -- 178,924 10,021 812,569
Technology and development...................... 200,057 1,374,012 364,605 2,742,789
Marketing and sales............................. 56,918 853,015 210,184 1,817,701
General and administrative...................... 280,621 744,761 282,691 1,912,386
-------------- -------------- ------------ --------------
Total costs and expenses.......................... 537,596 3,150,712 867,501 7,285,445
-------------- -------------- ------------ --------------
Loss from operations.............................. (529,972) (1,215,044) (616,632) (4,202,090)
Interest and other income, net.................... 9,157 93,810 57,201 219,369
-------------- -------------- ------------ --------------
Net loss.......................................... $ (520,815) $ (1,121,234) $ (559,431) $ (3,982,721)
-------------- -------------- ------------ --------------
-------------- -------------- ------------ --------------
Basic and diluted net loss per share.............. $ (1.17) $ (1.41) $ (0.82) $ (3.78)
-------------- -------------- ------------ --------------
-------------- -------------- ------------ --------------
Weighted-average shares used in per share
calculation..................................... 446,340 792,778 683,374 1,053,685
-------------- -------------- ------------ --------------
-------------- -------------- ------------ --------------
</TABLE>
See accompanying notes.
F-25
<PAGE>
BABYCENTER, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED NOTES
STOCK COMMON STOCK ADDITIONAL RECEIVABLE
---------------------- --------------------- PAID-IN FROM DEFERRED STOCK ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL OFFICERS COMPENSATION DEFICIT
--------- ----------- --------- ---------- ---------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock
for cash and conversion
of debt................ -- $ -- 1,759,138 $ 1,759 $ -- $ -- $ -- $ --
Issuance of Series A
convertible preferred
stock for cash, net of
issuance costs of
$10,000................ 1,202,046 771,333 -- -- -- -- -- --
Issuance of Series B
convertible preferred
stock for cash, net of
issuance costs of
$10,350................ 1,660,671 2,489,648 -- -- -- -- -- --
Net loss................. -- -- -- -- -- -- -- (520,815)
--------- ----------- --------- ---------- ---------- ----------- -------------- -------------
Balance at September 30,
1997................... 2,862,717 3,260,981 1,759,138 1,759 -- -- -- (520,815)
Issuance of Series B
convertible preferred
stock for cash......... 33,213 50,000 -- -- -- -- -- --
Net loss................. -- -- -- -- -- -- -- (1,121,234)
--------- ----------- --------- ---------- ---------- ----------- -------------- -------------
Balance at September 30,
1998................... 2,895,930 3,310,981 1,759,138 1,759 -- -- -- (1,642,049)
Issuance of Series C
convertible preferred
stock for cash, net of
Issuance costs of
$65,339................ 2,000,000 9,934,661 -- -- -- -- -- --
Issuance of common stock
upon exercises of stock
options................ -- -- 537,958 1,102,847 -- (1,102,000) -- --
Issuance of warrant for
services............... -- -- -- -- 405,523 -- -- --
Deferred compensation.... -- -- -- -- 9,468,773 -- (9,468,773) --
Amortization of deferred
compensation........... -- -- -- -- -- -- 572,629 --
Net loss................. -- -- -- -- -- -- -- (3,982,721)
--------- ----------- --------- ---------- ---------- ----------- -------------- -------------
Balance at March 31,
1999................... 4,895,930 $13,245,642 2,297,096 $1,104,606 $9,874,296 $(1,102,000) $ (8,896,144) $(5,624,770)
--------- ----------- --------- ---------- ---------- ----------- -------------- -------------
--------- ----------- --------- ---------- ---------- ----------- -------------- -------------
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
--------------
<S> <C>
Issuance of common stock
for cash and conversion
of debt................ $ 1,759
Issuance of Series A
convertible preferred
stock for cash, net of
issuance costs of
$10,000................ 771,333
Issuance of Series B
convertible preferred
stock for cash, net of
issuance costs of
$10,350................ 2,489,648
Net loss................. (520,815)
--------------
Balance at September 30,
1997................... 2,741,925
Issuance of Series B
convertible preferred
stock for cash......... 50,000
Net loss................. (1,121,234)
--------------
Balance at September 30,
1998................... 1,670,691
Issuance of Series C
convertible preferred
stock for cash, net of
Issuance costs of
$65,339................ 9,934,661
Issuance of common stock
upon exercises of stock
options................ 847
Issuance of warrant for
services............... 405,523
Deferred compensation.... --
Amortization of deferred
compensation........... 572,629
Net loss................. (3,982,721)
--------------
Balance at March 31,
1999................... $ 8,601,630
--------------
--------------
</TABLE>
See accompanying notes.
F-26
<PAGE>
BABYCENTER, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION SIX MONTHS ENDED
(FEBRUARY 11, MARCH 31,
1997) TO YEAR ENDED ----------------------------
SEPTEMBER 30, SEPTEMBER 30, 1998
1997 1998 ------------ 1999
-------------- -------------- (UNAUDITED) --------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (520,815) $ (1,121,234) $ (559,431) $ (3,982,721)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation.................................... 9,443 80,101 26,225 188,211
Issuance of warrant for services................ -- -- -- 405,523
Amortization of deferred compensation........... -- -- -- 572,629
Changes in operating assets and liabilities:
Accounts receivable........................... (11,500) (694,636) 3,000 36,748
Inventories................................... -- -- -- (201,286)
Other current assets.......................... (18,913) (50,454) (162,041) (10,782)
Other assets.................................. (29,906) (6,986) (8,329) (3,133)
Accounts payable.............................. 34,004 258,435 29,526 400,979
Accrued liabilities........................... 6,206 18,996 5,051 579,728
Deferred revenue.............................. 53,876 411,044 87,257 248,241
-------------- -------------- ------------ --------------
Net cash used in operating activities............. (477,605) (1,104,734) (578,742) (1,765,863)
-------------- -------------- ------------ --------------
INVESTING ACTIVITIES
Purchases of property and equipment............... -- (400,112) (2,900) (659,682)
Purchase of short-term investments................ (972,713) -- -- --
Proceeds from maturity of short-term
investments..................................... -- 972,713 972,713 --
-------------- -------------- ------------ --------------
Net cash provided by (used in) investing
activities...................................... (972,713) 572,601 969,813 (659,682)
-------------- -------------- ------------ --------------
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock......... 3,260,981 50,000 -- 9,934,661
Proceeds from issuance of common stock............ 1,759 -- -- 847
Proceeds from lease financing of equipment........ -- -- -- 400,112
Repayments of principal on capital leases......... (16,481) (112,022) (40,407) (112,226)
-------------- -------------- ------------ --------------
Net cash provided by (used in) financing
activities...................................... 3,246,259 (62,022) (40,407) 10,223,394
-------------- -------------- ------------ --------------
Net increase (decrease) in cash and cash
equivalents..................................... 1,795,941 (594,155) 350,664 7,797,849
Cash and cash equivalents at beginning of
period.......................................... -- 1,795,941 1,795,941 1,201,786
-------------- -------------- ------------ --------------
Cash and cash equivalents at end of period........ $ 1,795,941 $ 1,201,786 $2,146,605 $ 8,999,635
-------------- -------------- ------------ --------------
-------------- -------------- ------------ --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid..................................... $ -- $ 17,008 $ 5,234 $ 11,513
-------------- -------------- ------------ --------------
-------------- -------------- ------------ --------------
Property and equipment acquired under lease
financing....................................... $ 100,981 $ 190,318 $ 102,623 $ 231,066
-------------- -------------- ------------ --------------
-------------- -------------- ------------ --------------
</TABLE>
See accompanying notes.
F-27
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF BUSINESS
BabyCenter, Inc. (the "Company") is an Internet information and commerce
company serving new and expectant parents. BabyCenter, Inc. produces
BabyCenter.com, the Web's information source on preconception, pregnancy and
baby, and operates the BabyCenter Store, an online store with related products
and supplies. BabyCenter, Inc. also develops Internet information and marketing
products for healthcare companies. BabyCenter, Inc. was incorporated in Delaware
on February 11, 1997. BabyCenter, Inc. conducts its business within one industry
segment and all operations through September 30, 1998 were based in the United
States.
Since its incorporation, BabyCenter, Inc. has incurred cumulative losses
totaling approximately $5,625,000 and expects to incur additional losses for the
next several years. BabyCenter, Inc.'s current operating plan shows that
BabyCenter, Inc. will continue to require additional capital to fund its
operations and market its products. To date, BabyCenter, Inc. has financed its
operations with the net proceeds from private placements of its equity
securities, and capital equipment lease financing. BabyCenter, Inc. plans to
seek additional funding through public or private financing or other
arrangements with third parties. If the financing arrangements contemplated by
management are not consummated, BabyCenter, Inc. may have to seek other sources
of capital or reevaluate its operating plans.
INTERIM FINANCIAL STATEMENTS
The accompanying statements of operations and cash flows for the six months
ended March 31, 1998 are unaudited. In the opinion of management, the unaudited
financial statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting of normal recurring
adjustments, necessary for fair presentation of the results of operations and
cash flows for the interim period.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ materially from these estimates.
CASH, CASH EQUIVALENTS, AND SHORT-TERM INVESTMENTS
BabyCenter, Inc. considers all highly liquid investments with a maturity
from date of purchase of three months or less to be cash equivalents. Management
has designated these investments as available for sale. BabyCenter, Inc. invests
its excess cash in money market funds and corporate debt obligations of
financial institutions in the United States. The short-term investments at
September 30, 1997 were comprised of corporate debt obligations with maturities
of less than one year. These investments are reported at amortized cost which
approximates fair value. BabyCenter, Inc. had no short-term investments at
September 30, 1998 and March 31, 1999. The carrying amount reported on the
balance sheet for cash and cash equivalents approximates their fair value. Fair
values are estimated based on quoted market prices or pricing models using
current
F-28
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
market rates. Realized gains or losses for the period from inception (February
11, 1997) to September 30, 1997 ("period ended September 30, 1997"), the year
ended September 30, 1998, and the six months ended March 31, 1998 and 1999 were
not material.
CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments that subject BabyCenter, Inc. to concentrations of
credit risk consist principally of cash investments and accounts receivable.
BabyCenter, Inc. invests cash which is not required for immediate operating
needs principally in deposits and money market funds, which bear minimal risk.
BabyCenter, Inc. has not experienced any significant losses on these
investments.
For the period ended September 30, 1997, 3 customers (Health Trac, Inc.,
Charles Schwab, Inc. and Palo Alto Medical Foundation) accounted for 41%, 41%,
and 18%, respectively, of total revenue. At September 30, 1997, 1 customer
represented 100% of the total balance of accounts receivable. For the year ended
September 30, 1998, 3 customers (The Procter and Gamble Distributing Company,
SmithKline Beecham, Inc. and Blue Shield of California) accounted for 31%, 18%,
and 16%, respectively, of total revenue. At September 30, 1998, 2 customers
represented 66% and 11% of the total balance of accounts receivable. For the six
months ended March 31, 1999, 3 customers (Blue Shield of California, The Procter
and Gamble Distributing Company and Johnson & Johnson Consumer Company, Inc.)
represented 36%, 13%, and 10%, respectively, of total revenue. At March 31,
1999, 2 customers represented 60% and 10% of the total balance of accounts
receivable. BabyCenter, Inc. performs ongoing credit evaluations of its
customers but does not require collateral. There have been no material losses on
individual customer receivables.
INVENTORIES
Inventories are stated at the lower of cost (using the first-in, first-out
method) or market and consist primarily of finished goods.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated amortization
and depreciation. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets, typically three to five
years. Assets acquired under lease and leasehold improvements are amortized
using the straight-line method over the shorter of the estimated life of the
asset or the remaining term of the lease.
REVENUE RECOGNITION
Revenues primarily consist of online and publishing services revenues.
Online revenues are derived principally from the sale of banner advertisements
and sponsorship advertising. In general, the sponsorship advertising contracts
have longer terms than standard banner advertising contracts and also involve
more integration, such as the placement of buttons which provide users with
direct links to the advertiser's website. Advertising revenues on each banner
and sponsorship contract are recognized ratably in the period in which the
advertisement is displayed, provided that no significant Company obligations
remain and collection of the resulting receivable is probable.
F-29
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Company obligations typically include guarantees of a minimum number of
"impressions," or times that an advertisement appears in pages viewed by users
of BabyCenter, Inc.'s online properties. To the extent minimum guaranteed
impressions are not met, BabyCenter, Inc. defers recognition of the
corresponding revenues until the remaining guaranteed impression levels are
achieved.
BabyCenter, Inc. also earns revenue on sponsorship and Internet marketing
contracts which generally involve fees relating to the design, coordination,
editorial content, website hosting, and integration of the customer's content
and links into BabyCenter, Inc.'s online properties. These fees are generally
recognized as revenue as earned over the period in which related impressions or
services are delivered.
Publishing services revenue consists of developing customized print
products. Such revenue is recorded when earned, generally upon delivery of the
product. Payments received which are related to future performance are deferred
and recognized as revenue when earned.
Revenues from electronic commerce transactions, which consist primarily of
merchandise sold via the Internet, include outbound shipping and handling
charges and are recognized when the products are shipped. Revenues from
electronic commerce transactions from inception through September 30, 1998 were
not significant. Such revenues and cost of revenues were approximately $610,000
and $560,000 for the six months ended March 31, 1999.
COST OF REVENUES
Cost of online revenues consist of merchandise sold, inbound, and outbound
shipping costs and direct cost of order fulfillment. Cost of publishing services
revenue comprises direct printing and publishing cost. Such costs are expensed
as incurred.
TECHNOLOGY AND DEVELOPMENT
Technology and development expenses consist principally of payroll and
related expense for development, editorial, systems and telecommunications
operations personnel and consultants, systems and telecommunications
infrastructure, store management, and costs of acquired content. To date, all
such development costs have been expensed as incurred.
ADVERTISING COSTS
Advertising costs are accounted for as expenses in the period in which they
are incurred. Advertising expense for the period ended September 30, 1997 and
the year ended September 30, 1998 was approximately $14,500 and $260,000.
Advertising expense for the six months ended March 31, 1998 and 1999 was
approximately $60,450 and $609,000.
STOCK-BASED COMPENSATION
BabyCenter, Inc. grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
grant date. BabyCenter, Inc. accounts for stock option grants in accordance with
the provisions of the Accounting Principles Board's Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25") and, accordingly, recognizes no
F-30
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
compensation expense for stock options granted with exercise prices that are not
less than the fair value of BabyCenter, Inc.'s common stock on the date of
grant.
NET LOSS PER SHARE
Basic and diluted net loss per share has been computed using the
weighted-average number of shares of common stock outstanding during the period
less shares subject to repurchase. Had BabyCenter, Inc. been in a net income
position, diluted earnings per share would have included the shares used in the
computation of basic net income per share as well as the impact of outstanding
options and warrants to purchase common stock, using the treasury stock method,
to purchase an additional 281,895 shares for the period ended September 30,
1997, 677,320 shares for the year ended September 30, 1998 and 537,507 and
1,024,858 shares for the six months ended March 31, 1998 and 1999. Such shares
have been excluded because they are antidilutive for all periods presented.
Shares of convertible preferred stock have been excluded from the computation.
A reconciliation of shares used in the calculation of basic and diluted net
loss per share follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
PERIOD ENDED YEAR ENDED MARCH 31,
SEPTEMBER 30, SEPTEMBER 30, ------------------------------
1997 1998 1999
-------------- -------------- 1998 --------------
--------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net loss.................... $ (520,815) $ (1,121,234) $ (559,431) $ (3,982,721)
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
Basic and diluted:
Weighted-average shares of
common stock
outstanding............. 1,759,138 1,759,138 1,759,138 1,827,702
Less weighted-average
shares subject to
repurchase.............. (1,312,798) (966,360) (1,075,764) (774,017)
-------------- -------------- -------------- --------------
Shares used in computing
basic and diluted net
loss per share.......... 446,340 792,778 683,374 1,053,685
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
Basic and diluted net loss
per share................. $ (1.17) $ (1.41) $ (0.82) $ (3.78)
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
</TABLE>
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"), and No. 131, "Disclosures About Segments of an Enterprise
and Related Information" ("SFAS 131") (collectively, the "Statements").
BabyCenter, Inc. adopted these Statements as of October 1, 1998.
F-31
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SFAS 130 establishes new standards for reporting and displaying comprehensive
income and its components. The adoption of SFAS 130 had no impact on the
BabyCenter, Inc.'s results of operations or financial condition. SFAS 131
requires disclosure of certain information regarding operating segments,
products and services, geographic areas of operation, and major customers.
BabyCenter, Inc. operates as one reportable segment and has determined that the
specific additional information and disclosure requirements under SFAS 131 are
not material to BabyCenter, Inc. for the period ended March 31, 1999.
In June 1998, the FASB issued Statement of Financial Accounting Standard No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities," which will be effective for the year ending September 30, 2000.
This statement establishes accounting and reporting standards requiring that
every derivative instrument, including certain derivative instruments embedded
in other contracts, be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. BabyCenter, Inc. believes the adoption of SFAS 133
will not have a material effect on the financial statements, since it currently
does not invest in derivative instruments and engage in hedging activities.
In March 1998, the American Institute of Certified Public Accountants issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use" ("SOP 98-1"). SOP 98-1 requires that entities capitalize
certain costs related to internal use software once certain criteria have been
met. BabyCenter, Inc. is required to implement SOP 98-1 for the year ending
September 30, 2000. Adoption of SOP 98-1 is expected to have no material impact
on BabyCenter, Inc.'s financial condition or results of operations.
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------ MARCH 31,
1997 1998 1999
----------- ----------- -------------
<S> <C> <C> <C>
Furniture and equipment.............................. $ 98,593 $ 685,858 $ 1,458,850
Software............................................. 2,388 2,653 120,409
Leasehold improvements............................... -- 2,900 2,900
----------- ----------- -------------
100,981 691,411 1,582,159
Less accumulated depreciation........................ (9,443) (89,544) (277,755)
----------- ----------- -------------
Property and equipment, net.......................... $ 91,538 $ 601,867 $ 1,304,404
----------- ----------- -------------
----------- ----------- -------------
</TABLE>
Property and equipment includes certain furniture, computers, and equipment
financed under capital leases. The cost of such assets under capital leases was
$100,981 and $285,745 at September 30, 1997 and 1998, and $916,924 at March 31,
1999. Accumulated amortization for these assets was $9,443 and $88,748 at
September 30, 1997 and 1998 and $169,616 at March 31, 1999.
F-32
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
3. COMMITMENTS
OPERATING LEASE COMMITMENTS
BabyCenter, Inc. leases its facilities under noncancelable operating leases
expiring in May and July 1999. Rent expense for facilities under operating
leases was approximately $25,300 and $107,000 for the period ended September
1997 and for the year ended September 30, 1998. Rent expense was approximately
$65,600 and $141,600 for the six months ended March 31, 1998 and 1999. Future
minimum rental commitments under operating leases at March 31, 1999 are as
follows:
<TABLE>
<S> <C>
1999............................................................. $ 121,328
2000............................................................. 125,818
---------
$ 247,146
---------
---------
</TABLE>
CAPITAL LEASE OBLIGATIONS
BabyCenter, Inc. leases certain furniture, computers and equipment under
noncancelable capital leases. Obligations under capital leases represent the
present value of future noncancelable rental payments under various lease
agreements.
Future minimum lease payments under capital leases are as follows at March
31, 1999:
<TABLE>
<S> <C>
Fiscal year ended
1999.......................................................... $ 144,166
2000.......................................................... 259,018
2001.......................................................... 170,032
2002.......................................................... 160,166
2003.......................................................... 39,272
2004 and thereafter........................................... 2,355
---------
Total minimum lease payments.................................... 775,009
Less amount representing interest............................... (93,261)
---------
Present value of net minimum lease payments..................... 681,748
Less current portion............................................ (117,659)
---------
Long-term portion............................................... $ 564,089
---------
---------
</TABLE>
4. STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK
BabyCenter, Inc.'s Certificate of Incorporation provide for the issuance of
up to 5,700,000 shares of convertible preferred stock, 1,307,693 of which have
been designated as Series A, 1,860,672 as Series B, and 2,500,000 as Series C.
Shares outstanding at March 31, 1999 are 1,202,046 Series A, 1,693,884 Series B
and 2,000,000 Series C.
F-33
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
4. STOCKHOLDERS' EQUITY (CONTINUED)
Each share of Series A, B and C preferred stock is convertible, at the
option of the holder, into a share of common stock, on a one-for-one basis,
subject to certain adjustments for dilution, if any, resulting from future stock
issuances. Additionally, the preferred shares automatically convert into common
stock concurrent with the closing of an underwritten public offering of common
stock under the Securities Act of 1933 in which BabyCenter, Inc. receives at
least $15,000,000 in gross proceeds and the price per share is at least $10.00
(subject to adjustment for a recapitalization or certain other stock
adjustments).
Series A, B and C preferred stockholders are entitled to annual
noncumulative dividends, before and in preference to any dividends paid on
common stock, when and as declared by the board of directors. No dividends have
been declared through March 31, 1999.
The Series A, B and C preferred stockholders are entitled to receive, upon
liquidation or merger, a distribution of $0.65, $1.51 and $5.00 per share
(subject to adjustment for a recapitalization) plus all declared but unpaid
dividends. Thereafter, the remaining assets and funds, if any, shall be
distributed ratably on a per-share basis among the common stockholders and the
Series A, B and C preferred stockholders.
The Series A, B and C preferred stockholders have voting rights equal to the
common shares they would own upon conversion.
As of March 31, 1999, BabyCenter, Inc. has reserved 4,895,930 shares of
common stock for issuance upon conversion of its Series A, B and C preferred
stock.
COMMON STOCK
Since inception (February 11, 1997), BabyCenter, Inc. issued 2,277,397
shares of common stock to founders and officers for cash and notes receivable.
The common stock is subject to repurchase, at the Company's option, until
vested. Shares generally vest over a period of three to four years. At March 31,
1999, approximately 928,113 shares were subject to repurchase. The
weighted-average fair value of unvested stock issued during the period since
inception (February 11, 1997) is $3.11 per share.
WARRANTS
In October 1998, BabyCenter, Inc. entered into an agreement with a vendor
for the supply goods and certain fulfillment services to support electronic
commerce transactions of BabyCenter, Inc. In connection with this agreement,
BabyCenter, Inc. granted the vendor a warrant to purchase up to 120,000 shares
of common stock of BabyCenter, Inc. at a price of $0.25 per share. The warrant
becomes exercisable ratably over the term of the agreement. At March 31, 1999,
warrants for 60,000 shares were not exercisable. The warrant expires in November
2003. The warrant has been accounted for as a variable award and as such during
the six months ended March 31, 1999, the Company recorded a charge of $405,523
related to the value of the warrants which became exercisable during the period.
This amount is included in marketing and sales expense in the accompanying
Statement of Operations.
F-34
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
4. STOCKHOLDERS' EQUITY (CONTINUED)
In October 1998, BabyCenter, Inc. issued warrants to purchase up to 22,000
shares of Series C convertible preferred stock at $5.00 per share in connection
with an equipment lease financing arrangement. These warrants are immediately
exercisable and expire in October 2003 or earlier upon completion of the merger.
No amount was allocated to the value these warrants as such amounts were not
significant.
NOTES RECEIVABLE FROM OFFICERS
Notes receivable from officers, totaling $1,102,000 at March 31, 1999
represent interest bearing full recourse notes from certain officers issued to
finance the purchase of 527,000 shares of common stock of BabyCenter, Inc. The
notes bear interest at a rate of 4.77% per annum, with principal and interest
due and payable on various dates in March 2003.
1997 STOCK PLAN
In February 1997, the board of directors adopted the 1997 Stock Plan (the
"Plan") for issuance of options of common stock to eligible participants.
Options granted may be either incentive stock options or nonstatutory stock
options. Incentive stock options may be granted to employees with exercise
prices of no less than the fair value and nonstatutory options may be granted to
eligible participants at exercise prices of no less than 85% of the fair value
of the common stock on the grant date as determined by the board of directors.
Options generally vest at the rate of 25% after one year from the date of grant,
with the remaining balance vesting monthly over the next three years with a term
of 10 years. BabyCenter, Inc. has reserved 2,261,500 shares of common stock for
the grant of options under the Plan.
Pro forma information regarding net loss is required by Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), and has been determined as if BabyCenter, Inc. had
accounted for its employee stock options under the fair value method as
specified by SFAS 123. The fair value of these options was estimated at the date
of grant using the minimum value method with the following weighted-average
assumptions: no dividends; an expected life of five years; and a risk-free
interest rate of approximately 6% for the period ended September 30, 1997, for
the year ended September 30, 1998 and for the six months ended March 31, 1998
and 1999.
The effect of applying the FASB statement's minimum value method to
BabyCenter, Inc.'s stock options granted did not result in pro forma net loss
amounts that are materially different from the reported historical amounts.
Therefore, such pro forma information is not separately presented herein. Future
pro forma net income (loss) results may be materially different from actual
amounts reported.
F-35
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
4. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of activity under BabyCenter, Inc.'s stock option plan was as
follows:
<TABLE>
<CAPTION>
SHARES UNDER WEIGHTED-
SHARES AVAILABLE OPTIONS AVERAGE
FOR GRANT OUTSTANDING EXERCISE PRICE
----------------- -------------- ---------------
<S> <C> <C> <C>
Shares authorized for issuance............. 559,440 -- --
Options granted............................ (281,895) 281,895 $ 0.07
----------------- --------------
Balance at September 30, 1997.............. 277,545 281,895 $ 0.07
Additional authorization................... 602,060 -- --
Options granted............................ (521,612) 521,612 $ 0.17
Options exercised.......................... -- -- --
Options forfeited.......................... 126,187 (126,187) $ 0.08
----------------- --------------
Balance at September 30, 1998.............. 484,180 677,320 $ 0.14
Additional authorization................... 1,100,000 -- --
Options granted............................ (792,038) 792,038 $ 2.38
Options exercised.......................... -- (537,958) $ 2.05
Options forfeited.......................... 48,542 (48,542) $ 0.40
----------------- --------------
Balance at March 31, 1999.................. 840,684 882,858 $ 1.34
----------------- --------------
----------------- --------------
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ---------------------------
OPTIONS WEIGHTED- OPTIONS WEIGHTED-
OUTSTANDING AT AVERAGE EXERCISABLE AT AVERAGE
EXERCISE PRICE SEPTEMBER 30, EXERCISE SEPTEMBER 30, EXERCISE
RANGE 1998 PRICE 1998 PRICE
- ---------------- --------------- WEIGHTED- ----------- -------------- -----------
AVERAGE
REMAINING
CONTRACTUAL
LIFE
---------------
(IN YEARS)
<S> <C> <C> <C> <C> <C>
$0.07-$0.95 688,570 8.92 $ 0.31 215,208 $ 0.13
$2.00-$4.00 194,288 9.93 $ 3.50 7,750 $ 3.20
--------------- --------------
$0.07-$4.00 882,858 9.25 $ 1.34 222,958 $ 0.47
--------------- --------------
--------------- --------------
</TABLE>
The weighted-average fair value of options granted during the period ended
September 30, 1997, the year ended September 30, 1998 and the six months ended
March 31, 1999 was $0.04, $0.04 and $0.56.
DEFERRED COMPENSATION
BabyCenter, Inc. recorded deferred compensation of $9,469,000 for the six
months ended March 31, 1999. The amount recorded represents the difference
between the grant price and the deemed fair value of BabyCenter, Inc.'s common
stock subject to options granted. The amortization of deferred compensation is
being amortized to operations over the vesting period of the options, which is
typically four years. Total amortization recognized was $573,000 for the six
months ended March 31, 1999.
F-36
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
5. INCOME TAXES
As of March 31, 1999, BabyCenter, Inc. had federal net operating loss
carryforwards of approximately $4,800,000. The net operating loss and credit
carryforwards will expire at various dates beginning in 2012 through 2019, if
not utilized.
Utilization of the net operating losses may be subject to a substantial
annual limitation due to the "change in ownership" provisions of the Internal
Revenue Code of 1986 and similar state provisions. The annual limitation may
result in the expiration of net operating losses and credits before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. As of September 30, 1997
and 1998, and March 31, 1999, BabyCenter, Inc. had deferred tax assets of
approximately $200,000, $600,000 and $2,000,000. The net deferred tax assets
relate primarily to net operating loss carryforwards and have been fully offset
by a valuation allowance.
6. YEAR 2000 ISSUE (UNAUDITED)
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries in order to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and/or software used by many companies will need to be upgraded to
comply with Year 2000 requirements. Significant uncertainty exists concerning
the potential effects associated with this issue. Although BabyCenter, Inc.
believes that its products and services are Year 2000 compliant, there can be no
assurance that Year 2000 errors or defects will not be discovered in BabyCenter,
Inc.'s current and future products or services. Any failure by BabyCenter, Inc.
to make its products Year 2000 compliant could result in a decrease in revenue
and an increase in the allocation of resources to address Year 2000 problems
without additional revenue commensurate with such dedication of resources, or an
increase in litigation costs relating to losses suffered by BabyCenter, Inc.'s
customers due to such Year 2000 problems.
BabyCenter is in the process of reviewing the year 2000 compliance of its
internally developed proprietary software. This review has included testing to
determine how its systems will function at and beyond the year 2000. BabyCenter
expects to complete these tests during the summer of 1999. Since inception,
BabyCenter has internally developed substantially all of the systems for the
operation of its Web site. These systems include the software used to provide
its Web site's search, customer interaction, and transaction-processing and
distribution functions, as well as monitoring and back-up capabilities. Based
upon its assessment to date, BabyCenter believes that its internally developed
proprietary software is year 2000 compliant.
BabyCenter is currently assessing the year 2000 readiness of its third-party
supplied software, computer technology and other services, which include
software for use in its accounting, database and security systems. The failure
of such software or systems to be year 2000 compliant could have a material
negative impact on BabyCenter's corporate accounting functions and the operation
of its Web site. As part of the assessment of the year 2000 compliance of these
systems, BabyCenter has sought assurances from these vendors that their
software, computer technology
F-37
<PAGE>
BABYCENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE SIX MONTHS ENDED MARCH 31, 1998 IS UNAUDITED)
6. YEAR 2000 ISSUE (UNAUDITED) (CONTINUED)
and other services are year 2000 compliant. BabyCenter has expensed amounts
incurred in connection with year 2000 assessment since its formation through
March 31, 1999. Such amounts have not been material. BabyCenter expects this
assessment process to be completed during the summer of 1999. Based upon the
results of this assessment, BabyCenter will develop and implement, if necessary,
a remediation plan with respect to third-party software, third-party vendors and
computer technology and services that may fail to be year 2000 compliant.
BabyCenter expects to complete any required remediation during the summer of
1999. At this time, the expenses associated with this assessment and potential
remediation plan that may be incurred in the future cannot be determined;
therefore, BabyCenter has not developed a budget for these expenses. The failure
of BabyCenter's software and computer systems and of its third-party suppliers
to be year 2000 compliant would have a material adverse effect on it.
The year 2000 readiness of the general infrastructure necessary to support
its operations is difficult to assess. For instance, BabyCenter depends on the
integrity and stability of the Internet to provide its services. BabyCenter also
depends on the year 2000 compliance of the computer systems and financial
services used by consumers. Thus, the infrastructure necessary to support its
operations consists of a network of computers and telecommunications systems
located throughout the world and operated by numerous unrelated entities and
individuals, none of which has the ability to control or manage the potential
year 2000 issues that may impact the entire infrastructure. BabyCenter's ability
to assess the reliability of this infrastructure is limited and relies solely on
generally available news reports, surveys and comparable industry data. Based on
these sources, BabyCenter believes most entities and individuals that rely
significantly on the Internet are carefully reviewing and attempting to
remediate issues relating to year 2000 compliance, but it is not possible to
predict whether these efforts will be successful in reducing or eliminating the
potential negative impact of year 2000 issues. A significant disruption in the
ability of consumers to reliably access the Internet or portions of it or to use
their credit cards would have an adverse effect on demand for BabyCenter's
services and would have a material adverse effect on BabyCenter.
At this time, BabyCenter has not yet developed a contingency plan to address
situations that may result if BabyCenter or its vendors are unable to achieve
year 2000 compliance because BabyCenter currently does not believe that such a
plan is necessary. The cost of developing and implementing such a plan, if
necessary, could be material. Any failure of its material systems, BabyCenter's
vendors' material systems or the Internet to be year 2000 compliant could have
material adverse consequences for BabyCenter. Such consequences could include
difficulties in operating BabyCenter's Web site effectively, taking product
orders, making product deliveries or conducting other fundamental parts of
BabyCenter's business.
7. SUBSEQUENT EVENT
On April 18, 1999, BabyCenter, Inc. and eToys Inc. signed a definitive
agreement to merge BabyCenter, Inc. with eToys Inc. Consummation of the merger
is expected by the end of the quarter ended June 30, 1999 and is subject to
certain closing conditions, including governmental approvals and approval by the
stockholders of BabyCenter, Inc. Under the terms of agreement, eToys Inc. would
issue its shares to the stockholders of BabyCenter, Inc. The merger is to be
treated as a purchase by eToys Inc. for accounting purposes.
F-38
<PAGE>
UNDERWRITING
eToys and the Underwriters named below (the "underwriters") have entered
into an underwriting agreement with respect to the shares being offered. Subject
to certain conditions, each underwriter has severally agreed to purchase the
number of shares indicated in the following table. Goldman, Sachs & Co.,
BancBoston Robertson Stephens Inc., Donaldson, Lufkin & Jenrette Securities
Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated are the
representatives of the underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
- --------------------------------------------------------------- -----------
<S> <C>
Goldman, Sachs & Co............................................ 2,829,000
BancBoston Robertson Stephens Inc.............................. 1,415,000
Donaldson, Lufkin & Jenrette Securities Corporation............ 1,415,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated............. 1,415,000
Crowell, Weedon & Co........................................... 178,000
Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated................................................. 178,000
EVEREN Securities, Inc......................................... 178,000
Gerard Klauer Mattison & Co., Inc.............................. 178,000
Hambrecht & Quist LLC.......................................... 178,000
Sutro & Co. Incorporated....................................... 178,000
Wit Capital Corporation........................................ 178,000
-----------
Total...................................................... 8,320,000
-----------
-----------
</TABLE>
------------------------
The underwriters are committed to take and pay for all of the shares
indicated in the table above, if any are taken.
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional
1,248,000 shares from eToys to cover such sales. They may exercise that option
for 30 days. If any shares are purchased pursuant to this option, the
underwriters will severally purchase shares in approximately the same proportion
as set forth in the table above.
The following tables show the per share and total underwriting discounts and
commissions to be paid to the underwriters by eToys. Such amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase 1,248,000 additional shares.
Paid by eToys
<TABLE>
<CAPTION>
No Exercise Full Exercise
------------ -------------
<S> <C> <C>
Per Share....................................... $ 1.35 $ 1.35
Total........................................... $11,232,000 $12,916,800
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $0.80 per share from the initial public offering price. Any such
securities dealers may resell any shares purchased from the underwriters to
certain other brokers or dealers at a discount of up to $0.10 per share from the
initial public offering price. If all the shares are not sold at the initial
public offering price, the representatives may change the offering price and the
other selling terms.
U-1
<PAGE>
eToys and its directors, officers, employees and other securityholders have
agreed with the underwriters not to dispose of or hedge any of their common
stock or securities convertible into or exchangeable for shares of common stock
during the period from the date of this prospectus continuing through the date
180 days after the date of this prospectus, except with the prior written
consent of the representatives. See "Shares Eligible for Future Sale" for a
discussion of certain transfer restrictions.
Prior to this offering, there has been no public market for the common
stock. The initial public offering price for the common stock has been
negotiated among eToys and the representatives of the underwriters. Among the
factors considered in determining the initial public offering price of the
shares, in addition to prevailing market conditions, were eToys' historical
performance, estimates of eToys' business potential and earnings prospects, an
assessment of eToys' management and the consideration of the above factors in
relation to market valuation of companies in related businesses.
The common stock has been approved for quotation on the Nasdaq National
Market under the symbol "ETYS".
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such underwriter in stabilizing or short-sale covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
The underwriters have reserved for sale, at the initial public offering
price, up to 1,365,000 of the common stock offered hereby for certain
individuals designated by eToys who have expressed an interest in purchasing
such shares of common stock in the offering. The number of shares available for
sale to the general public will be reduced to the extent such persons purchase
such reserved shares. Any reserved shares not so purchased will be offered by
the underwriters to the general public on the same basis as other shares offered
hereby.
eToys estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $1,700,000.
eToys has agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act of 1933.
U-2
<PAGE>
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No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
---------
<S> <C>
Prospectus Summary................... 3
Risk Factors......................... 8
Use of Proceeds...................... 22
Dividend Policy...................... 22
Capitalization....................... 23
Dilution............................. 25
Selected Financial Data.............. 26
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 27
Business............................. 37
Recent Developments.................. 50
Management........................... 52
Certain Transactions................. 62
Principal Stockholders............... 66
Description of Capital Stock......... 69
Shares Eligible for Future Sale...... 72
Legal Matters........................ 74
Experts.............................. 74
Additional Information............... 75
Index to Financial Statements........ F-1
Underwriting......................... U-1
</TABLE>
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Through and including June 13, 1999 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to an unsold allotment or subscription.
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<PAGE>
8,320,000 Shares
ETOYS INC.
Common Stock
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[LOGO]
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GOLDMAN, SACHS & CO.
BANCBOSTON ROBERTSON STEPHENS
DONALDSON, LUFKIN & JENRETTE
MERRILL LYNCH & CO.
Representatives of the Underwriters
