<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended SEPTEMBER 30, 1999 Commission File No. 000-25709
------------------------
ETOYS INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4633006
(State or other (I.R.S. Employer
jurisdiction of
incorporation or Identification
organization) No.)
</TABLE>
3100 OCEAN PARK BLVD., SUITE 300
SANTA MONICA, CA 90405
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code: (310) 664-8100
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
119,756,125 shares of $0.0001 par value common stock outstanding as of
October 31, 1999
Page 1 of 32
Exhibit Index on Page 32
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ETOYS INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C> <C> <C>
PART I--FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements........................................ 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................ 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk............... 28
PART II--OTHER INFORMATION
Item 1. Legal Proceedings........................................................ 30
Item 2. Changes in Securities and Use of Proceeds................................ 30
Item 3. Defaults upon Senior Securities.......................................... 30
Item 4. Submission of Matters to a Vote of Security Holders...................... 30
Item 5. Other Information........................................................ 30
Item 6. Exhibits and Reports on Form 8-K......................................... 30
Signatures..................................................................................... 31
Exhibit Index.................................................................................. 32
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ETOYS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales................................................... $ 13,306 $ 608 $ 21,281 $ 989
Cost of sales............................................... 10,752 496 17,209 807
--------- --------- --------- ---------
Gross profit................................................ 2,554 112 4,072 182
Operating expenses:
Marketing and sales....................................... 20,012 2,372 31,585 3,742
Product development....................................... 12,188 697 17,023 1,101
General and administrative................................ 4,298 554 7,254 893
Goodwill amortization..................................... 9,546 80 9,626 159
Deferred compensation amortization........................ 3,314 69 7,096 113
--------- --------- --------- ---------
Total operating expenses................................ 49,358 3,772 72,584 6,008
--------- --------- --------- ---------
Operating loss.............................................. (46,804) (3,660) (68,512) (5,826)
Interest income, net........................................ 1,860 277 2,786 272
Provision for taxes......................................... -- -- (1) --
--------- --------- --------- ---------
Net loss.................................................... $ (44,944) $ (3,383) $ (65,727) $ (5,554)
========= ========= ========= =========
Basic net loss per equivalent share......................... $ (0.38) $ (0.10) $ (0.71) $ (0.17)
========= ========= ========= =========
Pro forma basic net loss per equivalent share............... $ (0.38) $ (0.04) $ (0.60) $ (0.07)
========= ========= ========= =========
Shares used in computation of basic net loss per equivalent
share (1)................................................. 119,374 32,893 92,960 32,866
========= ========= ========= =========
Shares used to compute pro forma basic net loss per
equivalent share (2)...................................... 119,374 87,523 108,784 74,645
========= ========= ========= =========
</TABLE>
- ------------------------
(1) Includes shares associated with the Redeemable Convertible Preferred Stock
effective as of the closing of the Company's initial public offering. See
Note 5 to the Consolidated Financial Statements.
(2) Includes shares associated with the Redeemable Convertible Preferred Stock
as if such conversion occurred on April 1, 1998, or at the date of original
issuance, if later. See Note 5 to the Consolidated Financial Statements.
See accompanying notes.
3
<PAGE>
ETOYS INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 1999
------------- ----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 140,601 $ 20,173
Inventories.......................................................................... 51,379 5,067
Prepaids and other current assets.................................................... 18,684 1,577
----------- ----------
Total current assets................................................................... 210,664 26,817
Property and equipment................................................................. 23,365 2,505
Accumulated depreciation............................................................. (2,156) (369)
----------- ----------
21,209 2,136
Goodwill, net of accumulated amortization.............................................. 180,066 637
Other assets........................................................................... 2,238 1,076
----------- ----------
Total assets........................................................................... $ 414,177 $ 30,666
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................................... $ 66,471 $ 4,236
Accrued expenses..................................................................... 6,798 530
Current portion of long-term notes payable and capital lease obligations............. 3,083 230
----------- ----------
Total current liabilities.............................................................. 76,352 4,996
Long-term notes payable and capital lease obligations.................................. 6,371 477
Redeemable Convertible Preferred Stock, 19,593,089 shares authorized:
Series A Preferred Stock; $.0001 par value; none and 7,023,645 shares issued and
outstanding at September 30, 1999 and March 31, 1999, respectively................. -- 4,355
Series B Preferred Stock; $.0001 par value; none and 11,886,649 shares issued and
outstanding at September 30, 1999 and March 31, 1999, respectively................. -- 24,952
Series C Preferred Stock; $.0001 par value; none and 666,666 shares issued and
outstanding at September 30, 1999 and March 31, 1999, respectively................. -- 19,984
Commitments and contingencies
Stockholders' equity:
Common stock; $.0001 par value, 600,000,000 shares authorized; 119,643,088 and
34,535,415 issued and outstanding at September 30, 1999 and March 31, 1999,
respectively....................................................................... 12 3
Additional paid-in-capital........................................................... 474,886 45,837
Receivables from stockholders........................................................ (1,892) (138)
Deferred compensation................................................................ (44,997) (38,974)
Accumulated other comprehensive loss................................................. (2) --
Accumulated deficit.................................................................. (96,553) (30,826)
----------- ----------
Total stockholders' equity (deficit)................................................... 331,454 (24,098)
----------- ----------
Total liabilities and stockholders' equity............................................. $ 414,177 $ 30,666
=========== ==========
</TABLE>
See accompanying notes.
4
<PAGE>
ETOYS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
------------------------
1999 1998
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss............................................................................... $ (65,727) $ (5,554)
Adjustments to reconcile net loss to net cash used in operating activities:
Noncash interest..................................................................... -- 38
Depreciation......................................................................... 1,373 109
Amortization of intangibles.......................................................... 9,906 159
Deferred compensation amortization related to stock options.......................... 7,096 113
Other, net........................................................................... 71 --
Changes in operating assets and liabilities:
Inventories........................................................................ (44,692) (1,667)
Prepaids and other current assets.................................................. (15,500) (2,892)
Accounts payable................................................................... 59,660 1,964
Accrued expenses................................................................... 1,836 23
--------- ---------
Net cash used in operations............................................................ (45,977) (7,707)
INVESTING ACTIVITIES
Capital expenditures for property and equipment........................................ (10,024) (1,435)
Net cash received from acquisition of BabyCenter, net of acquisition costs............. 2,571 --
Other, net............................................................................. (1,389) (831)
--------- ---------
Net cash used in investing activities.................................................. (8,842) (2,266)
FINANCING ACTIVITIES
Proceeds from bridge loan.............................................................. -- 5,000
Payments on bridge loan................................................................ -- (2,238)
Proceeds from issuance of Redeemable Convertible Preferred Stock....................... -- 22,008
Proceeds from issuance of common stock and exercise of stock options................... 176,190 2
Payments on notes payable and capital leases........................................... (1,051) (14)
Proceeds from receivables from stockholders............................................ 108 13
--------- ---------
Net cash provided by financing activities.............................................. 175,247 24,771
--------- ---------
Net increase in cash and cash equivalents.............................................. 120,428 14,798
Cash and cash equivalents at beginning of period....................................... 20,173 1,552
--------- ---------
Cash and cash equivalents at end of period............................................. $ 140,601 $ 16,350
========= =========
Supplemental disclosures:
Interest paid........................................................................ $ 180 $ 44
Notes payable and capital lease obligations incurred................................. $ 7,788 $ 75
Acquisition of BabyCenter:
Fair value of assets acquired (including goodwill)................................. $ 197,635 $ --
Liabilities assumed................................................................ (9,017) --
Stock issued....................................................................... (189,988) --
Assumption of stockholders' receivables............................................ 1,862 --
--------- ---------
Cash paid.......................................................................... 492 --
Cash acquired...................................................................... (3,063) --
--------- ---------
Net cash received from acquisition of BabyCenter..................................... $ 2,571 $ --
========= =========
</TABLE>
See accompanying notes.
5
<PAGE>
ETOYS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--ACCOUNTING POLICIES
UNAUDITED INTERIM FINANCIAL INFORMATION
The consolidated financial statements as of September 30, 1999 and 1998 have
been prepared by eToys Inc. ("the Company") pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC"). These
statements are unaudited and, in the opinion of management, include all
adjustments (consisting of normal recurring adjustments and accruals) necessary
to present fairly the results for the periods presented. The balance sheet at
March 31, 1999 has been derived from the audited financial statements at that
date. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted pursuant to such SEC rules and regulations.
Operating results for the quarter and six months ended September 30, 1999 are
not necessarily indicative of the results that may be expected for the fiscal
year ending March 31, 2000. These consolidated financial statements should be
read in conjunction with the audited financial statements and the accompanying
notes included in the Company's Form S-1 Registration Statement declared
effective May 19, 1999 (the "S-1").
Certain prior-period balances have been reclassified to conform to the
current-period presentation.
CASH AND CASH EQUIVALENTS
All highly liquid investments with maturities of three months or less at the
date of purchase are considered to be cash equivalents and are carried at cost
plus accrued interest, which approximates fair value. Interest income was
$2.0 million and $0.3 million for the quarters ended September 30, 1999 and
1998, respectively, and $3.0 million and $0.3 million for the six months ended
September 30, 1999 and 1998, respectively, and is included within interest
income, net, in the accompanying consolidated statements of operations.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's foreign subsidiary is the local
currency. Assets and liabilities of the foreign subsidiary are translated into
U.S. dollars at the period end exchange rates, and revenues and expenses are
translated at average rates prevailing during the periods presented. Translated
adjustments are included in accumulated other comprehensive loss, a separate
component of stockholders' equity. Transaction gains or losses arising from
transactions denominated in a currency other than the functional currency of the
entity involved, which have been insignificant, are included in the consolidated
statements of operations.
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
6
<PAGE>
ETOYS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 1--ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE LOSS
As of April 1, 1999, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income, which establishes standards
for the reporting and display of comprehensive loss and its components in the
financial statements. Comprehensive loss is composed of net loss and foreign
currency translation adjustments. Comprehensive loss was $44.9 million and
$3.4 million for the quarters ended September 30, 1999 and 1998, respectively,
and $65.7 million and $5.6 million for the six months ended September 30, 1999
and 1998, respectively.
NOTE 2--BABYCENTER ACQUISITION
On July 1, 1999, the Company completed its acquisition of BabyCenter, Inc.
("BabyCenter") pursuant to a reorganization agreement executed in April 1999. As
consideration for the purchase, the Company issued to the stockholders of
BabyCenter approximately 16.0 million shares of the Company's common stock
valued at $190.0 million based upon the stock price as of the date that the
transaction was announced.
The acquisition has been accounted for as a purchase and the acquisition
costs of $190.0 million have been allocated to the assets acquired and the
liabilities assumed based upon estimates of their respective fair values. A
total of $189.0 million, representing the excess of the purchase price over the
fair value of the net tangible assets acquired, has been allocated to intangible
assets and is being amortized over five years. Accumulated amortization totaled
$9.9 million and $0.3 million as of September 30, 1999 and March 31, 1999,
respectively.
The Company's consolidated results of operations incorporates BabyCenter's
results of operations commencing upon the July 1, 1999 acquisition date. The
unaudited pro forma combined information below presents the combined results of
operations of the Company as if the acquisition had occurred at the beginning of
the respective periods presented. The unaudited pro forma combined information,
based upon the historical consolidated financial statements of the Company and
BabyCenter, is based on an acquisition cost of $190.0 million and assumes that
an estimated $189.0 million excess of acquisition cost over the book value of
BabyCenter's net tangible assets is allocated to intangible assets with a useful
life of five years.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
SEPTEMBER 30,
--------------------
1999 1998
--------- ---------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C>
Revenues...................................................................................... $ 23.3 $ 2.7
Net loss...................................................................................... $ (82.3) $ (25.0)
Net loss per share (1)........................................................................ $ (0.71) $ (0.28)
</TABLE>
- ------------------------
(1) Net loss per share excluding amortization of intangible assets and deferred
compensation would be $(0.47) and $(0.06) for the six months ended
September 30, 1999 and 1998, respectively. Net loss per share is calculated
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
7
<PAGE>
ETOYS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--BABYCENTER ACQUISITION (CONTINUED)
Stock and the issuance of approximately 16.0 million shares to stockholders
of BabyCenter as if such events had occurred on April 1, 1998.
The unaudited pro forma combined information is not necessarily indicative
of the results of operations of the combined company had the acquisition
occurred at the beginning of the periods presented, nor is it necessarily
indicative of future results.
NOTE 3--STOCK SPLIT
In March 1999, the Company's Board of Directors declared a stock split of
three shares for every one share of common stock then outstanding. The stock
split was effective May 24, 1999, the date the Company's public offering of
common stock 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.
NOTE 4--COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
From time to time, the Company is subject to legal proceedings and claims in
the ordinary course of business, including employment related claims and claims
of alleged infringement of trademarks, copyrights and other intellectual
property rights. The Company currently is not aware of any such legal
proceedings or claims that it believes will have, individually or in the
aggregate, a material adverse effect on its business, prospects, financial
condition and operating results.
NOTE 5--STOCKHOLDERS' EQUITY
On May 24, 1999, the Company completed its initial public offering of
9,568,000 shares of its common stock. Net proceeds to the Company aggregated
$175.8 million. As of the closing date of the offering, all of the convertible
preferred stock outstanding was converted into an aggregate of 58,779,267 shares
of common stock.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares outstanding. Shares associated with stock options are not included
because they are antidilutive. The shares of Redeemable Convertible Preferred
Stock automatically converted into common stock effective upon the closing of
the Company's initial public offering and are included in the calculation of
weighted average number of shares as of that date.
PRO FORMA NET LOSS PER SHARE
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, 1998, or at
the date of original issuance, if later.
8
<PAGE>
ETOYS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5--STOCKHOLDERS' EQUITY (CONTINUED)
The following table sets forth the computation of basic and pro forma net
loss per share for the periods indicated (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
1999 1998 1999 1998
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Numerator:
Net loss--as reported............................................ $ (44,944) $ (3,383) $ (65,727) $ (5,554)
Denominator:
Weighted average shares.......................................... 119,374 32,893 92,960 32,866
---------- --------- ---------- ---------
Denominator for basic calculation................................ 119,374 32,893 92,960 32,866
Weighted average effect of pro forma securities:
Series A Redeemable Convertible Preferred Stock.................. -- 18,970 5,685 18,962
Series B Redeemable Convertible Preferred Stock.................. -- 35,660 9,601 22,817
Series C Redeemable Convertible Preferred Stock.................. -- -- 538 --
---------- --------- ---------- ---------
Denominator for pro forma calculation............................ 119,374 87,523 108,784 74,645
========== ========= ========== =========
Net loss per share:
Basic............................................................ $ (0.38) $ (0.10) $ (0.71) $ (0.17)
========== ========= ========== =========
Pro forma........................................................ $ (0.38) $ (0.04) $ (0.60) $ (0.07)
========== ========= ========== =========
</TABLE>
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-Q and the following "Management's Discussion and Analysis of
Financial Condition and Results of Operations" include "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. This Act provides a "safe harbor" for forward-looking statements to
encourage companies to provide prospective information about themselves so long
as they identify these statements as forward-looking and provide meaningful
cautionary statements identifying important factors that could cause actual
results to differ from the projected results. All statements other than
statements of historical fact the Company makes in this Form 10-Q are
forward-looking. In particular, the statements herein regarding industry
prospects and the Company's future results of operations or financial position
are forward-looking statements. Forward-looking statements reflect the Company's
current expectations and are inherently uncertain. The Company's actual results
may differ significantly from the Company's expectations. The section entitled
"Additional Factors That May Affect Future Results" describes some, but not all,
of the factors that could cause these differences.
RESULTS OF OPERATIONS
NET SALES
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 % CHANGE 1999 1998 % CHANGE
--------- --------- ----------- --------- --------- -----------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Net sales............................. $ 13,306 $ 608 2,089% $ 21,281 $ 989 2,052%
</TABLE>
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. Growth in net sales for the quarter ended and
six months ended September 30, 1999 versus the same periods in the prior year
reflect a significant increase in units sold due to the growth of the Company's
customer base, repeat purchases from the Company's existing customers, and the
addition of BabyCenter's operations and growing customer base. Cumulative
customer accounts increased during the quarter to 611,000 at September 30, 1999,
an increase of more than 30% from 467,000 customer accounts at June 30, 1999 and
a 1,697% increase in customer accounts over September 30, 1998. Repeat customer
orders represented approximately 42% of orders placed in the quarter ended
September 30, 1999.
GROSS PROFIT
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 % CHANGE 1999 1998 % CHANGE
--------- --------- ----------- --------- --------- -----------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Gross profit............................... $ 2,554 $ 112 2,180% $ 4,072 $ 182 2,137%
</TABLE>
Gross profit is net sales less the cost of sales, which consists of the cost
of products sold to customers, outbound and inbound shipping and handling costs,
and gift wrapping costs. Gross profit increased in absolute dollars for the
quarter ended and six months ended September 30, 1999 versus the same periods in
the prior year, reflecting the Company's increased sales volume. Additionally,
gross profit increased as a percentage of sales by 0.8% for the quarter ended
and 0.7% for the six months ended September 30, 1999 as compared to the same
periods in the prior year. The increase of gross profit as a percentage of sales
is primarily attributable to better purchasing efficiencies, partially offset by
a shift in product mix towards lower-margin video game products. The Company
believes that providing its customers with superior customer service is an
essential component of its business strategy. Accordingly, the Company may incur
additional costs in order to meet customer expectations, which would impact
gross profit. The Company over time intends to expand its operations by the
addition of new product categories and by expanding the
10
<PAGE>
breadth and depth of its product or service offerings. Gross margins
attributable to new business areas may be lower than those associated with the
Company's existing business activities.
MARKETING AND SALES
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 % CHANGE 1999 1998 % CHANGE
--------- --------- ------------- --------- --------- -------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Marketing and sales................... $ 20,012 $ 2,372 744% $ 31,585 $ 3,742 744%
</TABLE>
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 in absolute dollars for the quarter ended and six months
ended September 30, 1999 as compared to the same periods in the prior year
primarily due to increases in the Company's advertising and promotional
expenditures in anticipation of the upcoming peak holiday shopping season,
increased payroll and related costs for fulfilling the higher level of customer
demand, and additional costs incurred in the expansion of the Company's
distribution facilities. Such expenses decreased as a percentage of net sales
for the quarter ended and six months ended September 30, 1999, as compared to
the corresponding prior year periods, due to the significant increase in net
sales for the respective periods. The Company intends to continue to pursue an
aggressive branding and marketing campaign and, therefore, expects marketing and
sales expenses to increase significantly in absolute dollars in future periods.
In addition, the Company expects marketing and sales expenses to increase in
absolute dollars as the Company expands and refines its distribution facilities
and operations to accommodate increases in sales volume and the Company may
incur additional costs in order to meet customer expectations.
PRODUCT DEVELOPMENT
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 % CHANGE 1999 1998 % CHANGE
--------- --------- ----------- --------- --------- -----------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Product development................... $ 12,188 $ 697 1,649% $ 17,023 $ 1,101 1,446%
</TABLE>
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. The absolute dollar increase in product development expenses for the
quarter ended and six months ended September 30, 1999 as compared to the same
periods in the prior year was primarily attributable to increased staffing and
associated costs related to enhancing the features, content and functionality of
the Company's Web site and transaction-processing systems, as well as increased
investment in systems and telecommunications infrastructure. Such expenses
decreased as a percentage of net sales for the quarter ended and six months
ended September 30, 1999, as compared to the corresponding prior year periods,
due to the significant increase in net sales for the respective periods. The
Company believes that continued investment in product development is critical to
attaining its strategic objectives. In addition to ongoing investments in its
Web site stores and infrastructure, the Company intends to increase investments
in product, service and international expansion. As a result, the Company
expects product development expenses to increase significantly in absolute
dollars.
11
<PAGE>
GENERAL AND ADMINISTRATIVE
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 % CHANGE 1999 1998 % CHANGE
--------- --------- ------------- --------- --------- -------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
General and administrative................. $ 4,298 $ 554 676% $ 7,254 $ 893 712%
</TABLE>
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. The increase in
general and administrative expenses for the quarter ended and six months ended
September 30, 1999 as compared to the same periods in the prior year was
primarily due to increased headcount and associated costs, legal and
professional fees, facilities and other related costs. The Company expects
general and administrative expenses to increase in absolute dollars as the
Company expands its staff and incurs additional costs related to the growth of
its business and international expansion.
GOODWILL AND INTANGIBLE ASSETS
As a result of the acquisition of BabyCenter, the Company recorded goodwill
of approximately $189.0 million, which is to be amortized over five years. As
such, goodwill amortization for the quarter ended and six months ended
September 30, 1999 of $9.5 million and $9.6 million, respectively, reflects a
full quarter of goodwill amortization from the BabyCenter purchase, in addition
to amortization of goodwill recorded from a previous acquisition. To the extent
the amount of this recorded goodwill is increased or the Company does 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, the net loss in any given period could be greater than
anticipated and the market price of the Company's stock could decline.
DEFERRED COMPENSATION
In the six months ended September 30, 1999, the Company recorded total
deferred stock compensation of $13.8 million in connection with stock options
granted during the period. Deferred stock compensation is amortized to expense
over the vesting periods of the applicable options, resulting in $3.3 million
and $7.1 million for the quarter ended and six months ended September 30, 1999,
respectively. The Company expects to record $7.0 million of amortization over
the remaining six months ended March 31, 2000. These amounts represent the
difference between the exercise price of stock option grants and the deemed fair
value of the Company's common stock at the time of such grants.
Amortization of deferred compensation for each of the next four fiscal years
is expected to be as follows:
<TABLE>
<CAPTION>
AMOUNT
IN
YEAR ENDED THOUSANDS
- ------------------------------------------------------------------------------------------------------ -----------
<S> <C>
March 31, 2001........................................................................................ $ 13,974
March 31, 2002........................................................................................ 13,970
March 31, 2003........................................................................................ 9,791
March 31, 2004........................................................................................ 276
</TABLE>
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INTEREST INCOME AND EXPENSE
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998 % CHANGE 1999 1998 % CHANGE
--------- --------- ----------- --------- --------- -------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest income............................ $ 2,022 $ 283 614% $ 2,966 $ 316 839%
Interest expense........................... $ 162 $ 6 2,600% $ 180 $ 44 309%
</TABLE>
Interest income increased for the quarter ended and six months ended
September 30, 1999 as compared to the corresponding prior year periods due to
higher cash balances resulting from the proceeds in the Company's initial public
offering. Interest expense consists primarily of interest on asset acquisitions
financed through notes payable and capital leases. Interest expense for the
quarter ended and six months ended September 30, 1999 increased as compared to
the corresponding prior year periods due to additional asset acquisitions
financed through notes payable and capital lease obligations.
INCOME TAXES
The Company has not generated any taxable income to date and therefore has
not paid any federal income taxes since inception. Utilization of the Company's
net operating loss carryforwards, which begin to expire in 2012, may be subject
to certain limitations under Section 382 of the Internal Revenue Code of 1986,
as amended. The Company has provided a full valuation allowance on the deferred
tax asset, consisting primarily of net operating loss carryforwards, because of
uncertainty regarding its realizability.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company's principal source of liquidity consisted
of $140.6 million of cash and cash equivalents compared to $20.2 million of cash
and cash equivalents at March 31, 1999.
Net cash used in operating activities was $46.0 million and $7.7 million for
the six months ended September 30, 1999 and 1998, respectively. Net operating
cash flows were primarily attributable to net losses, reduced by noncash charges
of depreciation and amortization, as well as increases in inventories, prepaid
expenses and other, which were offset by increases in accounts payable and
accrued expenses.
Net cash used in investing activities was $8.8 million for the six months
ended September 30, 1999 and consisted of purchases of fixed assets and other
assets, offset by cash received from the acquisition of BabyCenter. Cash
available for investment purposes increased substantially in 1999 as a result of
the proceeds from the issuance of common stock in the initial public offering.
Net cash used in investing activities for the six months ended September 30,
1998 was $2.3 million and consisted of purchases of fixed assets and other
assets.
Net cash provided by financing activities of $175.2 million for the six
months ended September 30, 1999 resulted from net proceeds from issuance of
common stock in the Company's initial public offering, offset by payments on
notes payable and capital leases. Net cash provided by financing activities for
the six months ended September 30, 1998 was $24.8 million and resulted from net
proceeds from the issuance of redeemable convertible preferred stock and
proceeds from bridge loan financing, offset by payments on the bridge loan.
The Company believes that current cash and cash equivalents will be
sufficient to meet its anticipated cash needs through the remainder of the
fiscal year ended March 31, 2000. However, any projections of future cash needs
and cash flows are subject to substantial uncertainty. If current cash, cash
equivalents and cash that may be generated from operations are insufficient to
satisfy the Company's liquidity requirements, the Company will likely seek to
sell additional equity or debt securities or to obtain a line of credit. The
sale of additional equity or convertible debt securities could result in
additional dilution to the Company's stockholders. In addition, the Company
will, from time to time, consider the acquisition of or
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<PAGE>
investment in complementary businesses, products, services and technologies,
which might impact the Company's liquidity requirements or cause the Company to
issue additional equity or debt securities. There can be no assurance that
financing will be available in amounts or on terms acceptable to the Company, if
at all.
YEAR 2000 IMPLICATIONS
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. The Company uses 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, the Company is dependent on the financial
institutions involved in processing customers' credit card payments for Internet
services and a third party that hosts the web servers. The Company is also
dependent on telecommunications vendors to maintain its network and the United
States Postal Service and other third-party carriers to deliver orders to
customers.
The Company has reviewed the year 2000 compliance of its internally
developed proprietary software. This review has included testing to determine
how systems will function at and beyond the year 2000. Since inception, the
Company has internally developed substantially all of the systems for the
operation of its Web site. These systems include the software used to provide
the 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, the Company believes that its internally developed
proprietary software is year 2000 compliant, although there can be no assurance
in this regard.
The Company has assessed 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
the accounting functions and the operation of the Web site. As part of the
assessment of the year 2000 compliance of these systems, the Company sought
assurances from these vendors that their software, computer technology and other
services are year 2000 compliant. The Company has expensed amounts incurred in
connection with year 2000 assessment since its formation through September 30,
1999. Such amounts have not been material. Based upon the results of this
assessment, the Company believes that its third-party supplied software,
computer technology and other services are year 2000 compliant. Accordingly, the
Company has determined that it is not necessary to develop a remediation plan
with respect to third-party software, third-party vendors and computer
technology and services with respect to year 2000 compliance.
The year 2000 readiness of the general infrastructure necessary to support
the Company's operations is difficult to assess. For instance, the Company
depends on the integrity and stability of the Internet to provide its services.
The Company 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. The
Company'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, the Company 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 the Company's services and would have a material adverse effect on
the Company.
14
<PAGE>
Any failure of material systems, vendors' material systems or the Internet
to be year 2000 compliant could have material adverse consequences. Such
consequences could include difficulties in operating the Web site effectively,
taking product orders, making product deliveries or conducting other fundamental
parts of the Company's business.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to the factors discussed in the "Overview" and "Liquidity and
Capital Resources" sections of this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and in the Company's S-1, the
following additional factors may affect the Company's future results.
THE COMPANY'S LIMITED OPERATING HISTORY MAKES FUTURE FORECASTING DIFFICULT
The Company was incorporated in November 1996. The Company began selling
products on the Company's Web site in October 1997. As a result of the Company's
limited operating history, it is difficult to accurately forecast its net sales
and the Company has limited meaningful historical financial data upon which to
base planned operating expenses. The Company bases its current and future
expense levels on its operating plans and estimates of future net sales, and the
Company's 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 the Company receives. As a result, the Company may be unable to
adjust its spending in a timely manner to compensate for any unexpected revenue
shortfall. This inability could cause the Company's net losses in a given
quarter to be greater than expected.
THE COMPANY ANTICIPATES FUTURE LOSSES AND NEGATIVE CASH FLOW
The Company expects operating losses and negative cash flow to continue for
the foreseeable future. The Company anticipates its losses will increase
significantly from current levels because it expects to incur additional costs
and expenses related to:
- brand development, marketing and other promotional activities;
- the expansion of the Company's inventory management and distribution
operations;
- the continued development of the Company's Web site and consumer-driven
technology, the systems that it uses to process customers' orders and
payments, and its computer network;
- the expansion of the Company's product offerings and Web site content;
- development of relationships with strategic business partners; and
- international expansion of the Company's operations
As of September 30, 1999, the Company had an accumulated deficit of
$96.6 million. The Company incurred net losses of $44.9 million for the quarter
ended September 30, 1999 and $20.8 million for the quarter ended June 30, 1999.
In addition, because of its acquisition of BabyCenter, the Company expects
that its 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;
- an increase in Web site development activities and associated content;
- additional facilities and infrastructure; and
- assimilation of operations and personnel.
15
<PAGE>
Also, as a result of the acquisition of BabyCenter, the Company has recorded
a significant amount of goodwill, the amortization of which will significantly
reduce the Company's earnings and profitability for the foreseeable future. The
recorded goodwill of approximately $189.0 million will be amortized over a
five-year period. To the extent the Company does 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,
the Company's net loss in any given period could be greater than anticipated and
the market price of the Company's stock could decline.
The Company's ability to become profitable depends on its ability to
generate and sustain substantially higher net sales while maintaining reasonable
expense levels. If the Company does achieve profitability, it cannot be certain
that it would be able to sustain or increase profitability on a quarterly or
annual basis in the future.
ANY FAILURE OF THE COMPANY TO SUCCESSFULLY EXPAND ITS DISTRIBUTION OPERATIONS
WOULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY
Any failure of the Company to successfully expand its distribution
operations to accommodate increases in demand and customer orders would have a
material adverse effect on the Company's business prospects, financial condition
and operating results. Under such circumstances, the material adverse effects
may include, among other things, an inability to increase net sales in
accordance with the expectations of securities analysts and investors; increases
in costs that the Company may incur to meet customer expectations; increases in
fulfillment expenses if the Company is required to rely on more expensive
fulfillment systems than anticipated or incur additional costs for balancing
merchandise inventories among multiple distribution facilities; loss of customer
loyalty and repeat business from customers if they become dissatisfied with the
Company's delivery services; and damage to the Company's reputation and brand
image arising from uncertainty with respect to its distribution operations.
These risks are greatest during the fourth calendar quarter of each year, when
the Company's sales increase substantially relative to other quarters and the
demand on its distribution operations increases proportionately. Since the
Company's limited operating history makes it difficult to accurately estimate
the number of orders that may be received during the fourth calendar quarter,
the Company may experience either inadequate or excess fulfillment capacity
during this quarter, either of which could have a material adverse impact on the
Company. The occurrence of one or more of these events would be likely to cause
the market price of the Company's common stock to decline.
The Company currently operates its own distribution facility in Commerce,
California and uses the services of third-party distribution facilities located
in Provo, Utah and St. Cloud, Minnesota operated by Fingerhut. The Company's
BabyCenter subsidiary also operates a distribution facility located in San
Francisco, California. The Company has in the past and continues to devote
substantial resources to the expansion of its distribution operations among
these facilities. This expansion may cause disruptions in the Company's business
as well as unexpected costs. The Company is not experienced with coordinating
and managing distribution operations in geographically distant locations or with
certain of the automation and technological features of the distribution
operations at the Provo, Utah facility, which continue to be developed and
refined to meet the Company's needs. The distribution facilities operated by
Fingerhut also rely on the service of unionized employees, exposing the Company
to risks related to labor strikes or similar activities. As the Company
continues to integrate its existing distribution operations with those of
Fingerhut, the Company anticipates that it will continue to fulfill orders from
its own Commerce, California and San Francisco, California facilities. This may
result in increased costs as the Company seeks to meet customers' expectations,
balance merchandise inventories among its distribution facilities and take other
steps that may be necessary to meet the demands placed on its distribution
operations, particularly during the fourth calendar quarter of the year. The
Company has also leased a distribution facility located in Virginia, which the
Company is devoting substantial resources to developing in order to begin
operations at that facility in 2000. Despite the fact that the Company devotes
substantial resources to the
16
<PAGE>
expansion and refinement of its distribution operations, there can be no
assurance that its existing or future distribution operations will be sufficient
to accommodate increases in demand and customer orders.
IF THE COMPANY EXPERIENCES PROBLEMS IN ITS DISTRIBUTION OPERATIONS, IT COULD
LOSE CUSTOMERS
The Company relies upon third-party carriers for product shipments,
including shipments to and from the Company's distribution facilities. The
Company is therefore subject to the risks, including employee strikes and
inclement weather associated with such carriers' ability to provide delivery
services to meet the Company's shipping needs. In addition, failure to deliver
products to the Company's customers in a timely manner would damage its
reputation and brand. The Company also depends upon temporary employees to
adequately staff the Company's distribution facilities, particularly during the
holiday shopping season. If the Company does not have sufficient sources of
temporary employees, it could lose customers.
THE COMPANY'S OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT. IF THE
COMPANY FAILS TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS,
THE MARKET PRICE OF THE COMPANY'S COMMON STOCK MAY DECLINE SIGNIFICANTLY
The Company's 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 the Company's control. Because the Company's
operating results are volatile and difficult to predict, the Company believes
that quarter-to-quarter comparisons of its operating results are not a good
indication of its future performance. It is likely that in some future quarter
the Company's operating results may fall below the expectations of securities
analysts and investors. In this event, the trading price of the Company's common
stock may decline significantly.
Factors that may harm the Company's business or cause its operating results
to fluctuate include the following:
- the Company's inability to obtain new customers at reasonable cost, retain
existing customers, or encourage repeat purchases;
- decreases in the number of visitors to the Company's Web site or the
Company's inability to convert visitors to its Web site into customers;
- the mix of children and baby products, including toys, video games,
software, videos, books and music sold by the Company;
- seasonality;
- the Company's inability to manage inventory levels or control inventory
shrinkage;
- the Company's inability to manage its distribution operations;
- the Company's inability to adequately maintain, upgrade and develop its
Web site, the systems that it uses to process customers' orders and
payments or its computer network;
- the ability of the Company's competitors to offer new or enhanced Web
sites, services or products;
- price competition;
- an increase in the level of the Company's product returns;
- fluctuations in the demand for children and baby products associated with
movies, television and other entertainment events;
17
<PAGE>
- the Company's inability to obtain popular children and baby products,
including toys, video games, software, videos, books and music from its
vendors;
- fluctuations in the amount of consumer spending on children and baby
products, including toys, video games, software, videos, books and music;
- the termination of existing or failure to develop new marketing
relationships with key business partners;
- the extent to which the Company is 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 the Company's operations, including international
expansion;
- 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 children and baby products, including toys,
video games, software, videos, books and music; and
- economic conditions specific to the Internet, online commerce and the
children and baby products industries
A number of factors will cause the Company's gross margins to fluctuate in
future periods, including the mix of children and baby products, including toys,
video games, software, videos, books and music sold by the Company, 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 the Company's gross
margins in future periods.
BECAUSE THE COMPANY EXPERIENCES SEASONAL FLUCTUATIONS IN ITS NET SALES, ITS
QUARTERLY RESULTS WILL FLUCTUATE AND ITS ANNUAL RESULTS COULD BE BELOW
EXPECTATIONS
The Company has historically experienced and expects to continue to
experience seasonal fluctuations in its net sales. These seasonal patterns will
cause quarterly fluctuations in the Company's operating results. In particular,
a disproportionate amount of the Company's net sales have been realized during
the fourth calendar quarter and the Company expects this trend to continue in
the future.
In anticipation of increased sales activity during the fourth calendar
quarter, the Company will hire a significant number of temporary employees to
bolster its permanent staff and the Company significantly increases its
inventory levels. For this reason, if the Company's net sales were below
seasonal expectations during this quarter, the Company's annual operating
results could be below the expectations of securities analysts and investors.
Due to the Company's limited operating history, it is difficult to predict
the seasonal pattern of its sales and the impact of such seasonality on its
business and financial results. In the future, the Company's seasonal sales
patterns may become more pronounced, may strain the Company's personnel and
warehousing and order shipment activities and may cause a shortfall in net sales
as compared to expenses in a given period.
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<PAGE>
THE COMPANY FACES SIGNIFICANT INVENTORY RISK BECAUSE CONSUMER DEMAND CAN CHANGE
FOR PRODUCTS BETWEEN THE TIME THAT THE COMPANY ORDERS PRODUCTS AND THE TIME THAT
THE COMPANY RECEIVES THEM
The Company carries a significant level of inventory. As a result, the
rapidly changing trends in consumer tastes in the market for children and baby
products, including toys, video games, software, videos, books and music subject
us to significant inventory risks. It is critical to the Company's success that
it accurately predicts these trends and does not overstock unpopular products.
The demand for specific products can change between the time the products are
ordered and the date of receipt. The Company is particularly exposed to this
risk because the Company derives a majority of its net sales in the fourth
calendar quarter of each year. The Company's failure to sufficiently stock
popular toys and other products in advance of such fourth calendar quarter would
harm the Company's operating results for the entire fiscal year.
In the event that one or more products do not achieve widespread consumer
acceptance, the Company may be required to take significant inventory markdowns,
which could reduce the Company's net sales and gross margins. This risk may be
greatest in the first calendar quarter of each year, after the Company has
significantly increased inventory levels for the holiday season. The Company
believes that this risk will increase as it opens new departments or enters new
product categories due to the Company's lack of experience in purchasing
products for these categories. In addition, to the extent that demand for the
Company's products increases over time, the Company may be forced to increase
inventory levels. Any such increase would subject the Company to additional
inventory risks.
THE COMPANY FACES THE RISK OF INVENTORY SHRINKAGE
If the security measures the Company uses at its distribution facilities do
not prevent inventory shrinkage, the Company's gross profit margin may
significantly decrease. The Company has undertaken a number of measures designed
to address inventory shrinkage, including the installation of enhanced security
measures at its distribution facilities. These measures may not successfully
reduce or prevent inventory shrinkage in future periods. The Company's failure
to successfully improve the security measures it uses at its distribution
facilities may cause its gross profit margins and results of operations to be
significantly below expectations in future periods.
BECAUSE THE COMPANY DOES NOT HAVE LONG-TERM OR EXCLUSIVE VENDOR CONTRACTS, THE
COMPANY MAY NOT BE ABLE TO GET SUFFICIENT QUANTITIES OF POPULAR CHILDREN'S
PRODUCTS IN A TIMELY MANNER. AS A RESULT, THE COMPANY COULD LOSE CUSTOMERS
If the Company is not able to offer its customers sufficient quantities of
toys or other products in a timely manner, the Company could lose customers and
its net sales could be below expectations. The Company's success depends on its
ability to purchase products in sufficient quantities at competitive prices,
particularly for the holiday shopping season. As is common in the industry, the
Company does 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, the Company does not have a predictable or guaranteed
supply of toys or other products.
TO MANAGE THE COMPANY'S GROWTH AND EXPANSION, THE COMPANY NEEDS TO CONTINUE TO
IMPROVE FINANCIAL AND MANAGERIAL CONTROLS AND REPORTING SYSTEMS AND PROCEDURES.
IF THE COMPANY IS UNABLE TO DO SO SUCCESSFULLY, ITS RESULTS OF OPERATIONS MAY BE
IMPAIRED
The Company's rapid growth in personnel and operations has placed, and will
continue to place, a significant strain on the Company's management, information
systems and resources. In addition, with the
19
<PAGE>
acquisition of BabyCenter, the Company added over 160 new employees, including
managerial, technical and operations personnel, and has been required to
assimilate substantially all of BabyCenter's operations into the Company's
operations. Further, during 1999, the Company expanded its distribution
operations to include not only its own distribution facility in Commerce,
California, but also the use of services of third-party distribution facilities
located in Provo, Utah and St. Cloud, Minnesota operated by Fingerhut. This
expansion may cause disruptions in the Company's business as well as unexpected
costs. The Company is not experienced with coordinating and managing
distribution operations in geographically distant locations or with certain of
the automation and technological features of the distribution operations at the
Provo, Utah facility, which continue to be developed and refined to meet the
Company's needs. The integration of information systems operated by the Company
and Fingerhut may negatively affect the Company's ability to obtain financial
information and other data on a timely and reliable basis.
In order to manage this growth effectively, the Company needs to continue to
improve its financial and managerial controls and reporting systems and
procedures. If the Company continues to experience a significant increase in the
number of its personnel and expansion of its distribution operations, the
Company's existing management team may not be able to effectively train,
supervise and manage all of the Company's personnel or effectively oversee all
of the Company's distribution operations. In addition, the Company's existing
information systems may not be able to handle adequately the increased volume of
information and transactions that would result from increased growth. The
Company's failure to successfully improve and integrate these systems and
procedures may cause its results of operations to be below expectations.
RISK OF INTERNATIONAL EXPANSION
The Company plans to expand its presence in foreign markets. The Company has
relatively little experience in purchasing, marketing and distributing products
or services for these markets and may not benefit from any first-to-market
advantages. It will be costly to establish international facilities and
operations, promote the Company's brand internationally, and develop localized
Web sites and stores and other systems. The Company may not succeed in its
efforts in these countries. If revenues from international activities do not
offset the expense of establishing and maintaining foreign operations, the
Company's business prospects, financial condition and operating results will
suffer.
As the international online commerce market continues to grow, competition
in this market will likely intensify. In addition, governments in foreign
jurisdictions may regulate Internet or other online services in such areas as
content, privacy, network security, encryption or distribution. This may affect
the Company's ability to conduct business internationally.
THE COMPANY 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 the Company's net sales and results of operations. The Company expects
competition to intensify in the future because current and new competitors can
enter its market with little difficulty and can launch new Web sites at a
relatively low cost. In addition, the children and baby products industries,
including toy, video game, software, video, books and music are intensely
competitive.
The Company currently or potentially competes with a variety of other
companies, including:
- traditional store-based toy and children and baby products retailers such
as Toys R Us, FAO Schwarz, Zany Brainy, Noodle Kidoodle, BabyGap,
Gymboree, The Right Start and Babies R Us;
- major discount retailers such as Wal-Mart, Kmart and Target;
20
<PAGE>
- online efforts of these traditional retailers, including the online stores
operated by Toys R Us, Wal-Mart, FAO Schwarz, BabyGap and Gymboree;
- physical and online stores of entertainment entities that sell and license
children and baby products, such as The Walt Disney Company and Warner
Bros.;
- catalog retailers of children and baby products and products for toddlers
and expectant mothers;
- vendors or manufacturers of children and baby products that currently sell
some of their products directly online, such as Mattel and Hasbro;
- other online companies that include toy and children and baby products as
part of their product offerings, such as Amazon.com, Barnesandnoble.com,
CDnow, Beyond.com, Reel.com, iBaby, BabyCatalog.com, iVillage and
Women.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 and baby products, such as BrainPlay.com, Red
Rocket and Toysmart.com
21
<PAGE>
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 the Company
does. Many of these competitors can devote substantially more resources to Web
site development than the Company can. In addition, larger, well-established and
well-financed entities may join with online competitors or suppliers of children
and baby products, including toys, video games, software, videos, books and
music as the use of the Internet and other online services increases.
The Company's 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 the Company can.
Traditional store-based retailers also enable customers to see and feel products
in a manner that is not possible over the Internet.
IF THE COMPANY ENTERS NEW BUSINESS CATEGORIES THAT DO NOT ACHIEVE MARKET
ACCEPTANCE, THE COMPANY'S BRAND AND REPUTATION COULD BE DAMAGED AND THE COMPANY
COULD FAIL TO ATTRACT NEW CUSTOMERS
Any new department or product category that is launched or acquired by the
Company, such as BabyCenter, which is not favorably received by consumers, could
damage the Company's brand or reputation. This damage could impair the Company's
ability to attract new customers, which could cause its net sales to fall below
expectations. The expansion of the Company's business to include BabyCenter or
any other new department or product category will require significant additional
expenses, and strain the Company's management, financial and operational
resources. This type of expansion would also subject us to increased inventory
risk. The Company may choose to expand its 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
the Company's market presence through relationships with third parties. In
addition, the Company may pursue the acquisition of other new or complementary
businesses, products or technologies, although it has no present understandings,
commitments or agreements with respect to any material acquisitions or
investments.
IF THE COMPANY DOES NOT SUCCESSFULLY EXPAND ITS WEB SITE AND THE SYSTEMS THAT
PROCESS CUSTOMERS' ORDERS, THE COMPANY COULD LOSE CUSTOMERS AND ITS NET SALES
COULD BE REDUCED
If the Company fails to rapidly upgrade its Web site in order to accommodate
increased traffic, the Company may lose customers, which would reduce the
Company's net sales. Furthermore, if the Company fails to rapidly expand the
computer systems that it uses to process and ship customer orders and process
payments, the Company may not be able to successfully distribute customer
orders. As a result, the Company could lose customers and its net sales could be
reduced. In addition, the Company's failure to rapidly upgrade its Web site or
expand these computer systems without system downtime, particularly during the
fourth calendar quarter, would further reduce its net sales. The Company may
experience difficulty in improving and maintaining such systems if its employees
or contractors that develop or maintain its computer systems become unavailable
to it. The Company has experienced periodic systems interruptions, which it
believes will continue to occur, while enhancing and expanding these computer
systems.
THE COMPANY'S FACILITIES AND SYSTEMS ARE VULNERABLE TO NATURAL DISASTERS AND
OTHER UNEXPECTED PROBLEMS. THE OCCURRENCE OF A NATURAL DISASTER OR OTHER
UNEXPECTED PROBLEM COULD DAMAGE THE COMPANY'S REPUTATION AND BRAND AND REDUCE
ITS NET SALES
The occurrence of an earthquake or other natural disaster or unanticipated
problems at the Company's leased facilities in Southern California or Northern
California, or at the third-party facility in
22
<PAGE>
Sunnyvale, California that houses substantially all of the Company's computer
and communications hardware systems, could cause interruptions or delays in the
Company's business, loss of data or render us unable to accept and fulfill
customer orders. The Company's leased facilities in Southern and Northern
California house substantially all of its product development and information
systems, as well as a significant portion of its inventory. Any such
interruptions or delays at either of these facilities would reduce the Company's
net sales. In addition, the Company's systems and operations are vulnerable to
damage or interruption from fire, flood, power loss, telecommunications failure,
break-ins, earthquake and similar events. The Company has no formal disaster
recovery plan and its business interruption insurance may not adequately
compensate it for losses that may occur. In addition, the failure by the
third-party facility to provide the data communications capacity required by the
Company, as a result of human error, natural disaster or other operational
disruptions, could result in interruptions in the Company's service. The
occurrence of any or all of these events could damage the Company's reputation
and brand and impair the Company's business.
THE COMPANY'S NET SALES COULD DECREASE IF ITS ONLINE SECURITY MEASURES FAIL
The Company's relationship with its customers may be adversely affected if
the security measures that the Company uses to protect their personal
information, such as credit card numbers, are ineffective. If, as a result, the
Company loses many customers, its net sales could decrease. The Company relies
on security and authentication technology that it licenses from third parties.
With this technology, the Company performs real-time credit card authorization
and verification with its bank. The Company cannot predict whether events or
developments will result in a compromise or breach of the technology it uses to
protect a customer's personal information.
Furthermore, the Company's servers may be vulnerable to computer viruses,
physical or electronic break-ins and similar disruptions. The Company may need
to expend significant additional capital and other resources to protect against
a security breach or to alleviate problems caused by any breaches. The Company
cannot assure that it can prevent all security breaches.
THE COMPANY'S NET SALES AND GROSS MARGINS WOULD DECREASE IF IT EXPERIENCES
SIGNIFICANT CREDIT CARD FRAUD
A failure to adequately control fraudulent credit card transactions would
reduce the Company's net sales and its gross margins because the Company does
not carry insurance against this risk. The Company has developed technology to
help it to detect the fraudulent use of credit card information. Nonetheless, to
date, the Company has 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, the Company
is liable for fraudulent credit card transactions because it does not obtain a
cardholder's signature.
IF THE COMPANY DOES NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, THE COMPANY'S
SERVICES COULD BECOME OBSOLETE AND IT COULD LOSE CUSTOMERS
If the Company faces material delays in introducing new services, products
and enhancements, its customers may forego the use of its services and use those
of its competitors. To remain competitive, the Company must continue to enhance
and improve the functionality and features of its 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, the Company's existing Web site and proprietary technology
and systems may become obsolete.
To develop the Company's Web site and other proprietary technology entails
significant technical and business risks. The Company may use new technologies
ineffectively or it may fail to adapt its Web site,
23
<PAGE>
systems that the Company uses to process customers' orders and payments and its
computer network to customer requirements or emerging industry standards.
INTELLECTUAL PROPERTY CLAIMS AGAINST THE COMPANY CAN BE COSTLY AND COULD IMPAIR
ITS BUSINESS.
Other parties may assert infringement or unfair competition claims against
the Company. In the past, a toy distributor using a name similar to the
Company's sent the Company notice of a claim of infringement of proprietary
rights, which claim was subsequently withdrawn. The Company has also received a
claim from the holders of a home shopping video catalog patent and a remote
query communication system patent that the Company's Internet marketing program
and Web site operations, respectively, infringe such patents. The Company
expects to receive other notices from other third parties in the future. The
Company cannot predict whether third parties will assert claims of infringement
against us, or whether any past or future assertions or prosecutions will harm
the Company's business. If the Company is forced to defend against any such
claims, whether they are with or without merit or are determined in the
Company's favor, then the Company may face costly litigation, diversion of
technical and management personnel, or product shipment delays. As a result of
such a dispute, the Company 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 the Company
and the Company is unable to develop non-infringing technology or license the
infringed or similar technology on a timely basis, it could impair the Company's
business.
IF THE PROTECTION OF THE COMPANY'S TRADEMARKS AND PROPRIETARY RIGHTS IS
INADEQUATE, THE COMPANY'S BRAND AND REPUTATION COULD BE IMPAIRED AND IT COULD
LOSE CUSTOMERS
The steps the Company takes to protect its proprietary rights may be
inadequate. The Company regards its copyrights, service marks, trademarks, trade
dress, trade secrets and similar intellectual property as critical to its
success. The Company relies on trademark and copyright law, trade secret
protection and confidentiality or license agreements with its employees,
customers, partners and others to protect its proprietary rights. In
September 1998, the United States Patent and Trademark Office granted the
Company a registered trademark for "eToys" for online retail services for toys
and games. The Company has 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 the Company will sell its products and
services online. Furthermore, the relationship between regulations governing
domain names and laws protecting trademarks and similar proprietary rights is
unclear. Therefore, the Company may be unable to prevent third parties from
acquiring domain names that are similar to, infringe upon or otherwise decrease
the value of its trademarks and other proprietary rights.
THE LOSS OF THE SERVICES OF ONE OR MORE OF THE COMPANY'S KEY PERSONNEL, OR THE
COMPANY'S FAILURE TO ATTRACT, ASSIMILATE AND RETAIN OTHER HIGHLY QUALIFIED
PERSONNEL IN THE FUTURE, COULD DISRUPT THE COMPANY'S OPERATIONS AND RESULT IN
LOSS OF NET SALES
The loss of the services of one or more of the Company's key personnel could
seriously interrupt its business. The Company depends on the continued services
and performance of the Company's senior management and other key personnel,
particularly Edward C. Lenk, the Company's President, Chief Executive Officer
and Uncle of the Board. The Company's future success also depends upon the
continued service of the Company's executive officers and other key sales,
marketing and support personnel. The majority of the Company's senior management
joined the Company in the last twelve months, including
24
<PAGE>
the Company's Chief Financial Officer, Chief Information Officer, Senior Vice
President of Operations and Senior Vice President of Marketing. The Company's
future success depends on these officers effectively working together with the
Company's original management team. The Company's success will also depend on a
successful integration of BabyCenter's management with the Company's senior
management team. None of the Company's officers or key employees is bound by an
employment agreement for any specific term other than the Chief Executive
Officer and the President of BabyCenter. The Company's relationships with these
officers and key employees are at will. The Company does not have "key person"
life insurance policies covering any of its employees.
THE COMPANY MAY BE ADVERSELY IMPACTED IF THE SOFTWARE, COMPUTER TECHNOLOGY AND
OTHER SYSTEMS IT USES ARE NOT YEAR 2000 COMPLIANT
Any failure of the Company's material systems, its vendors' material systems
or the Internet to be year 2000 compliant would have material adverse
consequences for the Company. Such consequences would include difficulties in
operating the Company's Web site effectively, taking product orders, making
product deliveries or conducting other fundamental parts of the Company's
business. The Company has assessed the year 2000 readiness of the software,
computer technology and other services that it uses which may not be year 2000
compliant. At this time, the Company has not developed a contingency plan to
address situations that may result if the Company or its vendors are unable to
achieve year 2000 compliance. The cost of developing and implementing such a
plan, if necessary, could be material.
The Company also depends 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 the Company's
services and would have a material adverse effect on us.
THERE ARE RISKS ASSOCIATED WITH THE BABYCENTER MERGER AND OTHER POTENTIAL
ACQUISITIONS. AS A RESULT, THE COMPANY MAY NOT ACHIEVE THE EXPECTED BENEFITS OF
THE BABYCENTER MERGER AND OTHER POTENTIAL ACQUISITIONS
The Company may not realize the anticipated benefits from the BabyCenter
merger. The Company may not be able to successfully assimilate the additional
personnel, operations, acquired technology and products into its business. The
merger may further strain the Company's existing financial and managerial
controls and reporting systems and procedures. In addition, key BabyCenter
personnel may decide not to work for the Company. These difficulties could
disrupt its ongoing business, distract its management and employees or increase
its expenses. Further, the physical expansion in facilities that has occurred as
a result of this merger may result in disruptions that seriously impair the
Company's business. In particular, as a result of the BabyCenter merger, the
Company now has operations in multiple facilities in geographically distant
areas. The Company is not experienced in managing facilities or operations in
geographically distant areas.
If the Company is presented with appropriate opportunities, the Company
intends to make other investments in complementary companies, products or
technologies. The Company may not realize the anticipated benefits of any other
acquisition or investment. If the Company buys another company, the Company will
likely face the same risks, uncertainties and disruptions as discussed above
with respect to the Company and its BabyCenter merger. Furthermore, the Company
may have to incur debt or issue equity securities to pay for any additional
future acquisitions or investments, the issuance of which would be dilutive to
the Company or its existing stockholders.
25
<PAGE>
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE THE COMPANY EVEN IF DOING SO
WOULD BE BENEFICIAL TO THE COMPANY'S STOCKHOLDERS
Provisions of the Company's Amended and Restated Certificate of
Incorporation, its Bylaws and Delaware law could make it more difficult for a
third party to acquire the Company, even if doing so would be beneficial to the
Company's stockholders.
The Company is 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:
- 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.
The Company's Amended and Restated 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 the
Company's Amended and Restated Certificate of Incorporation permits the Board of
Directors to issue preferred stock with voting or other rights without any
stockholder action. Commencing at the Company's first annual meeting of
stockholders following the date on which it has at least 800 stockholders, the
Company's Amended and Restated 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 the Company's management.
RISKS RELATED TO THE COMPANY'S INDUSTRY
IF THE COMPANY IS UNABLE TO ACQUIRE THE NECESSARY WEB DOMAIN NAMES, ITS BRAND
AND REPUTATION COULD BE DAMAGED AND IT COULD LOSE CUSTOMERS
The Company may be unable to acquire or maintain Web domain names relating
to its brand in the United States and other countries in which it may conduct
business. As a result, the Company may be unable to prevent third parties from
acquiring and using domain names relating to its brand. Such use could damage
its brand and reputation and take customers away from its Web site. The Company
currently holds 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
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
26
<PAGE>
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.
THE COMPANY MAY NEED TO CHANGE THE MANNER IN WHICH IT CONDUCTS ITS BUSINESS IF
GOVERNMENT REGULATION INCREASES
The adoption or modification of laws or regulations relating to the Internet
could adversely affect the manner in which the Company currently conducts its
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 the Company. 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 privacy, copyrights, taxation and the
transmission of sexually explicit material, and the Federal Trade Commission
recently published the new Children's Online Privacy Protection Rule to become
effective April 21, 2000. 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, the
Company may need to modify the manner in which it does business, which may
result in additional expenses. For instance, the Company may need to spend time
and money revising the process by which it fulfills customers' orders to ensure
that each shipment complies with applicable laws. The Company may need to hire
additional personnel to monitor its compliance with applicable laws. The Company
may also need to modify its software to further protect its customers' personal
information.
THE COMPANY MAY BE SUBJECT TO LIABILITY FOR THE INTERNET CONTENT IT PUBLISHES
As a publisher of online content, the Company faces potential liability for
defamation, negligence, copyright, patent or trademark infringement, or other
claims based on the nature and content of materials that the Company publishes
or distributes. If the Company faces liability, then its reputation and its
business may suffer. In the past, plaintiffs have brought these types of claims
and sometimes successfully litigated them against online services.
THE COMPANY'S NET SALES COULD DECREASE IF IT BECOMES SUBJECT TO SALES AND OTHER
TAXES
If one or more states or any foreign country successfully asserts that the
Company should collect sales or other taxes on the sale of its products, the
Company's net sales and results of operations could be harmed. The Company does
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 the
Company. In addition, any new operation in states outside California could
subject the Company's shipments in such states to state sales taxes under
current or future laws. If the Company becomes obligated to collect sales taxes,
the Company will need to update its 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 the Company's operating expenses. In addition, the Company's customers
may be discouraged from purchasing products from it because they have to pay
sales tax, causing the Company's net sales to decrease. As a result, the Company
may need to lower prices to retain these customers.
27
<PAGE>
RISKS RELATED TO SECURITIES MARKETS
THE COMPANY MAY BE UNABLE TO MEET ITS FUTURE CAPITAL REQUIREMENTS
The Company cannot be certain that additional financing will be available to
it on favorable terms when required, or at all. If the Company raises 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 the Company's common stock and the Company's stockholders will
experience additional dilution. The Company requires substantial working capital
to fund its business. Since the Company's inception, it has experienced negative
cash flow from operations and expects to experience significant negative cash
flow from operations for the foreseeable future. The Company believes that
current cash and cash equivalents will be sufficient to meet its anticipated
cash needs through the remainder of the fiscal year ended March 31, 2000. The
Company may need to raise additional funds prior to the expiration of such
period.
THE COMPANY'S COMMON STOCK PRICE MAY BE VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR INDIVIDUAL STOCKHOLDERS
The market price for the Company's 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 the Company's control:
- actual or anticipated variations in the Company's quarterly operating
results;
- announcements of technological innovations, increased cost of operations
or new products or services by the Company or its 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 the Company or its 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 the Company's
outstanding shares of common stock or sales of additional shares of common
stock; and
- potential litigation
IF THE COMPANY'S STOCK PRICE IS VOLATILE, THE COMPANY 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 the Company 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 the Company's stock price to fall.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk related to changes in interest rates
and foreign currency exchange rates. The Company does not use derivative
financial instruments.
28
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
INTEREST RATE RISK. The Company maintains a portfolio of highly liquid cash
equivalents maturing in three months or less as of the date of purchase. Given
the short-term nature of these investments, the Company believes it is not
subject to significant interest rate risk with respect to these investments.
Additionally, the Company is subject to interest rate risk related to its notes
payable and capital lease obligations. The Company's notes payable and capital
lease obligations bear interest at fixed rates, and their carrying amount
approximates fair value based on borrowing rates currently available to the
Company. As such, the Company believes that market risk arising from its notes
payable and capital lease obligations is not material.
FOREIGN CURRENCY RISK. The Company currently has a wholly-owned subsidiary
with operations in the United Kingdom. All sales and expenses incurred by the
foreign subsidiary are denominated in the British pound, which is considered the
functional currency. As such, the Company is exposed to foreign currency risk
which arises in part from funding denominated in British pounds provided to the
foreign subsidiary and from the translation of the foreign subsidiary's
financial results into U.S. dollars during consolidation. As exchange rates
vary, results from operations and profitability may be adversely impacted. As of
September 30, 1999, the effect of the foreign currency exchange rate
fluctuations on the Company has not been material.
29
<PAGE>
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 4 Commitments and Contingencies in Part I, Item 1, Financial
Statements
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Current Reports on Form 8-K
Current Report on Form 8-K dated July 1, 1999 pertaining to the acquisition of
BabyCenter, Inc., which included the following financial statements:
(i) Audited 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.
(ii) The Company's audited balance sheets of as of March 31, 1998 and 1999,
and the related statements of operations, stockholders' equity
(deficit), and cash flows for the years then ended.
(iii) The Company's 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.
30
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
eToys Inc. has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
ETOYS INC.
By: /s/ STEVEN J. SCHOCH
-----------------------------------------
Steven J. Schoch
SENIOR VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
</TABLE>
DATED: November 12, 1999
31
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
32
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS (IN
THOUSANDS, EXCEPT PER SHARE DATA)
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 140,601
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 51,379
<CURRENT-ASSETS> 210,664
<PP&E> 23,365
<DEPRECIATION> (2,156)
<TOTAL-ASSETS> 414,177
<CURRENT-LIABILITIES> 76,352
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 331,442
<TOTAL-LIABILITY-AND-EQUITY> 414,177
<SALES> 13,306
<TOTAL-REVENUES> 13,306
<CGS> 10,752
<TOTAL-COSTS> 10,752
<OTHER-EXPENSES> 49,358
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 162
<INCOME-PRETAX> (44,944)
<INCOME-TAX> 0
<INCOME-CONTINUING> (44,944)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (44,944)
<EPS-BASIC> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>
