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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported): NOVEMBER 28, 2000
ETOYS INC.
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(Exact Name of Registrant as Specified in Charter)
DELAWARE 0-25709 95-4633006
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(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
12200 W. OLYMPIC BLVD., LOS ANGELES, CALIFORNIA 90064
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (310) 998-6000
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(Former Name or Former Address, if Changed since Last Report)
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ITEM 5. OTHER EVENTS.
The Registrant is filing this current report on Form 8-K to
make generally available certain information concerning the risk factors
affecting the business, financial condition or operating results of the
Registrant and for purposes of enabling the Registrant to incorporate the
following information in its Registration Statement on Form S-3 (File No.
333-90311). The following information set forth below is substantially similar
to the information contained in such Registration Statement.
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED
BELOW BEFORE DECIDING WHETHER TO INVEST IN OUR COMMON STOCK. ADDITIONAL RISKS
AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL
MAY ALSO IMPAIR OUR BUSINESS OPERATIONS.
IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL
CONDITION OR OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED. IN SUCH
CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE PART
OR ALL OF YOUR INVESTMENT.
RISKS RELATED TO SERIES D PREFERRED SHARES
THE CONVERSION OF THE SERIES D PREFERRED SHARES AND THE EXERCISE OF THE RELATED
WARRANTS COULD RESULT IN SUBSTANTIAL NUMBERS OF ADDITIONAL SHARES BEING ISSUED
IF OUR MARKET PRICE DECLINES.
On June 12, 2000, we issued 10,000 shares of our series D convertible
preferred stock, $10,000 stated value per share, and warrants to purchase
5,018,296 shares of our common stock with a current warrant exercise price of
$7.17375 per share. The series D preferred shares convert at a floating rate
based on the market price of our common stock, provided the conversion price may
not exceed $25.00 per share, subject to adjustment. As a result, the lower the
price of our common stock at the time of conversion, the greater the number of
shares the holder will receive.
To the extent the series D preferred shares are converted or
dividends on the series D preferred shares are paid in shares of common stock
rather than cash, a significant number of shares of common stock may be sold
into the market, which could decrease the price of our common stock and
encourage short sales. Short sales could place further downward pressure on
the price of our common stock. In that case, we could be required to issue an
increasingly greater number of shares of our common stock upon future
conversions of the series D preferred shares, sales of which could further
depress the price of our common stock. In addition, in accordance with an
agreement with the selling securityholders, due to a recent market price
decline of our common stock, we are required to register a greater number of
shares of our common stock issuable upon conversion of the series D preferred
shares and exercise of the related warrants.
The conversion of and the payment of dividends in shares of common
stock in lieu of cash on the series D preferred shares may result in
substantial dilution to the interests of other holders of our common stock.
Even though no selling securityholder may convert its series D preferred
shares if upon such conversion the selling securityholder together with its
affiliates would have acquired a number of shares of common stock during the
60-day period ending on the date of conversion which, when added to the
number of shares of common stock held at the beginning of such 60-day period,
would exceed 9.99% of our then outstanding common stock, excluding for
purposes of such determination shares of common stock issuable upon
conversion of series D preferred shares which have not been converted and
upon exercise of warrants which have not been exercised, this restriction
does not prevent a selling securityholder from selling a substantial number
of shares in the market. By periodically selling shares into the market, an
individual selling securityholder could eventually sell more than 9.99% of
our outstanding common stock while never holding more than 9.99% at any
specific time.
As of December 5, 2000, 7,183 series D preferred shares, with an
aggregate stated value of approximately $71.8 million, had been converted into
35,581,563 shares of our common stock, representing an average conversion price
of $2.02 per share of common stock.
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WE MAY ISSUE ADDITIONAL SHARES AND DILUTE YOUR OWNERSHIP PERCENTAGE.
Some events could result in the issuance of additional shares of our
common stock, which would dilute your ownership percentage in eToys. We may
issue additional shares of common stock or preferred stock:
- to raise additional capital or finance acquisitions,
- upon the exercise or conversion of outstanding options, warrants and
shares of convertible preferred stock, and/or
- in lieu of cash payment of dividends.
As of September 30, 2000, other than the warrants issued to the holders
of series D preferred shares, there were outstanding warrants to acquire an
aggregate of 4,000 shares of common stock, and there were outstanding options to
acquire an aggregate of 28,701,671 shares of common stock. If converted or
exercised, these securities will dilute the percentage ownership of common stock
by existing stockholders. These securities, unlike the common stock, provide for
anti-dilution protection upon the occurrence of stock splits, redemptions,
mergers, reclassifications, reorganizations and other similar corporate
transactions, and, in some cases, major corporate announcements. If one or more
of these events occurs, the number of shares of common stock that may be
acquired upon conversion or exercise would increase. In addition, as disclosed
in the preceding risk factor, the number of shares that may be issued upon
conversion of or payment of dividends in lieu of cash on the series D preferred
shares could increase substantially if the market price of our common stock
decreases during the period the series D preferred shares are outstanding.
For example, the number of shares of common stock that we would be
required to issue upon conversion of the 2,817 series D preferred shares
outstanding as of December 5, 2000, excluding shares issued as accrued
dividends, would increase from approximately 21.8 million shares, based on
the applicable conversion price of $1.2925 per share as of December 5, 2000,
to approximately:
- 29.1 million shares if the applicable conversion price decreased 25%;
- 43.6 million shares if the applicable conversion price decreased 50%;
or
- 87.2 million shares if the applicable conversion price decreased
75%.
On September 12, 2000, in accordance with Nasdaq Rule 4460, which
generally requires stockholder approval for the issuance of securities
representing 20% or more of an issuer's outstanding listed securities, and under
the terms of the agreement pursuant to which we sold the series D preferred
shares and related warrants, we obtained stockholder approval of the shares of
common stock issuable upon conversion of the series D preferred shares.
Accordingly, there is no limit on the amount of shares that could be issued upon
conversion of the series D preferred shares.
On November 15, 2000, we entered into an agreement with the selling
securityholders under which we agreed to deliver a conversion notice to them
on or before January 1, 2001, requiring the conversion of an aggregate of at
least 1,000 series D preferred shares. On November 27, 2000, we delivered a
conversion notice to the selling securityholders requiring the conversion of
an aggregate of 1,000 series D preferred shares, of which, as of December 5,
2000, 583 shares have been converted into 4,950,015 shares of common stock.
Such notice was not delivered in connection with our November 15, 2000
agreement.
SUBSTANTIAL SALES OF OUR COMMON STOCK COULD CAUSE OUR STOCK PRICE TO FALL.
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If our stockholders sell substantial amounts of our common stock,
including shares issued upon the exercise of outstanding options and upon
conversion of and issuance of common stock dividends on the series D preferred
shares and exercise of the related warrants, the market price of our common
stock could fall. Such sales also might make it more difficult for us to sell
equity or equity-related securities in the future at a time and price that we
deem appropriate. As of September 30, 2000, we had outstanding 129,192,187
shares of common stock and options to acquire an aggregate of 28,701,671 shares
of common stock, of which 6,454,599 options were vested and exercisable. As of
September 30, 2000, of the shares that are currently outstanding, 67,492,230 are
freely tradeable in the public market and 61,699,957 are tradeable in the public
market subject to the restrictions, if any, applicable under Rule 144 and Rule
145 of the Securities Act of 1933, as amended. All shares acquired upon exercise
of options will be freely tradeable in the public market.
In general, under Rule 144 as currently in effect, a person who has
beneficially owned restricted securities for at least one year would be entitled
to sell within any three-month period a number of shares that does not exceed
the greater of (a) one percent of the number of shares of common stock then
outstanding (which for eToys was 1,291,922 shares as of September 30, 2000) or
(b) the average weekly trading volume of the common stock during the four
calendar weeks preceding the sale. Sales under Rule 144 are also subject to
requirements with respect to manner of sale, notice, and the availability of
current public information about us. Under Rule 144(k), a person who is not
deemed to have been our affiliate at any time during the three months preceding
a sale, and who has beneficially owned the shares proposed to be sold for at
least two years, is entitled to sell such shares without complying with the
manner of sale, public information, volume limitation or notice provisions of
Rule 144. Sales by stockholders of a substantial amount of our common stock
could adversely affect the market price of our common stock.
WE MAY BE REQUIRED TO PAY SUBSTANTIAL PENALTIES TO THE HOLDERS OF THE SERIES D
PREFERRED SHARES AND RELATED WARRANTS IF SPECIFIC EVENTS OCCUR.
In accordance with the terms of the documents relating to the issuance
of the series D preferred shares and the related warrants, we are required to
pay substantial penalties to a holder of the series D preferred shares under
specified circumstances, including, among others,
- the nonpayment of dividends on the series D preferred shares in a
timely manner,
- our failure to deliver shares of our common stock upon conversion of
the series D preferred shares or upon exercise of the related
warrants after a proper request,
- the nonpayment of the redemption price at maturity of the series D
preferred shares, or
- a registration statement relating to the series D preferred shares
and related warrants is unavailable to cover the resale of the shares
of common stock underlying such securities.
Such penalties are generally paid in the form of interest payments,
subject to any restrictions imposed by applicable law, on the amount that a
holder of series D preferred shares was entitled to receive on the date of
determination.
RISKS RELATED TO OUR BUSINESS
OUR LIMITED OPERATING HISTORY MAKES FUTURE FORECASTING DIFFICULT.
We were incorporated in November 1996. We began selling products on our
Web site in October 1997. As a result of our limited operating history, it is
difficult to accurately forecast our net sales and we have limited meaningful
historical financial data upon which to base planned operating expenses. We base
our current and future expense levels on our operating plans and estimates of
future net sales, and our expenses are to a large extent fixed.
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Sales and operating results are difficult to forecast because they generally
depend on the volume and timing of the orders we receive. As a result, we may be
unable to adjust our spending in a timely manner to compensate for any
unexpected revenue shortfall. This inability could cause our net losses in a
given quarter to be greater than expected.
WE ANTICIPATE FUTURE LOSSES AND NEGATIVE CASH FLOW.
We expect operating losses and negative cash flow to continue for the
foreseeable future. Among other things, the sources of such losses will include
costs and expenses related to:
- brand development, marketing and other promotional activities;
- the expansion of our inventory management and distribution
operations;
- the continued development of our Web site and consumer-driven
technology, transaction processing systems and our computer network;
- the expansion of our product offerings and Web site content;
- development of relationships with strategic business partners; and
- international operations.
As of September 30, 2000, we had an accumulated deficit of $339.9
million. We incurred net losses of $53.4 million for the quarter ended September
30, 2000.
Also, as a result of our acquisition of BabyCenter, we have recorded a
significant amount of goodwill, the amortization of which will significantly
reduce our earnings and profitability for the foreseeable future. The recorded
goodwill of approximately $189.0 million is being amortized over a five-year
period. To the extent we do not generate sufficient cash flow to recover the
amount of the investment recorded, the investment may be considered impaired and
could be subject to earlier write-off. In such event, our net loss in any given
period could be greater than anticipated and the market price of our stock could
decline.
Our ability to become profitable depends on our ability to generate and
sustain substantially higher net sales while maintaining reasonable expense
levels. If we do achieve profitability, we cannot be certain that we would be
able to sustain or increase profitability on a quarterly or annual basis in the
future. For more details, see below under the heading "We Have a Significant
Amount of Debt and May Have Insufficient Cash Flow to Satisfy Our Debt Service
Obligations. In Addition, the Amount of Our Debt Could Impede Our Operations and
Flexibility".
WE HAVE A SIGNIFICANT AMOUNT OF DEBT AND MAY HAVE INSUFFICIENT CASH FLOW TO
SATISFY OUR DEBT SERVICE OBLIGATIONS. IN ADDITION, THE AMOUNT OF OUR DEBT COULD
IMPEDE OUR OPERATIONS AND FLEXIBILITY.
We have a significant amount of debt and debt service obligations. If
we are unable to generate sufficient cash flow or otherwise obtain funds
necessary to make required payments on our indebtedness, including from cash and
cash equivalents on hand, we will be in default under the terms of our
indebtedness.
Even if we are able to meet our debt service obligations, the amount of
debt we have could adversely affect us in a number of ways, including by:
- limiting our ability to obtain any necessary financing in the future
for working capital, capital expenditures, debt service requirements
or other purposes;
- limiting our flexibility in planning for, or reacting to, changes in
our business;
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- placing us at a competitive disadvantage relative to our competitors
who have lower levels of debt;
- making us more vulnerable to a downturn in our business or the
economy generally;
- requiring us to use a substantial portion of our cash flow from
operations to pay principal and interest on our debt, instead of
contributing those funds to other purposes such as working capital
and capital expenditures; and
- requiring us to maintain specific financial ratios and comply with
other restrictive covenants in our existing and future agreements
governing our debt obligations, which if we are unable to meet,
could cause a default under such agreements.
To be able to meet our debt service requirements we must successfully
implement our business strategy. We cannot assure you that we will successfully
implement our business strategy or that we will be able to generate sufficient
cash flow from operating activities to meet our debt service obligations and
working capital requirements. Our ability to meet our obligations will be
dependent upon our future performance, which will be subject to prevailing
economic conditions and to financial, business and other factors.
To implement our business strategy, we will need to seek additional
financing. If we are unable to obtain such financing on terms that are
acceptable to us, we could be forced to dispose of assets to make up for any
shortfall in the payments due on our debt under circumstances that might not be
favorable to realizing the highest price for those assets. A substantial portion
of our assets consist of intangible assets, the value of which will depend upon
a variety of factors, including without limitation, the success of our business.
As a result, we cannot assure you that our assets could be sold quickly enough,
or for amounts sufficient, to meet our obligations. For an additional risk
related to financing, see above under the heading "We May Issue Additional
Shares and Dilute Your Ownership Percentage".
ANY FAILURE BY US TO SUCCESSFULLY EXPAND OUR DISTRIBUTION OPERATIONS WOULD HAVE
A MATERIAL ADVERSE EFFECT ON US.
Any failure by us to successfully expand our distribution operations to
accommodate increases in demand and customer orders would have a material
adverse effect on our 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 we
may incur to meet customer expectations; increases in fulfillment expenses if we
are 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 our delivery services; and damage to
our reputation and brand image arising from uncertainty with respect to our
distribution operations. These risks are greatest during the fourth calendar
quarter of each year, when our sales increase substantially relative to other
quarters and the demand on our distribution operations increases
proportionately.
In addition, consistent with industry practice for online retailers,
we notify our customers via our Web site that we cannot guarantee all
products ordered after a specified date in December will be delivered by
Christmas day, which may deter potential customers from purchasing from us
following that date. Since our limited operating history makes it difficult
to accurately estimate the number of orders that may be received during the
fourth calendar quarter, we may experience either inadequate or excess
fulfillment capacity during this quarter, either of which could have a
material adverse impact on us. The occurrence of one or more of these events
would be likely to cause the market price of our common stock to decline.
We currently conduct our distribution operations through six facilities
operated by us, consisting of an approximately 763,000 square foot facility in
Ontario, California; an approximately 105,000 square foot facility in Commerce,
California; two adjacent facilities totaling approximately 1.2 million square
feet in Pittsylvania County,
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Virginia; an approximately 272,000 square foot facility in Greensboro, North
Carolina; and an approximately 108,000 square foot facility in Belgium. We have
in the past and continue to devote substantial resources to the expansion of our
distribution operations among these facilities. This expansion may cause
disruptions in our business as well as unexpected costs. We are not experienced
with coordinating and managing distribution operations in geographically distant
locations. This may result in increased costs as we seek to meet customers'
expectations, balance merchandise inventories among our distribution facilities
and take other steps that may be necessary to meet the demands placed on our
distribution operations, particularly during the fourth calendar quarter of the
year. Despite the fact that we devote substantial resources to the expansion and
refinement of our distribution operations, there can be no assurance that our
existing or future distribution operations will be sufficient to accommodate
increases in demand and customer orders.
IF WE EXPERIENCE PROBLEMS IN OUR DISTRIBUTION OPERATIONS, WE COULD LOSE
CUSTOMERS.
We rely upon third-party carriers for product shipments, including
shipments to and from our distribution facilities. We are therefore subject to
the risks, including employee strikes and inclement weather, associated with
such carriers' ability to provide delivery services to meet our shipping needs.
In addition, failure to deliver products to our customers in a timely and
accurate manner would damage our reputation and brand. We also depend upon
temporary employees to adequately staff our distribution facilities,
particularly during the holiday shopping season. If we do not have sufficient
sources of temporary employees, we could lose customers.
OUR OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT. IF WE FAIL TO MEET
THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS, THE MARKET PRICE OF
OUR COMMON STOCK MAY DECLINE SIGNIFICANTLY.
Our annual and quarterly operating results have fluctuated in the past
and may fluctuate significantly in the future due to a variety of factors, many
of which are outside of our control. Because our operating results are volatile
and difficult to predict, we believe that quarter-to-quarter comparisons of our
operating results are not a good indication of our future performance. It is
likely that in some future quarter our operating results may fall below the
expectations of securities analysts and investors. In this event, the trading
price of our common stock may decline significantly.
Factors that may harm our business or cause our operating results to
fluctuate include the following:
- our inability to obtain new customers at reasonable cost, retain
existing customers, or encourage repeat purchases;
- decreases in the number of visitors to our Web site or our inability
to convert visitors to our Web site into customers;
- the mix of children's products, including toys, video games, books,
software, videos, music, hobby products, party goods and
baby-oriented products sold by us;
- seasonality;
- our inability to manage inventory levels or control inventory
shrinkage;
- our inability to manage our distribution operations;
- our inability to adequately maintain, upgrade and develop our Web
site, the systems that we use to process customers' orders and
payments or our computer network;
- the ability of our competitors to offer new or enhanced Web sites,
services or products;
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- price competition;
- an increase in the level of our product returns;
- fluctuations in the demand for children's and baby products
associated with movies, television and other entertainment events;
- our inability to obtain popular children's products, including toys,
video games, books, software, videos, music, hobby products, party
goods and baby-oriented products from our vendors;
- fluctuations in the amount of consumer spending on children's
products, including toys, video games, books, software, videos,
music, hobby products, party goods and baby-oriented products;
- the termination of existing or failure to develop new marketing
relationships with key business partners;
- the extent to which we are not able to participate in cooperative
advertising campaigns with major brand names as we have done in the
past;
- increases in the cost of online or offline advertising;
- the amount and timing of operating costs and capital expenditures
relating to expansion of our operations;
- unexpected increases in shipping costs or delivery times,
particularly during the holiday season;
- technical difficulties, system downtime or Internet brownouts;
- government regulations related to use of the Internet for commerce or
for sales and distribution of children's products, including toys,
video games, books, software, videos, music, hobby products, party
goods and baby-oriented products; and
- economic conditions specific to the Internet, online commerce and the
children's and baby products industries.
A number of factors will cause our gross margins to fluctuate in future
periods, including the mix of children's products, including toys, video games,
books, software, videos, music, hobby products, party goods and baby-oriented
products sold by us, inventory management, inbound and outbound shipping and
handling costs, the level of product returns and the level of discount pricing
and promotional coupon usage. Any change in one or more of these factors could
reduce our gross margins in future periods.
BECAUSE WE EXPERIENCE SEASONAL FLUCTUATIONS IN OUR NET SALES, OUR QUARTERLY
RESULTS WILL FLUCTUATE AND OUR ANNUAL RESULTS COULD BE BELOW EXPECTATIONS.
We have historically experienced and expect to continue to experience
seasonal fluctuations in our net sales. These seasonal patterns will cause
quarterly fluctuations in our operating results. In particular, a
disproportionate amount of our net sales have been realized during the fourth
calendar quarter and we expect this trend to continue in the future.
In anticipation of increased sales activity during the fourth calendar
quarter, we hire a significant number of temporary employees to bolster our
permanent staff and we significantly increase our inventory levels. For this
reason, if our net sales were below seasonal expectations during this quarter,
our annual operating results could be below the expectations of securities
analysts and investors.
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Due to our limited operating history, it is difficult to predict the
seasonal pattern of our sales and the impact of such seasonality on our business
and financial results. In the future, our seasonal sales patterns may become
more pronounced, may strain our personnel and warehousing and order shipment
activities and may cause a shortfall in net sales as compared to expenses in a
given period.
WE FACE SIGNIFICANT INVENTORY RISK BECAUSE CONSUMER DEMAND CAN CHANGE FOR
PRODUCTS BETWEEN THE TIME THAT WE ORDER PRODUCTS AND THE TIME THAT WE RECEIVE
THEM.
We carry a significant level of inventory. As a result, the rapidly
changing trends in consumer tastes in the market for children's products,
including toys, video games, books, software, videos, music, hobby products,
party goods and baby-oriented products, subject us to significant inventory
risks. It is critical to our success that we accurately predict these trends and
do not overstock unpopular products. The demand for specific products can change
between the time the products are ordered and the date of receipt. We are
particularly exposed to this risk because we derive a majority of our net sales
in the fourth calendar quarter of each year. Our failure to sufficiently stock
popular toys and other products in advance of such fourth calendar quarter would
harm our operating results for the entire fiscal year.
In the event that one or more products do not achieve widespread
consumer acceptance, we may be required to take significant inventory markdowns,
which could reduce our net sales and gross margins. This risk may be greatest in
the first calendar quarter of each year, after we have significantly increased
inventory levels for the holiday season. We believe that this risk will increase
as we open new departments or enter new product categories due to our lack of
experience in purchasing products for these categories. In addition, to the
extent that demand for our products increases over time, we may be forced to
increase inventory levels. Any such increase would subject us to additional
inventory risks.
BECAUSE WE DO NOT HAVE LONG-TERM OR EXCLUSIVE VENDOR CONTRACTS, WE MAY NOT BE
ABLE TO GET SUFFICIENT QUANTITIES OF POPULAR CHILDREN'S PRODUCTS IN A TIMELY
MANNER. AS A RESULT, WE COULD LOSE CUSTOMERS.
If we are not able to offer our customers sufficient quantities of toys
or other products in a timely manner, we could lose customers and our net sales
could be below expectations. Our success depends on our ability to purchase
products in sufficient quantities at competitive prices, particularly for the
holiday shopping season. As is common in the industry, we do not have long-term
or exclusive arrangements with any vendor or distributor that guarantee the
availability of toys or other children's products for resale. Therefore, we do
not have a predictable or guaranteed supply of toys or other products.
TO MANAGE OUR GROWTH AND EXPANSION, WE NEED TO IMPROVE AND IMPLEMENT FINANCIAL
AND MANAGERIAL CONTROLS AND REPORTING SYSTEMS AND PROCEDURES. IF WE ARE UNABLE
TO DO SO SUCCESSFULLY, OUR RESULTS OF OPERATIONS WILL BE IMPAIRED.
Our rapid growth in personnel and operations has placed, and will
continue to place, a significant strain on our management, information systems
and resources. In addition, with the acquisition of BabyCenter, we added over
160 new employees, including managerial, technical and operations personnel, and
have been required to assimilate substantially all of BabyCenter's operations
into our operations. Further, during 1999 and 2000, we continued to expand our
distribution operations, which now include six facilities operated by us,
consisting of an approximately 763,000 square foot facility in Ontario,
California; an approximately 105,000 square foot facility in Commerce,
California; two adjacent facilities totaling approximately 1.2 million square
feet in Pittsylvania County, Virginia; an approximately 272,000 square foot
facility in Greensboro, North Carolina; and an approximately 108,000 square foot
facility in Belgium. We have in the past and continue to devote substantial
resources to the expansion of our distribution operations among these
facilities. This expansion may cause disruptions in our business as well as
unexpected costs. We are not experienced with coordinating and managing
distribution operations in geographically distant locations. In order to manage
this growth effectively, we need to continue to improve our financial and
managerial controls and reporting systems and procedures. If we continue to
experience a significant increase in the
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number of our personnel and expansion of our distribution operations, our
existing management team may not be able to effectively train, supervise and
manage all of our personnel or effectively oversee all of our distribution
operations. In addition, our existing information systems may not be able to
handle adequately the increased volume of information and transactions that
would result from increased growth. Our failure to successfully implement,
improve and integrate these systems and procedures would cause our results of
operations to be below expectations.
RISK OF INTERNATIONAL EXPANSION
In October 1999, we launched eToys.co.uk, which serves customers in the
United Kingdom, and in November 1999, we began serving all provinces of Canada
through our eToys.com store. We also offer content and community to parents and
expectant parents through BabyCentre.co.uk. Our European operations are
conducted through a Netherlands subsidiary. We will only continue to expand our
presence in foreign markets in a manner consistent with the availability and
extent of financing opportunities for such operations. There can be no assurance
that such financing opportunities will be available on terms acceptable to us or
at all.
We have 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 our brand internationally, and develop
localized Web sites and stores and other systems. We may not succeed in our
efforts in these countries. If net sales from international activities do not
offset the expense of establishing and maintaining foreign operations, our
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 our ability to conduct business internationally.
WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE
COMPETITORS.
The online commerce market is new, rapidly evolving and intensely
competitive. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share, any of which could seriously
harm our net sales and results of operations. We expect competition to intensify
in the future. In addition, the children's products industries, including toy,
video game, books, software, video, music, hobby products, party goods and
baby-oriented products, are intensely competitive.
We currently or potentially compete with a variety of other companies,
including:
- other online companies that include toys and children's and baby
products as part of their product offerings, such as Amazon.com
(which has partnered with Toysrus.com), Barnesandnoble.com, CDnow,
Beyond.com, iBaby, BabyCatalog.com, iVillage and Women.com;
- traditional store-based toy and children's and baby products
retailers such as Toys R Us, FAO Schwarz, Zany Brainy, Noodle
Kidoodle, babyGap, GapKids, Gymboree, KB Toys, The Right Start and
Babies R Us;
- major discount retailers such as Wal-Mart, Kmart and Target;
- online efforts of these traditional retailers, including the online
stores operated by Toys R Us (at Amazon.com), Wal-Mart, Kmart,
Target, FAO Schwarz, babyGap, GapKids, KB Toys (i.e., KB Kids) 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.;
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- catalog retailers of children's and baby products as well as products
for toddlers and expectant mothers;
- vendors or manufacturers of children's and baby products that
currently sell some of their products directly online, such as Mattel
and Hasbro;
- Internet portals and online service providers that feature shopping
services, such as AOL, Yahoo!, Excite and Lycos; and
- various smaller online retailers of children's and baby products,
such as Smarterkids.com.
Many traditional store-based and online competitors have longer
operating histories, larger customer or user bases, greater brand recognition
and significantly greater financial, marketing and other resources than we do.
Many of these competitors can devote substantially more resources to Web site
development than we can. In addition, larger, well-established and well-financed
entities may join with online competitors or suppliers of children's products,
including toys, video games, books, software, video, music, hobby products,
party goods and baby-oriented products as the use of the Internet and other
online services increases.
Our competitors may be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we can. Traditional
store-based retailers also enable customers to see and feel products in a manner
that is not possible over the Internet.
IF WE ENTER NEW BUSINESS CATEGORIES THAT DO NOT ACHIEVE MARKET ACCEPTANCE, OUR
BRAND AND REPUTATION COULD BE DAMAGED AND WE COULD FAIL TO ATTRACT NEW
CUSTOMERS.
Any new department or product category that is launched or acquired by
us, which is not favorably received by consumers could damage our brand or
reputation. This damage could impair our ability to attract new customers, which
could cause our net sales to fall below expectations. The expansion of our
business to include any new department or product category will require
significant additional expenses, and strain our management, financial and
operational resources. This type of expansion would also subject us to increased
inventory risk. We may choose to expand our operations by developing other new
departments or product categories, promoting new or complementary products,
expanding the breadth and depth of products and services offered or expanding
our market presence through relationships with third parties. In addition, we
may pursue the acquisition of other new or complementary businesses, products or
technologies.
IF WE DO NOT SUCCESSFULLY EXPAND OUR WEB SITE AND THE SYSTEMS THAT PROCESS
CUSTOMERS' ORDERS, WE COULD LOSE CUSTOMERS AND OUR NET SALES COULD BE REDUCED.
If we fail to rapidly upgrade our Web site in order to accommodate
increased traffic, we may lose customers, which would reduce our net sales.
Furthermore, if we fail to rapidly expand the computer systems that we use to
process and ship customer orders and process payments, we may not be able to
successfully distribute customer orders. As a result, we could lose customers
and our net sales could be reduced. In addition, our failure to rapidly upgrade
our Web site or expand these computer systems without system downtime,
particularly during the fourth calendar quarter, would further reduce our net
sales. We may experience difficulty in improving and maintaining such systems if
our employees or contractors that develop or maintain our computer systems
become unavailable to us. We have experienced periodic systems interruptions,
which we believe will continue to occur, while enhancing and expanding these
computer systems.
OUR FACILITIES AND SYSTEMS ARE VULNERABLE TO NATURAL DISASTERS AND OTHER
UNEXPECTED PROBLEMS. THE OCCURRENCE OF A NATURAL DISASTER OR OTHER UNEXPECTED
PROBLEM COULD DAMAGE OUR REPUTATION AND BRAND AND REDUCE OUR NET SALES.
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We are vulnerable to natural disasters and other unanticipated problems
that are beyond our control. Our office facilities in California and London,
England, house substantially all of our product development and information
systems. Our third-party Web site hosting facilities located in Sunnyvale,
California and Herndon, Virginia, house substantially all of our computer and
communications hardware systems. Our distribution facilities located in
California, Virginia and Belgium house substantially all of our product
inventory. A natural disaster, such as an earthquake, or harsh weather or other
comparable problems that are beyond our control could cause interruptions or
delays in our business and loss of data or render us unable to accept and
fulfill customer orders. Any such interruptions or delays at these facilities
would reduce our net sales. In addition, our systems and operations are
vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, break-ins, earthquakes and similar events. We have
no formal disaster recovery plan and our business interruption insurance may not
adequately compensate us for losses that may occur. In addition, the failure by
the third-party facilities to provide the data communications capacity required
by us, as a result of human error, natural disaster or other operational
disruptions, could result in interruptions in our service. The occurrence of any
or all of these events could damage our reputation and brand and impair our
business.
OUR NET SALES COULD DECREASE IF OUR ONLINE SECURITY MEASURES FAIL.
Our relationships with our customers may be adversely affected if the
security measures that we use to protect their personal information, such as
credit card numbers, are ineffective. If, as a result, we lose many customers,
our net sales could decrease. We rely on security and authentication technology
that we license from third parties. With this technology, we perform real-time
credit card authorization and verification with our bank. We cannot predict
whether events or developments will result in a compromise or breach of the
technology we use to protect a customer's personal information.
Furthermore, our servers may be vulnerable to computer viruses,
physical or electronic break-ins, denial of service attacks and similar
disruptions. We may need to expend significant additional capital and other
resources to protect against a security breach or to alleviate problems caused
by any breaches. We cannot assure that we can prevent all security breaches.
OUR NET SALES AND GROSS MARGINS WOULD DECREASE IF WE EXPERIENCE SIGNIFICANT
CREDIT CARD FRAUD.
A failure to adequately control fraudulent credit card transactions
would reduce our net sales and our gross margins because we do not carry
insurance against this risk. We have developed technology to help us to detect
the fraudulent use of credit card information. Nonetheless, to date, we have
suffered losses as a result of orders placed with fraudulent credit card data
even though the associated financial institution approved payment of the orders.
Under current credit card practices, we are liable for fraudulent credit card
transactions because we do not obtain a cardholder's signature.
WE FACE THE RISK OF INVENTORY SHRINKAGE.
If the security measures we use at our distribution facilities do not
reduce or prevent inventory shrinkage, our gross profit margin may decrease. We
have undertaken a number of measures designed to address inventory shrinkage,
including the installation of enhanced security measures at our distribution
facilities. These measures may not successfully reduce or prevent inventory
shrinkage in future periods. Our failure to successfully improve the security
measures we use at our distribution facilities may cause our gross profit
margins and results of operations to be significantly below expectations in
future periods.
IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR SERVICES COULD BECOME
OBSOLETE AND WE COULD LOSE CUSTOMERS.
If we face material delays in introducing new services, products and
enhancements, our customers may forego the use of our services and use those of
our competitors. To remain competitive, we must continue to
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enhance and improve the functionality and features of our online store. The
Internet and the online commerce industry are rapidly changing. If competitors
introduce new products and services embodying new technologies, or if new
industry standards and practices emerge, our existing Web site and proprietary
technology and systems may become obsolete.
To develop our Web site and other proprietary technology entails
significant technical and business risks. We may use new technologies
ineffectively or we may fail to adapt our Web site, our transaction processing
systems and our computer network to meet customer requirements or emerging
industry standards.
INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND COULD IMPAIR OUR
BUSINESS.
Other parties may assert infringement or unfair competition claims
against us. In the past, a toy distributor using a name similar to ours sent us
notice of a claim of infringement of proprietary rights, which claim was
subsequently withdrawn. We have also received a claim from the holders of a home
shopping video catalog patent and a remote query communication system patent
that our Internet marketing program and Web site operations, respectively,
infringe such patents, and BabyCenter has received a claim from the holder of an
automated registry patent that its Web site infringes such patent. We expect to
receive other notices from other third parties in the future. We cannot predict
whether third parties will assert claims of infringement against us, or whether
any past or future assertions or prosecutions will harm our business. If we are
forced to defend against any such claims, whether they are with or without merit
or are determined in our favor, then we may face costly litigation, diversion of
technical and management personnel, or product shipment delays. As a result of
such a dispute, we may have to develop non-infringing technology or enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may be unavailable on terms acceptable to us, or at all. If there is a
successful claim of product infringement against us and we are unable to develop
non-infringing technology or license the infringed or similar technology on a
timely basis, it could impair our business.
IF THE PROTECTION OF OUR TRADEMARKS AND PROPRIETARY RIGHTS IS INADEQUATE, OUR
BRAND AND REPUTATION COULD BE IMPAIRED AND WE COULD LOSE CUSTOMERS.
The steps we take to protect our proprietary rights may be inadequate.
We regard our copyrights, service marks, trademarks, trade dress, trade secrets
and similar intellectual property as critical to our success. We rely on
trademark and copyright law, trade secret protection and confidentiality or
license agreements with our employees, customers, partners and others to protect
our proprietary rights. We currently hold registered trademarks for "eToys" and
"BabyCenter". Effective trademark, service mark, copyright and trade secret
protection may not be available in every country in which we will sell our
products and services online. Furthermore, the relationship between regulations
governing domain names and laws protecting trademarks and similar proprietary
rights is unclear. Therefore, we may be unable to prevent third parties from
acquiring domain names that are similar to, infringe upon or otherwise decrease
the value of our trademarks and other proprietary rights.
THE LOSS OF THE SERVICES OF ONE OR MORE OF OUR KEY PERSONNEL, OR OUR FAILURE TO
ATTRACT, ASSIMILATE AND RETAIN OTHER HIGHLY QUALIFIED PERSONNEL IN THE FUTURE,
COULD DISRUPT OUR OPERATIONS AND RESULT IN A REDUCTION IN NET SALES.
The loss of the services of one or more of our key personnel could
seriously interrupt our business. We depend on the continued services and
performance of our senior management and other key personnel, particularly
Edward C. Lenk, our President, Chief Executive Officer and Chairman of the
Board. Our future success also depends upon the continued service of our
executive officers and other key sales, marketing and support personnel. Our
relationships with these officers and key employees are generally at will. We do
not have "key person" life insurance policies covering any of our employees.
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THERE ARE RISKS ASSOCIATED WITH THE BABYCENTER MERGER AND OTHER POTENTIAL
ACQUISITIONS. AS A RESULT, WE MAY NOT ACHIEVE THE EXPECTED BENEFITS OF THE
BABYCENTER MERGER AND OTHER POTENTIAL ACQUISITIONS.
We may not realize the anticipated benefits from the BabyCenter merger.
During 2000, we united our baby businesses, which previously
consisted of BabyCenter and the Baby Store at eToys, under the BabyCenter
brand. As part of this initiative, we have directed all eToys customers
seeking baby-related content and commerce to the BabyCenter.com site. In
addition, we have moved all BabyCenter commerce functions, such as
distribution and customer service, from San Francisco to Southern California.
We may not be able to successfully assimilate BabyCenter's additional
personnel, operations, acquired technology and products into our business. The
merger may further strain our existing financial and managerial controls and
reporting systems and procedures. In addition, key BabyCenter personnel may
decide not to work for us. These difficulties could disrupt our ongoing
business, distract management and employees or increase our expenses. Further,
the physical expansion in facilities that has occurred as a result of this
merger may result in disruptions that seriously impair our business. In
particular, we have operations in multiple facilities in geographically distant
areas. We are not experienced in managing facilities or operations in
geographically distant areas.
If we are presented with appropriate opportunities, we intend to make
other investments in complementary companies, products or technologies. We may
not realize the anticipated benefits of any other acquisition or investment. If
we buy another company, we will likely face the same risks, uncertainties and
disruptions as discussed above with respect to the BabyCenter merger.
Furthermore, we may have to incur debt or issue equity securities to pay for any
additional future acquisitions or investments, the issuance of which would be
dilutive to us or our existing securityholders and could affect the price of our
securities.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US EVEN IF DOING SO WOULD BE
BENEFICIAL TO OUR SECURITYHOLDERS.
Provisions of our amended and restated certificate of incorporation,
our amended and restated bylaws and Delaware law could make it more difficult
for a third party to acquire us, even if doing so would be beneficial to our
securityholders.
We are subject to Section 203 of the Delaware General Corporation Law,
which regulates corporate acquisitions. In general, Section 203 prohibits a
publicly held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years following the date
the person became an interested stockholder, unless:
- the board of directors approved the transaction in which such
stockholder became an interested stockholder prior to the date the
interested stockholder attained such status;
- upon consummation of the transaction that resulted in the
stockholder's becoming an interested stockholder, he or she owned at
least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced, excluding shares owned by persons who
are directors and also officers; or
- on or subsequent to such date the business combination is approved by
the board of directors and authorized at an annual or special meeting
of stockholders.
A "business combination" generally includes a merger, asset or stock
sale, or other transaction resulting in a financial benefit to the interested
stockholder. In general, an "interested stockholder" is a person who,
together with affiliates and associates, owns, or within three years prior to
the determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock.
Our amended and restated certificate of incorporation and amended and
restated 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
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directors. In addition, our amended and restated certificate of incorporation
permits the board of directors to issue preferred stock with voting or other
rights without any stockholder action. Also in accordance with our amended and
restated certificate of incorporation, our board of directors has been 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. These
provisions of our amended and restated certificate of incorporation, which
require the vote of stockholders holding at least a majority of the outstanding
common stock to amend, may have the effect of deterring hostile takeovers or
delaying changes in our management.
RISKS RELATED TO OUR INDUSTRY
IF WE ARE UNABLE TO ACQUIRE THE NECESSARY WEB DOMAIN NAMES, OUR BRAND AND
REPUTATION COULD BE DAMAGED AND WE COULD LOSE CUSTOMERS.
We may be unable to acquire or maintain Web domain names relating to
our brand in the United States and other countries in which we may conduct
business. As a result, we may be unable to prevent third parties from acquiring
and using domain names relating to our brand. Such use could damage our brand
and reputation and take customers away from our Web site. We currently hold
various relevant domain names, including the "eToys.com" and "BabyCenter.com"
domain names. The acquisition and maintenance of domain names generally is
regulated by governmental agencies and their designees. The regulation of domain
names in the United States and in foreign countries is subject to change in the
near future. Such changes in the United States are expected to include the
creation of additional top-level domains. Governing bodies may establish
additional top-level domains, appoint additional domain name registrars or
modify the requirements for holding domain names.
WE MAY NEED TO CHANGE THE MANNER IN WHICH WE CONDUCT OUR BUSINESS IF GOVERNMENT
REGULATION INCREASES.
The adoption or modification of laws or regulations relating to the
Internet could adversely affect the manner in which we currently conduct our
business. In addition, the growth and development of the market for online
commerce may lead to more stringent consumer protection laws, both in the United
States and abroad, that may impose additional burdens on us. Laws and
regulations directly applicable to communications or commerce over the Internet
are becoming more prevalent. The United States Congress has enacted Internet
laws regarding children's privacy, copyrights, taxation and the transmission of
sexually explicit material, and the Federal Trade Commission's Children's Online
Privacy Protection Act became effective April 21, 2000. The European Union has
enacted its own privacy regulations. In addition, we are subject to existing
federal, state and local regulations pertaining to consumer protection, such as
the Federal Trade Commission's Mail and Telephone Order Rule. 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. Any failure by us to comply with the rules and
regulations applicable to our business could result in action being taken
against us that could have a material adverse effect on our business and results
of operations.
In order to comply with new or existing laws regulating online
commerce, we may need to modify the manner in which we do business, which may
result in additional expenses. For instance, we may need to spend time and money
revising the process by which we fulfill customers' orders to ensure that each
shipment complies with applicable laws. We may need to hire additional personnel
to monitor our compliance with applicable laws. We may also need to modify our
software to further protect our customers' personal information.
WE MAY BE SUBJECT TO LIABILITY FOR THE INTERNET CONTENT THAT WE PUBLISH.
As a publisher of online content, we face potential liability for
defamation, negligence, copyright, patent or trademark infringement, or other
claims based on the nature and content of materials that we publish or
distribute. In particular, our BabyCenter Web site offers a variety of content
for new and expectant parents, including content
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relating to pregnancy, fertility and infertility, nutrition, child rearing and
related subjects, and our ParentCenter Web site offers a variety of content for
children ages 2 and over, including content related to child rearing and related
subjects. If we face liability, then our reputation and our business may suffer.
In the past, plaintiffs have brought these types of claims and sometimes
successfully litigated them against online services. Although we carry general
liability insurance to cover claims of these types, there can be no assurance
that such insurance will be adequate to indemnify us for all liability that may
be imposed on us.
OUR NET SALES COULD DECREASE IF WE BECOME SUBJECT TO SALES AND OTHER TAXES.
If one or more states or any foreign country successfully asserts that
we should collect sales or other taxes on the sale of our products, our net
sales and results of operations could be harmed. We do not currently collect
sales or other similar taxes for physical shipments of goods into states other
than California. However, one or more local, state or foreign jurisdictions may
seek to impose sales tax collection obligations on us. In addition, any new
operation in states outside California could subject our shipments in such
states to state sales taxes under current or future laws. If we become obligated
to collect sales taxes, we will need to update our system that processes
customers' orders to calculate the appropriate sales tax for each customer order
and to remit the collected sales taxes to the appropriate authorities. These
upgrades will increase our operating expenses. In addition, our customers may be
discouraged from purchasing products from us because they have to pay sales tax,
causing our net sales to decrease. As a result, we may need to lower prices to
retain these customers.
RISKS RELATED TO SECURITIES MARKETS
WE MAY BE UNABLE TO MEET OUR FUTURE CAPITAL REQUIREMENTS.
We cannot be certain that additional financing will be available to us
on favorable terms when required, or at all. If we raise additional funds
through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of the
rights of our common stock and our stockholders will experience additional
dilution. We require substantial working capital to fund our business. Since our
inception, we have experienced negative cash flow from operations and expect to
experience significant negative cash flow from operations for the foreseeable
future. Significant volatility in the stock markets, particularly with respect
to Internet stocks, has increased the difficulty of raising additional capital.
Although we believe that current cash and cash equivalents and cash that may be
generated from operations will be sufficient to meet our anticipated cash needs
through June 30, 2001, there can be no assurance to that effect.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR INDIVIDUAL SECURITYHOLDERS.
The market price for our common stock has been and is likely to
continue to be highly volatile and subject to wide fluctuations in response to
factors including the following, some of which are beyond our control:
- actual or anticipated variations in our quarterly operating results;
- announcements of technological innovations, increased cost of
operations or new products or services by us or our competitors;
- changes in financial estimates by securities analysts;
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- 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;
- volatility in the stock markets, particularly with respect to
Internet stocks, and decreases in the availability of capital for
Internet-related businesses;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
- additions or departures of key personnel;
- transfer restrictions on our outstanding shares of common stock or
sales of additional shares of common stock; and
- potential litigation.
From May 20, 1999 (the first day of public trading of our common
stock), through December 6, 2000, the high and low sales prices for our common
stock fluctuated between $84.50 and $1.22. On December 6, 2000, the closing
price of our common stock was $1.34. In the past, following periods of
volatility in the market price of their securities, many companies have been the
subject of securities class action litigation. If we were sued in a securities
class action, it could result in substantial costs and a diversion of
management's attention and resources and would cause the prices of our
securities to fall.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
eToys Inc.
(Registrant)
By: /s/ Peter Juzwiak
---------------------------------------
Name: Peter Juzwiak
Title: Vice President and General Counsel
Date: December 6, 2000
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