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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____.
Commission File Number: 000-25119
uBID, INC.
(Exact name of registrant as specified in its charter)
Delaware 33-0775328
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
2525 Busse Road
Elk Grove Village, Illinois
(847) 860-5000 60007
(Address of principal executive offices (Zip Code)
and telephone number)
Securities registered under Section 12(b) of the Act:
Title of each class: Name of Exchange on which registered:
-------------------- -------------------------------------
None N/A
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
As of May 12, 1999, there were 9,146,833 shares of Common Stock ($.001 par
value) outstanding.
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uBID, INC.
FORM 10-Q
INDEX
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<CAPTION>
Page No.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of December 31, 1998 and March 31, 1999 (Unaudited)..... 3
Statements of Operations for the Three Months Ended March 31, 1998 and
1999 (Unaudited).......................................................... 4
Statements of Cash Flows for the Three Months Ended March 31, 1998 and
1999 (Unaudited).......................................................... 5
Notes to Financial Statements (Unaudited)................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................ 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk................ 29
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................... 29
SIGNATURES.............................................................................. 30
EXHIBIT INDEX........................................................................... 31
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
uBid, Inc.
BALANCE SHEETS
(in thousands, except share data)
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<CAPTION>
December 31, March 31,
----------- --------------
1998 1999
----------- --------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash................................................................. $ 26,053 $ 25,909
Accounts receivable, net of allowances of $20 and $41, respectively.. 623 482
Merchandise inventories.............................................. 7,235 7,981
Prepaid expenses and other........................................... 195 164
-------- --------
Total current assets.............................................. 34,106 34,536
Fixed assets, net.................................................... 519 1,165
-------- --------
Total assets...................................................... $ 34,625 $ 35,701
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................... $ 9,013 $ 12,275
Accrued expenses and other current liabilities....................... 2,371 3,019
Due to Parent........................................................ 1,277 910
-------- --------
Total current liabilities......................................... 12,661 16,204
Note payable to the Parent........................................... 3,331 3,331
Stockholders' equity (deficit):
Preferred Stock; $.001 par value; 5,000,000 shares
authorized; no shares issued or outstanding......................... -- --
Common Stock; $.001 par value; 20,000,000 shares authorized;
9,146,833 shares issued and outstanding as of December 31, 1998
and March 31, 1999, respectively..................................... 2 2
Additional paid-in-capital........................................... 37,138 37,138
Deferred compensation................................................ (8,025) (7,140)
Accumulated deficit.................................................. (10,482) (13,834)
-------- --------
Total stockholders' equity (deficit).............................. 18,633 16,166
-------- --------
Total liabilities and stockholders' equity (deficit).............. $ 34,625 $ 35,701
======== ========
</TABLE>
3
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uBid, Inc.
STATEMENTS OF OPERATIONS
(unaudited, in thousands, except share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------
1998 1999
---------- ----------
<S> <C> <C>
Net revenues.................................................... $ 2,075 $ 34,314
Cost of revenues................................................ 1,891 31,337
---------- ----------
Gross profit.................................................... 184 2,977
Operating expenses:
Sales and marketing.......................................... 144 2,660
Technology and development................................... 142 644
General and administrative................................... 762 2,341
Stock based compensation..................................... -- 885
---------- ----------
Total operating expenses................................. 1,048 6,530
Loss from operations............................................ (864) (3,553)
Interest income................................................. -- (271)
Interest expense to Parent...................................... 31 70
---------- ----------
Net interest expense (income)..................... 31 (201)
---------- ----------
Loss before income taxes........................................ (895) (3,352)
Provision for income taxes...................................... -- --
---------- ----------
Net loss........................................................ $ (895) $ (3,352)
========== ==========
Basic and diluted net loss per share............................ $(.12) $(.37)
========== ==========
Shares used to compute basic and diluted net loss per share..... 7,329,883 9,146,883
</TABLE>
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uBid, Inc.
STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1998 1999
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss..................................................................... $ (895) $(3,352)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................ 30 69
Non cash compensation expense................................................ -- 885
Changes in operating liabilities:
Accounts receivable, net................................................... (142) 141
Prepaid expenses........................................................... (5) 31
Merchandise inventories, net............................................... (1,613) (746)
Accounts payable........................................................... 971 3,262
Advances from Parent, Short term........................................... 93 (367)
Accrued expenses and other current liabilities............................. 59 648
------- -------
Net cash (used in) provided by operating activities............................. (1,502) 571
Cash flows from investing activities:
Purchases of property and equipment........................................... (34) (715)
------- -------
Net cash used in investing activities........................................... (34) (715)
Cash flows from financing activities:
Advances from the Parent...................................................... 1,536 --
Net cash provided by financing activities....................................... 1,536 --
------- -------
Net change in cash and cash equivalents......................................... -- (144)
Cash and cash equivalents at beginning of period................................ -- 26,053
------- -------
Cash and cash equivalents at end of period...................................... $ -- $25,909
======= =======
</TABLE>
5
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uBid, Inc.
NOTES TO FINANCIAL STATEMENTS
(in thousands, except share data)
1. Description of Company and Summary of Significant Accounting Policies
Description of Company
uBid is engaged in the retail sale of excess merchandise, including close-
out and refurbished products, utilizing an interactive online auction. The
Company currently specializes in selling primarily brand name computers,
consumer electronics, housewares, and sports and recreation products over the
World Wide Web to consumers and small and medium-sized businesses.
Revenue Recognition
The Company sells merchandise from vendors under one of two types of sales
transactions. The Company either purchases merchandise and sells it to
customers or sells merchandise to customers under consignment-type revenue
sharing agreements with vendors. The Company recognizes revenue for advertising
placed on its site during the period in which the advertisement is displayed,
provided that no significant Company obligations remain at the end of the period
and collection of the resulting receivable is probable.
Accounting for Stock-Based Compensation
The Company accounts for stock options as prescribed by APB Opinion No. 25
and includes pro forma information in the Stock options footnote, as permitted
by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation.
Stock Splits
On June 25, 1998, the Company effected a 100,000-for-1 split of its Common
Stock. On November 30, 1998, the Company effected a .7329883-for-1 reverse
split of its common stock. All common shares and per share data have been
retroactively adjusted to reflect these stock splits.
Net Loss per Share
Basic net loss per share excludes dilution and is computed by dividing net
loss by the weighted average number of common shares outstanding during the
reported periods. Diluted net loss per share reflects the potential dilution
that could occur if stock options and other commitments to issue common stock
were exercised. During the periods ended March 31, 1998 and March 31, 1999,
options to purchase 711,365 and 1,423,603 common shares were anti-dilutive and
have been excluded from the weighted average share computation.
Basis of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles and, in opinion of
management, reflect all adjustments, which include only normal recurring
adjustments, necessary to present fairly the Company's financial position,
results of operations and cash flows as of March 31, 1999 and for the three
months ended March 31, 1998 and 1999. These financial statements should be read
in conjunction with the Company's audited financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1998. The results of operations for the three month period ended March 31,
1999 are not necessarily indicative of the results to be expected for any
subsequent quarter or for the year ending December 31, 1999.
2. Segment Information
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131 "Disclosure about Segments of an Enterprise and Related Information"
(SFAS No. 131). This statement requires companies to report financial and
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descriptive information about its reportable operating segments, including
segment profit or loss, certain specific revenue and expense items, and segment
assets, as well as information about the revenues derived from the Company's
products or services, the countries in which the company earns revenues and
holds assets, and major customers. This statement also requires companies that
have a single reportable segment to disclose information about products and
services, information about geographic areas, and information about major
customers. The statement requires the use of the management approach to
determine the information to be reported. The management approach is based on
the way management organizes the enterprise to assess performance and make
operating decisions regarding the allocation of resources. It is management's
opinion that the Company has only one reportable segment. The following
discussion sets forth the required single segment information.
The Company operates as a single reportable segment as an online auction
for computers, consumer electronics, housewares, and sports and recreation
products in the United States. The Company sources its products from over 250
vendors and offers, on average, over 1,000 items in each of its auctions.
Product offerings are divided into the following four categories, with their
corresponding percentage of net revenues for the quarter ended March 31, 1998:
Computer Products - including desktops, portable computers,
computer accessories, disk drives, modems, monitors/video
equipment, components, printers, scanners, digital cameras,
software and home office products. 76%
Consumer Electronics - including home theater equipment,
home audio equipment, speakers, televisions, camcorders, VCRs,
DVD players, portable audio players and automobile audio
equipment. 15%
Housewares - including kitchen appliances, vacuum cleaners,
personal care devices, furniture, gifts, photography, jewelry
and sunglasses. 6%
Sports and Recreation - including sports memorabilia, golf
and tennis, health and fitness, outdoor sports, bicycles,
water sports, and team sports equipment. 3%
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
(Dollars in thousands, except per share data)
The Management's Discussion and Analysis of Financial Condition and
Results of Operations, which follows, contains forward-looking statements which
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including but not limited to those set forth under
the heading "Investment Considerations" herein and under the same heading in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998. The
following discussion should be read in conjunction with the financial statements
and notes thereto included in this Report. The historical information included
in this Report does not necessarily reflect what the Company's financial
condition and results of operations would have been had the Company been
operated as an independent entity during the periods presented and may not be
indicative of future performance. Dollar amounts are in thousands, except per
share data.
Overview
uBid operates an online auction for excess merchandise, offering close-out
and refurbished products to consumers and small to medium-sized businesses. The
Company believes that its online auction represents an exciting sales format for
users that leverages the interactive nature of the Internet. The Company's
Internet auctions feature a rotating selection of brand name computers, consumer
electronics, housewares, and sports and recreation products which
typically sell at significant discounts to prices found at traditional
retailers. uBid currently runs auctions seven days a week, offering on the
average over 1,000 total items in each of its auctions. From its first auction
in December 1997 through March 31, 1998 the Company has registered over 377,000
users and recorded more than 33.8 million visits to its Website.
uBid's online auctions provide an ideal distribution channel for
unpredictable, odd-lot quantities of close-out and refurbished goods. The
frequency of the Company's auctions and its ability to continuously add new
items allow vendors to dispose of inventory quickly to minimize the risk of
price erosion. Online sales also allow vendors to liquidate excess merchandise
directly to a nationwide audience, without cannibalizing their primary
distribution channels. Furthermore, uBid offers customers a unique retail
experience--the opportunity to set their own prices on popular, brand name
products with the convenience of shopping 24 hours a day, seven days a week. The
element of gamesmanship, combined with an ever-changing merchandise mix, entices
customers to participate in the auction in hopes of "hitting the jackpot" and
winning a bargain.
The Company employs sophisticated merchandising techniques to manage the
auction process, which allows the Company to maximize revenues on products put
into auction. uBid's sophisticated auction management methodology capitalizes on
the Company's direct marketing and merchandising expertise to help predict the
level of customer traffic to the Website, the appropriate product mix of each
auction and the ultimate price realized on each product.
The Company has designed its online auctions to offer a superior customer
experience and to encourage repeat visits by customers and potential customers.
The Company believes it offers a consistently superior experience to its
customers through an entertaining and fast auction process, tight control of the
order process and a high level of customer support. In addition, uBid has
established multiple channels for communicating with customers before and after
the sale, including telephone, e-mail and online support The Company has also
incorporated other features to encourage repeat visits, including a personalized
page with a user's bidding history.
In the electronic commerce industry, a strong brand is critical to creating
a high level of vendor awareness and attracting customer traffic. Accordingly,
the Company's strategy is to aggressively increase its visibility and brand
recognition through a variety of marketing and promotional efforts.
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The Company obtains merchandise directly from computer, consumer
electronics, housewares, and sports and recreation products manufacturers and
indirectly through other vendors, such as retailers, distributors and Fortune
1000 companies. Currently, this merchandise is sourced from over 250 vendors.
uBid's merchandise has included brands such as AST, AT&T, Aiwa, Apple, Canon,
Casio, Compaq, Dell, Gateway, Hewlett-Packard, IBM, JVC, Lexmark, Micron, NEC,
Panasonic, Seagate, Sony, Toshiba and Uniden. In March 1999, the Company
announced the introduction of the uBid Auction Community(TM), which will provide
approved vendors access to the uBid Website to place products on the site for
direct auction to customers.
The Company either purchases the merchandise outright ("purchased
inventory") or acquires the rights to sell the merchandise under consignment-
type relationships with vendors on a revenue sharing basis ("revenue sharing").
In the case where the Company purchases the merchandise outright, the Company
bears both inventory and credit risk. When merchandise is acquired on a revenue
sharing basis, title to the inventory passes to the Company only after the sale,
the Company invoices the customer and bears the credit and return risks. Under
both types of transactions (purchased inventory or revenue sharing), the Company
recognizes the full sales amount as revenue upon verification of the credit card
transaction authorization and shipment of the merchandise. In instances where
the credit card authorization has been received but the merchandise has not been
shipped, the Company defers revenue recognition until the merchandise is
shipped. The Company has begun offering credit to certain of its business
customers that have been pre-qualified as having appropriate credit ratings, and
accordingly, the Company will be required to manage the associated risks of
accounts receivable expansion and collection.
uBid's business was established by Creative Computers, Inc. (the "Parent")
in April 1997 and the Company was incorporated in Delaware on September 1997 as
a wholly-owned, indirect subsidiary of the Parent. In December 1998, the Company
completed an initial public offering of 1,817,000 shares of its Common Stock
(the "Offering" or "IPO"). As of May 12, 1999 the Parent owned approximately
80.1% of the Common Stock of the Company. The Company was initially set up as a
subsidiary of the Parent with the intention to function independently from the
Parent. To date, the Company has received services provided by the Parent,
including administrative (accounting, human resources, legal), warehousing and
distribution, Internet/telecom and joint marketing. In consideration for these
services, the Parent generally charges the Company its costs plus 10%.
Management believes that the amounts charged to the Company have been no less
favorable to the Company than costs the Company would have incurred to obtain
such services on its own or from unaffiliated third parties.
The Parent has announced that, subject to certain conditions, the Parent
intends to separate the Company from the Parent's other operations and
businesses (the "Separation") and to distribute to its stockholders all of the
uBid Common Stock owned by the Parent (the "Distribution") in no event prior to
180 days after the December 9, 1998 closing date of the Company's initial public
offering, (the "Offering Closing Date"). The Separation will establish the
Company as a stand-alone entity with objectives separate from those of the
Parent. The Company intends to focus its resources and management emphasis on
the operations and markets it views as critical to its long-term success as a
stand-alone entity. In December 1998, the Company and the Parent entered into a
Separation and Distribution Agreement (the "Separation and Distribution
Agreement") and certain other agreements providing for the Separation and the
Distribution, the provision by the Parent of certain interim services to the
Company, and addressing employee benefit arrangements, and tax and other
matters.
The Company has incurred expenses related to establishing itself as an
independent company of $100 and estimates that it will need to spend a total of
approximately $1,750 in capital expenditures to establish itself as an
independent company, approximately $350 of which was capitalized in the first
quarter of 1999. These expenditures will include warehouse and distribution
equipment, hardware and software for computer systems and furniture and
fixtures. The Company expects to fund its purchase of such capital equipment
with working capital (including the proceeds from the Offering). In addition,
the Company and the Parent expect that the Services Agreement, pursuant to which
the Parent provides certain administrative services to the Company, will be
terminated upon completion of the Distribution. Thereafter, the Company will
9
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have such services performed by Company personnel or will have to engage third
parties to perform certain administrative and transactional services previously
provided by the Parent.
Due to its dependence on the Parent for funding and certain services, the
Company's ability to grow prior to its initial public offering was constrained
by the allocation of resources made by the Parent. The Company's growth has also
been constrained by its inability to sell and ship products internationally due
to contractual restraints on the Parent and because it has been precluded from
selling certain lines of merchandise as a result of agreements to which the
Parent is subject. For example, certain of the Parent's contractual
relationships with manufacturers prevent the Parent and its subsidiaries,
including the Company, from selling such manufacturers' computers and computer-
related products at discounted prices, which has prevented the Company from
obtaining such products on a close-out or refurbished basis and selling them in
the Company's auctions. In addition, under the Parent's contractual
relationships with certain of its vendors, neither the Parent nor its
subsidiaries, including the Company, can sell the vendor's products outside the
U.S. As a result of the Distribution, the Company would no longer be subject to
these restrictions.
The Company has an extremely limited operating history upon which to base
an evaluation of the Company and its business and prospects. The Company's
business and prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets such as
electronic commerce. Although the Company has experienced significant growth in
revenue since its commencement of operations, there can be no assurance that the
Company's revenue will continue at its current level or rate of growth. The
Company's revenue depends substantially upon the level of auction activity on
its Website. In addition, the Company has relatively low gross margins and plans
to increase its operating expenses significantly by increasing the size of its
staff, expanding its marketing efforts, purchasing larger volumes of merchandise
to be sold at auction and building a larger infrastructure to support planned
growth. To the extent that increases in operating expenses precede or are not
subsequently followed by increased revenue, the Company's business, results of
operations and financial condition will be materially adversely affected
Beginning in October 1997, the Company granted stock options to attract and
retain key employees. These options were exercisable only in the event of a
successful initial public offering or sale of the Company. The completion
of the Offering on December 4, 1998 caused a new measurement date to occur,
requiring the Company to compute compensation expense based upon the difference
between the exercise price of the options and the IPO price. The Company will
record a non-cash compensation expense charge of approximately $13,292 in
connection with stock options granted prior to the IPO at prices less than the
initial public offering price of the Company's Common Stock. The compensation
charge will be recognized over the five-year vesting period of such options.
Accordingly, the Company recorded a compensation expense of approximately $5,267
in the fourth quarter of 1998 and $885 in the first quarter of 1999.
Results of Operations
Net Revenues. Net revenues are comprised of gross merchandise sales,
shipping income net of returns and advertising revenues. In the first quarter
of 1999, net revenues increased to $34,314 from $2,075 in the first quarter of
1998, and $24,107 in the fourth quarter of 1998. The increases in net revenues
were due to significant growth in the Company's customer base, an expanded
selection of merchandise offered and an increase in the number of auctions per
week. The Company intends to increase advertising to drive additional traffic to
its Website, further allowing it to broaden its customer base, increase the
number of auctions per week and expand the selection and number of items
offered.
Gross Profits. Gross profits are comprised of net revenues minus the cost
of merchandise, shipping and shipping-related expenses, net of returns. Gross
profits are affected by the Company's ability to cost-effectively source
merchandise and attract sufficient traffic to the Company's Website to achieve a
favorable balance between the number of bidders and the amount of merchandise
auctioned. In the first quarter of 1999, gross profits increased to $2,977 from
$184 in the first quarter of 1998, and $2,043 in the fourth quarter of 1998. As
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a percent of net revenues, the Company's gross profit for the first quarter of
1999 was 8.7%, compared to 8.9% in the first quarter of 1998 when the Company
was beginning operations and offering significantly fewer auctions and products.
Gross profit percentage increased however, from 8.5% in the fourth quarter of
1998 due to expansion into new higher margin product categories, and recognition
of advertising revenue.
Operating Expenses. The Company's operating expenses have increased
significantly since the Company's Inception. This trend is expected to continue
as the Company continues to expand its operations to increase its customer base,
enhance its brand name and increase its market share, all of which will require
significant increases in marketing and advertising, additional personnel,
enhancements to its Website and further development of its infrastructure. To
date, the Parent has provided administrative (accounting, human resources,
legal), warehousing and distribution, Internet/telecom and joint marketing
services to the Company. The costs of these services as a percent of total
operating expenses have declined each quarter since the Company's Inception. It
is expected that these costs will continue to decline as a percent of total
operating expenses and in absolute dollars in the future. After the
Distribution, the Company will have to have such services performed by Company
personnel or engage third parties to perform such services. The Company does not
expect that the costs associated with the transition to internal and third party
administration and transaction processing will be material.
Sales and Marketing. Sales and marketing expenses consist primarily of
advertising and promotional expenditures, as well as payroll and related
expenses for sales and marketing personnel. In the first quarter of 1999, sales
and marketing expenses increased to $2,660 from $144 in the first quarter of
1998 and $1,476 in the fourth quarter of 1998. Sales and marketing expenses as
a percent of net revenues were 7.8% for the first three months of 1999, an
increase from 6.9% in the first quarter of 1998 and 6.1% in the fourth quarter
of 1998. These expenses have increased due to increasing advertising
expenditures and personnel additions. The Company expects sales and marketing
expenses to increase significantly in absolute dollars as it endeavors to
increase its customer base.
Technology and Development. Technology and development expenses consist
primarily of payroll and related expenses for systems personnel who develop the
Company's Website and related systems, charges from the Parent relating to
hosting of the Company's Website and Internet/telecom operations, and
amortization of capitalized software development costs. The Parent has been
responsible for hosting the Company's Website and for Internet/telecom
operations. The Parent has charged the Company rates that management believes
are no less favorable than that which could be obtained from a third party. In
the first quarter of 1999, technology and development expenses increased to $644
from $142 in the first quarter of 1998 and $328 in the fourth quarter of 1998.
Technology and development costs as a percent of net revenues were 1.9% for the
first quarter of 1999, a decrease from 6.8% in the first quarter of 1998 when
initial investments related to the Company's Website and related systems were
relatively high as a percentage of net revenues. Technology and development
expenses as a percentage of sales increased however, from 1.4% in the fourth
quarter of 1998 due to increased staffing and associated costs relating to
enhancing the features and functionality of the Company's Website and related
systems.
General and Administrative. General and administrative expenses consist
primarily of credit card processing, payroll and related expenses, warehousing
and distribution, merchandising, customer service, accounting and
administration, executive and other general corporate expenses. The Parent has
provided certain general and administrative services for credit card processing,
accounting and benefits administration. In the first quarter of 1999, general
and administrative expenses increased to $2,341 from $762 in the first quarter
of 1998, and $2,150 in the fourth quarter of 1998. General and administrative
expenses as a percent of net revenues were 6.8% in the first quarter of 1999,
decreasing from 37% in the first quarter of 1998 and 8.9% in the fourth
quarter of 1998. General and administrative expenses have increased primarily
due to hiring additional personnel and related costs to support increased sales
such as credit card processing and distribution costs. The Company expects
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general and administrative expenses to increase in absolute dollars in the
future as the Company expands its operations.
Stock Option Compensation Expense. Prior to the Offering, the Company had
granted 1,038,278 options to purchase Common Stock at prices less than the
$15.00 per share Offering price. The options were exercisable only in the event
of a successful initial public offering or sale of the Company. The completion
of the Offering on December 4, 1998 caused a new measurement date to occur,
requiring the Company to compute compensation expense based upon the difference
between the exercise price of the options and the IPO price. Based upon the
difference between the IPO price of $15.00 per share and the exercise prices of
the 1,038,278 options outstanding at December 4, 1998, the total compensation
charge will be approximately $13,292, which will be amortized over the vesting
periods of the outstanding options. Approximately $885 of this charge to
compensation was recognized in the first three months of 1999.
Income Taxes. The Company records its income tax provision on a separate
return basis. The Company had a net loss since Inception in 1997 and expects to
incur losses for the foreseeable future. No benefit for income taxes was
provided in 1997 or 1998 due to the uncertainty of realization of these benefits
in future years.
Net Loss. Based on the foregoing information, the Company had a net loss of
$2,977 for the first three months of 1999 and $184 in the comparable period of
1998. The loss in the first three months of 1999 was due in part to investments
in infrastructure as the Company continued to expand its sales operations and a
non-cash charge for amortization of stock compensation expense related to pre-
IPO stock options. The Company expects to continue to experience losses for the
foreseeable future as it continues to make significant investments in building
its customer base and operating infrastructure.
Liquidity and Capital Resources
Prior to its December 1998 IPO, the Company financed its operations with
advances from the Parent and cash flow from operations. Net proceeds to the
Company from the IPO were $23,847.
Net cash provided by (used in) operating activities was $571 and ($1,502)
for the three months ended March 31, 1999 and 1998 respectively. During the
three months ended March 31, 1999, the net cash provided by operating activities
was primarily due to an increase in accounts payable of $3,262, an increase in
various accrued expenses of $648, and a decrease in accounts receivable of $141,
offset by a net loss of $3,352, a net increase in inventory of $746, a decrease
in short-term advances from the Parent of $367, and decrease in prepaid expenses
of $31.
Cash flows (used in) investing activities were ($715) and ($34) for the
three months ended March 31, 1999 and 1998 respectively. In the first quarter of
1999, net cash (used in) investing activities was due to purchases of various
warehousing and office equipment.
The Company anticipates that it will have negative cash flows for the
foreseeable future. The Parent advanced the Company cash for its operations
until the consummation of its December 1998 initial public offering. Upon
consummation of the Offering, these advances were converted into a note payable
to the Parent. The outstanding balance on the note bears interest at the prime
rate and will be repaid in June 2000. Interest income of $271 earned on the
proceeds of the IPO was offset by interest expense of $70 on the note payable to
the Parent. Net proceeds from the IPO are being used for working capital needs
to include advertising and brand development for growth, as well as development
of the Company's infrastructure. The Company has incurred expenses related to
establishing itself as an independent company of $100 and estimates that it will
need to spend a total of approximately $1,750 in capital expenditures to
establish itself as an independent company, approximately $350 of which was
capitalized in the first quarter of 1999. These expenditures will include
warehouse and distribution equipment, hardware and software for computer systems
and furniture and fixtures. The Company expects to fund its purchase of such
capital equipment with working capital.
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The Company intends to retain any earnings for the foreseeable future for
use in the operation and expansion of its business. Consequently, the Company
does not anticipate paying any cash dividends on its Common Stock to its
stockholders for the foreseeable future. In addition, it is probable that any
debt financing agreements to be entered into by the Company will contain
restrictions on the Company's ability to declare dividends.
The Company believes that the net proceeds from its initial public offering
will satisfy the Company's working capital and capital expenditure requirements
for at least the next 12 months, although the Company may seek to raise
additional capital during that period. There can be no assurance the Company
will not require additional funds prior to the expiration of such period. Even
if such additional funds are not required, the Company may seek additional
equity or debt financing. There can be no assurance that such financing will be
available on acceptable terms, if at all, or that such financing will not be
dilutive to the Company's stockholders.
Year 2000 Systems Costs
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed "year
2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with which the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has established
an internal project team comprised of all functional disciplines. This project
team has begun a three-phase process of identifying internal systems (both
information technology and non-information technology systems) that are not year
2000 compliant, determining their significance in the effective operation of the
Company, and developing plans to resolve the issues where necessary. The
Company has been communicating with the suppliers and others with whom it does
business to coordinate year 2000 readiness. The responses received by the
Company to date have indicated that steps are currently being undertaken to
address this concern. However, if such third parties are not able to make all
systems year 2000 compliant, there could be a material adverse impact on the
Company.
Initial review of the Company's principal transaction processing software
through which nearly all of the Company's business is transacted has determined
it to be year 2000 compliant and, as such, the Company does not anticipate any
material adverse operational issues to arise. The Company has completed 75% of
its year 2000 assessment for critical systems and plans to complete its
assessment by the end of the second quarter of 1999. The Company plans to
implement corrective solutions before the end of the third quarter of 1999. To
date, the costs incurred by the Company with respect to this project are
approximately $100. Based on current estimates, management expects that the
Company's total costs in connection with its year 2000 compliance project will
be approximately $500 and will be financed from general corporate funds;
however, future anticipated costs are difficult to estimate with any certainty
and may differ materially from those currently projected based on the results of
the assessment phase of the Company's year 2000 project. The anticipated costs
associated with the Company's year 2000 compliance program do not include time
and costs that may be incurred as a result of any potential failure of third
parties to become year 2000 compliant or costs to implement the Company's future
contingency plans. Management estimates that approximately one half of the
expected costs will be attributed to the redeployment of internal resources and
the other half will be comprised of external consulting fees and software
upgrades. The redeployment of internal data processing resources is not
expected to materially delay any significant projects.
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The Company believes its auction software to be year 2000 compliant;
however, full compliance of the auction software will be verified by an external
consultant no later than the end of the third quarter of 1999. The Company
currently runs various third party applications that require year 2000 updates.
These are available and are expected to be implemented no later than the end of
the third quarter of 1999. The Company has not yet developed a contingency plan
in the event that any non-compliant critical systems are not remedied by January
1, 2000, nor has it formulated a timetable to create such contingency plan. Upon
completion of this project, if systems material to the Company's operations have
not been made year 2000 compliant, or if third parties fail to make their
systems year 2000 compliant in a timely manner, the year 2000 issue could have a
material adverse effect on the Company's business, financial condition and
results of operations.
INVESTMENT CONSIDERATIONS
In addition to the other information in this Quarterly Report on Form
10-Q, the following factors should be considered carefully in evaluating the
Company and its business because such factors currently have a significant
impact or may have a significant impact on the Company's business, prospects,
financial condition and results of operations.
Extremely Limited Operating History
The Company was incorporated in September 1997 and began conducting
auctions on the Internet in December 1997. Prior to the incorporation of the
Company, the Parent, beginning on April 1, 1997, funded certain startup and
development activities. Accordingly, there is an extremely limited operating
history upon which to base an evaluation of the Company and its business and
prospects. The Company's business and prospects must be considered in light of
the risks, expenses and difficulties frequently encountered by companies in
their early stage of development, particularly companies in new and rapidly
evolving markets such as electronic commerce. Such risks for the Company
include: an evolving and unpredictable business model; management of growth; the
Company's ability to anticipate and adapt to a developing market; acceptance by
customers of the Company's Internet auctions and excess merchandise sold at such
auctions; dependence upon the level of auction activity; development of equal or
superior Internet auctions by competitors; dependence on vendors for
merchandise; dependence on the Parent for certain services; and the ability to
identify, attract, retain and motivate qualified personnel. To address these
risks, the Company must, among other things, continue to expand its vendor
channels and buyer resources, increase traffic to its Website, maintain its
customer base and attract significant numbers of new customers, respond to
competitive developments, implement and execute successfully its business
strategy and continue to develop and upgrade its technologies and customer
services. There can be no assurance that the Company will be successful in
addressing these risks. In addition, the Company's limited operating history
prevents the use of period-to-period comparisons of its financial results. The
financial information included herein may not necessarily provide any indication
as to expected or possible results of operations, financial condition and cash
flows of the Company in the future or what the results of operations, financial
condition and cash flows would have been had the Company been a separate,
independent entity during the periods presented. See "Dependence of the Company
on the Parent for Certain Services" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Future Capital Requirements; Need for Additional Capital; Absence of Parent
Funding
The Company's working capital requirements and cash flow provided by
operating activities can vary from quarter to quarter, depending on revenues,
operating expenses, capital expenditures and other factors. The Company requires
substantial working capital to fund its business. Since Inception, the Company
has experienced negative cash flow from operations and expects to continue to
experience significant negative cash flow from operations for the foreseeable
future. The Company currently anticipates that its existing capital resources
(including proceeds from the Company's initial public offering), will be
sufficient to meet the Company's capital requirements through the next 12
months, although there can be no assurance that the Company will not have
additional
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capital needs prior to the end of such period. Thereafter, the Company expects
that it will be required to raise additional funds. Prior to its initial public
offering, the Company's needs for working capital and general corporate purposes
were satisfied pursuant to the Parent's corporate-wide cash management policies.
However, since the Company's initial public offering, the Parent has not been
required to provide funds to finance the Company's operations, nor does the
Parent currently anticipate providing such funds in the future. If the Company
is unable to obtain financing in the amounts desired and on acceptable terms, or
at all, the Company may be required to reduce significantly the scope of its
presently anticipated advertising and other expenditures, which could have a
material adverse effect on the Company's growth prospects and the market price
of the Common Stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
History of Operating Losses; Accumulated Deficits; Anticipated Losses and
Negative Cash Flow
Since its formation, the Company has expended significant resources on its
technology, Website development, advertising, hiring of personnel and startup
costs. As a result, the Company has incurred losses since Inception and expects
to continue to incur losses for the foreseeable future. The Company had an
accumulated deficit of approximately $13.8 million at March 31, 1999. The
Company intends to expend significant financial and management resources on
brand development, marketing and advertising, Website development, strategic
relationships, and technology and operating infrastructure. Primarily as a
result of the significant increase in marketing and promotional expenses, the
Company expects to incur additional losses, and such losses are expected to
increase significantly from current levels. Because the Company has relatively
low gross margins, achieving profitability given planned investment levels
depends upon the Company's ability to generate and sustain substantially
increased levels of net revenue. In addition, the Company historically has had
relatively low operating margins and plans to continue to increase its operating
expenses significantly in order to increase its customer base, increase the size
of its staff, expand its marketing efforts to enhance its brand image, increase
its visibility on other companies' high-traffic Websites, purchase larger
volumes of merchandise to be sold at auction, increase its software development
efforts, and support its growing infrastructure. Moreover, to the extent that
increases in such operating expenses precede or are not subsequently followed by
increased revenues, the Company's business, results of operations and financial
condition will be materially adversely affected. There can be no assurance that
the Company's revenues will increase or even continue at their current level or
that the Company will achieve or maintain profitability or generate positive
cash flow from operations in future periods. The Company has made and expects in
the future to continue to make significant investments in infrastructure and
personnel in advance of levels of revenue necessary to offset such expenditures.
As a result, these expenditures are based on the Company's operating plans and
estimates of future revenues. Sales and operating results generally depend,
among other things, on the volume and timing of orders received, which are
difficult to forecast. The Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Unpredictability of, and Fluctuations in, Operating Results
The Company's operating results are unpredictable and are expected to
fluctuate in the future, due to a number of factors, many of which are outside
the Company's control. These factors include: (i) the Company's ability to
significantly increase its customer base, manage its inventory mix and the mix
of products offered at auction, meet certain pricing targets, liquidate its
inventory in a timely manner, maintain gross margins and maintain customer
satisfaction; (ii) the availability and pricing of merchandise from vendors;
(iii) product obsolescence and price erosion; (iv) consumer confidence in
encrypted transactions in the Internet environment; (v) the timing, cost and
availability of advertising on other entities' Websites; (vi) the amount and
timing of costs relating to expansion of the Company's operations; (vii) the
announcement or introduction of new types of merchandise, service offerings or
customer services by the Company or its competitors; (viii) technical
difficulties with respect to consumer use of the auction format on the Company's
Website; (ix) delays in shipments as a result of computer systems failures,
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strikes or other problems with the Company's delivery service or credit card
processing providers; (x) the level of merchandise returns experienced by the
Company; and (xi) general economic conditions and economic conditions specific
to the Internet and electronic commerce. As a strategic response to changes in
the competitive environment, the Company may from time to time make certain
service, marketing or supply decisions or acquisitions that could have a
material adverse effect on the Company's quarterly results of operations and
financial condition. The Company also expects that, in the future, it, like
other retailers, may experience seasonality in its business. Due to all of the
foregoing factors, in some future quarter the Company's operating results may
fall below the expectations of securities analysts and investors. In such event,
the trading price of the Company's Common Stock, would likely be materially
adversely affected. See "--Extremely Limited Operating History" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Uncertain Acceptance of the uBid Brand; Evolving and Unpredictable Business
Model
The Company believes that the importance of brand recognition will increase
as more companies engage in commerce over the Internet. Development and
awareness of the uBid brand will depend largely on the Company's success in
increasing its customer base. If vendors do not perceive the Company as an
effective marketing and sales channel for their merchandise, or consumers do not
perceive the Company as offering an entertaining and desirable way to purchase
merchandise, the Company will be unsuccessful in promoting and maintaining its
brand. Furthermore, in order to attract and retain customers and to promote and
maintain the uBid brand in response to competitive pressures, the Company is
finding it necessary to increase its marketing and advertising budgets and
otherwise to increase substantially its financial commitment to creating and
maintaining brand loyalty among vendors and consumers. If the Company is unable
to or incurs significant expenses in an attempt to achieve or maintain a leading
position in Internet commerce or to promote and maintain its brand, the
Company's business, results of operations and financial condition will be
materially adversely affected.
The Company expects to expand the focus of its operations beyond the
auction and sale of closeout and refurbished computers, consumer electronics,
housewares, and sports and recreation products to the auction and sale of other
excess merchandise. The Company also has begun to develop its business model and
to explore other opportunities such as the use of the Company's Website as an
advertising medium for services and products of other companies, promoting new
or complementary products or sales formats and expanding the breadth and depth
of products and services offered on its Website. In addition, the Company has
begun offering credit to certain of its business customers that have been pre-
qualified as having appropriate credit ratings. As its business model evolves,
the Company risks diluting its brand, confusing customers and decreasing
interest from vendors. In addition, the Company could be exposed to additional
or new risks associated with these new opportunities. If the Company is unable
to address these risks, the Company's business, results of operations and
financial condition will be materially adversely affected.
Competition
The electronic commerce market is new, rapidly evolving and intensely
competitive, and the Company expects competition to intensify in the future. The
Company currently or potentially competes with a variety of other companies
depending on the type of merchandise and sales format offered to customers.
These competitors include: (i) various Internet auction houses such as ONSALE,
eBay, Yahoo! Auctions, First Auction (the auction site for Internet Shopping
Network, a wholly-owned subsidiary of Home Shopping Network Inc.), Surplus
Auction (a wholly-owned subsidiary of Egghead, Inc.), WebAuction (the auction
site for MicroWarehouse, Inc.), Insight Auction (the auction site for Insight
Enterprises, Inc.) and Amazon.com Auctions; (ii) a number of indirect
competitors that specialize in electronic commerce or derive a substantial
portion of their revenue from electronic commerce, including Buy.Com, Internet
Shopping Network, AOL and Cendant Corp.; (iii) a variety of other companies that
offer merchandise similar to that of the Company but through physical auctions
and with which the Company competes for sources of supply; (iv) personal
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computer manufacturers that have their own direct distribution channels for
their excess inventory or refurbished products; and (v) companies with
substantial customer bases in the computer and peripherals catalog business,
including CDW Computer Centers, Inc., PC Connection, Inc. and the Parent, some
of which already sell online or may devote more resources to Internet commerce
in the future. In particular, ONSALE, Inc. began conducting auctions on the
Internet in May 1995 and has established significant market share and brand name
recognition for online auctions for computer-related equipment. In addition, AOL
has taken a minority equity interest in Bid.com (formerly, Internet Liquidators
International, Inc.), a competitor of the Company, and announced that the two
companies have formed a strategic partnership under which revenue from Bid.com's
auction platforms is shared with AOL and AOL provides a direct link for
Bid.com's members to reach Bid.com's electronic commerce site on the Web. The
Company has its own relationship with AOL pursuant to which the Company
advertises on AOL and which provides AOL's members with a direct link to the
Company's Website.
The Company believes that the principal competitive factors affecting its
market are the ability to attract customers at favorable customer acquisition
costs, operate the Website in an uninterrupted manner and with acceptable speed,
provide effective customer service and obtain merchandise at satisfactory
prices. There can be no assurance that the Company can maintain its competitive
position against current and potential competitors, especially those with
greater financial, marketing, customer support, technical and other resources
than the Company.
Current and potential competitors have established or may establish
cooperative relationships among themselves or directly with vendors to obtain
exclusive or semi-exclusive sources of merchandise. Accordingly, it is possible
that new competitors or alliances among competitors and vendors may emerge and
rapidly acquire market share. In addition, manufacturers may elect to liquidate
their products directly. Increased competition is likely to result in reduced
operating margins, loss of market share and a diminished brand franchise, any
one of which could materially adversely affect the Company's business, results
of operations and financial condition. Many of the Company's current and
potential competitors have significantly greater financial, marketing, customer
support, technical and other resources than the Company. As a result, such
competitors may be able to secure merchandise from vendors on more favorable
terms than the Company, and they may be able to respond more quickly to changes
in customer preferences or to devote greater resources to the development,
promotion and sale of their merchandise than can the Company.
Reliance on Relationships with Online Companies
The Company depends to some extent and is increasing its dependence on
relationships with other online companies. These relationships include, but are
not limited to, agreements for anchor tenancy, promotional placements,
sponsorships and banner advertisements. Generally, these agreements have terms
for up to a year, are not exclusive and do not provide for guaranteed renewal.
The risks included in this dependence include: (i) the possibility that a
competitor will purchase exclusive rights to attractive space on one or more key
sites; (ii) the uncertainty that significant spending on these relationships
will increase the Company's revenues substantially or at all; (iii) the
possibility that potential revenue increases resulting from such spending will
not occur within the time periods that the Company is expecting; (iv) the
possibility that space on other Websites or the same sites may increase in price
or cease to be available on reasonable terms or at all; (v) the possibility
that, if these relationships are successful, the Company may not be able to
obtain adequate amounts of merchandise to meet the increased demand that is
generated; (vi) the possibility that such online companies will be unable to
deliver a sufficient number of customer visits or impressions; and (vii) the
possibility that such online companies will compete with the Company for limited
online auction revenues. Any termination of the Company's arrangements with
other online companies could have a material adverse effect on the Company's
business, results of operations and financial condition.
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Risks of a Purchased Inventory Model
The Company purchases a majority of its merchandise from vendors and
thereby assumes the inventory and price risks of these products to be sold at
auction. These risks are especially significant because much of the merchandise
currently auctioned by the Company (e.g., computers, consumer electronics,
housewares, and sports and recreation products) is characterized by rapid
technological change, obsolescence and price erosion. Since the Company relies
heavily on purchased inventory, its success will depend on its ability to
liquidate its inventory rapidly through its auctions, the ability of its buying
staff to purchase inventory at attractive prices relative to its resale value at
auction, and its ability to manage customer returns and the shrinkage resulting
from theft, loss and misrecording of inventory. Due to the inherently
unpredictable nature of auctions, it is impossible to determine with certainty
whether an item will sell for more than the price paid by the Company. Further,
because minimum opening bid prices for the merchandise listed on the Company's
Website generally are lower than the Company's acquisition costs for such
merchandise, there can be no assurance that the Company will achieve positive
gross margins on any given sale. If the Company is unable to liquidate its
purchased inventory rapidly, if the Company's buying staff fails to purchase
inventory at attractive prices relative to its resale value at auction, or if
the Company fails to predict with accuracy the resale prices for its purchased
merchandise, the Company may be forced to sell its inventory at a discount or at
a loss and the Company's business, results of operations and financial condition
would be materially adversely affected.
Reliance on Merchandise Vendors
The Company depends upon vendors to supply it with excess merchandise for
sale through the Company's Internet auctions, and the availability of such
merchandise can be unpredictable. Since Inception, the Company has sourced
merchandise from over 250 vendors. None of these vendors is subject to a long-
term supply contract with the Company. There can be no assurance that the
Company's current vendors will continue to sell merchandise to the Company or
otherwise provide merchandise for sale in the Company's auctions or that the
Company will be able to establish new vendor relationships that ensure
merchandise will be available for auction on the Company's Website. A limited
number of these vendors process and ship merchandise directly to the Company's
customers. The Company has limited control over the shipping procedures of such
vendors, and shipments could be subject to delays outside the control of the
Company. Most merchandise sold by the Company carries a warranty supplied either
by the manufacturer or the vendor. In addition, although the Company is not
obligated to accept merchandise returns, the Company could be compelled to
accept returns from customers for which the Company did not receive
reimbursements from its vendors or manufacturers if such warranties are not
honored. If the Company is unable to develop and maintain satisfactory
relationships with vendors on acceptable commercial terms, if the Company is
unable to obtain sufficient quantities of merchandise, if the quality of service
provided by such vendors falls below a satisfactory standard or if the Company's
level of returns exceeds its expectations, the Company's business, results of
operations and financial condition will be materially adversely affected.
Reliance on Other Third Parties
In addition to its merchandise vendors, the Company's operations depend on
a number of third parties for Internet/telecom access, delivery services, credit
card processing and software services. The Company has limited control over
these third parties and no long-term relationships with any of them. For
example, the Company does not own a gateway onto the Internet, but instead,
through the Parent, relies on an Internet service provider, Pacific Bell, to
connect the Company's Website to the Internet. From time to time, the Company
has experienced temporary interruptions in its Website connection and also its
telecommunications access. Continuous or prolonged interruptions in the
Company's Website connection or in its telecommunications access, or slow
Internet transmissions, would have a material adverse effect on the Company's
business, results of operations and financial condition. The Company uses UPS
and Federal Express as its delivery services for substantially all of its
products. Should either or both be unable to deliver the Company's products for
a sustained time period as a result of a strike or other reason, the Company's
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business, results of operations and financial condition would be adversely
affected. If, due to computer systems failures or other problems related to
these third-party service providers, the Company experiences any delays in
shipment, its business, results of operations and financial condition would be
adversely affected. The Company's internally developed auction software depends
on operating system, database and server software that was developed and
produced by and licensed from third parties. The Company has from time to time
discovered errors and defects in the software from these third parties and, in
part, relies, on these third parties to correct these errors and defects in a
timely manner. If the Company is unable to develop and maintain satisfactory
relationships with such third parties on acceptable commercial terms, or the
quality of products and services provided by such third parties falls below a
satisfactory standard, the Company's business, results of operations and
financial condition will be materially adversely affected.
Risk of Capacity Constraints; Reliance on Internally-Developed Systems; System
Development Risks
A key element of the Company's strategy is to generate a high volume of
traffic to, and use of, its Website. The Company's revenues depend entirely on
the number of customers who use its Website to purchase merchandise.
Accordingly, the satisfactory performance, reliability and availability of the
Company's Website, transaction-processing systems, network infrastructure and
delivery and shipping systems are critical to the Company's operating results,
as well as to its reputation and its ability to attract and retain customers and
maintain adequate customer service levels.
The Company periodically has experienced minor systems interruptions,
including Internet disruptions, which it believes may continue to occur from
time to time. Any systems interruptions, including Internet disruptions, that
result in the unavailability of the Company's Website or reduced order
fulfillment performance would reduce the volume of goods sold, which could have
a material adverse effect on the Company's business, results of operations and
financial condition. The Company is continually enhancing and expanding its
transaction-processing systems, network infrastructure, delivery and shipping
systems and other technologies to accommodate a substantial increase in the
volume of traffic on the Company's Website. There can be no assurance that the
Company will be successful in these efforts or that the Company will be able to
accurately project the rate or timing of increases, if any, in the use of its
Website or timely expand and upgrade its systems and infrastructure to
accommodate such increases. There can be no assurance that the Company's or its
suppliers' network will be able to timely achieve or maintain a sufficiently
high capacity of data transmission, especially if the customer usage of the
Company's Website increases. The Company's failure to achieve or maintain high
capacity data transmission could significantly reduce consumer demand for its
services and have a material adverse effect on its business, results of
operations and financial condition.
Management of Potential Growth; New Management Team
The Company has rapidly and significantly expanded its operations and
anticipates that significant expansion of its operations will continue to be
required in order to address potential market opportunities. This rapid growth
has placed, and is expected to continue to place, a significant strain on the
Company's management, operational and financial resources. The Company expanded
from two employees at Inception to 112 employees and 54 full-time equivalent
contract personnel at March 31, 1999, and its sales increased from approximately
$9,000 from Inception to December 31, 1997 to over $34 million in the first
quarter of 1999. The Company expects to add additional key personnel in the near
future. Increases in the number of employees and the volume of merchandise sales
have placed significant demands on the Company's management, which as of March
31, 1999 included only five executive officers. In order to manage the expected
growth of its operations, the Company will be required to expand existing
operations, particularly with respect to customer service and merchandising, to
improve existing and implement new operational, financial and inventory systems,
procedures and controls. The Company also will be required to expand its
accounting staff. Further, the Company's management will be required to maintain
relationships with various merchandise vendors, freight companies, warehouse
operators, other Websites and services, Internet service providers and other
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third parties and to maintain control over the strategic direction of the
Company in a rapidly changing environment. Historically, the Company has been
dependent upon the Parent for various services, including administration
(accounting, human resources, legal), Internet/telecom and joint marketing. See
"--Dependence of the Company on the Parent for Certain Services." There can be
no assurance that the Company's current personnel, systems, procedures and
controls will be adequate to support the Company's future operations, that
management will be able to identify, hire, train, retain, motivate and manage
required personnel or that management will be able to manage and exploit
existing and potential market opportunities successfully. If the Company is
unable to manage growth effectively, the Company's business, results of
operations and financial condition will be materially adversely affected.
Risks Associated with Technological Change; Dependence on the Internet
The Internet and electronic commerce industries are characterized by rapid
technological change, changes in user and customer requirements, frequent new
service or product introductions embodying new technologies and the emergence of
new industry standards and practices that could render the Company's existing
Website and proprietary technology obsolete. The Company's performance will
depend, in part, on its ability to license or acquire leading technologies,
enhance its existing services, and respond to technological advances and
emerging industry standards and practices on a timely and cost-effective basis.
The development of Website and other proprietary technology entails significant
technical and business risks. There can be no assurance that the Company will be
successful in using new technologies effectively or adapting its Website and
proprietary technology to emerging industry standards. If the Company is unable,
for technical, legal, financial or other reasons, to adapt in a timely manner to
changing market conditions or customer requirements, or if the Company's Website
does not achieve market acceptance, the Company's business, results of
operations and financial condition would be materially adversely affected. The
success of the Company's services will depend in large part upon the development
of an infrastructure for providing Internet access and services. The Internet
could lose its viability due to delays in the development or adoption of new
standards and protocols intended to handle increased levels of Internet activity
or due to increased governmental regulation. There can be no assurance that the
infrastructure or complementary services necessary to make the Internet a viable
commercial marketplace will be developed or that, if they are developed, the
Internet will become a viable marketing and sales channel for excess merchandise
such as that offered by the Company. The recent growth in the use of the
Internet has caused frequent periods of performance degradation, requiring the
upgrade of routers and switches, telecommunications links and other components
forming the infrastructure of the Internet service providers and other
organizations with links to the Internet. Any perceived degradation in the
performance of the Internet as a whole could undermine the benefits of the
Company's services. The Company's ability to increase the speed with which it
provides services to customers and to increase the scope of such services
ultimately is limited by and reliant upon the speed and reliability of the
networks operated by third parties. Consequently, the emergence and growth of
the market for the Company's services is dependent on improvements being made to
the entire Internet infrastructure to alleviate overloading and congestion. If
the infrastructure or complementary services necessary to make the Internet a
viable commercial marketplace are not developed or if the Internet does not
become a viable commercial marketplace, the Company's business, results of
operations and financial condition will be materially adversely affected.
Government Regulation and Legal Uncertainties
The Company is not currently subject to direct regulation by any government
agency, other than regulations applicable to businesses generally, laws
applicable to auction companies and auctioneers, and laws or regulations
directly applicable to access to or commerce on the Internet. However, due to
the increasing popularity and use of the Internet, it is possible that a number
of laws and regulations may be adopted with respect to the Internet, covering
issues such as user privacy, pricing, and characteristics and quality of
products and services. Furthermore, the growth and development of the market for
Internet commerce may prompt calls for more stringent consumer protection laws
that may impose additional burdens on those companies conducting business over
the Internet. The adoption of any additional laws or regulations may decrease
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the growth of the Internet, which, in turn, could decrease the demand for the
Company's Internet auctions and increase the Company's cost of doing business or
otherwise have an adverse effect on the Company's business, results of
operations and financial condition. Moreover, the applicability to the Internet
of existing laws in various jurisdictions governing issues such as property
ownership, auction regulation, sales tax, libel and personal privacy is
uncertain and may take years to resolve, in addition, as the Company's service
is available over the Internet in multiple states, and as the Company sells to
numerous consumers resident in such states, such jurisdictions may claim that
the Company is required to qualify to do business as a foreign corporation in
each such state. The Company is qualified to do business in only three states,
and failure by the Company to qualify as a foreign corporation in a jurisdiction
where it is required to do so could subject the Company to taxes and penalties
for the failure to qualify. Any such new legislation or regulation, or the
application of laws or regulations from jurisdictions whose laws do not
currently apply to the Company's business, could have a material adverse effect
on the Company's business, results of operations and financial condition.
The tax treatment of the Internet and e-commerce is currently unsettled. A
number of proposals have been made at the federal, state and local level and by
certain foreign governments that could impose taxes on the sale of goods and
services and certain other Internet activities. Recently, the Internet Tax
Freedom Act was signed into law, placing a three-year moratorium on new state
and local taxes on Internet commerce. However, there can be no assurance that
future laws imposing taxes or other regulations on commerce over the Internet
would not substantially impair the growth of e-commerce and as a result have a
material adverse effect on the Company's business, results of operations and
financial condition.
Dependence on Key Personnel; Need for Additional Personnel
The Company's future performance depends to a significant degree upon the
continued contributions of members of Company's senior management and other key
personnel, particularly its CEO and President, Gregory K. Jones; Vice President-
- -Information Systems, George Lu; Vice President-Merchandising, Timothy Takesue;
and Vice President and Chief Financial Officer, Thomas E. Werner. The loss of
any of these individuals could have a material adverse effect on the Company's
business, results of operations and financial condition. In addition, as a
result of the Separation, the Company will need to employ additional personnel
for certain functions that were previously performed by employees of the Parent.
The Company has a long-term employment agreement with only one of its key
personnel, Gregory K. Jones, and maintains no key person life insurance. In
order to meet expected growth and to operate independently of the Parent, the
Company believes that its future success will depend upon its ability to
identify, attract, hire, train, motivate and retain other highly-skilled
managerial, merchandising, engineering, marketing and customer service
personnel. Competition for such personnel is intense. There can be no assurance
that the Company will be successful in attracting, assimilating or retaining the
necessary personnel, and the failure to do so could have a material adverse
effect on the Company's business, results of operations and financial condition.
Risk of System Failure; Single Site
The Company's success is largely dependent upon its communications hardware
and computer hardware, substantially all of which are located at a leased
facility in Torrance, California. The Company's systems are vulnerable to damage
from earthquake, fire, flood, power loss, telecommunication failure, break-in
and similar events. The Company currently has redundant systems but not
duplicate geographic locations. The Company plans to add a fully redundant site
outside of California in 1999 and recently entered into an agreement with a
leading hosting provider to co-locate the Company's servers and develop a
mirrored site. There can be no assurance that the second site will be
established or that it can be established without interruption in the Company's
systems. A substantial interruption in these systems would have a material
adverse effect on the Company's business, results of operations and financial
condition. To date, the Company has experienced variable interruptions to its
service as a result of loss of power and telecommunications connections. The
property and business interruption insurance covering the Company may not be
adequate to compensate the Company for all losses that may occur. Despite the
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implementation of network security measures and firewall security by the
Company, its servers are also vulnerable to computer viruses, physical or
electronic break-ins, attempts by third parties deliberately to exceed the
capacity of the Company's systems and similar disruptive problems. Computer
viruses, break-ins or other problems caused by third parties could lead to
interruptions, delays, and loss of data or cessation in service to users of the
Company's services and products. The occurrence of any of these risks could have
a material adverse effect on the Company's business, results of operations and
financial condition.
Internet Commerce Security Risks; Risk of Credit Card Fraud
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. The
Company relies on encryption and authentication technology licensed by the
Parent from third parties to provide the security and authentication necessary
to effect secure transmission of confidential information. This technology is
currently available to the Company under the Internet/Telecommunications
Agreement with the Parent. There can be no assurance that advances in computer
capabilities, new discoveries in the field of cryptography or other events or
developments will not result in a compromise or breach of the algorithms used by
the Company to protect customer transaction data. If any such compromise of the
Company's security were to occur, it could have a material adverse effect on the
Company's business, results of operations and financial condition. A party who
is able to circumvent the Company's security measures could misappropriate
proprietary information or cause interruptions in the Company's operations. The
Company may be required to expend significant capital and other resources to
protect against the threat of such security breaches or to alleviate problems
caused by such breaches. Concerns over the security of Internet transactions and
the privacy of users may also inhibit the growth of the Internet generally, and
the Web in particular, especially as a means of conducting commercial
transactions. To the extent that activities of the Company or third party
contractors involve the storage and transmission of proprietary information,
such as credit card numbers, security breaches could expose the Company to a
risk of loss or litigation and possible liability. There can be no assurance
that the Company's security measures will prevent security breaches or that
failure to prevent such security breaches will not have a material adverse
effect on the Company's business, results of operations and financial condition.
Protection of Intellectual Property
The Company's performance and ability to compete are dependent to a
significant degree on its proprietary technology. The Company relies on a
combination of trademark, copyright and trade secret laws, as well as
confidentiality agreements and non-compete agreements executed by each manager
and technical measures to establish and protect its proprietary rights. The
uBid(SM) service mark is registered in the United States. There can be no
assurance that the Company will be able to secure significant protection for its
service marks or trademarks. It is possible that competitors of the Company or
others will adopt product or service names similar to "uBid" or other service
marks or trademarks of the Company, thereby impeding the Company's ability to
build brand identity and possibly leading to customer confusion. The inability
of the Company to protect the name "uBid" adequately could have a material
adverse effect on the Company's business, results of operations and financial
condition. The Company's proprietary software is protected by copyright laws.
The source code for the Company's proprietary software also is protected under
applicable trade secret laws.
All patent, copyright and other proprietary rights with respect to the
Company's auction processing and auction management applications and certain
general purpose libraries are co-owned by the Company and the third-party
developers of such applications and libraries pursuant to various agreements
among such third-party developers and the Parent which the Parent has assigned
to the Company. As co-owners of such software and libraries, the two co-
developers and the Company have the right to grant licenses covering such
software and libraries without the consent or notification of the other co-
owners. In addition, the two co-developers have previously granted a license
covering such software and libraries to the Parent (which is included in the
rights assigned to the Company under an Assignment and License Agreement with
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the Parent) and another third party. Such licensees have the right to use,
distribute, re-license and otherwise modify the licensed source codes without
royalties or further payment to any of the other co-developers or licensees.
As part of its confidentiality procedures, the Company generally enters
into agreements with its employees and consultants and limits access to and
distribution of its software, documentation and other proprietary information.
There can be no assurance that the steps taken by the Company will prevent
misappropriation of its technology or that agreements entered into for that
purpose will be enforceable. Notwithstanding the precautions taken by the
Company, it might be possible for a third party to copy or otherwise obtain and
use the Company's software or other proprietary information without
authorization or to develop similar software independently. Policing
unauthorized use of the Company's technology is difficult, particularly because
the global nature of the Internet makes it difficult to control the ultimate
destination or security of software or other data transmitted. The laws of other
countries may afford the Company little or no effective protection of its
intellectual property.
The Company may in the future receive notices from third parties claiming
infringement by the Company's software or other aspects of the Company's
business. While the Company is not currently subject to any such claim that
would have a material effect on the Company's business or financial condition,
any future claim, with or without merit, could result in significant litigation
costs and diversion of resources, including the attention of management, and
require the Company to enter into royalty and licensing agreements, which could
have a material adverse effect on the Company's business, results of operations
and financial condition. Such royalty and licensing agreements, if required, may
not be available on terms acceptable to the Company or at all. In the future,
the Company may also need to file lawsuits to enforce the Company's intellectual
property rights, to protect the Company's trade secrets, or to determine the
validity and scope of the proprietary rights of others. Such litigation, whether
successful or unsuccessful, could result in substantial costs and diversion of
resources, which could have a material adverse effect on the Company's business,
results of operations and financial condition.
The Company also relies on a variety of technology that it licenses from
third parties. There can be no assurance that these third-party technology
licenses will continue to be available to the Company on commercially reasonable
terms. The loss of or inability of the Company to maintain or obtain upgrades to
any of these technology licenses could result in delays in completing its
proprietary software enhancements and new developments until equivalent
technology could be identified, licensed or developed and integrated. Any such
delays would materially adversely affect the Company's business, results of
operations and financial condition.
Risks Associated with Global Expansion
Although the Company currently may not sell merchandise to customers
outside the United States due to contractual restrictions involving the Parent,
it intends to do so after the Distribution. The Company does not currently have
any overseas fulfillment or distribution facility or arrangement or any Website
content localized for foreign markets, and there can be no assurance that the
Company will be able to establish a global presence. In addition, there are
certain risks inherent in doing business on a global level, such as regulatory
requirements, export restrictions, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, difficulties in
protecting intellectual property rights, longer payment cycles, problems in
collecting accounts receivable, political instability, fluctuations in currency
exchange rates and potentially adverse tax consequences, which could adversely
impact the success of the Company's global operations. In addition, the export
of certain software from the United States is subject to export restrictions as
a result of the encryption technology in such software and may give rise to
liability to the extent the Company violates such restrictions. There can be no
assurance that the Company will be able to successfully market, sell and
distribute its products in foreign markets or that one or more of such factors
will not have a material adverse effect on the Company's future global
operations, and consequently, on the Company's business, results of operations
and financial condition.
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Risks Associated with Acquisitions
The Company may choose to expand its market presence through acquisitions
of complementary businesses. Although no such acquisitions are currently being
negotiated, any future acquisitions would expose the Company to increased risks,
including risks associated with the assimilation of new operations, sites and
personnel, the diversion of resources from the Company's existing businesses,
sites and technologies, the inability to generate revenues from new sites or
content sufficient to offset associated acquisition costs, the maintenance of
uniform standards, controls, procedures and policies and the impairment of
relationships with employees and customers as a result of any integration of new
management personnel. Acquisitions may also result in additional expenses
associated with amortization of acquired intangible assets or potential
businesses. There can be no assurance that the Company would be successful in
overcoming these risks or any other problems encountered in connection with such
acquisitions, and its inability to overcome such risks could have a material
adverse effect on the Company's business, results of operations and financial
condition.
Risk of Noncompletion of a Tax-Free Distribution
The Parent has announced that, subject to certain conditions, following the
Offering, the Parent intends to distribute to its stockholders in 1999 all of
the Common Stock of the Company owned by the Parent. In connection with the
Company's IPO, the Parent received an opinion letter from PricewaterhouseCoopers
LLP to the effect that the Distribution will qualify as a tax-free distribution
for federal income tax purposes under Section 355 of the Internal Revenue Code
of 1986, as amended (the "Code"), and the Distribution is conditional upon
obtaining such an opinion letter in form and substance satisfactory to the
Parent and confirmation of such opinion at the time of Distribution. Although it
does not presently intend to do so, the Parent may also decide, in its sole
discretion, to seek a private letter ruling from the Internal Revenue Service
("IRS") in form and substance satisfactory to the Parent consistent with the
conclusions reached in the PwC Opinion. In that case, the Distribution would
also be conditioned upon receipt of the Letter Ruling. The Parent intends to
take all necessary steps to complete such a tax-free distribution after
obtaining the PwC Opinion and the Letter Ruling, as applicable, but in no event
will the Distribution occur prior to June 7, 1999. If the Parent decides to
apply for the Letter Ruling, the Parent does not plan to distribute its shares
of Common Stock to the Parent's stockholders without such a favorable Letter
Ruling. Due to recent changes in the tax law and other factors, there is no
assurance that the Parent will receive the Letter Ruling, or that it will
receive it within the time frame contemplated, and, consequently, there is no
assurance that the Distribution will occur or will occur within the time frame
contemplated. The Distribution also is subject to the condition that no events
or developments occur that, in the sole judgment of the Parent Board, would or
could result in the Distribution having a material adverse effect on the Parent
or the Parent's stockholders. In addition, as a condition to the Distribution,
the Parent will be required to obtain certain consents from third parties. There
can be no assurance that any of the foregoing conditions, or any other
conditions to the Distribution, will be satisfied, or that the Distribution will
occur in the time frame contemplated or at all. The failure of the Distribution
to occur could materially adversely affect the Company and the market price of
its Common Stock.
Control of the Company; Relationship with the Parent
Prior to its December 1998 initial public offering, the Company was a
wholly-owned, indirect subsidiary of the Parent. The Parent currently owns
approximately 80.1% of the outstanding shares of the Company's Common Stock. As
a result, until the Distribution, the Parent generally will be able to control
all matters requiring approval of the stockholders of the Company, including the
election of all of the Company's directors. The Company's Board of Directors
(the "Board") currently consists of five members, one of whom serves
concurrently as a member of the Parent's Board. The Parent intends to maintain
ownership of at least 80% of the voting power of the Common Stock until the
Distribution can be completed. There can be no assurance that the Parent will
complete the Distribution of the Common Stock held by it to the Parent's
stockholders. If the Distribution is not effected, the Parent could maintain a
controlling interest in the Company indefinitely, which may materially adversely
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affect the Company and the market price of the Common Stock. In addition, for so
long as the Parent maintains a significant interest in the Company, the market
price of the Common Stock may be adversely affected by events relating to the
Parent which are unrelated to the Company. It is the intention of the Parent to
complete the Distribution promptly but in no event prior to June 7, 1999.
Each member of a consolidated group for federal income tax purposes is
jointly and severally liable for the federal income tax liability of each other
member of the consolidated group. For benefit plan purposes, the Company will be
part of the Parent's consolidated group, which includes the Parent and its other
subsidiaries. Under the Employee Retirement Income Security Act of 1974, as
amended, and federal income tax law, each member of the consolidated group is
jointly and severally liable for funding and termination liabilities of tax
qualified defined benefit retirement plans as well as certain plan taxes.
Accordingly, during the period in which the Company is included in the Parent's
consolidated group, the Company could be liable under such provisions in the
event such liability or tax is incurred, and not discharged, by any other member
of the Parent's consolidated group.
Dependence of the Company on the Parent for Certain Services
The Company historically has been dependent upon the Parent for various
services, including administration (accounting, human resources, legal),
Internet/telecom and joint marketing. In December 1998, the Company and the
Parent entered into an agreement under which the Parent will continue to provide
these services to the Company in exchange for fees payable by the Company to the
Parent. The Company and the Parent expect that, as of the Distribution Date, the
Services Agreement will be terminated and the Parent will no longer perform
transactional, administrative and certain other services for the Company. The
Company anticipates that, after the Distribution, it will have to perform such
services internally by Company personnel or engage third parties to perform such
services. The Company believes that it will be able to make the transition to
internal and third party administration and transaction processing without
significant additional expense or disruption of the Company's business; however,
because the Company has historically relied heavily on the Parent for such
services, no assurance can be given that the transition will not cause the
Company to experience interruptions or temporary delays in the Company's
operations and its ability to process customer transactions and ship products on
a timely basis. Any significant unanticipated expenses or delays in connection
with such transition or any disruption in the Company's business or operations
could have a material adverse effect on the Company's business and financial
results.
Intercompany Agreements Not Subject to Arm's-Length Negotiations; Possible
Competition from the Parent; Indemnification Obligations
The Parent and the Company have entered into certain intercompany
agreements, including agreements pursuant to which the Parent will provide
various services, such as administration (accounting, human resources, legal),
Internet/telecom and joint marketing, that are material to the conduct of the
Company's business. Because the Company is a majority-owned, indirect subsidiary
of the Parent, none of these agreements resulted from arm's-length negotiations
and, therefore, there is no assurance that the terms and conditions of such
agreements will be no less favorable to the Company as could be obtained by the
Company from unaffiliated third parties. The Company's intercompany agreements
provide that the Parent, for a period of nine months after the date of the
Distribution, will not compete in the online Internet auction business in
substantially the same manner or format as currently conducted by the Company.
After that period, the Parent will not be prohibited from competing directly or
indirectly with the Company, including by way of acquiring other companies or
businesses, which could have a material adverse effect on the Company's
business, results of operations and financial condition. In addition, the
Company has agreed to indemnify, defend and hold harmless the Parent and each of
the Parent's directors, officers and employees from and against all liabilities
relating to, arising out of or resulting from: (i) the failure of the Company or
any other person to pay, perform or otherwise promptly discharge any liabilities
of the Company in accordance with their respective terms; (ii) any breach by the
Company of any of the intercompany agreements entered into by the parties in
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connection with the Separation and Distribution; and (iii) any untrue statement
or alleged untrue statement of a material fact or omission or alleged omission
to state a material fact required to be stated therein or necessary to make the
statements therein not misleading, with respect to all information contained in
the Prospectus or the Registration Statement used in connection with the
Offering.
Tax Indemnification Obligation; Limitations on Issuances of Equity Securities
Following the Distribution
As a condition to the Parent effecting the Distribution, the Company will
be required to indemnify the Parent for any tax liability suffered by the Parent
arising out of actions by the Company after the Distribution that would cause
the Distribution to lose its qualification as a tax-free distribution or to be
taxable to the Parent for federal income tax purposes under Section 355 of the
Code. For example, Section 355 generally provides that a company that
distributes shares of a subsidiary in a spin-off that is otherwise tax-free will
incur U.S. federal income tax liability if 50% or more, by vote or value, of the
capital stock of either the company making the distribution or the subsidiary is
acquired by one or more persons acting pursuant to a plan or series of related
transactions that include the spin-off. To ensure that issuances of equity
securities by the Company will not cause the Distribution to be taxable to the
Parent, the Tax Indemnification and Allocation Agreement between the Parent and
the Company contains certain restrictions on issuances of equity securities of
the Company and its repurchase of equity securities until three years following
the Distribution Date. Until the second anniversary of the Distribution Date,
the Company cannot issue Common Stock and other equity securities (including the
shares sold in the Offering) that would cause the number of shares of Common
Stock to be distributed by the Parent in the Distribution to constitute less
than 60% of the outstanding shares of Common Stock unless the Company first
obtains either the consent of the Parent or a favorable IRS letter ruling that
the issuance will not affect the tax-free status of the Distribution. After this
period until the end of the third year from the Distribution Date, the Company
cannot issue additional shares of Common Stock and other equity securities that,
when combined with equity securities sold in and after the Offering, would cause
the number of shares of Common Stock to be distributed by the Parent in the
Distribution to constitute less than 55% of the outstanding shares of Common
Stock unless the Company first obtains the consent of the Parent or a favorable
IRS letter or opinion of tax counsel that the issuance would not affect the tax-
free status of the Distribution. These restrictions on the issuance of equity
securities may impede the ability of the Company to raise necessary capital or
to complete acquisitions, if any, using equity securities. The foregoing
prohibitions do not apply to issuances of debt securities of the Company that
are not convertible into Common Stock or other equity securities. The same
requirements for an IRS ruling, consent of the Parent or an opinion of counsel
are applicable to any proposed repurchases of Common Stock during the
Restriction Period. In the event that the Company is required to indemnify and
reimburse the Parent for any tax liability incurred by the Parent arising out of
the Distribution, such indemnification and reimbursement would have a material
adverse effect on the business, results of operations and financial condition of
the Company.
Conflicts of Interest with the Parent
None of the executive officers of the Parent are executive officers of the
Company. However, one member of the Board of Directors of the Company is also a
member of the Parent's Board. In addition, certain executive officers, directors
and employees of the Company hold shares of Parent Common Stock and options to
acquire shares of Parent Common Stock. In particular, Mr. Frank F. Khulusi, a
director of the Company, is the Chairman of the Board of the Parent and
beneficially owned approximately 1.8 million shares of Parent Common Stock
constituting approximately 18% of the issued and outstanding Parent Common Stock
as of May 12, 1999. Accordingly, such individuals may have conflicts of interest
with respect to certain decisions relative to business opportunities and similar
matters that may arise in the ordinary course of the business of the Parent or
the Company, including with respect to relationships between the Parent and the
Company under intercompany agreements and whether to complete the Distribution.
The Company and the Parent intend to resolve such conflicts on a case-by-case
basis. In that regard, certain of the conflicts, if any, could be resolved in a
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manner adverse to the Company and its stockholders, which would have a material
adverse effect on the business, results of operations and financial condition of
the Company.
No Duty to Communicate Corporate Opportunities
Neither the Company nor the Parent has any duty to communicate or offer any
corporate opportunities to the other and may pursue or acquire any such
opportunities for itself or direct such opportunities to any other person. There
can be no assurance that the Parent's failure to communicate any corporate
opportunity to the Company, the Parent's pursuit of such opportunity for itself
or the Parent's communication of such corporate opportunity to a third party
will not have a material adverse affect on the Company's business, results of
operations or financial condition.
Limited Ability to Issue Common Stock Prior to Distribution
In order for the Distribution to be tax-free to the Parent and the Parent's
stockholders, among various other requirements, the Parent must distribute to
the Parent's stockholders on the Distribution Date (a) stock of the Company
possessing at least 80% of the total combined voting power of all classes of
voting stock of the Company and (b) 80% of the total number of shares of each
class of non-voting stock of the Company (the "Required Distribution
Percentage"). If the Parent were not able to distribute to its stockholders
shares of stock of the Company constituting the Required Distribution
Percentage, the Distribution would not be tax-free and would not occur.
Accordingly, the Company agreed in the Separation and Distribution Agreement not
to issue additional shares of Common Stock, or any other class of stock,
including preferred stock, without the consent of the Parent if such issuance
would, or could, dilute or otherwise reduce the Parent's ownership of Common
Stock, or any other such class of stock, below the Required Distribution
Percentage or otherwise prevent the Distribution from receiving tax-free status.
The Separation and Distribution Agreement will terminate if the Distribution
does not occur on or prior to December 31, 1999, unless extended by the Parent
and the Company. Prior to the Distribution Date, these restrictions may impede
the ability of the Company to issue equity securities, including Common Stock,
to raise necessary equity capital or to complete acquisitions using equity
securities, including Common Stock, as acquisition currency, or to attract
qualified persons to become employees, officers and directors of the Company.
Year 2000 Risk
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives. The
problem affects those systems or products that are programmed to accept a two-
digit code in date code fields. To correctly identify the year 2000, a four-
digit date code field will be required to be what is commonly termed "year 2000
compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant. The
potential areas of exposure include electronic data exchange systems operated by
third parties with whom the Company transacts business, certain products
purchased from third parties for resale, and computers, software, telephone
systems and other equipment used internally. To minimize the potential adverse
affects of the year 2000 problem, the Company has established an internal
project team comprised of all functional disciplines. This project team has
begun a three-phase process of identifying internal systems (both information
technology and non-information technology systems) that are not year 2000
compliant, determining their significance in the effective operation of the
Company, and developing plans to resolve the issues where necessary. The Company
has been communicating with the suppliers and others with whom it does business
to coordinate year 2000 readiness. The responses received by the Company to date
have indicated that steps are currently being undertaken to address this
concern. However, if such third parties are not able to make all systems year
2000 compliant, there could be a material adverse impact on the Company.
Initial review of the Company's principal transaction processing software
through which nearly all of the Company's business is transacted has determined
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it to be year 2000 compliant and, as such, the Company does not anticipate any
material adverse operational issues to arise. The Company has completed 75% of
its year 2000 assessment for critical systems and plans to complete its
assessment by the end of the second quarter of 1999. The Company plans to
implement corrective solutions before the end of the third quarter of 1999. To
date, the costs incurred by the Company with respect to this project are
approximately $100,000. Based on current estimates, management expects that the
Company's total costs in connection with its year 2000 compliance project will
be approximately $500,000 and will be financed from general corporate funds;
however, future anticipated costs are difficult to estimate with any certainty
and may differ materially from those currently projected based on the results of
the assessment phase of the Company's year 2000 project. The anticipated costs
associated with the Company's year 2000 compliance program do not include time
and costs that may be incurred as a result of any potential failure of third
parties to become year 2000 compliant or costs to implement the Company's future
contingency plans. Management estimates that approximately one half of the
expected costs will be attributed to the redeployment of internal resources and
the other half will be comprised of external consulting fees and software
upgrades. The redeployment of internal data processing resources is not expected
to materially delay any significant projects.
The Company believes its auction software to be year 2000 compliant;
however, full compliance of the auction software will be verified by an external
consultant no later than the end of the third quarter of 1999. The Company
currently runs various third party applications that require year 2000 updates.
These are available and are expected to be implemented no later than the end of
the third quarter of 1999. The Company has not yet developed a contingency plan
in the event that any non-compliant critical systems are not remedied by January
1, 2000, nor has it formulated a timetable to create such contingency plan. Upon
completion of this project, if systems material to the Company's operations have
not been made year 2000 compliant, or if third parties fail to make their
systems year 2000 compliant in a timely manner, the year 2000 issue could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Possible Volatility of Stock Price
The trading price of the Common Stock has been and is likely to be highly
volatile and could be subject to wide fluctuations in response to factors such
as actual or anticipated variations in the Company's quarterly operating
results, announcements of technological innovations, new services by the Company
or its competitors, changes in financial estimates by securities analysts,
conditions or trends in the Internet and online commerce industries, changes in
the market valuations of other Internet or online service companies,
announcements by the Company or its competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments, additions or
departures of key personnel, sales of Common Stock or other securities of the
Company in the open market and other events or factors, many of which are beyond
the Company's control. In the past, following periods of volatility in the
market price of a company's securities, securities class-action litigation has
often been instituted against such company. Such litigation, if instituted,
could result in substantial costs and a diversion of management's attention and
resources, which would have a material adverse effect on the Company's business,
results of operations and financial condition.
Possibility of Substantial Sales of Common Stock
Subject to applicable law and to the contractual restriction with the
underwriters of the Company's initial public offering as described below, the
Parent may sell any and all of the shares of Common Stock it owns after
completion of the Offering. The Separation and Distribution Agreement provides
that the Parent, and certain holders of more than 5% of Parent Common Stock,
will have the right in certain circumstances to require the Company to use its
best efforts to register for resale shares of Common Stock held by them. The
planned Distribution would involve the distribution of an aggregate of
approximately 7.3 million shares of Common Stock to the stockholders of the
Parent prior to December 31, 1999 (assuming that no shares of Common Stock are
disposed of or acquired by the Parent prior to the Distribution Date). In
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addition, pursuant to the Separation and Distribution Agreement, options to
purchase Parent Common Stock outstanding as of the Distribution Date will be
converted into options to purchase both Parent Common Stock and uBid Common
Stock. Based on the number of outstanding options to purchase Parent Common
Stock and the total shares of Parent Common Stock outstanding as of May 15,
1999, the Company anticipates that it will grant options to purchase
approximately 548,971 shares of the Company's Common Stock in connection with
the Distribution. Of these options, approximately 178,577 will have vested prior
to June 7, 1999 (the earliest date on which the Distribution could occur).
Except for shares held by affiliates of the Company, all of the shares of Common
Stock to be distributed to the Parent's stockholders in the Distribution
(including shares of Common Stock issuable upon exercise of stock options) will
be eligible for immediate resale in the public market. The Company is unable to
predict whether substantial amounts of Common Stock will be sold in the open
market in anticipation of, or following, the Distribution. Any sales of
substantial amounts of Common Stock in the public market, or the perception that
such sales might occur, whether as a result of the Distribution or otherwise,
could materially and adversely affect the market price of the Common Stock. In
connection with the Offering, the Company agreed, for a period of 180 days after
the date of the Offering, and Messrs. Frank and Sam Khulusi agreed, until 180
days after the Distribution, not to offer or sell any shares of Common Stock,
subject to certain exceptions (including the Distribution), without the prior
written consent of Merrill Lynch, Pierce, Fenner & Smith Incorporated.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's financial instruments include cash and government
repurchase agreements at fixed rates. At May 12, 1999, the carrying values of
the Company's financial instruments approximated their fair values based on
current market prices and rates. The Company has not entered into any
derivative financial instruments. The Company does not have any foreign
currency exposure because it does not transact business in foreign currencies.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
---------
The Exhibit Index attached hereto is hereby incorporated by reference
to this Item.
(b) Reports on Form 8-K:
--------------------
No reports on Form 8-K were filed by the Company during the period
covered by this Report.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: May 13, 1999
uBID, INC.
By: /s/ Gregory K. Jones
-----------------------------------------
Gregory K. Jones
Chairman of the Board, President and
Chief Executive Officer (Principal
Executive Officer)
By: /s/ Thomas E. Werner
--------------------------------------------
Thomas E. Werner
Chief Financial Officer (Principal
Financial and Accounting Officer)
30
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- ------- ----------------------
10.3* Tax Indemnification and Allocation Agreement by and between the
Company and Parent, dated as of December 7, 1998, as amended
10.14* Form of Indemnification Agreement, entered into as of February 12,
1999, between the Company and each of its directors and executive
officers
27 Financial Data Schedule (for Commission use only)
___________
* Incorporated by reference to the exhibit with the same number to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1998, on
file with the Securities and Exchange Commission.
31
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UBID
INC. FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 25,909
<SECURITIES> 0
<RECEIVABLES> 482
<ALLOWANCES> 0
<INVENTORY> 7,981
<CURRENT-ASSETS> 34,536
<PP&E> 1,165
<DEPRECIATION> 0
<TOTAL-ASSETS> 35,701
<CURRENT-LIABILITIES> 16,204
<BONDS> 0
0
0
<COMMON> 2
<OTHER-SE> 16,164
<TOTAL-LIABILITY-AND-EQUITY> 35,701
<SALES> 34,314
<TOTAL-REVENUES> 34,314
<CGS> 31,337
<TOTAL-COSTS> 31,337
<OTHER-EXPENSES> 6,530
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,352)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,352)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,352)
<EPS-PRIMARY> (0.37)
<EPS-DILUTED> (0.37)
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