<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
<TABLE>
<S> <C>
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER:
</TABLE>
----------------
UBID, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 33-0775328
(State or other jurisdiction of (I.R.S. Employer
Identification No.) incorporation or organization)
</TABLE>
2525 BUSSE ROAD, ELK GROVE VILLAGE, ILLINOIS 60007
(Address of principal executive offices, including zip code)
(847) 860-5000
(Registrant's telephone number, including area code)
----------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
NONE N/A
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $0.001 par value per share
----------------
Indicate 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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment the
Form 10-K. [X]
As of March 23, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $129,415,000, computed with reference to
the closing price quoted on the Nasdaq National Market on such date. Although
directors, executive officers and 10% stockholders were assumed to be
"affiliates" of the Registrant for purposes of this calculation, the
classification is not to be interpreted as an admission of such status.
As of March 23, 1999, there were 9,146,883 shares of Common Stock ($0.001 par
value) outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the registrant's definitive Proxy Statement for the
1999 Annual Meeting of Stockholders are incorporated by reference into Part
III of this Report.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
UBID, INC. FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PART I
Item 1 Business...................................................... 1
Item 2 Properties.................................................... 36
Item 3 Legal Proceedings............................................. 36
Item 4 Submission of Matters to a Vote of Security Holders........... 36
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 38
Item 6 Selected Financial Data....................................... 39
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 40
Item 7A Quantitative and Qualitative Disclosures About Market Risk.... 45
Item 8 Financial Statements and Supplementary Data................... 45
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 45
PART III
Item 10 Directors and Executive Officers of the Registrant............ 45
Item 11 Executive Compensation........................................ 45
Item 12 Security Ownership of Certain Beneficial Owners and
Management.................................................... 45
Item 13 Certain Relationships and Related Transactions................ 45
PART IV
Item 14 Exhibits, Financial Statements Schedules and Reports on Form
8-K........................................................... 46
Signatures............................................................. 47
Index to Exhibits...................................................... 48
</TABLE>
ii
<PAGE>
FORWARD-LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Annual Report on
Form 10-K that are not historical fact are "forward-looking statements" which
can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should" or "anticipates," or the
negative thereof or other variations thereon or comparable terminology, or by
discussions of strategy that involve risks and uncertainties. Management
cautions the reader that these forward-looking statements, including the
discussions of the Company's growth and operating strategies and expectations
concerning market position, future operations, margins, revenue,
profitability, liquidity and capital resources and other matters contained in
this Annual Report regarding matters that are not historical facts, are not
guarantees of future performance. No assurance can be given that the future
results indicated, whether expressed or implied, will be achieved. While
sometimes presented with numerical specificity, these forward-looking
statements are based upon a variety of assumptions relating to the business of
the Company, which, although considered reasonable by the Company, may not be
realized. Because of the number and range of the assumptions underlying the
Company's projections and forward-looking statements, many of which are
subject to significant uncertainties and contingencies that are beyond the
reasonable control of the Company, some of the assumptions inevitably will not
materialize and unanticipated events and circumstances may occur subsequent to
the date of this Report. The forward-looking statements contained herein are
based on current expectations, and the Company assumes no obligation to update
this information. Therefore, the actual experience of the Company and results
achieved during the period covered by any particular projections or forward-
looking statements may differ substantially from those projected. There can be
no assurance that any of these expectations will be realized or that any of
the forward-looking statements contained herein will prove to be accurate.
Factors that could cause actual results to differ materially from those
discussed in such forward-looking statements include, without limitation,
those discussed under "Investment Considerations" in this Report.
PART I
ITEM 1. BUSINESS
THE COMPANY
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
computer, consumer electronics and 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 December 31, 1998 the Company
auctioned over 278,000 merchandise units, registered over 229,000 users and
recorded more than 17.8 million visits to its Website.
The Company operates in the rapidly growing Internet commerce industry.
Jupiter Communications has estimated that U.S. retail consumer purchases of
goods and services over the Internet will increase from $5 billion in 1998 to
$29.4 billion in 2002. The single largest online retail category in the U.S.
is projected to be computers and consumer electronics (including software),
which is forecasted to grow from $2.4 billion in 1998 to $9.6 billion by the
year 2002. The personal computer and consumer electronics markets are
characterized by significant quantities of excess merchandise due to extremely
short product life cycles and the prevalence of returned items through the
consumer retail channel. Because of the highly fragmented and relatively
undeveloped liquidator channel, prices received by vendors for excess goods
tend to be highly variable. The Company estimates that the value of such
products exceeded $4 billion in 1998 in the U.S. alone.
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
1
<PAGE>
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.
Approximately 90% of the products shipped from the Company's warehouse are
shipped the next business day after an auction closes. 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. Repeat customers accounted
for approximately 69% of customer orders for the three months ended December
31, 1998.
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.
Specifically, the Company intends to increase points of access by establishing
relationships with other on line companies similar to its existing
relationships with AOL, CNET, Wired Digital, MSN/LinkExchange, PCWorld Online
and LookSmart.
The Company obtains merchandise directly from computer, consumer electronics
and home and leisure products manufacturers and indirectly through other
vendors, such as retailers, distributors and Fortune 1000 companies.
Currently, this merchandise is sourced from over 150 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.
uBid's business was established by Creative Computers, Inc. (the "Parent")
in April 1997 and the Company was incorporated in Delaware on September 19,
1997 as a wholly-owned 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 March 23, 1999, the Parent owned
approximately 80.1% of the outstanding shares of Common Stock of the Company.
The Company's executive offices are located at 2525 Busse Road, Elk Grove
Village, Illinois 60007, and its telephone number at such location is (847)
860-5000.
INDUSTRY BACKGROUND
Growth of the Internet and the Web
The Internet and the Web are experiencing dramatic growth in terms of the
number of Web users. International Data Corporation ("IDC") has estimated that
at the end of 1998 there were over 51 million Web users in the United States
and that by the end of 2002 the number of Web users in the United States will
increase to over 135 million. The growth in the number of Web users and the
amount of time users spend on the Web is being driven by the increasing
importance of the Internet as a communications medium and an information
resource and a sales and distribution channel.
2
<PAGE>
Growth of Online Commerce
The Internet is dramatically affecting the methods by which consumers and
businesses are buying and selling goods and services. The Web provides online
merchants with the ability to reach a global audience and to operate with
minimal infrastructure, reduced overhead and greater economies of scale, while
providing consumers and businesses with a broad selection, increased pricing
power and unparalleled convenience. As a result, a growing number of parties
are transacting business on the Web, including trading securities, buying
consumer goods, paying bills and purchasing airline tickets. In addition, IDC
has estimated that the percentage of U.S. Internet users buying goods and
services on the Internet is projected to grow from approximately 28% in
December 1998 to 40% in December 2002. Additionally, Jupiter Communications
has estimated that U.S. retail consumer purchases of goods and services over
the Internet will increase from $5 billion in 1998 to $29.4 billion in 2002.
The single largest online retail category is projected to be computers and
consumer electronics (including software), which is forecasted to grow from
$2.4 billion in 1998 to $9.6 billion by the year 2002 in the U.S. alone.
Market for Excess Computer Products and Consumer Electronics
Each year, vendors of computer products and consumer electronics, including
manufacturers, distributors, resellers and retailers, dispose of significant
volumes of excess merchandise, including close-out and refurbished
merchandise. Close-out merchandise includes overstocked or slow-moving new
products that have or will shortly become previous generation, typically due
to a change in selling seasons or the introduction of next generation software
or hardware. Refurbished products include products returned by the consumer to
the retailer or manufacturer. Refurbished products typically require a nominal
amount of service, such as minor repairs, cleaning and repackaging, and
installation of current versions of leading software prior to being sold as
refurbished goods.
The disposal of excess goods represents a substantial burden on many
vendors. Excess goods are currently sold through auction houses, catalogs,
company stores or "outlets," resellers and specialized retailers, as well as
large superstores and mass merchants that are not committed to the resale of
these goods and generally sell them as a supplementary product line or "loss
leader." Prices received by vendors for excess goods tend to be highly
variable and subject to negotiation based on quantity, age and condition of
the merchandise. In addition, since vendors lack control over product
placement these sales channels may compete with the vendor's more profitable,
primary sales channels.
The personal computer and consumer electronics markets are characterized by
significant quantities of close-out and refurbished merchandise due to
extremely short product life cycles and the prevalence of returned items
through the consumer retail channel. The U.S. end market for computer hardware
and peripherals is estimated by IDC to grow from approximately $86.3 billion
in 1997 to approximately $112.7 billion in 2001. According to IDC, in the
United States, the total market for personal computers alone was estimated to
be greater than $70 billion in 1997. The Company estimates that the portion of
this market that became close-out and refurbished goods exceeded $4 billion in
1997 in the U.S. alone. Jupiter Communications has estimated that the number
of on-line auction purchasers in the U.S. will grow from 1.2 million in 1998
to 6.5 million in 2002 and that business to consumer auctions will sell $3.2
billion in merchandise and services in 2002.
The Company believes that vendors will look favorably upon a distribution
channel that enables them to dispose of significant quantities of merchandise
quickly and at the best prices possible, without affecting their traditional
sales channels.
THE UBID SOLUTION
The Company believes that its online marketplace represents an exciting
sales format for users that leverages the interactive nature of the Internet.
The Company's Internet auctions provide vendors with an efficient and
economical channel for disposing of excess merchandise and provide consumers
and small and medium-sized businesses with a convenient method for obtaining
such products at substantial savings.
3
<PAGE>
VENDOR BENEFITS. The Company's online auctions provide manufacturers with 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. In addition, online sales allow vendors to
liquidate excess merchandise directly to a nationwide audience, without
cannibalizing their primary distribution channels.
CUSTOMER BENEFITS. 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. With an average of
over 1,000 total items available in each auction, the Company's broad
selection of goods also sells at significant discounts to prices found at
traditional retailers. 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.
BUSINESS STRATEGY
The Company's objective is to become the Internet auction site of choice for
vendors and consumers. The Company intends to achieve this objective by
pursuing the following key strategies:
. INCREASE BRAND AWARENESS. The Company operates in a market in which a
strong brand is critical to differentiating itself and attracting a high
level of vendor awareness and customer traffic. Accordingly, the
Company's strategy is to aggressively increase its visibility and brand
recognition through a variety of marketing and promotional techniques.
Specifically, the Company intends to increase points of access by forming
relationships with, and advertising on, leading Websites, such as the
Company's existing arrangements with AOL, CNET, Wired Digital,
MSN/LinkExchange, PCWorld Online and LookSmart. Premier positioning on
these sites not only drives traffic, but also gives uBid credibility to
users and vendors who are unfamiliar with the Company. The Company also
reinforces the uBid brand in users' minds by employing consistent
branding from the design of its Website to the use of distinctive uBid
packaging.
. PROMOTE REPEAT VISITS. The Company has designed its Website to encourage
repeat visits by customers and potential customers, since each return
visit represents another selling opportunity for uBid. The Company
believes that its auction format and Website encourage bidders to return
on a frequent basis to determine the status of their bids relative to
others and ultimately to find out if they've won their bids for
merchandise. The regular rotation of merchandise also encourages
customers to revisit the site frequently. In addition, the Company
believes that its "My Page" feature, which allows a customer to track his
or her complete bidding history and quickly update customer information,
increases user loyalty. Repeat customers accounted for approximately 69%
of customer orders for the three months ended December 31, 1998.
. OFFER A SUPERIOR CUSTOMER EXPERIENCE. 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. Every order is tracked at each step in the
process, from order placement to shipment. As a result of uBid's strict
inventory and shipping standards, approximately 90% of products shipped
from the Company's warehouse are shipped the next business day after an
auction closes, compared to competitors who take up to three weeks to
ship products from a variety of third-party sites across the country.
Because the Company believes that customer support is an essential
component of the shopping experience and leads to increased customer
loyalty, uBid has established multiple channels for communicating with
its customers before and after the sale, including telephone, e-mail and
online support. In addition, the Company's automated systems continually
monitor and measure its customer service response times to ensure user
satisfaction.
4
<PAGE>
. Continue to Employ Sophisticated Merchandising Techniques. The Company'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 auction
management model allows the Company to forecast the number of visitors
that will be derived from the Company's marketing and advertising efforts
and to maximize the flow of these visitors to the site. Additionally, the
model allows the Company to capture detailed information concerning
where, when, how and to whom product is sold and shipped, helping the
Company to predict customer preferences going forward. The auction
merchandising model allows the Company to maximize revenues on products
put into auction, by using a sophisticated statistical software package
to project the price at which each product will ultimately be sold to
consumers based on current traffic and demand, and by determining what
price to purchase products from over 150 vendors, the product mix, the
number of products the Company should auction on a given day to enable it
to maximize its margins, and the appropriate "add-on" and straight-sale
merchandising opportunities.
. Develop New Revenue Opportunities. The Company believes that significant
opportunities exist to develop new revenue opportunities by expanding its
lines of merchandise. Specifically, the Company expects to expand its
product mix by partnering with market leaders in various categories that
are well suited for the Company's online auction format. Although the
Company has focused primarily on the sale of computer products in an
effort to target and attract the "early adopters," as the Internet grows
and develops, the Company believes a broad array of categories of
merchandise can be sold effectively through its online auction format,
including any overstock products, limited source products and commodity-
type products for which pricing is highly competitive. In particular, the
Company has recently begun selling sporting goods and memorabilia, and
housewares, including kitchen appliances, vacuum cleaners, personal care
devices, furniture, gifts, photography, jewelry and sunglasses, and plans
to begin offering several categories of fine jewelry in the second
quarter of 1999.
. Increase Revenue Sharing Arrangements with Vendors. In order to reduce
the level of principal risk when the Company purchases products from
vendors for resale, the Company has entered into a number of revenue
sharing arrangements with vendors to split the sales proceeds on an
agreed-upon percentage basis. The Company believes these revenue sharing
arrangements provide margin upside for the vendors while also
guaranteeing gross margin percentage for the Company. As of December 31,
1998, the Company had entered into over 40 of these revenue sharing
agreements with vendors and expects to increase the number over time.
The uBid Auction
The Company has designed its attractive, fast, and easy-to-use Website to
provide a compelling shopping experience for the user through an interactive
auction format. Customers enter the auction at the uBid home page, which
displays a list of product categories and sub-categories and showcases the
auction's "best deals." Within a specific sub-category, uBid auctions a number
of identical items at the same time. The minimum opening bid for each item is
generally $7. The product page for each item features a concise product
description, full-color image, and detailed technical specifications. In
addition, a table lists the quantity available, the bid range, the minimum
incremental bid, the current winning bidders and the amount of their bids and
the time of auction close.
To participate in the auction, a first-time bidder must complete the simple
electronic registration form found on the Website. The bidder is then given an
identification number and chooses a password. Once registered, the customer
can bid and buy at will in the same or future auctions. After a customer bids
on a product, the corresponding bidder list is instantly updated to reflect
the bid and the customer's new position in the list of bidders. At the
customer's option, he or she may elect to receive an e-mail when outbid or to
use agent bidding to automatically increase the bid to a predetermined maximum
dollar amount. These functions increase the likelihood that the user will
place an additional bid.
When the auction closes, the highest bidders win the available inventory at
their actual bid prices. Each winning bidder may pay a price that is different
from the prices paid by other winning bidders. When bidders'
5
<PAGE>
prices are equal, bids for larger quantities and with earlier initial bid
times prevail. Using its proprietary software, uBid automatically determines
the winning bidders and sends an e-mail message to confirm their purchases the
same day. After being screened by the Company's anti-fraud software, the
customer's credit card is charged and the merchandise is shipped.
uBid Auction Community. In March 1999, the Company introduced the uBid
Auction Community(TM), which allows vendors to place products directly on the
uBid Website for auction. The Auction Community provides approved suppliers
access to the site directly, allowing them to benefit from the uBid
infrastructure, including the Company's marketing resources, call center
operations, credit card processing and auction software. Upon sale, the
Company processes the credit card transaction and receives a commission from
the sale, and the supplier ships the products directly to the customer. The
Company believes that the Auction Community will increase the number of
products offered on its Website and expand the number of vendors offering
products for auction.
Products and Merchandising
The Company offers on the average over 1,000 total items in each of its
auctions. Currently, the merchandise consists primarily of computers, consumer
electronics and housewares and 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. For the
quarter ended December 31, 1998, the product mix based on revenues consisted
of approximately 40% new merchandise and 60% refurbished products. This mix
can fluctuate from quarter to quarter depending on the type of products most
available for purchase at acceptable prices. Regardless of the source of the
merchandise, most merchandise sold by the Company is warranted by the
manufacturer or refurbisher. The customer may purchase an extended warranty
provided by a third party, Independent Dealer Services, Inc., in those states
where such third-party warranties are permitted by law. The Company believes
that this extended warranty combined with the Company's emphasis on customer
service provide it with an advantage over its competitors, which generally
rely solely on the warranties provided by the vendor.
The Company currently offers merchandise in the following categories:
Computer Products: Desktops, portable computers, computer accessories, disk
drives, modems, monitors/video equipment, components, printers, scanners,
digital cameras, software and home office products.
Consumer Electronics: Home theater equipment, home audio equipment,
speakers, televisions, camcorders, VCRs, DVD players, portable audio players
and automobile audio equipment.
Housewares: Kitchen appliances, vacuum cleaners, personal care devices,
furniture, gifts, photography, jewelry and sunglasses.
Sports and Recreation: Sports memorabilia, golf and tennis, health and
fitness, outdoor sports, bicycles, water sports, and team sports equipment.
In March 1999, the Company announced the addition of a fine jewelry
category, along with an alliance with D.G. Jewelry Canada Ltd. This new
category will cover a broad range of jewelry, including rings, earrings,
watches, bracelets and loose stones.
Vendor Relationships
The Company obtains merchandise directly from computer and electronics
manufacturers and indirectly through other vendors, such as retailers,
distributors and Fortune 1000 companies. Currently, this merchandise is
sourced from over 150 vendors. The Company believes that it has substantial
access to additional sources of excess merchandise and is in a position to
leverage its existing relationships and add new vendors to increase the
breadth and number of products offered. Since merchandise availability can be
unpredictable, a strong base of vendor relationships is important to the
Company's success. See "Investment Considerations--Reliance on Merchandise
Vendors." As a result, the Company's buying staff maintains ongoing contact
with its vendors to learn when new merchandise becomes available. The
percentage of the Company's revenues attributable to sales of products sourced
from the Parent has declined from over 90% in the first two months of
operations to less than 10% in 1998.
6
<PAGE>
The Company directly purchases most of its products and holds them for
resale. By purchasing merchandise, the Company assumes the full inventory and
price risk involved in selling such merchandise. The Company believes its
ability to sell its inventory quickly through its auctions justifies the cost
of and risk involved in carrying inventory. The Company attempts to minimize
its exposure to inventory and price risk through its auction management model
that employs a sophisticated statistical software package to project the price
at which each product will ultimately be sold to consumers based on current
traffic and demand, and by determining at which price to purchase products
from vendors. In the event the Company is left with excess inventory, the
Company seeks to immediately dispose of such inventory through its auction
site. To date, the Company's exposure to excess inventory has not been
material. See "Investment Consideration--Risks of a Purchased Inventory
Model."
REVENUE SHARING. The Company also has entered into revenue sharing
arrangements with several vendors to split the sales proceeds on an agreed-
upon percentage basis. The Company believes these revenue sharing arrangements
are attractive to vendors because it allows the vendor to potentially realize
more revenue than in the case where the Company purchases the merchandise for
a fixed price. The Company's avoidance of any inventory risk, unlimited margin
upside for the vendors and guaranteed gross margin percentage for the Company
make revenue sharing agreements an attractive arrangement to both the Company
and vendors. As of December 31, 1998, the Company had entered into over 40 of
these revenue sharing agreements with vendors. Such agreements represented
slightly under 4% of the Company's revenue for the quarter ended December 31,
1998. The Company believes that the percentage of its revenues represented by
revenue sharing arrangements will continue to increase over the next 12
months.
SALES AND MARKETING
The Company sells to consumers and small and medium-sized businesses. To
achieve its objective of becoming the Internet auction site of choice for
vendors and consumers, the Company has developed a marketing strategy in order
to strengthen its brand name and increase customer traffic to its Website.
This marketing strategy consists of establishing relationships with leading
online companies, as well as employing a mix of media and promotional
activities to achieve these goals.
RELATIONSHIPS WITH LEADING ONLINE COMPANIES. uBid has established
relationships with a number of Internet service and content providers to
increase its access to online customers and to build brand recognition. The
Company intends to complement its existing relationships and establish a
leading brand name by pursuing additional agreements. See "Investment
Consolidations--Reliance on Relationships with Online Companies."
Representative relationships include:
. AOL. This relationship provides access to AOL's members through a premier
button (a fixed icon displaying the uBid logo, visible on the computer
screen without using the scroll button, which provides a direct link to
the Company's Website) in the Auction and Outlets and Computer Hardware
departments of AOL's Shopping Channel. Additionally, uBid's promotional
banners (rectangular graphic advertisements) rotate throughout the AOL
Shopping Channel.
. CNET. uBid has a rotating position on the home page of Computers.com,
CNET's computer channel designed to provide consumers with pertinent news
and advice in purchasing computer hardware and software.
. WIRED DIGITAL. uBid is a featured sponsor on the Computer Hardware
Channel of Wired's HotBot Shopping Directory. The Company receives
premier positioning within the Computer Hardware Channel along with a
link to its Website on the Directory home page under the Computer
Hardware listing. uBid also has promotional links within each of the
Auctions, Computer Software and Small Business Needs Channels, along with
banner ads circulating throughout the entire HotBot Shopping Directory.
. MSN/LINKEXCHANGE. uBid is the premier auction sponsor on the
MSN/LinkExchange network. The Company receives a text link on the
homepage of the MSN/LinkExchange member site as well as banner ads
circulating throughout the entire MSN/LinkExchange network.
7
<PAGE>
. PCWORLD ONLINE. uBid is the premier auction sponsor in the PCWorld Online
website. The Company receives a non-rotating banner within the "Where To
Shop" block, access to the "TipWorld" e-mail list and banner ads
circulating throughout the entire PCWorld Online website.
. LOOKSMART. uBid is the exclusive co-branded auction partner for
LookSmart. The Company receives keyword banner ads, category banner ads,
and a homepage link, as well as banner ads circulating throughout the
entire LookSmart website.
INTERNET ADVERTISING. The Company has taken a disciplined and selective
approach in its advertising strategy that primarily considers the costs of
customer acquisition. The Company attempts to maximize the return from
promotional expenditures by choosing advertising media based on the cost
relative to the likely audience and ability to generate increased traffic for
the Company's Website. The Company places advertisements on various high-
profile and high-traffic conduit Websites, including AOL, CNET, Excite, Yahoo!
and others, as well as Websites that are targeted at a more focused audience.
These advertisements usually take the form of banner ads that encourage
readers to click through directly to the Company's Website. In addition, the
Company and the Parent have reciprocal links on their Websites.
CUSTOMER ELECTRONIC MAIL BROADCASTS. The Company actively markets to its own
base of customers through e-mail broadcasts. All bidders in the Company's
auctions are automatically added to the Company's electronic mailing list,
which numbered over 229,000 registrants through December 31, 1998. The Company
currently sends more than 2 million e-mail messages each month announcing new
items available at each auction, special products available, site changes and
new features. The Company has a strict policy of sending only solicited e-
mail, and a customer can remove his or her name from the Company's mailing
list at any time.
ORDER FULFILLMENT
The Company obtains products from its vendor network shortly before the
products are put into auction. Although most products are held in inventory at
the Company's distribution facility, in the case of refurbished products, the
products may be held at the refurbisher's facility and shipped directly to the
customer. In addition, certain vendors drop-ship products directly to
customers. However, the refurbisher is required to use uBid labeling and
packaging standards and transmit shipment information to the Company to
provide a uniform customer experience.
The product fulfillment process, from receipt of products through shipment,
is largely automated, enabling the Company to capture real-time data on
inventory receiving, shipping and stock levels. Approximately 90% of the
products shipped from the Company's warehouse are shipped the next business
day after an auction closes, and the Company's tight shipping controls have
historically kept shipping errors at negligible levels. The Company believes
that the speed and accuracy of its order fulfillment process reinforces and
enhances its customers' total purchase experience.
Pursuant to the Company's exclusive agreement with the Parent, the Company
has contracted its distribution functions to the Parent utilizing the Parent's
fully developed distribution infrastructure which, in 1997, was responsible
for the distribution of over one million orders of computer-related products.
In July 1998, the Company entered into a sublease currently covering 100,000
square feet of the Parent's 325,000 square foot distribution center in
Memphis, Tennessee. The sublease also provides for the Company's continued use
of the Parent's sophisticated inventory control and shipping systems during
the term of the sublease. This distribution arrangement enables uBid to
provide distribution services, which the Company believes far exceed that of
the competition, who generally rely upon contract warehouses for the bulk of
their fulfillment and logistics requirements.
CUSTOMER SUPPORT AND SERVICE
The Company believes that its ability to establish and maintain long-term
relationships with its customers and encourage repeat visits and purchases is
dependent, in part, on the strength of its customer support and
8
<PAGE>
service operations and staff. In contrast to most of the Company's
competitors, uBid has established multiple channels for communicating with its
customers before and after the sale, including phone, e-mail and online
support. The Company currently employs a staff of customer support and service
personnel who are responsible for handling customer inquiries, tracking
shipments and investigating problems with merchandise. While merchandise sold
by the Company is sold on an "as is" basis, products may be covered by
manufacturers' warranties or third party warranties purchased by the customer.
The Company, though not obligated to do so, may in specific instances accept
merchandise returns if a product is defective or does not conform to the
specifications of the item sold at auction, and attempts to work with its
customers to resolve complaints about merchandise. In addition, the Company
has automated certain of its customer service functions, including providing
users of the Website with online access to information such as product
shipping status. The Company is committed to continue enhancing its customer
support and service operations, through a variety of measures including
improved customer reporting systems. See "Investment Considerations--Reliance
on Merchandise Vendors" and "--Management of Potential Growth; New Management
Team."
TECHNOLOGY
The Company has implemented a broad array of customer support, transaction-
processing and fulfillment systems using a combination of both proprietary and
commercially available, licensed technologies. These systems are designed to
make both the customer experience and the transaction reporting and tracking
process as seamless and simple as possible, with an emphasis on speed. The
Company's hardware and software systems are designed to integrate seamlessly
and manage real-time transactions with limited human intervention. The
Company's current strategy is to license commercially available technology
wherever possible rather than seek internally-developed solutions and to focus
its internal software development efforts on creating and enhancing the
specialized, proprietary software that is unique to its business. The
Company's auction processing and auction management applications discussed
below are jointly owned, in perpetuity, by the Parent and the third-party
developers of the software pursuant to agreements between the Parent and such
third-party developers. The agreements provide that the Parent and the third-
party developers of the software jointly own all patent, copyright and other
proprietary rights with respect to the Company's auction processing and
auction management applications and certain general purpose libraries (used
for general website and Java software development) which have been developed
by the third-party developers and are used with the auction processing and
auction management applications. The agreements provide that the Parent and
the third-party developers of the software jointly own all patent, copyright
and other proprietary rights with respect to the initial auction processing
and auction management applications software platform developed for the Parent
by the third-party developers (the "Original Auction Software") and certain
general purpose libraries (used for general website and Java software
development) (the "Libraries") used with the Original Auction Software. The
three agreements material to the Company's ownership rights in externally
developed software are the agreements with each of the two co-developers of
the Original Auction Software (one of which is David L. Matthews, the
Company's Director of Applications Development) and an Assignment and License
Agreement between the Parent and the Company. Under the first two agreements
with the co-developers of the Original Auction Software, such individuals have
granted the Parent (i) joint ownership rights in the Original Auction
Software, related work product and the Libraries developed by them prior to
December 1997 and (ii) in the case of Mr. Matthews, sole ownership rights to
the software and related work product developed for the Parent beginning in
December 1997. Under the Assignment and License Agreement with the Parent, the
Parent has assigned to the Company all of its right, title and interest in the
copyrights in (i) the Original Auction Software and Libraries covered by the
third-party developer agreements described above and (ii) the on-line auction
software developed by the Parent's employees for the Company, which consist
primarily of interfaces with existing distribution, credit processing and
other administrative systems. Under the Assignment and License Agreement, the
Company has granted to the Parent a perpetual, non-exclusive, transferable,
royalty-free license to those portions of the assigned software that are not
specific to the operation of the Company's current on-line auction system.
As co-owners of the Original Auction Software and the 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
9
<PAGE>
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 being assigned to the Company under an Assignment and License
Agreement with 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.
Substantial modifications and enhancements to the Company's Original Auction
Software and Libraries have been made by employees of the Parent and the
Company on a work-for-hire basis and are the property of the Company.
AUCTION PROCESSING AND AUCTION MANAGEMENT APPLICATIONS. The Company uses a
set of automated software applications for receiving and validating bids,
registering bidders, placing customers on the Company's mailing list, listing
currently active and recent winning and losing bids and reviewing and
submitting customer service requests. The Company's internally developed
proprietary auction management software continually tracks every bid posted on
all auctions and utilizes regression analysis to assist the Company in
determining the number of products to auction at any given time. The Company
believes that this system enables it to maximize margins in each product
category.
ORDER PROCESSING APPLICATIONS. The Company uses a set of applications for
processing successful bids as they are converted into customer orders. These
applications charge customer credit cards, print order information, transmit
order information electronically to the Company's contract warehouse and
vendors, and deposit transaction information into the Company's accounting
system. All credit card numbers and financial and credit information are
secured using the Internet security protocol Secure Socket Layer, Version 3,
an encryption standard, and credit card numbers are maintained behind
appropriate fire walls.
MARKETING APPLICATIONS. The Company has developed a set of applications for
sending automated broadcast e-mails to customers on a frequent basis. This
software extracts e-mail addresses from the Company's mailing list, sends e-
mails to the designated recipients and automatically services requests from
customers to remove them from the mailing list.
SYSTEMS OPERATIONS
The continued uninterrupted operation of the Company's Website is critical
to its business, and the Company strives to maximize uptime of the Website.
The Company uses the services of Pacific Bell and other Internet service
providers to provide connectivity to the Internet over a dedicated DS-3 line.
IDT Corporation provides Internet traffic and data routing services to the
Company as well as e-mail services. MCI provides frame relay services for the
Company's back office operations. The Company believes that these
telecommunication and Internet service facilities are essential to the
Company's operation. The Pacific Bell, IDT Corporation and MCI Internet
access, traffic, data routing and e-mail services and frame relay services are
provided by such parties through agreements with the Parent and are made
available to the Company under the Internet/Telecommunications Agreement with
the Parent. See "Investment Considerations--Management of Potential Growth;
New Management Team," "--Risk of System Failure; Single Site" and
"Transactions between the Company and the Parent--Internet/Telecommunications
Agreement."
The Company's hardware and software systems run in parallel on multiple
servers, which allows the system to balance the workload among the servers.
The system also includes redundant hardware on mission critical components,
which the Company believes would enable it to survive a potential failure of
any server with minimal downtime. In addition, capacity can be quickly and
easily expanded by adding additional servers, without incurring significant
development costs. In particular, the Company strives to maintain access to
its Website and speed of use during the most heavily trafficked times of day--
the evening hours around the time scheduled for auction close. In order to do
this, the Company anticipates expanding its system as usage increases to avoid
any decrease in system response time. The Company pays the Parent for use of
hardware systems that are located in Torrance, California. In December 1998,
the Company and the Parent entered into an agreement
10
<PAGE>
pursuant to which the Parent will continue to provide the Company with certain
Internet and telecommunications services, including the related hardware
systems. In March 1999, the Company entered into an agreement with a leading
hosting provider to co-locate the Company's servers and to develop a mirrored
site location. Although the Company anticipates continuing to use the Parent's
hardware systems for the near term, the Company intends to purchase its own
hardware and software systems, by the end of 1999, at an estimated cost of
approximately $500,000. The Company expects to fund its purchase of such
capital equipment with working capital (including the proceeds from the
Offering). See "Transactions between the Company and the Parent--
Internet/Telecommunications Agreement."
Insurance Coverage
Through the date of the Distribution (as defined under "Separation from the
Parent" below), the Company will be covered by the insurance policies
maintained by the Parent. As of December 31, 1998, the Parent maintained,
among other types of coverage, a commercial liability policy with an aggregate
limit of $27 million, including a $25 million umbrella policy, and a transit
cargo policy with a limit of $1.5 million, a workers compensation policy with
a limit of $1 million and blanket crime coverage with a limit of $2 million.
Following the Distribution, the Company will be required to obtain its own
insurance.
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 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 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 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. Although the Company believes that it currently competes
favorably with respect to such factors, 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
11
<PAGE>
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. See
"Investment Considerations--Competition."
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
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
uBidSM 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 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 technologies that it licenses from
third parties, including its database and Internet server software, which is
used in the Company's Website to perform key functions. 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 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
12
<PAGE>
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. See
"Investment Considerations--Protection of Intellectual Property."
EMPLOYEES
As of December 31, 1998, the Company had 74 employees and 35 full-time
equivalent contract personnel. None of the Company's employees is represented
by a labor union, and the Company considers its employee relations to be good.
Competition for qualified personnel in the Company's industry is intense,
particularly for software development and other technical staff. The Company
believes that its future success will depend in part on its continued ability
to attract, hire and retain qualified personnel. See "Investment
Considerations--Management of Potential Growth; New Management Team" and "--
Dependence on Key Personnel; Need for Additional Personnel."
SEPARATION FROM THE PARENT
Background of the Separation and Distribution. 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. These agreements (the "Ancillary Agreements") are discussed in
"Transactions between the Company and the Parent" below. The Parent currently
owns approximately 80.1% of the outstanding Common Stock of the Company.
The Company and the Parent believe that the Separation and the Distribution
will enhance the Company's ability to implement its growth and operating
strategies. The Company believes that its future growth would be enhanced if
its management were compensated on a separate basis from the Parent.
Similarly, the Parent believes that its future growth would be enhanced if
management of its remaining business segments were more focused on such
segments without also being responsible for the online auction segment.
Finally, upon completion of the Distribution, holders of Parent Common Stock
as of the record date for the Distribution will be entitled to receive a
dividend of uBid Common Stock without the payment of further consideration,
although the Parent expects the market value of shares of Parent Common Stock
to diminish upon effecting the Distribution to reflect the value (per share of
Parent Common Stock) of the shares of uBid Common Stock distributed by the
Parent. The consummation of the Distribution will also remove current
restrictions on the Company's growth as a result of certain contractual
restrictions of the Parent that are applicable to the Parent and its
subsidiaries. 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.
Conditions to the Distribution. In connection with the Company's IPO, the
Parent received the opinion of PricewaterhouseCoopers LLP (the "PwC Opinion")
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 will not result in recognition of any
gain or loss for federal income tax purposes to the Parent, the Company, or
the Parent's or the Company's respective stockholders. The Parent may, but
13
<PAGE>
presently does not intend to, apply for a private letter ruling ("Letter
Ruling") from the Internal Revenue Service. In accordance with the Separation
and Distribution Agreement, completion of the Distribution will be subject to
the satisfaction, or waiver by the Board of Directors of the Parent (the
"Parent Board"), of the following conditions: (i) the PwC Opinion shall have
been obtained, in form and substance satisfactory to the Parent, and be
confirmed at the time of Distribution; (ii) if the Parent decides to seek a
Letter Ruling, the Letter Ruling shall have been obtained and remain effective
consistent with the conclusions reached in the PwC Opinion, and such ruling
shall be in form and substance satisfactory to the Parent, in its sole
discretion; (iii) any material Governmental Approvals and Consents (as such
terms are defined in the Separation and Distribution Agreement) necessary to
consummate the Distribution shall have been obtained and shall be in full
force and effect; (iv) no order, injunction or decree issued by any court or
agency of competent jurisdiction or other legal restraint or prohibition
preventing the consummation of the Distribution shall be in effect, and no
other event outside the control of the Parent shall have occurred or failed to
occur that prevents the consummation of the Distribution; and (v) no other
events or developments shall have occurred subsequent to the closing of the
Offering that, in the judgment of the Parent Board, would result in the
Distribution having a material adverse effect on the Parent or on the
stockholders of the Parent. The Parent Board will have the sole discretion to
set the Distribution for any time commencing after June 7, 1999. The Parent
has agreed to consummate the Distribution, subject to the satisfaction of the
conditions set forth above. The Parent may terminate the obligation to
consummate the Distribution if the Distribution has not occurred by December
31, 1999, unless extended by the Parent and the Company. In addition, the
Separation and Distribution Agreement may be amended or terminated at any time
prior to the Distribution Date by the mutual consent of the Company and the
Parent. See "Investment Considerations--Risk of Noncompletion of a Tax-Free
Distribution" and "Transactions between the Company and the Parent."
TRANSACTIONS BETWEEN THE COMPANY AND THE PARENT
HISTORICAL INTERCOMPANY RELATIONSHIPS
Prior to the Offering, the Company was a wholly-owned, indirect subsidiary
of the Parent. As a wholly-owned subsidiary, the Company received various
services provided by the Parent, including administration (accounting, human
resources, legal), warehousing and distribution (through June 1998),
Internet/telecom and joint marketing. The Parent has also provided the Company
with the services of a number of its executives and employees. In
consideration for these services, the Parent historically allocated a portion
of its overhead costs related to such services to the Company. Management of
the Company believes that the amounts allocated to the Company have been no
less favorable to the Company than the expenses the Company would have
incurred to obtain such services on its own or from unaffiliated third
parties. None of these services were provided to the Company pursuant to any
written agreement between the Company and the Parent.
SEPARATION AND DISTRIBUTION AGREEMENT
The Separation and Distribution Agreement entered into between the Company
and the Parent sets forth certain agreements among the Company and the Parent,
with respect to the principal corporate transactions required to effect the
Separation, the Offering and the Distribution, and certain other agreements
governing the relationship among the parties thereafter.
The Distribution. The Separation and Distribution Agreement provides that,
subject to the terms and conditions thereof, the Parent and the Company will
take all reasonable steps necessary and appropriate to cause all conditions to
the Distribution to be satisfied and to effect the Distribution. The Parent
Board will have the sole discretion to set the date of the distribution (the
"Distribution Date") for any date after June 7, 1999 and ending on or prior to
December 31, 1999. The Parent has agreed to consummate the Distribution
promptly but in no event prior to June 7, 1999, subject to the satisfaction or
waiver by the Parent Board of the conditions described under "Separation from
the Parent--Conditions to the Distribution" above.
The Company and the Parent have agreed that none of the parties will take,
or permit any of its affiliates to take, any action which reasonably could be
expected to prevent the Distribution from qualifying as a tax-free
14
<PAGE>
distribution to the Parent and the Parent's stockholders pursuant to Section
355 of the Code. The parties have also agreed to take any reasonable actions
necessary in order for the Distribution to qualify as a tax-free distribution
to the Parent and the Parent's stockholders pursuant to Section 355 of the
Code. Without limiting the foregoing, prior to the Distribution Date, the
Company will not issue or grant, directly or indirectly, any shares of its
capital stock or any rights, warrants, options or other securities to purchase
or acquire (whether upon conversion, exchange or otherwise) any shares of its
capital stock (whether or not then exercisable, convertible or exchangeable)
that would affect the tax-free nature of the Distribution.
Registration Rights. The Separation and Distribution Agreement provides that
the Parent, and Messrs. Frank and Sam Khulusi, holders of approximately 18%
and 19%, respectively of Parent Common Stock, will have the right in certain
circumstances, but in no event prior to June 7, 1999 (in the case of the
Parent) and 180 days after the Distribution (in the case of Messrs. Frank and
Sam Khulusi), to require the Company to use its best efforts to register for
resale shares of Common Stock held by them under the Securities Act of 1933,
as amended ("1933 Act"), subject to certain conditions, limitations and
exceptions ("Demand Registration"). The Company also has agreed with the
Parent and Messrs. Frank and Sam Khulusi that if the Company files a
registration statement for the sale of securities under the 1933 Act, then
such persons may, subject to certain conditions, limitations and exceptions,
include in such registration statement shares of Common Stock held by them
("Piggyback Registration"). In addition, for an additional 90 days after the
applicable 180-day period, the Company will be entitled to include its shares
in any requested Demand Registration and to reduce the number of shares to be
sold by the Parent or Messrs. Frank and Sam Khulusi thereunder to a minimum of
20%, collectively, of the total offering plus the amount of any underwriters'
over-allotment option. In the case of Messrs. Frank and Sam Khulusi, the
Company will bear up to $100,000 of the cost of the first, and up to $50,000
of the second, requested registrations and will bear the cost of all piggyback
registrations. In addition, the Parent's registration rights will terminate
upon consummation of the Distribution.
Releases and Indemnification. The Separation and Distribution Agreement
provides for a full and complete release and discharge as of the Offering
Closing Date of all liabilities, known or unknown, existing or arising from
all acts and events occurring or failing to occur or alleged to have occurred
or to have failed to occur and all conditions existing or alleged to have
existed on or before the Offering Closing Date, between the Company and the
Parent (including any contractual agreements or arrangements existing or
alleged to exist between them on or before the Offering Closing Date), except
as expressly set forth in the Separation and Distribution Agreement.
Except as provided in the Separation and Distribution Agreement, 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 the Separation and Distribution Agreement or any of
the Ancillary Agreements; 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.
Except as provided in the Separation and Distribution Agreement, the Parent
has agreed to indemnify, defend and hold harmless the Company and each of the
Company's directors, officers and employees from and against all liabilities
relating to, arising out of or resulting from: (i) the failure of the Parent
or any other person to pay, perform or otherwise promptly discharge any
liabilities of the Parent other than the liabilities of the Company; and (ii)
any breach by the Parent of the Separation and Distribution Agreement or any
of the Ancillary Agreements. Neither the Company nor the Parent is obligated
under the Separation and Distribution Agreement to indemnify the other for:
(i) any liability, contingent or otherwise, assumed, transferred, assigned or
allocated to the other under the Separation and Distribution Agreement or any
Ancillary Agreement; (ii) any liability for the sale, lease, construction or
receipt of goods, property or services purchased, obtained or used in the
ordinary course of business between the parties prior to December 9, 1998;
(iii) any liability for unpaid amounts for
15
<PAGE>
products or services or refunds owing on products or services due on a value-
received basis for work done by one party at the request or on behalf of the
other; (iv) any liability that the Company or the Parent may have with respect
to indemnification or contribution pursuant to the Separation and Distribution
Agreement for claims brought against other party by third persons; or (v)
generally, any liability the release of which would result in the release of
any person other than a person released pursuant to the Separation and
Distribution Agreement.
The Separation and Distribution Agreement contains provisions that govern,
except as otherwise provided in any Ancillary Agreement, the resolution of
disputes, controversies or claims that may arise between or among the parties.
These provisions contemplate that efforts will be made to resolve disputes,
controversies and claims by escalation of the matter to senior management (or
other mutually agreed) representatives of the parties. If such efforts are not
successful, any party may submit the dispute, controversy or claim to
mandatory, binding arbitration, subject to the provisions of the Separation
and Distribution Agreement. The Separation and Distribution Agreement contains
procedures for the selection of a sole arbitrator of the dispute, controversy
or claim and for the conduct of the arbitration hearing, including certain
limitations on discovery rights of the parties. These procedures are intended
to produce an expeditious resolution of any such dispute, controversy or
claim.
In the event that any dispute, controversy or claim is, or is reasonably
likely to be, in excess of $5 million, or in the event that an arbitration
award in excess of $5 million is issued in any arbitration proceeding
commenced under the Separation and Distribution Agreement, subject to certain
conditions, any party may submit such dispute, controversy or claim to a court
of competent jurisdiction and the arbitration provisions contained in the
Separation and Distribution Agreement will not apply. In the event that the
parties do not agree that the amount in controversy is in excess of $5
million, the Separation and Distribution Agreement provides for arbitration of
such disagreement.
Noncompetition; Certain Business Transactions. The Separation and
Distribution Agreement provides that, for a period of nine months after the
Distribution Date, the Parent will not directly or indirectly, including by
way of acquisition of other companies, engage in the Internet online auction
business in substantially the same manner and format as conducted by the
Company on the date of the Separation and Distribution Agreement (the "Company
Business"). The Separation and Distribution Agreement also provides for the
allocation of certain corporate opportunities during the period prior to the
Distribution Date. During this period, neither the Company nor the Parent will
have any duty to communicate or offer such opportunities to the other and may
pursue or acquire any such opportunity for itself or direct such opportunity
to any other Person. Except as otherwise contemplated under the intercompany
agreements, it is anticipated that all contracts between the Company and the
Parent after consummation of the Offering will be at arms length. See
"Investment Considerations--No Duty to Communicate Corporate Opportunities."
Expenses. Except as expressly set forth in the Separation and Distribution
Agreement or in any Ancillary Agreement, whether or not the Distribution is
consummated, each party will bear its own respective third-party fees, costs
and expenses paid or incurred in connection with the Distribution.
Parent Stock Options. Options to purchase common stock of the Parent that
are outstanding as of the Distribution Date will, as of the Distribution Date,
become options to purchase shares of both Parent Common Stock and Common Stock
("Adjusted Options"). The number of shares of Common Stock that will be
subject to such Adjusted Options will be based upon the ratio of the number of
shares of uBid Common Stock distributed to the Parent's stockholders in the
Distribution divided by the total number of shares of Parent Common Stock
outstanding on the record date for the Distribution. In addition, the exercise
price for each Adjusted Option will be allocated between the option to
purchase Parent Common Stock and the option to purchase Common Stock based on
the respective pre- and post-Distribution prices of Parent Common Stock and
Common Stock on the Nasdaq National Market. The options to purchase uBid
Common Stock covered by the Adjusted Options will be issued under the
Company's 1998 Stock Incentive Plan. As of March 26, 1999 there were
outstanding options to purchase 777,051 shares of Parent Common Stock. Based
on the number of shares of Parent Common Stock and
16
<PAGE>
options to purchase Parent Common Stock outstanding on March 26, 1999 and the
number of shares of Common Stock outstanding on such date, options to purchase
approximately 548,935 shares of uBid Common Stock would be granted in
connection with Adjusted Options.
Termination. The Separation and Distribution Agreement may be terminated at
any time prior to the Distribution Date by the mutual consent of the Parent
and the Company. In the event of any termination of the Separation and
Distribution Agreement, only the provisions of the Separation and Distribution
Agreement that obligate the parties to pursue the Distribution, or take, or
refrain from taking, actions which would or might prevent the Distribution
from qualifying for tax-free treatment under Section 355 of the Code, will
terminate, and the other provisions of the Separation and Distribution
Agreement and each Ancillary Agreement will remain in full force and effect.
Services Agreement
In December 1998, the Company and the Parent entered into a services
agreement (the "Services Agreement") pursuant to which the Parent provides to
the Company various administrative services, including general accounting
services, credit services and payroll and benefits administration. The
following services will be provided by the Parent until the Distribution is
consummated.
General Accounting Services. Pursuant to the Services Agreement, the Parent
provides uBid with accounts payable services and general ledger services. The
services are provided on a cost-plus 10% basis.
Credit Services. The Services Agreement also provides for the provision by
the Parent to uBid of credit services, including full credit checking and
analysis at a cost to uBid of $1.50 per transaction. The Parent will undertake
to use its best efforts to process each credit check within 24 hours of
receipt of the Company's request.
Payroll and Benefits Administration. Under the Services Agreement, the
Parent administers uBid's payroll and uBid's employees are covered under the
Parent's health insurance plan and participate in the Parent's 401(k) plan.
The Company reimburses the Parent for all payroll and benefits costs, and the
Parent receives a monthly servicing fee on a cost-plus 10% basis per covered
or participating employee.
Payments pursuant to the Service Agreement are made monthly in arrears
within 30 days after the Company's receipt of an invoice detailing the
services rendered. The Company believes that the fees for services to be
provided under the Services Agreement are no less favorable to the Company
than could have been obtained by the Company from unaffiliated third parties.
Any services rendered to the Company by the Parent beyond the services to be
provided under the terms of the Services Agreement that the Parent determines
are not covered by the fees provided for under the terms of the Services
Agreement will be billed to the Company as described in the Services
Agreement, or on such other basis as the Company and the Parent may agree,
provided that the price payable by the Company for non-covered services will
be established on a negotiated basis which is no less favorable to the Company
than the charges for comparable services from unaffiliated third parties.
Termination of the Services Agreement at Distribution. 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 the transactional and
administrative services described above and certain other services
historically performed by the Parent. The Company anticipates that, after the
Distribution, it will have to engage third parties to perform such services or
perform such services internally by Company personnel. 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.
17
<PAGE>
TAX INDEMNIFICATION AND ALLOCATION AGREEMENT
The Company and the Parent have entered into a Tax Indemnification and
Allocation Agreement, which provides that if any one of certain events occurs,
and such event causes the Distribution not to be a tax-free transaction to the
Parent under Section 355 of the Code, then the Company will indemnify the
Parent for income taxes the Parent may incur by reason of the Distribution not
so qualifying under the Code (the "Distribution Taxes"). Such events include
any breach of representations relating to the Company's activities and
ownership of its capital stock made to the Parent or in connection with the
PwC Opinion or any solicitation of a Letter Ruling. In connection with the
Distribution, confirmation of the PwC Opinion at the time of the Distribution
and any Letter Ruling, the Company will likely make certain representations
regarding its intentions at the time of the Distribution with respect to its
business.
The Tax Indemnification and Allocation Agreement also provides that the
Parent will indemnify the Company for Distribution Taxes for which the Company
has no liability to the Parent under the circumstances described above.
In addition to the foregoing indemnities, the Tax Indemnification and
Allocation Agreement provides for: (i) the allocation and payment of taxes for
periods during which the Company and the Parent are included in the same
consolidated group for federal income tax purposes or the same consolidated,
combined or unitary returns for state tax purposes; (ii) the allocation of
responsibility for the filing of tax returns; (iii) the conduct of tax audits
and the handling of tax controversies; and (iv) various related matters.
For periods during which the Company is included in the Parent's
consolidated federal income tax returns or state consolidated, combined, or
unitary tax returns (which will include the periods on or before the
Distribution Date), the Company will be required to pay an amount of income
tax equal to the amount it would have paid had it filed its tax return as a
separate entity, except in cases where the consolidated or combined group as a
whole realizes a detriment from consolidation or combination. The Company will
be responsible for its own separate tax liabilities that are not determined on
a consolidated or combined basis. The Company will also be responsible in the
future for any increases to the consolidated tax liability of the Company and
the Parent that is attributable to the Company, and will be entitled to
refunds for reductions of tax liabilities attributable to the Company for
prior periods.
The Company will be included in the Parent's consolidated group for federal
income tax purposes so long as the Parent beneficially owns at least 80% of
the total voting power and value of the outstanding Common Stock. Each
corporation that is a member of a consolidated group during any portion of the
group's tax year is jointly and severally liable for the federal income tax
liability of the group for that year. While the Tax Indemnification and
Allocation Agreement allocates tax liabilities between Company and the Parent
during the period on or prior to the Distribution Date in which the Company is
included in the Parent's consolidated group, the Company could be liable in
the event federal tax liability allocated to the Parent is incurred, but not
paid, by the Parent or any other member of the Parent's consolidated group for
the Parent's tax years that include such periods. In such event, the Company
would be entitled to seek indemnification from the Parent pursuant to the Tax
Indemnification and Allocation Agreement. See "Investment Considerations--
Control of Company; Relationship with the Parent."
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
contains certain restrictions on issuances of equity securities of the Company
and its repurchase of equity securities until three years following
18
<PAGE>
the Distribution Date (the "Restriction Period"). 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 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 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 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. See "Investment
Considerations--Tax Indemnification Obligation, Limitation on Issuances of
Equity Securities Following the Distribution" and "--Limited Ability to Issue
Common Stock Prior to Distribution."
JOINT MARKETING AGREEMENT
The Company and the Parent have entered into a joint marketing agreement
(the "Marketing Agreement"), pursuant to which the Parent and the Company
agreed to continue certain joint marketing efforts presently in place. The
Marketing Agreement provides that the Company will continue to be presented on
the home page of the Parent's "PC Mall" Website on at least one quarter of the
page as well as receive a banner advertisement on the home page of the
Parent's "PC Mall" Website. The Marketing Agreement provides that uBid will
provide to the Parent a button that "clicks through" from the home page of the
Company's Website to the Parent's "PC Mall" Website. As consideration for
these marketing services, the Company will either make a payment of $10,000
per month to the Parent or the Parent, in its sole discretion, may elect to
receive a banner advertisement on each page of the Company's Website in lieu
of the monthly payment. The Marketing Agreement has a term of one year and is
terminable by either party upon 60 days prior written notice.
INTERNET/TELECOMMUNICATIONS AGREEMENT
The Company and the Parent have also entered into an
Internet/telecommunications agreement (the "Internet/Telecommunications
Agreement") pursuant to which the Parent will continue to provide the Company
with certain Internet and telecommunications services, including hosting the
Company's Website. The Company agreed to reimburse the Parent for all
telecommunications charges (other than personnel charges), as well as pay
additional monthly personnel charges on a cost-plus 10% basis and capital
equipment charges based on standard lease rates. The
Internet/Telecommunications Agreement has an initial term of one year and is
cancelable, at the option of either party, upon 90 days prior written notice,
provided that, upon such cancellation, the Company will be required to
purchase all capital equipment from the Parent at its depreciated book value.
SUBLEASE AGREEMENT
In July 1998, the Company and the Parent entered into a sublease currently
covering 100,000 square feet of the Parent's 325,000 square foot distribution
center in Memphis, Tennessee. The sublease provides for the Company's
continued use of the Parent's sophisticated inventory control and shipping
systems during the term of the sublease. The sublease is at a monthly rate
equal to the Parent's obligations to the landlord, plus taxes and utilities,
and will expire in 2002.
19
<PAGE>
OTHER RELATIONSHIPS WITH THE PARENT
As of March 23, 1999 the Parent owned 7,329,883 shares of Common Stock,
which represents approximately 80.1% of the voting power of all outstanding
shares of Common Stock. Frank F. Khulusi, a director of the Company, also is
the Chairman, President and Chief Executive Officer of the Parent.
Parent Credit Agreement. The Parent is party to a credit agreement pursuant
to which it has a credit facility of up to $60 million. Under the credit
agreement, each of the Parent's subsidiaries, including the Company, is
required to guarantee the Parent's obligations and to grant the lender a
security interest in its assets to secure the obligations under the guaranty.
The lender has signed a letter consenting to the Distribution and releasing
the Company's guaranty obligations and the lender's security interest in the
Company's assets. In connection with obtaining the lender's consent thereto,
the Company and the Parent have entered into an agreement with the lender that
provides that, through the Distribution Date, neither the Company nor the
Parent will make certain transfers to each other of their respective assets
which might impair the effectiveness or enforceability of the lender's
security interest in assets of the Parent.
Payable to Parent. Since April 1, 1997 ("Inception") the Parent has provided
the funds to finance the Company's operations in the form of advances that
bear interest at the prime rate. The Company had amounts due to the Parent for
working capital and fixed asset purchases (the "Payable") totaling
approximately $4.6 million as of December 31, 1998, of which $3.3 million is
represented by a note due in June 2000 with interest payable monthly, and the
remaining $1.3 million of which was repaid during the first quarter of 1999.
Advances made by the Parent after the first quarter of 1999, if any, will be
repaid within the respective quarter.
20
<PAGE>
INVESTMENT CONSIDERATIONS
In addition to the other information in this Annual Report on Form 10-K, 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. See "Forward-Looking Statements."
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 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."
21
<PAGE>
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 $10.5 million at December 31,
1998. 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."
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. Accordingly, the
Company recorded a non-cash charge to compensation expense in the quarter
ended December 31, 1998, calculated based upon the initial public offering
price for the Common Stock. The Company expects to record a non-cash
compensation charge of approximately $13.3 million over the five-year vesting
period of the options. The Company recorded approximately $5.3 million of this
charge in the fourth quarter of 1998. See Note 5 to the financial statements.
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, 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
22
<PAGE>
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. See "Business--
Business Strategy," and "--Sales and Marketing."
The Company expects to expand the focus of its operations beyond the auction
and sale of closeout and refurbished computer, consumer electronics and home
and leisure 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 Auction; (ii) a number of indirect
competitors that specialize in electronic commerce or derive a substantial
portion of their revenue from electronic commerce, including 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 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
23
<PAGE>
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. See "Business--Competition."
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. See
"Business--Sales and Marketing."
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 and
home and leisure 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
24
<PAGE>
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. See "Business--Products and
Merchandising" and "--Vendor Relationships."
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 150 vendors. Merchandise acquired from 10 of these
vendors has represented approximately 52% of the Company's gross merchandise
sales since Inception. In addition, merchandise acquired from one vendor, the
Parent, represented over 90% of the merchandise sold by the Company in the
first two months of operations, but represented less than 10% in 1998. 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. See "Business--
Products and Merchandising," "--Vendor Relationships" and "--Customer Support
and Service."
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 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
25
<PAGE>
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. See
"Business--Order Fulfillment," "--Technology" and "--Systems Operations."
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. See "Business--
Technology" and "--Systems Operations."
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 74 employees and 35 full-time
equivalent contract personnel at December 31, 1998, and its sales increased
from approximately $9,000 from Inception to December 31, 1997 to over $24
million in the fourth quarter of 1998. 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 December 31, 1998 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 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
26
<PAGE>
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. See
"Business--Employees and Management."
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. See
"Business--Industry Background," "--Technology," and "--Systems Operations."
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 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
27
<PAGE>
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 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
28
<PAGE>
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. See
"Business--Technology," "--Systems Operations," "--Insurance Coverage," "--
Facilities" and "Item 2. Properties."
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. See "Business--Technology" and "--Systems
Operations."
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
uBidSM 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
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
29
<PAGE>
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. See "Business--
Intellectual Property and Other Proprietary Rights."
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.
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
30
<PAGE>
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. See "Separation from the
Parent" and "Transactions between the Company and the Parent--Separation and
Distribution Agreement." 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 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 the Common
Stock. See "Separation from the Parent" and "Transactions between the Company
and the Parent--Tax Indemnification and Allocation Agreement."
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 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 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. See "Separation from the Parent."
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
31
<PAGE>
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.
See "Transactions between the Company and the Parent--Tax Indemnification and
Allocation Agreement."
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 engage third parties to perform such services or
perform such services internally by Company personnel. 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. See "Transactions between the Company and the Parent--Services
Agreement."
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. See
"Transactions between the Company and the Parent." 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 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. See "--No Duty to
Communicate Corporate Opportunities" and "Transactions between the Company and
the Parent--Releases and Indemnification."
32
<PAGE>
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. See "--Limited Ability to Issue Common Stock Prior
to Distribution," and "Transactions between the Company and the Parent--Tax
Indemnification and Allocation Agreement."
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 17.7% of the issued and outstanding Parent Common
Stock as of March 23, 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. See "Transactions between the Company and the
Parent." 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 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
33
<PAGE>
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. See "Transactions between the Company and the
Parent--Separation and Distribution Agreement."
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 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 $10,000. Based on current estimates, management expects that
the Company's total costs in connection with its year 2000 compliance
34
<PAGE>
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 operation 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. See
"Transactions between the Company and the Parent--Separation and Distribution
Agreement." 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 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 March 26, 1999, the Company anticipates that it will grant
options to purchase approximately 548,935 shares of the Company's Common Stock
in connection with the Distribution. Of these options,
35
<PAGE>
approximately 188,379 will have vested on or prior to June 7, 1999 (the
earliest date on which the Distribution could occur). See "Transactions
between the Company and the Parent--Separation and Distribution Agreement."
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 2. Properties
The Company's principal administrative, engineering, merchandising and
marketing facilities total approximately 9,000 square feet, and are located in
Elk Grove Village, Illinois under leases that are shared with the Parent and
expire in 2002. Until July 1998, the Company was dependent upon the Parent for
warehousing and distribution services. In July 1998, the Company became
responsible for its own warehousing and distribution and entered into a
sublease for 100,000 square feet of the Parent's 325,000 square foot
distribution center in Memphis, Tennessee. The sublease provides for the
Company's continued use of the Parent's sophisticated inventory control and
shipping systems during the term of the sublease. The sublease is at a monthly
rate equal to the Parent's obligation to the landlord, plus taxes and
utilities, and will expire in 2002. The Company believes that it has adequate
space for its current needs. As the Company expands, it expects that suitable
additional space will be available on commercially reasonable terms, although
no assurance can be made in this regard. The Company does not own any real
estate.
Item 3. Legal Proceedings
The Company is not currently a party to any legal proceedings which may or
could have a material adverse impact on the Company or its operations.
Item 4. Submission of Matters to a Vote of Security Holders
On November 30 1998, the Parent executed a written consent as sole
stockholder of the Company in lieu of an annual meeting, pursuant to which the
Parent (1) approved Amended and Restated Articles of Incorporation effecting a
.7329883-for-one reverse stock split, (2) approved the Company's Amended and
Restated Bylaws, and (3) elected the following four directors to serve until
the next annual meeting of the year set forth beside their respective names:
Gregory K. Jones (2001); Howard A. Tullman (2000); Norman H. Wesley (2000);
and Frank F. Khulusi (1999).
36
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and key employees and directors of the Company are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Gregory K. Jones................. 38 Chairman, President and Chief
Executive Officer
Thomas E. Werner................. 41 Vice President and Chief Financial
Officer
George Lu........................ 34 Vice President - Information Systems
Timothy E. Takesue............... 30 Vice President - Merchandising
David L. Hirschman............... 36 Senior Vice President - Operations
</TABLE>
GREGORY K. JONES. Mr. Jones has been President and Chief Executive Officer of
the Company since November 1997, and Chairman of the Board since July 1998.
Prior thereto, from October 1995 to November 1997, Mr. Jones was Senior Vice
President of Strategic Markets at APAC TeleServices, Inc., a provider of
outsourced telephone-based marketing, sales and customer management solutions.
Prior thereto, from October 1990 to October 1995, Mr. Jones served as the
President and Chief Operating Officer of The Reliable Corporation/Office 1, a
Chicago-based direct mail/retailer of office products. Before that, from
January 1988 to October 1990, Mr. Jones was a Senior Manager, consulting on
systems and technology strategic planning for the accounting/consulting firm of
Ernst & Young LLP. He sits on the Board of Directors of Ohio-based D.I.Y. Home
Warehouse, an operator of 16 warehouse-format home improvement centers, and of
E-Sport, an Internet sports content company. Mr. Jones received his B.A. degree
from Miami University (Ohio) and his M.M. in marketing and finance from the
J.L. Kellogg Graduate School of Management of Northwestern University.
THOMAS E. WERNER. Mr. Werner has been Vice President and Chief Financial
Officer of the Company since October 1998. From December 1995 to October 1998,
Mr. Werner was Corporate Controller for Gateway, Inc., a manufacturer and
marketer of personal computers and related products. From March 1995 until
December 1995, Mr. Werner was Vice President and Assistant Corporate Controller
for Dade International, a manufacturer of medical diagnostic equipment and
products. From 1989 until 1995, Mr. Werner held various financial management
positions with Baxter International, a manufacturer and distributor of health
care products. Mr. Werner received his B.S. degree in Business from Indiana
University and is a Certified Public Accountant.
GEORGE LU. Mr. Lu has been Vice President--Information Systems of the Company
since February 1998. Prior thereto, from March 1994 to January 1998, Mr. Lu was
employed by Rand McNally & Company, most recently in the position of technical
development manager for Rand McNally New Media and TDM. Prior thereto, from
March 1993 to March 1994, Mr. Lu was with AECOM Corp. as a senior systems
analyst. Mr. Lu received his B.S. degree from Huazhong University, currently
known as Central China Normal University, and his M.S. degree from the
University of Memphis.
TIMOTHY E. TAKESUE. Mr. Takesue joined uBid as Vice President--Merchandising
in December 1997. Prior to December 1997, Mr. Takesue was Director of
Merchandising/Purchasing for Elek-Tek Inc., a catalog, retail and corporate
reseller. Mr. Takesue was a buyer of computer and computer-related products and
accessories at Montgomery Ward from March 1996 to August 1996 and from February
1988 to March 1996, Mr. Takesue held several positions with Fretter, Inc., a
specialty retailer in appliances, consumer electronics and computers. During
his eight years with that company, Mr. Takesue held the positions of General
Store Manager, District Sales Manager of Indiana, Marketing Manager of the Ohio
region with responsibility for all marketing functions, Regional Marketing
Manager for the New England region, Merchandise Manager with responsibility for
all buying and marketing of computer peripheral, software and accessory
products, and Senior Merchandise Manager with responsibility for all buying and
marketing of computer and related products. Mr. Takesue attended Wayne State
University.
DAVID L. HIRSCHMAN. Mr. Hirschman has been the Company's Senior Vice
President--Operations since April 1997. Prior thereto, Mr. Hirschman served as
Vice President of Marketing Operations at the Parent from August 1996 to March
1997, as Vice President of the Macintosh Marketing Division of the Parent from
May 1996 to July 1996, and from June 1993 to April 1996 as the Vice President
of Product Management at the Parent with responsibility for purchasing,
inventory maintenance and vendor relations. From 1990 to 1993, Mr. Hirschman
was the Purchasing Manager for Sun Computers, a large regional computer
reseller. Mr. Hirschman holds a B.S. degree in business from Washington
University in St. Louis.
37
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE OF COMMON STOCK
uBid's Common Stock is traded on the Nasdaq National Market under the symbol
"UBID." The table below presents high and low closing price information for
the Common Stock by quarter as reported on Nasdaq since December 4, 1998, the
date the Company's Common Stock commenced trading. Prior to such time, there
was no public market for the Company's Common Stock.
<TABLE>
<CAPTION>
1998 HIGH LOW
---- ------- ------
<S> <C> <C>
Fourth Quarter (commencing December 4, 1998).................. $188.00 $33.00
</TABLE>
On March 23, 1999, the last sale price of the Company's Common Stock as
quoted on Nasdaq was $71.50. As of March 23, 1999, the number of stockholders
of record of the Company's Common Stock was 41. The Company has not paid any
cash dividends to date and currently intends to retain any earnings for use in
business and does not anticipate paying any cash dividends in the foreseeable
future.
RECENT SALES OF UNREGISTERED SECURITIES
Prior to the Company's initial public offering, options to purchase an
aggregate of 1,097,278 shares of the Company's Common Stock had been granted
in reliance upon the exemption provided in Rule 701 under the Securities Act
of 1933, as amended.
USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES
The Company commenced its initial public offering on December 4, 1998
pursuant to a Registration Statement on Form S-1 (File No. 333-58447), which
was declared effective by the Commission on December 3, 1998. In the IPO the
Company sold an aggregate of 1,817,000 shares of its Common Stock (including
237,000 shares sold pursuant to the exercise of the underwriters' over-
allotment option) at an initial public offering price of $15.00 per share. The
IPO was closed on December 9, 1998. Merrill Lynch & Co. and William Blair &
Company served as managing underwriters for the IPO.
Aggregate proceeds from the IPO were $27,255,000, which included $2,055,000
in aggregate proceeds due to the exercise of the underwriters' option to
purchase shares to cover over-allotments. The Company paid underwriters'
discounts and commissions of $1,907,850 and other expenses of approximately
$1,500,000 in connection with the IPO. The total expenses paid by the Company
in the IPO were $3,407,850 and the net proceeds to the Company were
$23,847,000, all of which has been allocated for general corporate purposes,
including working capital requirements of the Company resulting from its
growth. From the closing date of the Offering to March 1, 1999, the Company
paid an aggregate of $447,000 to the Parent (which owns approximately 80.1% of
the Company's Common Stock), consisting of payments for certain administrative
services provided by the Parent under the Services Agreement and excluding
repayments of advances from the Parent. With the exception of the foregoing,
none of the proceeds of the IPO were paid directly or indirectly to any
officer or director of the Company or their respective associates, persons
owning 10 percent or more of any class of equity securities of the Company, or
any affiliate of the Company.
38
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is certain selected financial and operating data of the
Company for the periods indicated, which have been derived from the Company's
audited financial statements. The selected financial data set forth below
should be read in conjunction with the Company's financial statements and
notes thereto included elsewhere in this Form 10-K and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
INCEPTION YEAR
(APRIL 1, 1997) ENDED
TO DECEMBER 31, DECEMBER 31,
1997 1998
--------------- ------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues..................................... $ 9 $ 48,232
Gross profit..................................... 1 3,975
Loss from operations before stock-based
compensation.................................... (287) (4,732)
Loss from operations............................. (287) (9,999)
Net Loss......................................... (313) (10,169)
Basic and diluted net loss per share (1)......... $ (0.04) $ (1.36)
Shares used to compute basic and diluted net loss
per share (1)................................... 7,329,833 7,461,061
<CAPTION>
DECEMBER 31,
----------------------------
1997 1998
--------------- ------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................ $ -- $ 26,053
Working capital.................................. 31 21,444
Total assets..................................... 358 34,625
Advances and notes from the Parent............... 670 4,608
Total stockholders' equity (deficit)............. (312) 18,632
</TABLE>
- --------
(1) See Notes 1 and 7 of the notes to the financial statements for an
explanation of the number of shares used in computing the amount of basic
and diluted net loss per common share and Note 5 for an explanation of the
non-cash charge recorded in the fourth quarter of 1998 in connection with
certain employee and director stock options granted prior to the Company's
initial public offering.
39
<PAGE>
ITEM 7. 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
"Investment Considerations" in Item 1 and elsewhere in this Annual Report on
Form 10-K. 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 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 brand name computer, consumer
electronics and home and leisure products over the World Wide Web to consumers
and small and medium-sized businesses. The Company was incorporated in
September 1997. Prior to the incorporation of the Company, the Parent,
beginning on April 1, 1997, funded certain startup and development activities.
During 1997, the Company's operating activities related primarily to
recruiting personnel, developing the computer infrastructure necessary to
conduct live auctions on the Internet, building an operating infrastructure
and establishing vendor relationships. From its first auction in December 1997
through December 31, 1998, the Company auctioned over 278,000 merchandise
units, registered over 229,000 users and recorded more than 17.8 million
visits to its Website. The Company's net loss of $10,169 for 1998 was due in
part to a $5,267 non-cash charge for amortization of stock compensation
expense related to pre-IPO stock options, and investments in infrastructure as
the Company commenced sales operations. 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.
Prior to its initial public offering, the Company was a wholly-owned
subsidiary of the Parent. The Company was set up as a subsidiary 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. It is estimated that the Company
will need to spend approximately $1,750 in capital expenditures to establish
itself as an independent company. 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 will be terminated upon completion of the Distribution. Thereafter,
the Company will have to engage third parties to perform certain
administrative and transactional services previously provided b the Parent or
have such services performed by Company personnel.
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'
40
<PAGE>
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 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.
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. See "Investment Considerations--
Extremely Limited Operating History."
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 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. See Note 5 to the financial statements
and "Investment Considerations--History of Operating Losses; Accumulated
Deficits; Anticipated Losses and Negative Cash Flow."
RESULTS OF OPERATIONS
Net Revenues. Net revenues are comprised of gross merchandise sales plus
shipping income net of returns. The Company held its first auction the last
week of December 1997. For the year ended December 31, 1998, net revenues were
$48,232. Growth in net revenues was 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 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 for the year ended December 31, 1998 were $3,975. As a
41
<PAGE>
percent of net revenues, the Company's gross margin was 8.2% for the year
ended December 31, 1998. Gross margin is 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. Merchandise acquired from the Parent
represented over 90% of the merchandise sold in the first two months of
operations, decreased to approximately 30% in March and April 1998, and
represented less than 10% for 1998.
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 cost of
these services represented 72% and 21% of the Company's total operating
expenses from Inception to December 31, 1997 and for the year ended December
31, 1998, respectively. 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 engage third
parties to perform certain administrative and transactional services
previously provided by the Parent or have such services performed by Company
personnel. 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. Sales and marketing expenses were
$10 and $2,829 from Inception to December 31, 1997 and for the year ended
December 31, 1998, respectively. Sales and marketing expenses as a percent of
net revenues were 5.9% for the year ended December 31, 1998. These expenses
have increased significantly each month of operations 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. The Company has established
relationships with a number of online companies, such as AOL, CNET, Wired
Digital, MSN/LinkExchange, PCWorld Online and LookSmart to increase its access
to online customers and build brand recognition.
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 as well as charges from the Parent
relating to hosting of the Company's Website and Internet/telecom operations.
Technology and development expenses were $66 and $1,022 from Inception to
December 31, 1997 and for the year ended December 31, 1998, respectively.
Technology and development costs as a percent of net revenues were 2.1% for
the year ended December 31, 1998. In addition to the expenses in 1997, the
Company capitalized $267 relating to the development of the core software for
the Website. These costs are being amortized over three years. The increase in
technology and development expenses during 1998 was primarily attributable to
increased staffing and associated costs relating to enhancing the features and
functionality of the Company's Website and related systems. 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.
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. General and
administrative expenses were $212 and $4,856 for the period from Inception to
December 31, 1997 and for the year ended December 31, 1998, respectively.
General and administrative expenses as a percent of net revenues were 10.1%
for the year ended December 31, 1998. The Parent supplied general and
administrative services for warehousing and distribution, credit card
processing, accounting and benefits administration. Although the Parent will
continue to supply certain general and administrative services to the Company
until the Distribution, the current warehousing and distribution services
conducted by the Parent were assumed by the Company in July 1998
42
<PAGE>
pursuant to a sublease agreement between the Company and the Parent. The
Parent charged the Company rates that were no less favorable than what a third
party would have charged. General and administrative expenses have increased
during 1998 primarily due to hiring additional personnel and related costs to
support increased sales such as credit card processing and distribution costs.
The Company expects 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 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 $5,267 of this charge to compensation was
recognized in December 1998.
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
$313 and $10,169 for the period from Inception to December 31, 1997 and for
the year ended December 31, 1998, respectively. In the year ended December 31,
1998 the loss from operations before the non-cash stock option compensation
expense was $4,732, and the stock option compensation expense totaled $5,267.
LIQUIDITY AND CAPITAL RESOURCES
From Inception until its December 1998 initial public offering, the Company
financed its operations with advances from the Parent and cash flow from
operations. Net cash (used in) operating activities were ($340) and ($108) for
the period from Inception to December 31, 1997 and for the year ended December
31, 1998, respectively. For 1997, the net cash used in operating activities
was primarily attributable to the net loss of $313. For the year ended
December 31, 1998, the net cash used in operating activities was primarily due
to the net loss of $4,732, (before the non-cash stock option compensation
expense), an increase in accounts receivable of $614, a net increase in
inventory of $7,233 offset by an increase in accounts payable of $9,014,
short-term advances from the Parent of $1,277 and various accrued expenses of
$2,371.
Cash flows provided by (used in) investing and financing activities were
($340) and $26,161 for 1997 and the year ended December 31, 1998,
respectively. In 1997, investing activities were for the capitalization of
software development. In 1998, financing activities included the proceeds of
the initial public offering of $23,847 and advances from the Parent of $2,661,
offset by purchases of equipment of $347.
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
repayable to the Parent. The outstanding balance on the note bears interest at
the prime rate and will be repaid in June 2000. Interest expense was $26 and
$244 for 1997 and the twelve months ended December 31, 1998, respectively. 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. It is estimated that the Company will need to spend
approximately $1,750 in capital expenditures to establish itself as an
independent company. 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.
The Company intends to retain all 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.
43
<PAGE>
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 12
month 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 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 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 $10. 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.
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.
44
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and government repurchase
agreements at fixed rates. At March 23, 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are filed under this
Item, beginning on page F-1 of this Report. The financial statement schedules
required under Regulation S-X are filed pursuant Item 14 of this Report,
beginning on page F-14 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 regarding directors is incorporated by
reference from the Company's definitive proxy statement for its 1999 Annual
Meeting of Stockholders under the caption "Election of Directors." The
information relating to the Company's executive officers is included under the
heading "Executive Officers of the Registrant" in Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to compensation of executive officers and directors
required by Item 11 is incorporated by reference from the Company's definitive
proxy statement for its 1999 Annual Meeting of Stockholders under the captions
"Executive Compensation" and "Election of Directors--Compensation of
Directors."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference from the
Company's definitive proxy statement for its 1999 Annual Meeting of
Stockholders under the caption "Voting Securities and Principal Holders
Thereof."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the
Company's definitive proxy statement for its 1999 Annual Meeting of
Stockholders under the caption "Certain Relationships and Related
Transactions."
45
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
(a)(1) Financial Statements and Report of Ernst & Young LLP,
Independent Auditors
Report of Independent Auditors.................................. F-2
Financial Statements:
Balance Sheets as of December 31, 1998 and 1997................. F-3
Statements of Operations for the period April 1, 1997
(Inception) to December 31, 1997 and the year ended December 31,
1998............................................................ F-4
Statements of Cash Flows for the period April 1, 1997
(Inception) to December 31, 1997 and the year ended December 31,
1998............................................................ F-5
Statements of Changes in Stockholders' Equity (Deficit) for the
period April 1, 1997 (Inception) to December 31, 1997 and the
year ended December 31, 1998.................................... F-6
Notes to Financial Statements................................... F-7
(a)(2) Schedule II--Valuation and Qualifying Accounts.................. F-14
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
period covered by this Report.
(c) Exhibits
The Exhibit Index appearing on page 48 of this Report is
incorporated into this Item 14(c) by reference.
</TABLE>
46
<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.
UBID, INC.
Dated: March 29, 1999 By: /s/ Gregory K. Jones
-------------------------------------
Gregory K. Jones
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Gregory K. Jones Chairman of the Board, March 29, 1999
____________________________________ President and Chief
Gregory K. Jones Executive Officer (Principal
Executive Officer)
/s/ Thomas E. Werner Vice President and Chief March 29, 1999
____________________________________ Financial Officer (Principal
Thomas E. Werner Financial and Accounting
Officer)
/s/ Frank F. Khulusi Director March 29, 1999
____________________________________
Frank F. Khulusi
/s/ Howard A. Tullman Director March 29, 1999
____________________________________
Howard A. Tullman
/s/ Norman H. Wesley Director March 29, 1999
____________________________________
Norman H. Wesley
/s/ Mark C. Layton Director March 29, 1999
____________________________________
Mark C. Layton
</TABLE>
47
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<C> <S>
3.1** Restated Certificate of Incorporation of the Company
3.2** Amended and Restated By-Laws of the Company
4.1** Form of the Company's Common Stock Certificate
4.2** Registration Rights Agreement by and between the Company and the
Parent, dated as of December 7, 1998
4.3** Registration Rights Agreement by and between the Company and Frank
Khulusi and Sam Khulusi, dated as of December 7, 1998
10.1** Separation and Distribution Agreement by and between the Company and
Parent dated as of December 7, 1998
10.2** Services Agreement by and between the Company and Parent, dated as of
December 7, 1998
10.3 Tax Indemnification and Allocation Agreement by and between the
Company and Parent, dated as of December 7, 1998, as amended
10.4** Joint Marketing Agreement by and between the Company and the Parent,
dated as of December 7, 1998
10.5** Internet/Telecommunications Agreement by and between the Company and
the Parent, dated as of December 7, 1998
10.6** Employment Agreement between the Company and Gregory K. Jones*
10.7** uBid, Inc. 1998 Stock Incentive Plan*
10.8** Sublease Agreement between the Company and the Parent, dated as of
July 1, 1998
10.9 [intentionally omitted]
10.10** Agreement Restricting Transfer of Assets and Letter Agreement dated as
of September 23, 1998 by and between Deutsche Financial Services
Corporation and the Parent and the Company
10.11** Letter Agreement dated November 30, 1998 by and between the Parent and
Paul Colton
10.12** Letter Agreement dated September 9, 1998 by and between the Parent and
David Matthews
10.13** Assignment and License Agreement by and between the Company and the
Parent, dated as of November 30, 1998
10.14 Form of Indemnification Agreement, entered into as of February 12,
1999, between the Company and each of its directors and executive
officers
23 Consent of Ernst & Young LLP
27 Financial Data Schedule (for Commission use only)
</TABLE>
- --------
* The referenced exhibit is a compensatory contract, plan or arrangement.
** Incorporated by reference to the exhibit with the same number to the
Company's Registration Statement on Form S-1 (No. 333-58477), on file with
the Securities and Exchange Commission.
48
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors........................................... F-2
Balance Sheets as of December 31, 1997 and December 31, 1998............. F-3
Statements of Operations for the Period April 1, 1997 (Inception) to
December 31, 1997 and the Year Ended December 31, 1998.................. F-4
Statements of Cash Flows for the Period April 1, 1997 (Inception) to
December 31, 1997 and the Year Ended December 31, 1998.................. F-5
Statements of Changes in Stockholders' Equity (Deficit) for the Period
April 1, 1997 (Inception) to December 31, 1997 and the Year Ended
December 31, 1998....................................................... F-6
Notes to Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
uBid, Inc.
Elk Grove Village, IL
We have audited the accompanying balance sheets of uBid, Inc. as of December
31, 1997 and 1998, and the related statements of operations, cash flows and
changes in stockholders' equity for the period from April 1, 1997 (Inception)
to December 31, 1997 and the year ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of uBid, Inc. at December 31,
1997 and 1998, and the results of its operations and its cash flows for the
period from April 1, 1997 (Inception) to December 31, 1997 and the year ended
December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Chicago, Illinois
January 22, 1999
F-2
<PAGE>
UBID, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1998
------ -------
<S> <C> <C>
ASSETS
Current assets:
Cash.......................................................... $ -- $26,053
Accounts receivable, net of allowances of $20 at December 31,
1998......................................................... 9 623
Merchandise inventories....................................... 2 7,235
Prepaid expenses and other.................................... 20 195
------ -------
Total current assets...................................... 31 34,106
Fixed assets, net............................................. 327 519
------ -------
Total assets.............................................. $ 358 $34,625
====== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ -- $ 9,013
Accrued expenses and other current liabilities................ -- 2,371
Due to Parent................................................. -- 1,277
------ -------
Total current liabilities................................. -- 12,661
Note payable to the Parent.................................... 670 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;
7,329,833 shares issued and outstanding as of December 31,
1997 and 9,146,833 shares issued and outstanding as of
December 31, 1998............................................ 1 2
Additional paid-in-capital.................................... -- 37,138
Deferred compensation......................................... -- (8,025)
Accumulated deficit........................................... (313) (10,482)
------ -------
Total stockholders' equity (deficit)...................... (312) 18,633
------ -------
Total liabilities and stockholders' equity (deficit)...... $ 358 $34,625
====== =======
</TABLE>
See notes to the financial statements.
F-3
<PAGE>
UBID, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 1, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
-------------- ------------
<S> <C> <C>
Net revenues...................................... $ 9 $ 48,232
Cost of revenues.................................. 8 44,257
--------- ---------
Gross profit...................................... 1 3,975
Operating expenses:
Sales and marketing............................. 10 2,829
Technology and development...................... 66 1,022
General and administrative...................... 212 4,856
--------- ---------
Total operating expenses...................... 288 8,707
--------- ---------
Loss from operations before stock based
compensation..................................... (287) (4,732)
Stock based compensation.......................... -- 5,267
--------- ---------
Loss from operations.............................. (287) (9,999)
Interest income................................... -- (74)
Interest expense to Parent........................ 26 244
--------- ---------
Loss before income taxes.......................... (313) (10,169)
Provision for income taxes........................ -- --
--------- ---------
Net loss.......................................... $ (313) $ (10,169)
========= =========
Basic and diluted net loss per share.............. $ (0.04) $ (1.36)
========= =========
Shares used to compute basic and diluted net loss
per share........................................ 7,329,883 7,461,061
</TABLE>
See notes to the financial statements.
F-4
<PAGE>
UBID, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 1, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
-------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss......................................... $ (313) $(10,169)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.................... 4 155
Non cash compensation expense.................... -- 5,267
Changes in operating assets and liabilities:
Accounts receivable, net....................... (9) (614)
Prepaid expenses............................... (20) (175)
Merchandise inventories, net................... (2) (7,233)
Accounts payable............................... -- 9,013
Advances from Parent, short term............... -- 1,277
Accrued expenses and other current
liabilities................................... -- 2,371
------ --------
Net cash (used in) provided by operating
activities........................................ (340) (108)
Cash flows from investing activities:
Purchases of property and equipment.............. (331) (347)
------ --------
Net cash used in investing activities.............. (331) (347)
Cash flows from financing activities:
Issuance of common stock to the Parent........... 1 --
Advances from the Parent......................... 670 (670)
Note payable to the Parent....................... -- 3,331
Proceeds from initial public offering of common
stock........................................... -- 23,847
------ --------
Net cash provided by financing activities.......... 671 26,508
------ --------
Net change in cash and cash equivalents............ -- 26,053
Cash and cash equivalents at beginning of period... -- --
------ --------
Cash and cash equivalents at end of period......... $ -- $ 26,053
====== ========
</TABLE>
See notes to the financial statements.
F-5
<PAGE>
UBID, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------- PAID-IN DEFERRED ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT TOTAL
------ ------ ---------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock
to the Parent.......... 7,330 $ 1 $ -- $ -- $ -- $ 1
Net loss for the
period................. -- -- -- -- (313) (313)
----- ----- ------- ------- -------- --------
Balance at December 31,
1997................... 7,330 $ 1 $ -- $ -- $ (313) $ (312)
Issuance of common stock
in IPO................. 1,817 1 23,846 -- -- 23,847
Stock based
compensation........... -- -- 13,292 (13,292) -- --
Amortization of stock
based compensation..... -- -- 5,267 -- 5,267
Net loss for the year... -- -- -- -- (10,169) (10,169)
----- ----- ------- ------- -------- --------
Balance at December 31,
1998................... 9,147 $ 2 $37,138 $(8,025) $(10,482) $ 18,633
===== ===== ======= ======= ======== ========
</TABLE>
See notes to the financial statements.
F-6
<PAGE>
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 computer,
consumer electronics and home and leisure products over the World Wide Web to
consumers and small and medium-sized businesses.
The Company, a majority-owned, indirect subsidiary of Creative Computers,
Inc. ("Parent"), a publicly-traded corporation, was incorporated on September
19, 1997. Beginning on April 1, 1997 ("Inception"), prior to the formation of
the Company, the Parent began funding certain startup and development costs
related to the Company's business. For the period from Inception to September
19, 1997, incorporation of the Company, such costs aggregated approximately
$127 of which approximately $49 were capitalized. The net loss for the period
Inception to September 19, 1997 was approximately $78. On September 19, 1997,
assets and liabilities related to the Company were recorded by the Company at
the Parent's basis. The financial statements have been prepared as if the
Company operated as a stand-alone entity since Inception.
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. For the year ended December 31, 1998, the
Company's sales of purchased inventory comprised approximately 96% of
revenues, with consignment-type revenue sharing representing approximately 4%
of revenues.
CASH EQUIVALENTS
All highly liquid debt instruments purchased with a maturity of three months
or less are considered cash equivalents.
SALES-PURCHASED INVENTORY
For sales of merchandise owned and warehoused by the Company, the Company is
responsible for conducting the auction, billing the customer, shipping the
merchandise to the customer, processing merchandise returns and collecting
accounts receivable. The Company recognizes the gross 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 yet been shipped, the Company defers
revenue recognition until the merchandise is shipped. The Company had no
deferred revenue at December 31, 1997 or December 31, 1998.
SALES-REVENUE SHARING AGREEMENTS
For sales of merchandise under revenue sharing agreements, the Company
either takes physical possession of the merchandise or the vendor retains
physical possession of the merchandise. In either case, the Company is not
obligated to take title to the merchandise nor does it take title unless it
successfully sells the merchandise at auction. Upon completion of an auction,
the Company purchases the inventory, takes title to the merchandise, charges
the customer's credit card and either ships the merchandise directly or
arranges for a third party to complete delivery to the customer. The Company
records the gross sales amount as revenue upon verification of the credit card
authorization and shipment of the merchandise. In instances where 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 had no deferred revenue at December 31, 1997 or December 31, 1998.
F-7
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
MERCHANDISE RETURN POLICY
The Company's return policy is that merchandise sold by the Company is sold
on an "as is" basis and is not returnable. However, the Company, although not
obligated to do so, may accept merchandise returns if a product is defective
or does not conform to the specifications of the item sold at auction, and
attempts to work with its customers to resolve complaints about merchandise.
The Company provides for allowances for estimated future returns at the time
of shipment based on historical experience.
MERCHANDISE INVENTORY
The Company accounts for merchandise inventory under the first-in first-out
method. Inventory is carried at lower of cost or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method based on the estimated useful lives of the assets
which range from three to five years.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived assets and certain intangible assets for
impairment when events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable. In the event the sum of the
expected undiscounted future cash flows resulting from the use of the asset is
less than the carrying amount of the asset, an impairment loss equal to the
excess of the asset's carrying value over its fair value is recorded. The
Company has recognized no such losses.
SOFTWARE DEVELOPMENT COSTS
In accordance with SOP 98-1, internal and external costs incurred to develop
internal-use computer software are expensed during the preliminary project
stage and capitalized during the application development stage and amortized
over three years. During the period ended December 31, 1997 and the year ended
December 31, 1998, $39 and $0 was expensed, respectively. As of December 31,
1997 and December 31, 1998, capitalized software net of accumulated
amortization was $264 and $176, respectively.
ADVERTISING COSTS
Advertising costs are charged to expense as incurred. Advertising expense
was $0 and $2,669 for the periods ended December 31, 1997 and December 31,
1998, respectively.
INCOME TAXES
Deferred income taxes are recognized by applying enacted statutory tax rates
applicable to future years to differences between the tax bases and financial
reporting amounts of existing assets and liabilities. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized.
The operations of the Company are included in the consolidated tax return of
the Parent. The tax provision presented in these financial statements was
determined as if the Company filed a separate return.
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.
F-8
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
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 December 31, 1997 and December 31,
1998, options to purchase 458,118 and 1,107,278 common shares were anti-
dilutive and have been excluded from the weighted average share computation.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of accounts receivable from individuals
and merchants located in the United States. Sales are generally made through
credit cards and are pre-approved. The Company maintains an allowance for
doubtful accounts receivable based upon the expected collectibility of
accounts receivable and potential credit losses. Such losses have been
immaterial.
CONCENTRATION OF VENDORS
The Company is dependent upon vendors to supply it with merchandise for sale
through the Company's Internet auctions. For the period from Inception to
December 31, 1997 one vendor, the Parent, accounted for approximately 100% of
net revenues from related product sales. For the twelve-month period ended
December 31, 1998, the Parent accounted for approximately 6% of net revenues
from related product sales.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
respective reporting periods. Actual results could differ from those
estimates.
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.
2. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
Computer, machinery and equipment................. $ 64 $ 372
Computer software................................. 267 306
----- -----
331 678
Less accumulated depreciation and amortization.... (4) (159)
----- -----
$ 327 $ 519
===== =====
</TABLE>
F-9
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
3. RELATED PARTY TRANSACTIONS
Since Inception, the Parent has provided advances to the Company for working
capital and fixed asset purchases of $670 and $3,331 through December 31, 1997
and December 31, 1998, respectively. Upon consummation of the Offering the
$3,331 was converted to 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 expense on intercompany advances and notes payable was $26 and $244
for the period ended December 31, 1997 and the year ended December 31, 1998,
respectively. In addition, from the date of the IPO until December 31, 1998,
the Parent advanced the Company an additional $1,277 in short-term non-
interest bearing advances. The advances relate to cash disbursements made by
the Parent on behalf of the Company during the transition period while the
Company establishes its own cash management programs. These advances are
settled on at least a monthly basis. During the transition period, the Company
will continue to participate in the Parent's cash management process. In
connection therewith, cash receipts related to the Company's business are
applied directly to reduce the Advances from the Parent.
In addition, the Parent provides various services such as administration
(accounting, human resources, legal), warehousing and distribution,
Internet/telecom and joint marketing to the Company. In consideration for
those services, the Parent has historically allocated a portion of its
overhead costs related to such services to the Company. The charges for these
services were:
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 1, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
-------------- ------------
<S> <C> <C>
Administrative.................................. $ 36 $ 481
Warehousing and distribution.................... -- 550
Internet/telecom and joint marketing............ 172 773
---- ------
$208 $1,804
==== ======
</TABLE>
Administration costs for services provided by the Parent to the Company were
determined by identifying all of the Parent's personnel who supported the
Company. Their pay, based on the number of hours of service provided,
benefits, plus an allocation of overhead, was used to calculate these costs.
Credit card processing for transactions above a certain dollar amount was
based on $1.50 per order. Prior to June 30, 1998, warehousing and distribution
was charged at $4.00 per order and was based on the Parent's fully burdened
cost per order for warehousing and distribution. Effective July 1, 1998 the
Company began subleasing 50,000 square feet of warehouse space from the Parent
at the Parents marginal cost. In October 1998, the sublease was increased to
100,000 square feet on the same terms. The Company is also charged a pro-rata
share, based on square footage, of the warehouse utilities, property taxes,
and other warehouse costs. Direct labor to operate the warehouse was charged
directly to the Company. Internet/telecom service costs includes an allocation
of monthly depreciation for all hardware and software based on usage by the
Company, as well as monthly rates for telecommunication expenses consumed by
the Company. Management asserts that the methods to identify and allocate
costs to the Company for these services provided by the Parent are reasonable.
The Company and the Parent entered into on or prior to the consummation of
the IPO, certain agreements governing various interim and ongoing
relationships, including subleasing a portion of the Parent's warehouse,
between the Company and the Parent after the completion of the anticipated IPO
and subsequent Distribution. The terms of such agreements generally provide
for services to be rendered by the Parent similar to those described above.
The costs of general accounting services, payroll and benefits administration,
and internet/telecommunications are charged based on the Parent's cost plus
10%. Credit services are charged at
F-10
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
$1.50 per transaction. For warehousing and distribution, effective July 1,
1998, the Company is subleasing a portion of the Parent's distribution
facility pursuant to a sublease agreement and is being charged a pro rata
portion of the Parent's occupancy costs for this facility. Pursuant to the
Sublease Agreement, future minimum lease payments to the Parent are $275
annually in 1999 through 2002 and $206 in 2003. The rates or amounts to be
paid by the Company under these agreements are not expected to be materially
different than the rates or amounts currently being charged to the Parent. The
agreement pursuant to which the Parent provides the Company with certain
administrative and transactional services will be terminated upon completion
of the Separation and the Distribution.
One of the Company's directors also serves as an officer and a director of
the Parent.
4. INCOME TAXES
No tax benefit has been provided for the periods ended December 31, 1997 and
December 31, 1998 pretax losses due to the uncertainty of realization of these
benefits in future years.
The provision for income taxes differed from the amount computed by applying
the U.S. federal statutory rate to income (loss) before income taxes due to
the effects of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1998
------ ------
<S> <C> <C>
Expected taxes at federal statutory tax rate............... 34% 34 %
Nonrecognition of tax benefits............................. (34) (34)
------ ------
-- % -- %
====== ======
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<CAPTION>
DECEMBER 31,
---------------
1997 1998
------ ------
<S> <C> <C>
Deferred tax assets:
Start-up and development costs............................. $ 105 $ 84
Net operating loss....................................... 10 1,990
Stock based compensation................................. -- 2,107
Other.................................................... 10 12
------ ------
125 4,193
------ ------
Valuation allowance...................................... (125) (4,193)
====== ======
$ -- $ --
====== ======
</TABLE>
The cumulative amount of the deferred tax attributes for the Company at
December 31, 1997 and 1998 is $125 and $4,193, respectively. Of this amount
$10 and $1,990 relates to the total cumulative net operating losses incurred
by the Company through December 31, 1997 and 1998, respectively.
5. EMPLOYEE BENEFITS
401(K) SAVINGS PLAN
The Parent has a 401(k) Savings Plan which covers substantially all Company
full-time employees. Participants may make tax-deferred contributions of up to
15% of annual compensation (subject to other
F-11
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
limitations specified by the Internal Revenue Code). Administrative and
matching costs, which are charged to the Company by the Parent, were not
significant for the period from Inception to December 31, 1997 and for the
twelve-month period ended December 31, 1998.
EMPLOYEE STOCK OPTION PLANS
The Company has granted non-qualified options to certain employees and
directors of the Company to purchase common stock. Each option agreement
provides that options may not be exercised prior to the earlier of (i) the day
following the distribution of all Company stock held by the Parent to its
shareholders or (ii) 18 months from the closing date of the Company's IPO.
Accordingly, no options were exercisable at December 31, 1998.
The terms of the options provide for vesting, generally over a 5-year
period, except for options to purchase 183,247 shares of common stock at
December 31, 1998 which vested as to the first 20% of the shares covered by
such options upon completion of the Company's IPO. The options expire 10 years
from the date of grant.
The following table summarizes stock option activity:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER EXERCISE PRICE
--------- --------------
<S> <C> <C>
Granted............................................ 458,118 $0.27
Canceled........................................... --
Exercised.......................................... --
---------
Outstanding at December 31, 1997................. 458,118 $0.27
Granted............................................ 651,725 $4.62
Canceled........................................... (2,565) $0.27
Exercised.......................................... --
---------
Outstanding at December 31, 1998................. 1,107,278 $2.79
---------
</TABLE>
The options outstanding at December 31, 1997 all have an exercise price of
$0.27. Of the options granted during the year ended December 31, 1998, options
to purchase 370,526, 18,325, 109,948, 1,832, 79,529 and 69,000 common shares
are outstanding and have exercise prices of $0.27, $6.82, $8.87, $10.20,
$11.79 and $15.00, respectively. Options at December 31, 1998 have a weighted
average estimated remaining life of 5.95 years.
The Company commenced its IPO on December 4, 1998 causing a measurement date
to occur and 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 $13.3 million, which will be
recognized over the vesting period, approximately $5.3 million of which was
recognized in December 1998.
F-12
<PAGE>
uBid, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share data)
The fair value of each stock option grant has been estimated pursuant to
SFAS No. 123 on the date of grant using the minimum value method for those
options granted prior to the IPO, and the Black-Scholes option pricing method
for those options issued concurrent with the IPO, with the following weighted
average assumptions:
<TABLE>
<CAPTION>
Minimum Value Black-Scholes
Assumptions Assumptions
------------- -------------
<S> <C> <C>
Risk free interest rate................... 6.3% 4.89%
Expected dividend yield................... none none
Expected lives............................ 6 years 6 years
Expected volatility....................... 100% 142%
</TABLE>
The weighted average grant date fair values of options granted during the
twelve months ended December 31, 1998 and the period from Inception to
December 31, 1997 were $4.03 and $0.08, respectively.
Had the Company accounted for stock options under SFAS No. 123, reported net
loss for the year ended December 31, 1998 would have been $5,172 and net loss
per share would have been $0.69. The effect of applying SFAS No. 123 on net
income and earnings per share is not likely to be representative of the effect
on reported net income and earnings per share for future years.
1998 Stock Incentive Plan
In August 1998, the Company's Board of Directors adopted the 1998 Stock
Incentive Plan (the "1998 Plan") and reserved 1,832,470 shares of common stock
for issuance thereunder. The plan authorized the award of options, stock
appreciation rights, restricted stock awards and performance based stock
awards (each an "Award"). The maximum number of shares with respect to options
and stock appreciation rights granted to any employee in any fiscal year is
476,442 shares. Options granted under the Plan may be either incentive stock
options ("ISOs") or non-qualified stock options ("NSOs"). ISOs may be granted
only to employee (including officers and directors who are also employees).
Awards other than ISOs may be granted to employees, directors and consultants,
as defined.
Options under the Plan may be granted for periods up to ten years and at
prices no less than 85% of the fair value of the shares on the date of grant
provided, however, that the exercise price of an ISO may not be less than 100%
of the fair market value of the shares on the date of grant and the exercise
price of an ISO granted to a 10% shareholder may not be less than 110% of the
fair market value of the shares on the date of grant.
There have been no options granted under the 1998 Plan through December 31,
1998.
6. Initial Public Offering of Common Stock
In December 1998, the Company completed its Initial Public Offering of
1,817,000 shares common stock ("IPO"). Based on the offering price of $15.00
per share, the gross proceeds from the offering were $27,255. After
commissions paid to the underwriters, and other offering costs, the net
proceeds were $23,846. Following the completion of the IPO, the Parent owns
approximately 80% of the Company's outstanding common stock and as a result,
continues to control the Company. The Parent also announced that, subsequent
to the completion of the IPO, it intends to distribute to the Parent's
shareholders in 1999, subject to certain conditions and consents, all of the
Parent's remaining equity interest in the Company.
7. 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
F-13
<PAGE>
uBid, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share data)
report financial and 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 several operating
segments, however 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
computer, consumer electronics and housewares, and sports and recreation
products in the United States. The Company's revenues are divided into two
categories; sales of merchandise that has been purchased by the Company
(approximately 96% of revenues) and sales of merchandise under consignment-
type revenue sharing agreements with vendors (approximately 4% of revenues).
The Company sources its products from over 150 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 year ended December 31, 1998:
<TABLE>
<S> <C>
Computer Products - including desktops, portable computers, computer 83%
accessories, disk drives, modems, monitors/video equipment, components,
printers, scanners, digital cameras, software and home office products.
Consumer Electronics - including home theater equipment, home audio 11%
equipment, speakers, televisions, camcorders, VCR's, DVD players, portable
audio players and automobile audio equipment.
Housewares - including kitchen appliances, vacuum cleaners, personal care 6%
devices, furniture, gifts, photography, jewelry and sunglasses.
Sports and Recreation - including sports memorabilia, golf and tennis, 0%
health and fitness, outdoor sports, bicycles, water sports, and team
sports equipment.
All of the Company's revenues in 1997 were in the computer products
category.
</TABLE>
F-14
<PAGE>
SCHEDULE II
UBID, INC.
VALUATION AND QUALIFYING ACCOUNTS
PERIOD APRIL 1, 1997 (INCEPTION) TO DECEMBER 31, 1997
AND THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCES AT ADDITIONS BALANCE
BEGINNING CHARGED AT END
OF PERIOD TO OTHER (1) DEDUCTIONS OF PERIOD
----------- ------------ ---------- ---------
<S> <C> <C> <C> <C>
Year Ended December 31, 1998:
Allowances for doubtful
accounts--trade receivables.... $ 0 $20 $ 0 $20
=== === === ===
Period April 1, 1997 (Inception)
to December 31, 1997:
Allowances for doubtful
accounts--trade receivables.... $ 0 $ 0 $ 0 $ 0
=== === === ===
</TABLE>
- --------
(1) The amount represents the allowance for doubtful accounts balance on the
balance sheet for uBid at the end of the 1998 fiscal year.
F-15
<PAGE>
EXHIBIT 10.3
TAX INDEMNIFICATION AND ALLOCATION AGREEMENT
(AS AMENDED)
<PAGE>
EXHIBIT 10.3
TAX INDEMNIFICATION AND ALLOCATION AGREEMENT
(AS AMENDED)
TAX INDEMNIFICATION AND ALLOCATION AGREEMENT dated as of December 7, 1998
by and between Creative Computers, Inc., a Delaware corporation ("CCI") and
uBid, Inc., a Delaware corporation ("uBid").
RECITALS
A. CCI is the common parent of an affiliated group of corporations (the
"CCI Group") within the meaning of Section 1504(a) of the Internal Revenue Code
of 1986, as amended (the "Code"). The CCI Group includes uBid. The members of
the CCI Group have heretofore joined in filing consolidated Federal income tax
returns.
B. CCI expects (i) to cause uBid to make an initial public offering of its
Common Stock, par value $.001 per share (the "Offering"), and (ii) no earlier
than 180 days following consummation of the Offering, pursuant to a Separation
and Distribution Agreement, dated as of December 7, 1998, (the "Distribution
Agreement") to distribute all of the stock of uBid then held by the CCI Group
pro rata to the CCI stockholders in a transaction intended to qualify as a tax-
free distribution under Code (S)355 (the "Distribution").
C. At the close of the business day on which the Distribution occurs (the
"Distribution Date"), the taxable year of uBid shall close for U.S. federal
income tax purposes and uBid shall cease to be a member of the CCI Group.
D. The parties hereto wish to provide for the payment of Income Taxes (as
defined herein) and entitlement to refunds thereof, allocate responsibility and
provide for cooperation in connection with the filing of returns in respect of
Income Taxes, and provide for certain other matters relating to Income Taxes;
NOW, THEREFORE, in consideration of the agreements herein contained and
intending to be legally bound hereby, CCI and uBid hereby agree as follows:
ARTICLE I
DEFINITIONS
Capitalized terms used but not otherwise defined herein shall have the
respective meanings assigned to them in the Distribution Agreement. For
purposes of this Agreement, the following terms shall have the meanings set
forth below (such meanings to be equally applicable to both the singular and the
plural forms of the terms defined).
1.1 "Action" shall mean any action, claim, suit, arbitration, inquiry,
proceeding or investigation by or before any court, any governmental, regulatory
or other administrative agency or commission or any arbitration tribunal.
1
<PAGE>
1.2 "Actual Tax Payment" shall have the meaning set forth in Section 3.3
hereof.
1.3 "Actually Realized" or "Actually Realizes" shall mean, for purposes
of determining the timing of the incurrence of any Income Tax Liability or the
realization of a Refund (or any related Income Tax Detriment or Benefit) by a
Person in respect of any payment, transaction, occurrence or event, the time at
which the amount of Income Taxes paid by such Person is increased above or
reduced below the amount of Income Taxes that such Person would have been
required to pay but for such payment, transaction, occurrence or event.
1.4 "Aggregate Spin-Off Tax Liabilities" means the sum of the Spin-Off
Tax Liabilities with respect to each Taxing Jurisdiction.
1.5 "Business Day" shall mean any day other than a Saturday, a Sunday or
a day on which banking institutions located in the State of New York are
authorized or obligated by law or executive order to close.
1.6 "Carryback" shall mean the carryback of a Tax Attribute (including,
without limitation, a net operating loss, a net capital loss or a tax credit) by
uBid from a Post-Distribution Taxable Period to a CCI Consolidated Return
Period.
1.7 "Code" shall have the meaning set forth in Recital A.
1.8 "CCI Consolidated Group" shall mean CCI and the other members of the
affiliated group of corporations (within the meaning of Section 1504(a) of the
Code without regard to the exclusions in Section 1504(a)(1) through (8)) of
which CCI is the common parent.
1.9 "CCI Consolidated Federal Return" shall mean any consolidated
federal Income Tax Return or amendment thereof of the CCI Consolidated Group for
any CCI Consolidated Return Period.
1.10 "CCI Consolidated Return Period" shall mean a taxable period that
ends within the Effective Period for which a consolidated, combined or unitary
(as applicable) federal, state, local or foreign Income Tax Return is filed or
required to be filed by the CCI Consolidated Group.
1.11 "CCI Consolidated Tax Liability" means, with respect to any CCI
Consolidated Return Period, the consolidated, combined or unitary Income Tax
Liability of the CCI Consolidated Group.
1.12 "CCI Group" shall mean, solely for purposes of this Agreement, CCI
and each of the other members of the CCI Consolidated Group other than uBid.
1.13 "CCI State, Local and Foreign Returns" shall mean any combined,
consolidated or unitary state, local or foreign Income Tax Returns or amendment
thereof which are required to be filed by CCI or a member of the CCI
Consolidated Group.
2
<PAGE>
1.14 "Deemed Tax Payment" shall have the meaning set forth in Section 3.3
hereof.
1.15 "Distribution" shall have the meaning set forth in Recital B.
1.16 "Distribution Agreement" shall have the meaning set forth in Recital
B.
1.17 "Effective Period" shall include all taxable periods that begin or
end on or after the date of the Offering, provided that uBid is included in the
CCI Consolidated Group for a portion of such taxable period.
1.18 "Equity Securities" shall mean any stock or other equity securities
treated as stock for tax purposes, or options, warrants, rights, convertible
debt, or any other instrument or security that affords any Person the right,
whether conditional or otherwise, to acquire stock.
1.19 "Fifty-Percent or Greater Interest" shall have the meaning ascribed
to such term for purposes of Code (S)(S) 355(d) and (e).
1.20 "Final Determination" shall mean the final resolution of liability
for any Income Tax, which resolution may be for a specific issue or adjustment
or for a taxable period, (i) by Internal Revenue Service Form 870 or 870-AD (or
any successor forms thereto), on the date of acceptance by or on behalf of the
taxpayer, or by a comparable form under the laws of a state, local, or foreign
taxing jurisdiction, except that a Form 870 or 870-AD or comparable form shall
not constitute a Final Determination to the extent that it reserves (whether by
its terms or by operation of law) the right of the taxpayer to file a claim for
Refund or the right of the Taxing Jurisdiction to assert a further deficiency in
respect of such issue or adjustment or for such taxable period (as the case may
be); (ii) by a decision, judgment, decree, or other order by a court of
competent jurisdiction, which has become final and unappealable; (iii) by a
closing agreement or accepted offer in compromise under Sections 7121 or 7122 of
the Code, or a comparable agreement under the laws of a state, local, or foreign
taxing jurisdiction; (iv) by any allowance of a Refund or credit in respect of
an overpayment of Income Tax, but only after the expiration of all periods
during which such Refund may be recovered (including by way of offset) by the
jurisdiction imposing such Income Tax; or (v) by any other final disposition,
including by reason of the expiration of the applicable statute of limitations
or by mutual agreement of the parties.
1.21 "Income Tax" (a) shall mean (i) any foreign or any United States
federal, state or local tax, charge, fee, impost, levy or other assessment that
is based upon, measured by, or calculated with respect to (1) net income or
profits (including, but not limited to, any capital gains, gross receipts, or
minimum tax, and any tax on items of tax preference, but not including sales,
use, value added, real property gains, real or personal property, transfer or
similar taxes), or (2) multiple bases (including, but not limited to, corporate
franchise, doing business or occupation taxes), if one or more of the bases upon
which such tax may be based, by which it may be measured, or with respect to
which it may be calculated is described in clause (a)(i)(1) of this definition,
together with (B) any
3
<PAGE>
interest and any penalties, fines, additions to tax or additional amounts
imposed by any Taxing Jurisdiction with respect thereto and (b) shall include
any transferee liability in respect of an amount described in clause (a) of this
definition.
1.22 "Income Tax Benefit" shall mean, in respect of a Person or group of
Persons for any taxable period, the excess of (A) the hypothetical Income Tax
Liability of such Person or group of Persons for such taxable period, calculated
as if carryover of a Tax Attribute had not occurred but with all other facts
unchanged, over (B) the actual Income Tax Liability of such Person or group of
Persons for such taxable period, calculated taking into account the carryover of
such Tax Attribute (and treating a Refund as a negative Income Tax Liability,
and taking into account credits (if any), for purposes of such calculation).
1.23 "Income Tax Detriment" shall mean, in respect of any Person or group
of Persons for any taxable period, the excess of (A) the actual Income Tax
Liability of such Person or group of Persons for such taxable period, calculated
taking into account the carryover of a Tax Attribute, as the case may be, over
(B) the hypothetical Income Tax Liability of such Person or group of Persons for
such taxable period, calculated as if the carryover of a Tax Attribute had not
occurred but with all other facts unchanged (and treating a Refund as a negative
Income Tax Liability, and taking into account credits (if any), for purposes of
such calculation).
1.24 "Income Tax Liabilities" shall mean all liabilities for Income
Taxes.
1.25 "Income Tax Return" shall mean any return, report, filing,
statement, questionnaire, declaration or other document required to be filed
with a Taxing Jurisdiction in respect of Income Taxes.
1.26 "Indemnified Party" shall mean any Person seeking indemnification
pursuant to the provisions of this Agreement.
1.27 "Indemnifying Party" shall mean any party hereto from which any
Indemnified Party is seeking indemnification pursuant to the provisions of this
Agreement.
1.28 "Internal Spin" shall mean the distribution of the uBid Common Stock
by CCI Computers, Inc., a California corporation, to CCI.
1.29 "Losses" shall mean any and all losses, liabilities, claims,
damages, obligations, payments, costs and expenses, matured or unmatured,
absolute or contingent, accrued or unaccrued, liquidated or unliquidated, known
or unknown (including, without limitation, the costs and expenses of any and all
Actions, threatened Actions, demands, assessments, judgments, settlements and
compromises relating thereto and attorneys' fees and any and all expenses
whatsoever reasonably incurred in investigating, preparing or defending against
any such Actions or threatened Actions).
1.30 "Notice Date" with respect to Subsequent Tax Legislation or
Regulation (as defined below) shall mean the earliest of (i) the date such
legislation or materially
4
<PAGE>
identical legislation is introduced as a bill in the United States House of
Representatives or the United States Senate, (ii) the date any amendment to any
bill incorporating such legislation is approved by the Congressional committee
having jurisdiction or by the United States House of Representatives or the
United States Senate, (iii) the date any written proposal incorporating such
legislation is transmitted by the President of the United States to Congress,
(iv) the date any written proposal either by the Chairman of the United States
House of Representatives Ways and Means Committee or any successor thereto or
the Chairman of the United States Senate Finance Committee incorporating such
legislation is published in the Bureau of National Affairs' "Daily Tax Report,"
or any successor publication or (v) the date such regulation is published in the
Federal Register as proposed, temporary, or final Treasury Regulations.
1.31 "Overpayment Rate" shall mean the annual rate of interest described
in Code (S)6621(a)(1) (or similar provision of state, local, or foreign Income
Tax law, as applicable), as determined from time to time.
1.32 "Person" shall mean and include any individual, partnership, joint
venture, limited liability company, corporation, association, joint stock
company, trust, unincorporated organization or similar entity or a governmental
authority or any department or agency or other unit thereof.
1.33 "Post-Distribution Taxable Period" shall mean a taxable period that,
to the extent it relates to uBid, begins after the Distribution Date.
1.34 "Pre-Distribution Taxable Period" shall mean a taxable period that,
to the extent it relates to uBid, ends on or before the Distribution Date.
1.35 "Preexisting Tax Benefit" shall have the meaning set forth in
Section 2.5.
1.36 "Proceeding" shall mean any audit or other examination, judicial or
administrative proceeding relating to liability for, or Refunds or adjustments
with respect to, Income Taxes.
1.37 "PWC Opinion" shall mean the opinion letter dated August 5, 1998,
of PricewaterhouseCoopers LLP to the Board of Directors and Stockholders of CCI.
1.38 "Qualified Tax Counsel" shall mean independent tax counsel of
recognized national standing that is acceptable to CCI.
1.39 "Refund" shall mean any refund of Income Taxes, including any
reduction in Income Tax Liabilities by means of a credit, offset or otherwise.
1.40 "Restriction Period" shall mean the period beginning on the date
hereof and ending on the three-year anniversary of the Distribution Date.
1.41 "Spin-Off Tax Liabilities," with respect to any Taxing Jurisdiction,
as defined below, shall mean the sum of (i) the product of (x) the additional
corporate-level gain or income recognized with respect to the failure of the
Initial Spin or the
5
<PAGE>
Distribution to qualify for Tax-Free Status, as defined below, under the income
tax law of such Taxing Jurisdiction pursuant to any settlement, Final
Determination, judgment, assessment, proposed adjustment or otherwise and (y)
the Taxing Jurisdiction's highest marginal tax rate applicable to the taxable
income of corporations on income of the character subject to tax and indemnified
against under Article III, (ii) interest on such amount calculated pursuant to
such Taxing Jurisdiction's laws regarding interest on tax liabilities at the
highest Underpayment Rate, as defined below, for corporations in such Taxing
Jurisdiction from the date such additional gain or income was recognized until
full payment with respect thereto is made pursuant to Article III hereof, and
(iii) any penalties actually paid to such Taxing Jurisdiction that would not
have been paid but for the failure of the Distribution to qualify for Tax-Free
Status in such Taxing Jurisdiction.
1.42 "Subsequent Tax Legislation or Regulation" shall mean any bill
introduced in the United States House of Representatives or the United States
Senate that amends the Code, or any amendment to any such bill; any written
proposal to amend the Code that is officially recommended by the President of
the United States; any written proposal to amend the Code that is made available
to the general public either by the Chairman of the United States House of
Representatives Ways and Means Committee or any successor thereto, the Chairman
of the United States Senate Finance Committee or any successor thereto, or the
temporary or final Treasury Regulation; provided, however, that no such bill,
amendment, proposal, or regulation shall constitute Subsequent Tax Legislation
or Regulation unless the Notice Date of such bill, amendment, proposal or
regulation is subsequent to the date of this Agreement.
1.43 "Tax Attribute" shall mean a consolidated net operating loss, a
consolidated net capital loss, a consolidated unused investment credit, a
consolidated unused foreign tax credit, or a consolidated excess charitable
contribution (as such terms are used in Treasury Regulations (S)(S)1.1502-79 and
1.1502-79A), or a U.S. federal minimum tax credit or U.S. federal general
business credit (but not tax basis or earnings and profits) that arises in a
Pre-Distribution Taxable Period (including the taxable period in which the
Distribution Date occurs) and can be carried to a taxable period ending after
the Distribution Date.
1.44 "Tax-Free Status" shall mean the qualification of the Initial Spin
and the Distribution (i) as transactions described in Code 355(a)(1), (ii) as
transactions in which the stock distributed thereby is qualified property for
purposes of Code (S)355(c)(2), and (iii) as transactions in which the CCI Group
recognizes no income or gain other than intercompany items or excess loss
accounts taken into account pursuant to the Treasury Regulations promulgated
pursuant to Code (S)1502.
1.45 "Tax Opinion" means an unqualified opinion of Qualified Tax Counsel
on which CCI may rely, in form and substance reasonably acceptable to CCI (and
in determining whether an opinion is reasonably acceptable, CCI may consider,
among other factors, the appropriateness of any underlying assumptions and
management's representations if used as a basis for the opinion) to the effect
that a transaction will not disqualify the Initial Spin or the Distribution from
Tax-Free Status, assuming that the
6
<PAGE>
Initial Spin and the Distribution would have qualified for Tax-Free Status if
such transaction did not occur.
1.46 "Tax-Related Losses" shall mean: (i) the Aggregate Spin-Off Tax
Liabilities, (ii) all accounting, legal and other professional fees, and court
costs incurred in connection with any settlement, Final Determination, judgment
or other determination with respect to such Aggregate Spin-Off Tax Liabilities,
and (iii) all costs, expenses and damages associated with stockholder litigation
or controversies and any amount paid by CCI or uBid in respect of the liability
of stockholders, whether paid to stockholders or to the IRS or any other Taxing
Jurisdiction payable by CCI or uBid or their respective Affiliates, in each
case, resulting from the absence of Tax-Free Status for the Internal Spin or the
Distribution.
1.47 "Taxing Jurisdiction" shall mean the United States and every other
government or governmental unit having jurisdiction to tax CCI, uBid or any of
their respective Affiliates.
1.48 "uBid Business" shall mean the Auction Sales Business currently
conducted by uBid described in the PWC Opinion.
1.49 "Underpayment Rate" shall mean the annual rate of interest described
in Section 6621(c) of the Code for large corporate underpayments of Income Tax
(or similar provision of state, local, or foreign Income Tax law, as
applicable), as determined from time to time.
ARTICLE II
PREPARATION AND FILING OF TAX RETURNS; PAYMENT OF TAX
2.1 CCI Consolidated Federal Returns.
(a) General. For any CCI Consolidated Return Period, CCI shall
have sole and exclusive responsibility for the preparation and filing of all CCI
Consolidated Federal Returns and amendments thereto with the IRS. Such returns
shall include all income, gains, losses, deductions and credits of uBid.
(b) Cooperation. uBid shall furnish CCI, at least sixty (60) days
before the due date (including extensions) of any such CCI Consolidated Federal
Return, with its completed section of such CCI Consolidated Federal Return,
prepared in accordance with this Agreement, in accordance with instructions from
CCI and in a manner consistent with prior returns, if any, provided that such
actions are not inconsistent with this Agreement. uBid will also furnish CCI
work papers and other such information and documentation as is reasonable
requested by CCI with respect to uBid.
2.2 CCI State, Local and Foreign Returns.
(a) General. For any CCI Consolidated Return Period, CCI shall
have sole and exclusive responsibility for the preparation and filing of all CCI
State, Local and Foreign Returns.
7
<PAGE>
(b) Cooperation. CCI will timely advise uBid of the inclusion of
uBid in any CCI State, Local and Foreign Returns and the jurisdictions in which
such returns will be filed. uBid ill evidence its agreement to be included in
such return on the appropriate form(s) and will take such other actions as may
be appropriate, in the opinion of CCI, to carry out the purposes and intent of
this Section 2.2, provided that such actions are not inconsistent with this
Agreement. uBid shall furnish CCI, at least sixty (60) days before the due date
(including extensions) of any such CCI State, Local and Foreign Returns, with
its completed section of such CCI State, Local and Foreign Returns, prepared in
accordance with this Agreement, in accordance with instructions from CCI and in
a manner consistent with prior returns, if any, provided that such actions are
not inconsistent with this Agreement. uBid will also furnish CCI work papers and
other such information and documentation as is reasonable requested by CCI with
respect to uBid.
2.3 CCI Tax Liability.
(a) CCI Consolidated Federal Return Liability. Except to the extent
otherwise provided herein, for each CCI Consolidated Return Period, CCI shall be
liable for and indemnify uBid against all Taxes due in respect of all CCI
Consolidated Federal Returns, subject to reimbursement from uBid as contemplated
by Section 2.6 of this Agreement.
(b) CCI State, Local and Foreign Return Liability. Except to the
extent otherwise provided herein, for each CCI Consolidated Return Period, CCI
shall be liable for and indemnify uBid against all Taxes due in respect of all
CCI State, Local and Foreign Returns, subject to reimbursement from uBid as
contemplated by Section 2.6 of this Agreement.
2.4 uBid Separate Tax Return Amount.
(a) General. For any taxable period ending during the Effective
Period of this Agreement, the term "uBid Separate Tax Return Amount" shall mean
the aggregate amount, whether a negative or positive, of (i) the uBid Separate
Federal Amount and (ii) the uBid Separate State, Local and Foreign Amount, each
as adjusted pursuant to the terms of this Agreement.
(b) Computation of uBid Separate Federal Amount. For each CCI
Consolidated Return Period that ends during the Effective Period of this
Agreement, uBid shall compute the uBid Separate Federal Amount for the portion
of such periods in which uBid is a Member of the CCI Affiliated Group. "uBid
Separate Federal Amount" means, with respect to each CCI Consolidated Return
Period, the federal Tax liability that would be payable by uBid to the IRS (in
which case such amount will be positive), or the federal Tax refund that would
be payable by the IRS to uBid (in which case such amount will be negative) if
uBid had filed a separate federal income tax return for the CCI Consolidated
Return Period. In the event that uBid has a net operating loss, tax credit or
other favorable Tax attribute (a "Tax Attribute") for federal Tax purposes for a
particular CCI Consolidated Return Period that would eliminate the federal Tax
liability of uBid for such taxable period but would not yield a federal Tax
refund for uBid on a separate
8
<PAGE>
federal income tax return basis, the uBid Separate Federal Amount shall be zero
for such taxable period, and such federal Tax Attribute shall be recoverable, if
at all, by uBid in a subsequent CCI Consolidated Return Period on such separate
return basis, as herein provided. In computing the uBid Separate Federal Amount,
uBid shall follow the Tax elections and other Tax positions adopted or
prescribed by CCI and shall take into account the adjustments and modifications
set forth in Section 2.5 of this Agreement.
(c) Computation of uBid Separate State, Local and Foreign Amount.
For each CCI Consolidated Return Period that ends on or after the first day of
the Effective Period of this Agreement, uBid shall compute the uBid Separate
State, Local and Foreign Amount for the portion of such periods in which uBid is
a Member of the CCI Affiliated Group. "uBid Separate State, Local and Foreign
Amount" means, with respect to each CCI Consolidated Return Period, the state,
local and foreign Tax liability that would be payable by uBid to the applicable
taxing authorities (in which case such amount will be positive), or the state,
local and foreign Tax refund that would be payable by the applicable taxing
authorities to uBid (in which case such amount will be negative) if uBid had
filed a separate state, local and foreign income or franchise tax return for the
CCI Consolidated Return Period. In the event that uBid would have a net
operating loss, tax credit or other favorable Tax attribute (a "Tax Attribute")
for state, local or foreign Tax purposes for a particular CCI Consolidated
Return Period that would eliminate the state, local or foreign Tax liability of
uBid for such taxable period but would not yield a state, local or foreign Tax
refund for uBid on a separate federal income tax return basis, the uBid Separate
State, Local and Foreign Amount shall be zero for such taxable period, and such
state, local or foreign Tax Attribute shall be recoverable, if at all, by uBid
in a subsequent CCI Consolidated Return Period on such separate return basis, as
herein provided. In computing the uBid Separate State, Local and Foreign Amount,
uBid shall follow the Tax elections and other Tax positions adopted or
prescribed by CCI and shall take into account the adjustments and modifications
set forth in Section 2.5 of this Agreement.
2.5 Adjustments. In computing the uBid Separate Federal Amount (and to
the extent appropriate, the uBid Separate State, Local and Foreign Amount), uBid
shall take into account the following adjustments and modifications:
(a) The uBid Separate Federal Amount shall be computed as if uBid
came into existence in a Code (S)351 transaction on the date of the Offering,
and unless otherwise provided, uBid shall be deemed not to have existed prior to
such date. uBid shall not be entitled to any Tax Benefits of either the CCI
Affiliated Group or uBid that existed prior to the date of the Offering (a
"Preexisting Tax Benefit").
(b) Dividends from any Member of the CCI Affiliated Group shall be
eliminated.
(c) Items of income, gain, loss or deduction arising from a
transaction described in Treasury Regulation (S)1.1552-1(a)(2)(ii) shall be
taken into account by uBid in the same manner and in the same taxable years as
such items are actually taken into account on the CCI Consolidated Federal
Return.
9
<PAGE>
(d) Carryforwards and carrybacks of any Tax Benefits shall be
calculated as though CCI were the IRS and uBid filed a separate return.
(e) Characterization of items of income, expense, gain or loss that
are determined on a consolidated or combined basis in the calculation of CCI
Consolidated Federal Return Liability and CCI State, Local and Foreign
Liability, such as characterizations under Code (S)1231, shall retain their
characterization for purposes of determining the uBid Separate Federal Amount
and the uBid Separate State, Local and Foreign Amount.
(f) All ordinary income and capital gains shall be deemed to be
subject to Tax at the highest applicable Tax rate applicable to taxable ordinary
income of corporations.
(g) Estimated Tax payments made pursuant to Section 2.6(c) of this
Agreement shall not be included in the computation of the uBid Separate Tax
Return Amount.
(h) Other adjustments reasonably specified by CCI shall be made.
2.6 Payment of uBid Separate Tax Return Amount.
(a) Payment from uBid to CCI. For any CCI Consolidated Return
Period covered by this Agreement, if the uBid Separate Tax Return Amount is a
positive amount, uBid shall pay such amount to CCI on or before the due date
(without extensions) of the CCI Consolidated Federal Returns for the appropriate
CCI Consolidated Return Period. Such payment shall be reduced by the estimated
Tax payments made by uBid for such taxable period pursuant to Section 2.6(c) of
this Agreement. For administrative or other reasons, CCI may direct or allow the
above payment to be made after the prescribed date. If all relevant information
necessary to determine the amount of the payment is not available by the due
date, the payment shall be based on estimates, and adjustments shall be made
when sufficient information is available or as soon as practicable after the CCI
Consolidated Federal Return for the appropriate CCI Consolidated Return Period
is filed.
(b) Payment from CCI to uBid. For any CCI Consolidated Return
Period covered by this Agreement, if the uBid Separate Tax Return Amount is a
negative amount CCI shall pay to uBid the amount that would have been allowed as
a net Tax refund to uBid on or before the due date (without extensions) of the
CCI Consolidated Federal Returns for the appropriate CCI Consolidated Return
Period. Such payment shall be increased by the estimated Tax payments made by
uBid Subgroup for such taxable period pursuant to Section 2.6(c) of this
Agreement. For administrative or other reasons, CCI may decide to make the above
payment after the prescribed date. If all relevant information necessary to
determine the amount of the payment is not available by the due date, the
payment shall be based on estimates, and adjustments shall be made when
sufficient information is available or as soon as practicable after the CCI
Consolidated Federal Return for the appropriate CCI Consolidated Return Period
is filed.
10
<PAGE>
(c) Estimated Tax Payments.
(i) uBid shall pay to CCI quarterly installments of estimated
Tax. The amount of such payments for the first, second, third and fourth
installments shall cumulatively equal 25 percent, 50 percent, 75 percent and 100
percent, respectively, of the estimated full-year uBid Separate Tax Return
Amount (including the minimum tax and environmental tax). Settlement for such
payment shall be made on or before, or as soon as practicable after, the due
date of the applicable estimated Tax payment to be paid by CCI.
(ii) uBid Subgroup shall pay to CCI any and all interest and
penalties imposed on the CCI Affiliated Group as a result of the underpayment of
estimated Tax attributable to the uBid Subgroup. For purposes of this Section
2.6(c)(ii), the Chief Financial Officer of CCI shall determine to which Member
or Members of the CCI Affiliated Group the underpayment is attributable. Such
determination of the Chief Financial Officer shall be final. A payment of such
interest and penalties shall not be considered a payment of estimated Tax.
2.7 Adjustments to CCI Consolidated Tax Liability.
(a) General. If any adjustment in the CCI Consolidated Tax
Liability is made as a result of an audit by a Taxing Authority, the granting of
a claim for refund, a final decision by a court, the carryback or carryforward
of a loss, deduction or credit or any other similar circumstance, the Tax refund
or Tax liability resulting therefrom, including any interest and penalties (an
"Adjustment"), shall be allocated between the CCI Affiliated Group and uBid in
accordance with the principles of this Agreement as if such adjustments had been
taken into account in the year to which they relate.
(b) Adjustment Resulting in Basis Increase to uBid. If any
Adjustment results in an increase in the adjusted basis of any asset transferred
by CCI to uBid, uBid shall pay to CCI the amount of any Tax benefit resulting to
it by virtue of such basis increase to CCI as and when such Tax benefit is
realized. The preceding sentence shall survive the expiration of the Effective
Period of this Agreement.
ARTICLE III
INDEMNIFICATION FOR INCOME TAXES
3.1 Indemnification by CCI. Except as otherwise provided in this Article
III, CCI shall indemnify and hold uBid, its Representatives and Affiliates
harmless from and against (i) all Spin-Off Tax Liabilities incurred by any
member of the CCI Group, (ii) without duplication, all Income Tax Liabilities
that any member of the CCI Group is liable for, or required to reimburse uBid
for, pursuant to Article II hereof, and (iii) all Income Taxes incurred by uBid
by reason of the breach by CCI of any of its covenants hereunder and, in each
case, any related costs and expenses (including, without limitation, reasonable
attorneys' fees and expenses).
11
<PAGE>
3.2 Indemnification by uBid. From and after the Distribution Date, uBid
shall indemnify and hold each member of the CCI Group and each of their
respective Representatives and Affiliates harmless from and against (i) all
Income Tax Liabilities that uBid is required to pay, or reimburse CCI for, under
Article II hereof and (ii) all Income Taxes, Spin-Off Tax Liabilities or other
Tax-Related Losses incurred by any member of the CCI Group by reason of the
breach by uBid of any of its covenants hereunder, and, in each case, any related
costs and expenses(including, without limitation, reasonable attorneys' fees and
expenses).
3.3 Time of Payment. To the extent an indemnification obligation relates
to Spin-Off Tax Liabilities, the Indemnifying Party shall make payment pursuant
to such indemnification obligation no later than (i) five Business Days prior to
the date the Indemnified Party makes a payment of taxes, interest, or penalties
with respect to a proposed adjustment of taxes or an assessment of tax
deficiency asserted or made by any Taxing Jurisdiction that is premised in whole
or part on Spin-Off Tax Liabilities, including a payment made in settlement of
an asserted tax deficiency (each, an "Actual Tax Payment"), or (ii) five
Business Days after the date the Indemnified Party gives written notice to the
Indemnifying Party that the Indemnified Party has notified any Taxing
Jurisdiction, or gives the Indemnifying Party written notice or an
acknowledgment by any Taxing Jurisdiction, that such proposed adjustment of
taxes or tax deficiency would not result in a net payment by the Indemnified
Party because of the carryover, carryback or carryforward of net operating
losses or credits, the crediting of previously paid taxes, the utilization of
deductions or credits not claimed on the Indemnified Party's tax returns as
originally filed, the exclusion of income reported on such returns, or the
utilization of any other tax attributes that offset the asserted taxes (each, a
"Deemed Tax Payment"). The amount payable pursuant to the preceding sentence
shall be the Tax-Related Loss implied by such Actual Tax Payments and Deemed Tax
Payments.
3.4 Subsequent Tax Legislation or Regulation. To the extent Tax-Related
Losses would not have arisen but for Subsequent Tax Legislation or Regulation,
such Losses shall be borne equally by CCI and uBid. The party making actual
payment of such Losses shall be indemnified by the other party to the extent of
the other party's allocated share of such Losses.
3.5 Effect of Ruling, Determination or Opinion. CCI shall be indemnified
and held harmless pursuant to this Article 3 without regard to the fact that (i)
CCI or uBid may have received a ruling from the Internal Revenue Service, (ii)
CCI may have made a determination pursuant to Section 5.7, or (iii) uBid may
have obtained a Tax Opinion pursuant to Section 5.7.
ARTICLE IV
REPRESENTATIONS SPECIFIC TO DISTRIBUTION TAX MATTERS
4.1 PWC Opinion. uBid hereby represents and warrants that (i) it has
examined the PWC Opinion (including, without limitation, the representations
referred to therein to the extent that they relate to the plans, proposals,
intentions, and policies of
12
<PAGE>
uBid or the uBid Business) and (ii) to the extent descriptive of uBid or the
uBid Business, the facts presented and the representations made therein are true
and correct, except to the extent that any such facts or representations:
(a) are about the CCI Group (except for facts about the uBid
Business);
(b) describe or characterize the purposes of CCI management for the
Distribution; or
(c) set forth legal conclusions.
4.2 No Plan or Intention.
(a) uBid hereby represents and warrants that it has no plan or
intention of taking any action, or failing or omitting to take any action, that
would (i) cause the Distribution not to have Tax-Free Status or (ii) cause any
representation or factual statement made in this Agreement or in the PWC Opinion
to be untrue in a manner that would have an adverse effect on the Tax-Free
Status of the Distribution.
(b) uBid hereby represents and warrants that the Distribution is
not part of a plan (or series of related transactions) pursuant to which a
Person will acquire stock representing a Fifty-Percent or Greater Interest in
uBid or any successor to uBid.
ARTICLE V
COVENANTS SPECIFIC TO DISTRIBUTION TAX MATTERS
5.1 No Action. uBid shall not take any action, nor fail or omit to take
any action, that would (i) cause the Distribution not to have Tax-Free Status or
(ii) cause any representation or factual statement made in this Agreement or the
PWC Opinion to be untrue in a manner that would have an adverse effect on the
Tax-Free Status of the Distribution.
5.2 Active Conduct of Business. Until the first day after the
Restriction Period, uBid shall continue the active conduct of the uBid Business.
uBid shall not liquidate, dispose of, or otherwise discontinue the conduct of
any material portion of the uBid Business. uBid shall continue the active
conduct of the uBid Business primarily through officers and employees of uBid
(and not through independent contractors). For purposes of this Section 5.2,
asset retirements and discontinuations of product lines with respect to the uBid
Business in the ordinary course of business shall not be treated as a
disposition of a portion of the uBid Business.
5.3 Sale of Equity Securities. Until the first day after the Restriction
Period, uBid shall not sell or otherwise issue to any Person, or redeem or
otherwise acquire from any Person, any Equity Securities of uBid; provided,
however, that (i) the adoption by uBid of a rights plan shall not constitute a
sale or issuance of Equity Securities; (ii) uBid may repurchase Equity
Securities to the extent that such repurchases meet the requirements of section
4.05(1)(b) of Revenue Procedure 96-30, and (iii) uBid may issue Equity
Securities of uBid (including issuances as compensation for services or pursuant
13
<PAGE>
to the exercise of compensatory stock options) that do not exceed in the
aggregate a [40%] or greater interest in the Equity Securities of uBid over the
period from and including the date of the Offering to the second anniversary of
the Distribution Date and [45%] of the Equity Securities of uBid over the period
from the date of the Offering to the end of the Restriction Period. For purposes
of the preceding sentence (A) Equity Securities sold by shareholders of uBid
pursuant to a uBid registration statement shall be considered to be Equity
Securities issued by uBid, and (B) aggregate percentages shall be determined
after taking into account the Equity Securities to be issued.
5.4 Solicitation of Sale. Until the first day after the Restriction
Period, uBid shall not (i) solicit any Person to make a tender offer for, or
otherwise acquire or sell, the Equity Securities of uBid, (ii) participate in or
support any unsolicited tender offer for, or other acquisition, issuance or
disposition of, the Equity Securities of uBid or (iii) approve or otherwise
permit any proposed business combination or any transaction which, in the case
of (i), (ii) or (iii), individually or in the aggregate, together with the
transactions contemplated by this Agreement, the Distribution Agreement, any
Other Agreements or the PWC Opinion, results in one or more Persons acquiring
(other than in acquisitions not taken into account for purposes of Code
(S)355(e)) directly or indirectly stock representing a Fifty-Percent or Greater
Interest in uBid. In addition, uBid shall not at any time, whether before or
subsequent to the expiration of the Restriction Period, engage in any action
described in clauses (i), (ii) or (iii) of the preceding sentence if it is
pursuant to an arrangement negotiated (in whole or in part) prior to the
Distribution, even if at the time of the Distribution it is subject to various
conditions, nor shall any member take any action, or fail or omit to take any
action, that would cause Code (S)(S) 355(d) or (e) to apply to the Distribution.
5.5 Sale of Assets. Until the first day after the Restriction Period,
uBid Group shall not sell, transfer, or otherwise dispose of or agree to dispose
of assets (including, for such purpose, any shares of capital stock of a
subsidiary) that, in the aggregate, constitute more than 60 percent of the gross
assets of uBid, nor shall uBid sell, transfer, or otherwise dispose of or agree
to dispose of assets (including, for such purpose, any shares of capital stock
of a subsidiary) that, in the aggregate, constitute more than 60 percent of the
consolidated gross assets of uBid. The foregoing sentence shall not apply to
sales, transfers, or dispositions of assets in the ordinary course of business.
The percentages of gross assets or consolidated gross assets of uBid sold,
transferred, or otherwise disposed of, shall be based on the fair market value
of the gross assets of uBid as of the Distribution Date. Sales, transfers or
other dispositions by uBid or any of its subsidiaries to uBid or any of its
subsidiaries are not subject to this Section 5.5 to the extent not inconsistent
with the Tax-Free Status of the Distribution.
5.6 Dissolution, Liquidation and Merger. Until the first day after the
Restriction Period, uBid shall not voluntarily dissolve or liquidate. Until the
first day after the Restriction Period, uBid shall not merge, consolidate or
reorganize unless Persons owning uBid stock immediately prior to the merger,
consolidation or other reorganization will own, directly or indirectly, a Fifty-
Percent or Greater Interest in the surviving corporation. For purposes of
calculating the Fifty-Percent or Greater Interest, the interest of such Persons
shall be taken into account only to the extent that the
14
<PAGE>
percentage of stock owned directly or indirectly in the surviving corporation by
each person owning stock in uBid immediately before the transaction does not
decrease. In addition, uBid stock acquired before the merger, consolidation or
other reorganization by any Person shall not be counted if the acquisition was
pursuant to a plan (or series of related transactions) in anticipation of the
merger, consolidation or reorganization. Nothing in this Section 5.6 shall
preclude uBid from acquiring another corporation, limited liability company,
limited partnership, general partnership or joint venture solely for cash or
other consideration that is not an Equity Security of uBid. Reorganizations of
uBid with its subsidiaries, and liquidations of uBid subsidiaries are not
subject to this Section 5.6 to the extent not inconsistent with the Tax-Free
Status of the Distribution.
5.7 Waiver. Any of the provisions of Section 5.2, 5.3, 5.4, 5.5 or 5.6
shall be waived with respect to any particular transaction or transactions if
(i) CCI or uBid has obtained a ruling from the IRS, in form and substance
reasonably satisfactory to CCI, to the effect that such proposed transaction
will not adversely affect the Tax-Free Status of the Distribution, (ii) CCI has
determined, in its sole and absolute discretion that it could not reasonably be
expected that such proposed transaction would have an adverse effect on the Tax-
Free Status of the Distribution, or (iii) with respect to a transaction
occurring at least two years after the Distribution Date, uBid obtains a Tax
Opinion (at its own expense), in form and substance reasonably satisfactory to
CCI, with respect to such proposed transaction. Waiver with respect to one
transaction or group of transactions shall not constitute a waiver with respect
to any other transaction.
5.8 Enforcement. The parties hereto acknowledge that irreparable harm
would occur in the event that any of the provisions of this Article V were not
performed in accordance with their specific terms or were otherwise breached.
The parties hereto agree that, in order to preserve the Tax-Free Status of the
Distribution, injunctive relief is appropriate to prevent any violation of the
foregoing covenants, provided, however, that injunctive relief shall not be the
exclusive legal or equitable remedy for any such violation.
ARTICLE VI
COOPERATION RELATED TO DISTRIBUTION TAX MATTERS
6.1 Ruling Requests. Until the first day after the Restriction Period,
uBid shall furnish CCI with a copy of any ruling request that uBid may file with
the IRS or any other Taxing Jurisdiction and any opinion received that relates
to or otherwise reasonably could be expected to have any effect on the Tax-Free
Status of the Distribution.
6.2 Determinations. uBid shall cooperate with CCI in connection with (i)
any determination pursuant to subsection 5.7(ii) above or (ii) any request by
CCI for a ruling. Such cooperation shall include, without limitation, providing
any information and representations reasonably requested by CCI or its counsel
to enable CCI or its counsel to make any such determination or to obtain and
maintain any ruling with respect to the Distribution. From and after the date of
the filing of any such request until the first day after the four-year
anniversary of the date that CCI makes the correlative determination
15
<PAGE>
or receives the correlative ruling, uBid shall not take (nor shall it refrain
from taking) any action that would have caused a representation given by uBid in
connection with any such determination or CCI's request for a ruling to have
been untrue as of the relevant representation date, had uBid intended to take
(or refrain from taking) such action on the relevant representation date.
6.3 Tax Opinion. CCI shall cooperate with uBid in connection with any
request by uBid for a Tax Opinion.
6.4 Notice of Actions. Until the first day after the Restriction Period,
uBid will provide adequate notice to CCI of action described in Sections 5.2
through 5.6 above, without regard to the exceptions thereto, within a period of
time sufficient to enable CCI (i) to make the determination referred to in
Section 5.7(ii), (ii) to prepare and seek any ruling in connection with such
proposed transaction, or (iii) to seek injunctive relief pursuant to Section 5.8
hereof in a court of competent jurisdiction. Each such notice shall set forth
the terms and conditions of the proposed transaction, including, without
limitation, the nature of any related action proposed to betaken by the board of
directors of uBid, the approximate number of shares of uBid stock (if any)
proposed to be sold by uBid or otherwise issued by uBid, the approximate value
of uBid assets (or assets of any of the uBid subsidiaries) proposed to be
transferred, and the proposed timetable for such transaction, all with
sufficient particularity to enable CCI to make such determination, prepare and
seek such ruling, or seek such injunctive relief. Promptly, but in any event
within 30 Business Days, after CCI receives such written notice from uBid, CCI
shall notify uBid in writing of such determination or of CCI's intent to seek a
ruling and the proposed date for the initial submission thereof, which date
shall not be more than 60 Business Days after CCI so notifies uBid of its intent
to seek such ruling, provided that such 30-day period or 60-day period, as the
case maybe, shall be appropriately extended for any period of noncompliance by
uBid with this Section 6.4.
ARTICLE VII
INCOME TAX CONTESTS
7.1 Notification. uBid shall promptly upon receipt of notice thereof,
notify CCI in writing of any communication with respect to any pending or
threatened Proceeding in connection with an Income Tax Liability (or an issue
related thereto) for which CCI may be responsible pursuant to this Agreement.
uBid shall include with such notification a true, correct and complete copy of
any written communication, and an accurate and complete written summary of any
oral communication, so received uBid. The failure of uBid timely to forward such
notification in accordance with the immediately preceding sentence shall not
relieve CCI of its obligation to pay such Income Tax Liability or indemnify uBid
therefor, except and to the extent that the failure timely to forward such
notification actually prejudices the ability of CCI to contest such Income Tax
Liability or increases the amount of such Income Tax Liability.
16
<PAGE>
7.2 CCI Consolidated Return Periods. CCI (or such member of the CCI
Consolidated Group as CCI shall designate) shall have the sole right to
represent the interests of uBid in any Proceeding relating to CCI Consolidated
Return Periods and to employ counsel of its choice at its expense; provided,
however, that any expenses relating to items for which uBid is responsible
pursuant to Section 2 in connection with such a Proceeding shall be borne by
uBid; provided, further, however, that uBid shall be entitled to designate
counsel with respect to any such Proceeding with respect to an Income Tax Return
that includes solely uBid and relates solely to items for which uBid is
responsible hereunder.
7.3 Power of Attorney. uBid shall execute and deliver to CCI (or such
member of the CCI Group as CCI shall designate) any power of attorney or other
document requested by CCI (or such designee) in connection with any Proceeding
described in Section 7.2 hereof.
ARTICLE VIII
APPORTIONMENT OF TAX ATTRIBUTES; REFUNDS
8.1 Apportionment of Tax Attributes.
(a) If the CCI Consolidated Group has a Tax Attribute, the portion,
if any, of such Tax Attribute that shall be apportioned to uBid and treated as a
carryover to the first Post-Distribution Taxable Period of uBid shall be
determined in accordance with Treasury Regulation (S)(S)1.1502-79 and 1.1502-
79A; provided, however, that the portion, if any, of any consolidated unused
foreign tax credit which shall be apportioned to uBid or such member shall be
determined separately with respect to each of the items of income listed in
Section 904(d) of the Code.
(b) No consolidated U.S. federal income Tax Attribute of the CCI
Consolidated Group, other than those described in Section 8.1(a) hereof, and no
consolidated, combined or unitary state, local, or foreign income Tax Attribute
arising in respect of a CCI State, Local and Foreign Return, shall be
apportioned to uBid, except as CCI (or such member of the CCI Group as CCI shall
designate) determines is otherwise required under the provisions of applicable
law.
(c) CCI (or its designee) shall determine the portion, if any, of
any Tax Attribute which must (absent a Final Determination to the contrary) be
apportioned to uBid in accordance with this Section 8.1 and applicable law, and
the amount of tax basis and earnings and profits to be apportioned to uBid in
accordance with applicable law, and shall provide written notice of the
calculation thereof to uBid as soon as practicable after the information
necessary to make such calculation becomes available to CCI.
(d) uBid shall prepare, or cause to be prepared, and file, or cause
to be filed, all Income Tax Returns for which it is responsible under this
Agreement, so as to take into account, to the extent permitted by applicable
law, any Tax Attribute (and the
17
<PAGE>
amount of tax basis and earnings and profits) apportioned to uBid as calculated
pursuant to Section 8.1(c) hereof. Until such time as any such Tax Attribute has
been utilized by uBid (or would have been so utilized had uBid complied with the
requirements of the previous sentence), uBid shall, in connection with each
Income Tax Return filed by it, provide CCI with a statement, signed by uBid's
chief financial officer and certified by uBid's independent accounting firm,
setting forth in reasonable detail a calculation of the extent to which any such
Tax Attribute was utilized on such Income Tax Return (or would have been so
utilized had uBid complied with the requirements of the previous sentence).
(e) Except to the extent otherwise consented to by CCI or
prohibited by applicable law, uBid shall elect to relinquish, waive or otherwise
forego all Carrybacks. In the event that uBid is prohibited by applicable law to
relinquish, waive or otherwise forego a Carryback (or CCI consents thereto), (i)
CCI shall cooperate with uBid, at uBid's expense, in seeking from the
appropriate Taxing Jurisdiction such Refund as reasonably would result from such
Carryback, and (ii) uBid shall be entitled to any Income Tax Benefit Actually
Realized by a member of the CCI Group (including any interest thereon received
from such Taxing Jurisdiction), to the extent that such Refund is directly
attributable to such Carryback, within 10 days after such Refund is Actually
Realized; provided, however, that uBid shall indemnify and hold the members of
the CCI Group harmless from and against any and all collateral tax consequences
resulting from or caused by any such Carryback, including (but not limited to)
the loss or postponement of benefit from the use of tax attributes generated by
a member of the CCI Group or an Affiliate thereof and (x) that expire
unutilized, but would have been utilized but for such Carryback, or (y) the use
of which is postponed to a later taxable period than the taxable period in which
such tax attributes otherwise would have been utilized but for such Carryback.
If there is a Final Determination that results in any change to or adjustment of
18
<PAGE>
an Income Tax Benefit Actually Realized by a member of the CCI Group that is
directly attributable to a Carryback, then CCI (or its designee) shall make a
payment to uBid, or uBid shall make a payment to CCI (or its designee), as may
be necessary to adjust the payments between uBid and CCI (or its designee) to
reflect the payments that would have been made under this Section 8.1(e) had the
adjusted amount of such Income Tax Benefit been taken into account in computing
the payments due under this Section 8.1(e).
8.2 Refunds. Except to the extent provided in Section 8.1(e)
hereof, CCI shall be entitled to all Refunds (and any interest thereon received
from the applicable Taxing Jurisdiction) in respect of Income Taxes for all CCI
Consolidated Return Periods. Except to the extent provided in Section 8.1(e),
uBid shall be entitled to all Refunds (and any interest thereon received from
the applicable Taxing Jurisdiction) in respect of Income Taxes paid by uBid for
all Post-Distribution Taxable Periods. A party receiving a Refund to which
another party is entitled pursuant to this Section 8.2 shall pay the amount to
which such other party is entitled within ten days after such Refund is Actually
Realized. CCI shall be permitted to file, and uBid shall fully cooperate with
CCI in connection with, any claim for Refund in respect of an Income Tax for
which any member of the CCI Group is responsible pursuant to Section 2 hereof.
ARTICLE IX
COOPERATION AND EXCHANGE OF INFORMATION
9.1 Cooperation. uBid, on behalf of itself and each of its
Affiliates, agrees to provide CCI (or its designee) with such cooperation or
information as CCI (or its designee) reasonably shall request in connection with
the determination of any other calculations described in this Agreement, the
preparation or filing of any Income Tax Return or claim for Refund, or the
conduct of any Proceeding. Such cooperation and information shall include,
without limitation, upon reasonable notice (i) promptly forwarding copies of
appropriate notices and forms or other communications (including, without
limitation, information document requests, revenue agent's reports and similar
reports, notices of proposed adjustments and notices of deficiency)received from
or sent to any Taxing Jurisdiction or any other administrative, judicial or
governmental authority, (ii) providing copies of all relevant Income Tax
Returns, together with accompanying schedules and related workpapers, documents
relating to rulings or other determinations by taxing authorities, and such
other records concerning the ownership and tax basis of property, or other
relevant information that uBid or its Affiliates may possess, (iii) the
provision of such additional information and explanations of documents and
information provided under this Agreement (including statements, certificates
and schedules delivered by either party) as shall be reasonably requested by CCI
(or its designee), (iv) the execution of any document that may be necessary or
reasonably helpful in connection with the filing of an Income Tax Return, a
claim for a Refund, or in connection with any Proceeding, including such
waivers, consents or powers of attorney as may be necessary for CCI to exercise
its rights under this Agreement, and (v) the use of uBid's reasonable efforts to
obtain any documentation from a governmental authority or a third party that may
be necessary or reasonably helpful in connection with any of the foregoing. It
is expressly the intention of the parties to this Agreement to take all actions
that shall be necessary to establish CCI as the sole agent for Income Tax
purposes with respect to all
19
<PAGE>
CCI Consolidated Federal Returns and CCI State, Local and Foreign Returns. Upon
reasonable notice, uBid shall make its, or shall cause its Affiliates to make
their, employees and facilities available on a mutually convenient basis to
provide explanation of any documents or information provided hereunder. Any
information obtained under this Section 9.1 shall be kept confidential, except
as otherwise reasonably may be necessary in connection with the filing of Income
Tax Returns or claims for Refund or in conducting any Proceeding.
Notwithstanding any other provision of this Agreement, neither uBid, nor any of
its Affiliates nor any other Person shall have any right to receive or obtain
any information relating to Income Taxes of CCI or any of its Affiliates other
than information relating solely to uBid.
9.2 Retention of Records. uBid agrees to retain all Income Tax
Returns, related schedules and workpapers, and all material records and other
documents as required under Code (S)6001 of the Code and the regulations
promulgated thereunder (and any similar provision of state, local, or foreign
Income Tax law) existing on the date hereof or created in respect of (i) any
taxable period that ends on or before or includes the Distribution Date or (ii)
any taxable period that may be subject to a claim hereunder, until the later of
(x)the expiration of the statute of limitations (including extensions) for the
taxable periods to which such Income Tax Returns and other documents relate and
(y) the Final Determination of any payments that may be required in respect of
such taxable periods under this Agreement. From and after the end of the period
described in the preceding sentence of this Section 9.2, if uBid wishes to
dispose of any such records and documents, then uBid shall provide written
notice thereof to CCI and shall provide CCI the opportunity to take possession
of any such records and documents within 90 days after such notice is delivered;
provided, however, that if CCI does not, within such 90-day period, confirm its
intention to take possession of such records and documents, uBid may destroy or
otherwise dispose of such records and documents.
9.3 Inadequate Remedy. uBid hereby acknowledges and agrees that (a)
its failure to comply with the provisions of this Article 9 may result in
substantial harm to CCI, including the inability to determine or appropriately
substantiate an Income Tax Liability (or a position in respect thereof) for
which the CCI Consolidated Group (or a member thereof) would be responsible
under this Agreement or appropriately defend against an adjustment thereto by a
taxing authority, and (a) the remedies available to the CCI Consolidated Group
for the breach by uBid of its obligations hereunder shall include (without
limitation) the indemnification by uBid of the CCI Consolidated Group for any
Income Tax Liabilities incurred or any Income Tax benefit lost or postponed by
reason of such breach and the forfeiture by uBid of any related rights to
indemnification by CCI. In addition, if uBid fails to provide any cooperation or
information requested pursuant to this Agreement (x) within the specified time
or (y) in the absence of such specified time, within a reasonable period (as
determined in good faith by the party requesting such information), then,
without limiting any other remedy available to any member of the CCI
Consolidated Group for breach of uBid's obligations under this Agreement, CCI
shall have the right to engage a nationally recognized accounting firm of its
choice to gather such information. uBid agrees to permit any such nationally
recognized accounting firm full access to all appropriate records or other
information in the
20
<PAGE>
possession uBid during normal business hours, and promptly to reimburse or pay
directly all costs and expenses in connection with the engagement of such
accountants.
ARTICLE X
PAYMENTS
10.1 Method of Payment. All payments required by this Agreement
shall be made by (a) wire transfer to the appropriate bank account as may from
time to time be designated by the parties for such purpose; provided that, on
the date of such wire transfer, notice of the transfer is given to the recipient
thereof in accordance with Section 12.1 hereof, or (ii) any other method agreed
to by the parties. All payments due under this Agreement shall be deemed to be
paid when available funds are actually received by the payee.
10.2 Interest. Any payment required by this Agreement that is not
made on or before the date required hereunder shall bear interest, from and
after such date through the date of payment, at the Underpayment Rate.
10.3 Characterization of Payments. For all tax purposes, the
parties hereto agree to treat, and to cause their respective Affiliates to
treat, (i) any payment required by this Agreement, as either a contribution by
CCI to uBid or a distribution by uBid to CCI, as the case may be, occurring
immediately prior to the Distribution and (ii) any payment of interest or non-
federal Income Taxes by or to a Taxing Jurisdiction, as taxable or deductible,
as the case may be, to the party entitled under this Agreement to retain such
payment or required under this Agreement to make such payment, in either case
except as otherwise mandated by applicable law; provided that in the event it is
determined as a result of a Final Determination that any such treatment is not
permissible, the payment in question shall be adjusted to place the parties in
the same after-tax position they would have enjoyed absent such Final
Determination.
ARTICLE XI
RESOLUTION OF DISPUTES
11.1 Distribution Agreement. Except as specifically modified by
this Article XI, the provisions of Article VIII of the Distribution Agreement
shall apply to any dispute arising in connection with this Agreement; provided,
however, that no provision in this Article XI or such Article VIII shall be
construed to extend the time periods set forth in this Agreement during which
any party may make a payment, deliver a notice, provide information, grant or
withhold approval or consent or take any other action.
11.2 Arbitrator. CCI shall select the arbitrator, who shall be an
attorney or accountant who is generally recognized in the tax community as a
qualified and competent tax practitioner with experience in the tax area
involved in the issue or issues to be resolved.
11.3 Settlement Proposals. In connection with such arbitration,
each party shall present an overall settlement proposal to the arbitrator that
shall encompass all
21
<PAGE>
issues to be resolved, and the two proposals shall set the outer limits of the
range within which the arbitrator may make a determination as to the appropriate
settlement result.
11.4 Costs. All costs of the arbitration process shall be borne by
the party determined by the arbitrator to have lost the arbitration; provided,
however, (i) in the event the arbitrator makes a determination that reflects a
50-50 settlement, CCI and uBid shall share equally the costs of the arbitration,
and (ii) in the event the arbitrator makes a determination that reflects a
divided settlement, the arbitrator shall determine the proportion in which the
parties shall share the costs of arbitration.
ARTICLE XII
MISCELLANEOUS
12.1 Notices. Notices, requests, permissions, waivers, and other
communications hereunder shall be in writing and shall be deemed to have been
duly given upon (a) a transmitter's confirmation of a receipt of a facsimile
transmission (but only if followed by confirmed delivery of a standard overnight
courier the following Business Day or if delivered by hand the following
Business Day), or (b) confirmed delivery of a standard overnight courier or
delivered by hand, to the parties at the following addresses (or at such other
addresses for a party as shall be specified by like notice):
If to CCI, to: Creative Computers, Inc.
2555 West 190th Street
Torrance, California 90504
Attention: Chief Financial Officer
If to uBid, to: uBid, Inc.
2525 Busse Highway
Elk Grove Village, Illinois 60007
Attention: Chief Financial Officer
Such names and addresses may be changed by notice given in accordance with this
Section 12.1.
12.2 Designation of Affiliate. CCI may assign any of its rights or
obligations under this Agreement to any member of the CCI Group as it shall
designate; provided, however, that no such assignment shall relieve CCI of any
obligation to make a payment hereunder to uBid to the extent such designee fails
to make such payment.
12.3 Entire Agreement. This Agreement contains the entire
understanding of the parties hereto with respect to the subject matter contained
herein, and supersedes and cancels all prior agreements, negotiations,
correspondence, undertakings and communications of the parties, oral or written,
respecting such subject matter.
12.4 Amendment. This Agreement may be amended, modified or
supplemented only by a written agreement signed by both of the parties hereto.
22
<PAGE>
12.5 Governing Law. This Agreement shall be governed by, and
construed in accordance with, the laws of the State of California, without
reference to choice of law principles, including matters of construction,
validity and performance.
12.6 Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall be deemed to be an original, but all of which
shall constitute one and the same original.
12.7 Titles and Headings. Titles and headings to sections herein
are included for convenience of reference only and are not intended to be a
part, or to affect the meaning or interpretation, of this Agreement.
12.8 Successors and Assigns. This Agreement and all of the
provisions hereof shall be binding upon and inure to the benefit of the parties
and their respective successors and permitted assigns.
12.9 Severability. If any term or other provision of this Agreement
is invalid, illegal or incapable of being enforced by any rule of law or public
policy, all other conditions and provisions of this Agreement shall nevertheless
remain in full force and effect so long as the economic or legal substance of
the transactions contemplated hereby is not affected in any manner materially
adverse to any party. Upon such determination that any term or other provision
is invalid, illegal or incapable of being enforced, the parties hereto shall
negotiate in good faith to modify this Agreement so as to effect the original
intent of the parties as closely as possible in an acceptable manner.
IN WITNESS WHEREOF, each of the parties has caused this Agreement to
be executed on its behalf by its officers thereunto duly authorized, all as of
the day and year first written above.
CREATIVE COMPUTERS, INC.
By: /s/ THEODORE R. SANDERS
-----------------------------------------
Name: Theodore R. Sanders
Title: Chief Financial Officer
UBID, INC.
By: /s/ THOMAS E. WERNER
-----------------------------------------
Name: Thomas E. Werner
Title: Chief Financial Officer
23
<PAGE>
EXHIBIT 10.14
INDEMNIFICATION AGREEMENT
This INDEMNIFICATION AGREEMENT (the "Agreement") is made and entered into
this 12th day of February, 1999 (the "Effective Date") by and between uBid,
Inc., a Delaware corporation (the "Company"), and (the
"Indemnitee").
WHEREAS, it is essential to the Company to retain and attract as directors
and officers the most capable persons available;
WHEREAS, Indemnitee is a director and officer of the Company;
WHEREAS, both the Company and Indemnitee recognize the increased risk of
litigation and other claims being asserted against directors and officers of
public companies in today's environment;
WHEREAS, the Company's Bylaws (the "Bylaws") require the Company to
indemnify and advance expenses to its directors and officers to the extent
permitted by the DGCL and the Indemnitee has been serving and continues to
serve as a director and officer of the Company in part in reliance on the
Bylaws; and
WHEREAS, in recognition of Indemnitee's need for (i) substantial protection
against personal liability based on Indemnitee's reliance on the Bylaws, (ii)
specific contractual assurance that the protection promised by the Bylaws will
be available to Indemnitee, regardless of, among other things, any amendment
to or revocation of the Bylaws or any change in the composition of the
Company's Board of Directors or acquisition transaction relating to the
Company, and (iii) an inducement to continue to provide effective services to
the Company as a director and officer thereof, the Company wishes to provide
for the indemnification of Indemnitee and to advance expenses to Indemnitee to
the fullest extent permitted by law and as set forth in this Agreement, and,
to the extent insurance is maintained, to provide for the continued coverage
of Indemnitee under the Company's directors' and officers' liability insurance
policies.
NOW, THEREFORE, in consideration of the premises contained herein and of
Indemnitee continuing to serve the Company directly or, at its request, with
another enterprise, and intending to be legally bound hereby, the parties
hereto agree as follows:
1. Certain Definitions:
(a) "Affiliate" shall mean any corporation that directly, or indirectly
through one or more intermediaries, controls or is controlled by, or is under
common control with, the person specified.
(b) "Change in Control" shall be deemed to have occurred if
(i) any "person," as such term is used in Sections 13(d) and 14(d) of the
Securities Exchange Act of 1934 (the "Exchange Act"), as amended, other
than (a) a trustee or other fiduciary holding securities under an employee
benefit plan of the Company, (b) a corporation owned, directly or
indirectly, by the stockholders of the Company in substantially the same
proportions as their ownership of stock of the Company, or (c) any current
beneficial stockholder or group, as defined by Rule 13d-5 of the Exchange
Act, including the heirs, assigns and successors thereof, of beneficial
ownership, within the meaning of Rule 13d-3 of the Exchange Act, of
securities possessing more than fifty percent (50%) of the total combined
voting power of the Company's outstanding securities, hereafter becomes the
"beneficial owner," as defined in Rule 13d-3 under of the Exchange Act,
directly or indirectly, of securities of the Company representing twenty
percent (20%) or more of the total combined voting power represented by the
Company's then outstanding Voting Securities, or
(ii) during any period of two consecutive years, individuals who at the
beginning of such period constitute the Board of Directors of the Company
and any new director whose election by the Board of
1
<PAGE>
Directors or nomination for election by the Company's stockholders was
approved by a vote of at least two-thirds (2/3) of the directors then still
in office who either were directors at the beginning of the period or whose
election or nomination for election was previously so approved, cease for
any reason to constitute a majority thereof, or
(iii) the stockholders of the Company approve a merger or consolidation
of the Company with any other corporation, other than a merger or
consolidation which would result in the Voting Securities of the Company
outstanding immediately prior thereto continuing to represent (either by
remaining outstanding or by being converted into Voting Securities of the
surviving entity) at least eighty percent (80%) of the total voting power
represented by the Voting Securities of the Company or such surviving
entity outstanding immediately after such merger or consolidation, or the
stockholders of the Company approve a plan of complete liquidation of the
Company or an agreement for the sale or disposition by the Company, in one
transaction or a series of transactions, of all or substantially all of the
Company's assets.
Notwithstanding the foregoing, a Change of Control shall not be deemed to
have occurred as a result of (i) any of the transactions contemplated by the
Separation and Distribution Agreement between the Company and Creative
Computers, Inc. (Delaware) ("Creative"), dated as of December 7, 1998,
including without limitation the transfer of the Company's Voting Securities
from Creative Computers, Inc. (California) to Creative and the subsequent
distribution of those Voting Securities to Creative stockholders or (ii) the
sale by Creative or Creative Computers, Inc. (California) in one or more
offerings of the Company's Voting Securities to the public.
(c) "DGCL" shall mean the General Corporation Law of the State of Delaware,
as the same exists or may hereafter be amended or interpreted; provided,
however, that in the case of any such amendment or interpretation, only to the
extent that such amendment or interpretation permits the Company to provide
broader indemnification rights than were permitted prior thereto.
(d) "Expense" shall mean attorneys' fees and all other costs, expenses and
obligations paid or incurred in connection with investigating, defending,
being a witness in or participating in (including on appeal), or preparing for
any of the foregoing, any Proceeding relating to any Indemnifiable Event.
(e) "Indemnifiable Event" shall mean any event or occurrence that takes
place either prior to or after the execution of this Agreement, related to the
fact that Indemnitee is or was a [director or] officer of the Company, or is
or was serving at the request of the Company as a director, officer, employee,
or agent of another corporation or of a partnership, joint venture, trust or
other enterprise, including service with respect to employee benefit plans.
(f) "Proceeding" shall mean any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative, or investigative.
(g) "Reviewing Party" shall mean any appropriate person or body consisting
of a member or members of the Company's Board of Directors or any other person
or body appointed by the Board (including the special, independent counsel
referred to in Section 6) who is not a party to the particular Proceeding with
respect to which Indemnitee is seeking Indemnification.
(h) "Voting Securities" shall mean any securities of the Company which vote
generally in the election of directors.
2. Indemnification. In the event Indemnitee was or is a party to or is
involved (as a party, witness, or otherwise) in any Proceeding by reason of
(or arising in part out of) an Indemnifiable Event, whether the basis of the
Proceeding is Indemnitee's alleged action in an official capacity as a
director or officer or in any other capacity while serving as a director or
officer, the Company shall indemnify Indemnitee to the fullest extent
permitted by the DGCL against any and all Expenses, liability, and loss
(including judgments, fines, ERISA excise taxes or penalties, and amounts paid
or to be paid in settlement, and any interest, assessments, or other charges
imposed thereon, and any federal, state, local, or foreign taxes imposed on
any director or officer as a
2
<PAGE>
result of the actual or deemed receipt of any payments under this Agreement)
(collectively, the "Liabilities") reasonably incurred or suffered by such
person in connection with such Proceeding. The Company shall provide
indemnification pursuant to this Section 2 as soon as practicable, but in no
event later than thirty (30) days after it receives written demand from
Indemnitee. Notwithstanding anything in this Agreement to the contrary and
except as provided in Section 5 below, Indemnitee shall not be entitled to
indemnification pursuant to this Agreement in connection with any Proceeding
initiated by Indemnitee against the Company or any director or officer of the
Company unless the Company has joined in or consented to the initiation of
such Proceeding.
3. Advancement of Expenses. If so requested by Indemnitee, the Company shall
advance Expenses to Indemnitee within thirty (30) business days of such
request (an "Expense Advance"); provided, however, that if required by the
DGCL such Expenses shall be advanced only upon delivery to the Company of an
undertaking by or on behalf of the Indemnitee to repay such amount if it is
ultimately determined that Indemnitee is not entitled to be indemnified by the
Company. Expenses incurred by Indemnitee while not acting in his capacity as a
director or officer, including service with respect to employee benefit plans,
may be advanced upon such terms and conditions as the Board of Directors of
the Company, in its sole discretion, deems appropriate.
4. Review Procedure for Indemnification. Notwithstanding the foregoing, (i)
the obligations of the Company under Sections 2 and 3 above shall be subject
to the condition that the Reviewing Party shall not have determined (in a
written opinion, in any case in which the special, independent counsel
referred to in Section 6 hereof is involved) that Indemnitee would not be
permitted to be indemnified under applicable law, and (ii) the obligation of
the Company to make an Expense Advance pursuant to Section 3 above shall be
subject to the condition that, if, when and to the extent that the Reviewing
Party determines that Indemnitee would not be permitted to be so indemnified
under applicable law, the Company shall be entitled to be reimbursed by
Indemnitee (who hereby agrees to reimburse the Company) for all such amounts
theretofore paid; provided, however, that if Indemnitee has commenced legal
proceedings in a court of competent jurisdiction pursuant to Section 5 below
to secure a determination that Indemnitee should be indemnified under
applicable law, any determination made by the Reviewing Party that Indemnitee
would not be permitted to be indemnified under applicable law shall not be
binding and Indemnitee shall not be required to reimburse the Company for any
Expense Advance until a final judicial determination is made with respect
thereto (as to which all rights of appeal therefrom have been exhausted or
have lapsed). Indemnitee's obligation to reimburse the Company for Expense
Advances pursuant to this Section 4 shall be unsecured and no interest shall
be charged thereon. If there has not been a Change in Control, the Reviewing
Party shall be selected by the Board of Directors, and if there has been such
a Change in Control, other than a Change in Control which has been approved by
a majority of the Company's Board of Directors who were directors immediately
prior to such Change in Control, the Reviewing Party shall be the special,
independent counsel referred to in Section 6 hereof.
5. Enforcement of Indemnification Rights. If the Reviewing Party determines
that Indemnitee substantively would not be permitted to be indemnified in
whole or in part under applicable law, or if Indemnitee has not otherwise been
paid in full pursuant to Sections 2 and 3 above within thirty (30) days after
a written demand has been received by the Company, Indemnitee shall have the
right to commence litigation in any court in the State of Delaware having
subject matter jurisdiction thereof and in which venue is proper to recover
the unpaid amount of the demand ("Enforcement Proceeding") and, if successful
in whole or in part, Indemnitee shall be entitled to be paid any and all
Expenses in connection with such Enforcement Proceeding. The Company hereby
consents to service of process for such Enforcement Proceeding and to appear
in any such Enforcement Proceeding. Any determination by the Reviewing Party
otherwise shall be conclusive and binding on the Company and Indemnitee.
6. Change in Control. The Company agrees that if there is a Change in
Control of the Company, other than a Change in Control which has been approved
by a majority of the Company's Board of Directors who were directors
immediately prior to such Change in Control, then with respect to all matters
thereafter arising concerning the rights of Indemnitee to indemnity payments
and Expense Advances under this Agreement or any other agreement or under
applicable law or the Company's Certificate of Incorporation or Bylaws now or
hereafter in effect relating to indemnification for Indemnifiable Events, the
Company shall seek legal advice only
3
<PAGE>
from special, independent counsel selected by Indemnitee and approved by the
Company, which approval shall not be unreasonably withheld. Such special,
independent counsel shall not have otherwise performed services for the
Company or the Indemnitee, other than in connection with such matters, within
the last five (5) years. Such independent counsel shall not include any person
who, under the applicable standards of professional conduct then prevailing,
would have a conflict of interest in representing either the Company or
Indemnitee in an action to determine Indemnitee's rights under this Agreement.
Such counsel, among other things, shall render its written opinion to the
Company and Indemnitee as to whether and to what extent the Indemnitee would
be permitted to be indemnified under applicable law. The Company agrees to pay
the reasonable fees of the special, independent counsel referred to above and
to indemnify fully such counsel against any and all expenses (including
attorneys' fees), claims, liabilities and damages arising out of or relating
to this Agreement or the engagement of special, independent counsel pursuant
hereto.
7. Partial Indemnity. If Indemnitee is entitled under any provision of this
Agreement to indemnification by the Company for some or a portion of the
Expenses and Liabilities, but not, however, for all of the total amount
thereof, the Company shall nevertheless indemnify Indemnitee for the portion
thereof to which Indemnitee is entitled.
8. Non-exclusivity. The rights of the Indemnitee hereunder shall be in
addition to any other rights Indemnitee may have under any statute, provision
of the Company's Certificate of Incorporation or Bylaws, vote of stockholders
or disinterested directors or otherwise, both as to action in an official
capacity and as to action in another capacity while holding such office;
provided, however, that this Agreement shall supersede any prior
indemnification by agreement between the Company and the Indemnitee. To the
extent that a change in the DGCL permits greater indemnification by agreement
than would be afforded currently under the Company's Certificate of
Incorporation and Bylaws and this Agreement, it is the intent of the parties
hereto that Indemnitee shall enjoy by this Agreement the greater benefits so
afforded by such change.
9. Liability Insurance. To the extent the Company maintains an insurance
policy or policies providing directors' and officers' liability insurance,
Indemnitee shall be covered by such policy or policies, in accordance with its
or their terms, to the maximum extent of the coverage available for any
Company director or officer.
10. Settlement of Claims. The Company shall not be liable to indemnify
Indemnitee under this Agreement (a) for any amounts paid in settlement of any
action or claim effected without the Company's written consent, which consent
shall not be unreasonably withheld; or (b) for any judicial award if the
Company was not given a reasonable and timely opportunity, at its expense, to
participate in the defense of such action.
11. Period of Limitations. No legal action shall be brought and no cause of
action shall be asserted by or on behalf of the Company or any affiliate of
the Company against Indemnitee, Indemnitee's spouse, heirs, executors or
personal or legal representatives after the expiration of two years from the
date of accrual of such cause of action, or such longer period as may be
required by state law under the circumstances, and any claim or cause of
action of the Company or its affiliate shall be extinguished and deemed
released unless asserted by the timely filing of a legal action within such
period; provided, however, that if any shorter period of limitations is
otherwise applicable to any such cause of action, such shorter period shall
govern.
12. Amendment of this Agreement. No supplement, modification or amendment of
this Agreement shall be binding unless executed in writing by both of the
parties hereto. No waiver of any of the provisions of this Agreement shall be
deemed or shall constitute a waiver of any other provisions hereof (whether or
not similar), nor shall such waiver constitute a continuing waiver. Except as
specifically provided herein, no failure to exercise or any delay in
exercising any right or remedy hereunder shall constitute a waiver thereof.
13. Subrogation. In the event of payment under this Agreement, the Company
shall be subrogated to the extent of such payment to all of the rights of
recovery of Indemnitee, who shall execute all papers required and shall do
everything that may be necessary to secure such rights, including the
execution of such documents necessary to enable the Company effectively to
bring suit to enforce such rights.
4
<PAGE>
14. No Duplication of Payments. The Company shall not be liable under this
Agreement to make any payment in connection with any claim made against
Indemnitee to the extent Indemnitee has otherwise actually received payment
(under any insurance policy, Bylaw, vote, agreement or otherwise) of the
amounts otherwise indemnifiable hereunder.
15. Binding Effect. This Agreement shall be binding upon and inure to the
benefit of and be enforceable by the parties hereto and their respective
successors, assigns, including any direct or indirect successor by purchase,
merger, consolidation or otherwise to all or substantially all of the business
and/or assets of the Company, spouses, heirs, and personal and legal
representatives. The Company shall require and cause any successor (whether
direct or indirect by purchase, merger, consolidation or otherwise) to all,
substantially all, or a substantial part, of the business and/or assets of the
Company, by written agreement in form and substance satisfactory to the
Indemnitee, expressly to assume and agree to perform this Agreement in the
same manner and to the same extent that the Company would be required to
perform if no such succession had taken place. This Agreement shall continue
in effect regardless of whether Indemnitee continues to serve as a director or
officer of the Company or of any other enterprise at the Company's request.
16. Severability. The provisions of this Agreement shall be severable in the
event that any of the provisions hereof (including any provision within a
single section, paragraph or sentence) is held by a court of competent
jurisdiction to be invalid, void or otherwise unenforceable, and the remaining
provisions shall remain enforceable to the fullest extent permitted by law.
Furthermore, to the fullest extent possible, the provisions of this Agreement
(including, without limitation, each portion of this Agreement containing any
provision held to be invalid, void or otherwise unenforceable, that is not
itself invalid, void or unenforceable) shall be construed so as to give effect
to the intent manifested by the provision held invalid, illegal or
unenforceable.
17. Governing Law. This Agreement shall be governed by and construed and
enforced in accordance with the laws of the State of Delaware applicable to
contracts made and to be performed in such State without giving effect to the
principles of conflicts of laws.
18. Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
19. Notices. All notices, demands, and other communications required or
permitted hereunder shall be made in writing and shall be deemed to have been
duly given if delivered by hand, against receipt, or mailed, postage prepaid,
certified or registered mail, return receipt requested, and addressed to the
Company at:
uBid, Inc.
2525 Busse Road
Elk Grove Village, Illinois 60007
Attn: Gregory K. Jones
and to Indemnitee at:
-------------------------------------
-------------------------------------
-------------------------------------
Notice of change of address shall be effective only when done in accordance
with this Section. All notices complying with this Section shall be deemed to
have been received on the date of delivery or on the third business day after
mailing.
5
<PAGE>
IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this
Agreement as of the day first set forth above.
uBID, INC.
By:
--------------------------------
Thomas E. Werner, Vice
President and
Chief Financial Officer
----------------------------------
Indemnitee
6
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-69355) pertaining to the 1998 Stock Incentive Plan of uBid,
Inc. of our report dated January 22, 1999, with respect to the financial
statements and schedule of uBid, Inc. included in the Annual Report (Form 10-
K) for the year ended December 31, 1998.
/s/ Ernst & Young LLP
Chicago, Illinois
March 29, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> OTHER 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> APR-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 DEC-31-1998
<CASH> 0 26,053
<SECURITIES> 0 0
<RECEIVABLES> 9 623
<ALLOWANCES> 0 0
<INVENTORY> 2 7,235
<CURRENT-ASSETS> 20 195
<PP&E> 327 519
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 358 34,625
<CURRENT-LIABILITIES> 0 12,661
<BONDS> 0 0
0 0
0 0
<COMMON> 1 2
<OTHER-SE> 357 21,962
<TOTAL-LIABILITY-AND-EQUITY> 358 34,625
<SALES> 9 48,232
<TOTAL-REVENUES> 9 48,232
<CGS> 8 44,257
<TOTAL-COSTS> 8 44,257
<OTHER-EXPENSES> 288 13,974
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 26 170
<INCOME-PRETAX> (313) (10,169)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (313) (10,169)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (313) (10,169)
<EPS-PRIMARY> 0 0
<EPS-DILUTED> (0.04) (1.36)
</TABLE>
