<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 18, 1999
REGISTRATION NO. 333-76121
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
DVD EXPRESS, INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 5735 95-4603442
(State or Other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification
Organization) No.)
</TABLE>
--------------------------
7083 HOLLYWOOD BOULEVARD
LOS ANGELES, CALIFORNIA 90028
(323) 465-1183
(Address, Including Zip Code and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
--------------------------
MICHAEL J. DUBELKO
CHAIRMAN, CHIEF EXECUTIVE OFFICER AND PRESIDENT
DVD EXPRESS, INC.
7083 HOLLYWOOD BOULEVARD
LOS ANGELES, CALIFORNIA 90028
(323) 465-1183
(Name, Address, Including Zip Code and Telephone Number, Including Area Code, of
Agent for Service)
--------------------------
COPIES TO:
SCOTT W. ALDERTON, ESQ. BRUCE R. HALLETT, ESQ.
SCOTT D. GALER, ESQ. ALLEN Z. SUSSMAN, ESQ.
JENNIFERLYNN GREGA, ESQ. SEAN M. PENCE, ESQ.
TROOP STEUBER PASICH REDDICK & TOBEY, LLP BROBECK, PHLEGER & HARRISON, LLP
2029 CENTURY PARK EAST 38 TECHNOLOGY DRIVE
LOS ANGELES, CALIFORNIA 90067 IRVINE, CALIFORNIA 92618
(310) 728-3200 (949) 790-6300
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement is declared effective.
If any of the securities being registered in this form are offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act, check
the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If the delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. / /
--------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED PRICE(1) REGISTRATION FEE(2)
<S> <C> <C>
Common Stock, $.0001 par value................................. $56,925,000 $15.825
</TABLE>
(1) Estimated solely for the purpose of computing the registration fee, in
accordance with Rule 457(o) under the Securities Act of 1933, as amended.
(2) $15,985 previously paid by registrant in connection with the filing of the
Registration Statement on April 12, 1999.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
SUBJECT TO COMPLETION, DATED JUNE 18, 1999
PROSPECTUS
4,500,000 SHARES
[LOGO]
COMMON STOCK
------------------
This is our initial public offering, and we are offering 4,500,000 shares of
common stock. We anticipate that the initial public offering price will be
between $10.00 and $12.00 per share. We have applied to list the common stock on
the Nasdaq National Market under the symbol "DVDS."
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF FACTORS THAT YOU
SHOULD CONSIDER BEFORE YOU INVEST IN THE COMMON STOCK BEING SOLD WITH THIS
PROSPECTUS.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PER SHARE TOTAL
<S> <C> <C>
Public Offering Price................................................... $ $
Underwriting Discounts and Commissions.................................. $ $
Proceeds to DVD EXPRESS................................................. $ $
</TABLE>
The underwriters have reserved up to 337,500 shares of common stock being
sold by DVD EXPRESS for sale at the initial public offering price to directors,
officers, employees and friends of DVD EXPRESS.
The underwriters may purchase up to an additional 675,000 shares from DVD
EXPRESS at the public offering price, less underwriting discounts, solely to
cover over allotments.
ING BARING FURMAN SELZ LLC
FRIEDMAN BILLINGS RAMSEY
NEEDHAM & COMPANY, INC.
------------------------
THIS PROSPECTUS IS DATED , 1999.
<PAGE>
THE OUTSIDE GATEFOLD PAGE INCLUDES:
THE FOLLOWING TEXT IS ACROSS THE TOP OF THE PAGE:
This is the future of family entertainment.
THE FOLLOWING PICTURES AND TEXT ARE IN A CIRCULAR LAYOUT IN THE CENTER OF
THE PAGE:
<TABLE>
<S> <C>
[A picture of Mother] [A picture of Father]
WITH THE FOLLOWING TEXT BELOW THE PICTURE: WITH THE FOLLOWING TEXT BELOW THE PICTURE:
Software Movies
A better 30-minute meal with the DVD-Rom Dad's a hit with
"Ultimate DVD Cookbook." "You've Got Mail."
[A picture of a dog]
WITH THE FOLLOWING TEXT BELOW THE PICTURE:
Even Scooter has a new best friend!
[A picture of Daughter] [A picture of Son]
WITH THE FOLLOWING TEXT BELOW THE PICTURE: WITH THE FOLLOWING TEXT BELOW THE PICTURE:
Music Games
First homework for Leslie, then Mariah Carey. David's got straight A's and
As good as live on DVD. the record on "Riven." A 90s dude.
</TABLE>
THE FOLLOWING TEXT IS AT THE BOTTOM OF THE PAGE:
THE ULTIMATE DVD COOKBOOK -C-1998 BETTER HOMES AND GARDENS -C-1998 M2K;
YOU'VE GOT MAIL -C-1998 WARNER HOME VIDEO; RIVEN: THE SEQUEL TO MYST
DVD-ROM -C-1998 RED ORB ENTERTAINMENT; MARIAH CAREY -C-1999 SONY MUSIC
THE TWO-PAGE INSIDE GATEFOLD INCLUDES:
THE FOLLOWING TEXT IS ACROSS THE TOP OF THE GATEFOLD:
DVD: The New Consumer Standard For Entertaiment.
[Two-page screen shot of the dvdexpress.com and dvd.com home pages]
WITH THE FOLLOWING TEXT BELOW THE DVDEXPRESS.COM HOME PAGE:
WWW.DVDEXPRESS.COM
The DVD Superstore That Delivers!-TM-
AND THE FOLLOWING TEXT BELOW THE DVD.COM HOME PAGE:
WWW.DVD.COM
The DVD Destination.-TM-
THE FOLLOWING TEXT IS PRESENTED IN BULLET POINTS DOWN THE LEFT EDGE OF THE
GATEFOLD NEXT TO THE DVDEXPRESS.COM SCREEN SHOT:
- SELECTION: Select from thousands of in-stock movies, as well as games,
software, music and studio merchandise items, all at discount prices.
Nearly every title available in the DVD format.
- CUSTOMER SERVICE: Comprehensive sales support via email and toll-free
telephone service seven-days-a-week. Real-time inventory status on each
product page and order tracking.
- AFFINITY: Stay informed with a twice monthly email, featuring new releases
and special offers. Contests and promotions are offered weekly. Track
future purchases using the DVD EXPRESS wish list feature.
- CUSTOMER REVIEWS: Find ratings, recommendations, and reviews by DVD
EXPRESS customers.
- PRE-ORDER: Pre-order titles up to two months in advance and receive the
movie on the same day it is available in stores.
- INFORMATION: Get reviews, recommendatioins, news and facts about new and
existing titles and products. View over 700 streaming movie trailers.
- QUICK CHECKOUT: Purchase with one click of the mouse using EXPRESS
Checkout. Store personal preferences, credit card and shipping information
in a secure environment.
- RAPID DELIVERY: Inventory is managed so that order shipment usually occurs
the same day that orders are placed, including weekends. Orders are shipped
directly from the DVD EXPRESS warehouse for fast delivery.
THE FOLLOWING TEXT IS PRESENTED IN BULLET POINTS DOWN THE RIGHT EDGE OF THE
GATEFOLD NEXT TO THE DVD.COM SCREEN SHOT:
- CONTENT: A magazine-style supersite delivering news and features about
digital entertainment with convenient links to DVD product.
- TECHNICAL SUPPORT: DOC DVD, a DVD specialist, personally responds to DVD
related questions via email the same day.
- COMMUNITY: Weekly consumer polls provide valuable feedback for the DVD
industry. Results are shared directly with all major studios, tying them
directly to DVD consumers.
- INDUSTRY EXPERTS: The people who make movies and DVDs take consumers
inside the DVD movie process.
- NEWS: Daily news on DVD title announcements, movie production, and hot
digital trends.
- RESOURCES: Features on home theater components, the latest DVD technology
and a DVD dictionary.
- ENTERTAINMENT: Digital fun with email postcards, reviews and interviews
with celebrities.
THE INSIDE BACK COVER INCLUDES:
THE FOLLOWING LOGO AND TEXT IS CENTERED ON THE PAGE:
[DVD EXPRESS Logo]
DVD EXPRESS-Registered Trademark-
high speed entertainment-TM-
www.dvdexpress.com
2
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS APPEARING
ELSEWHERE IN THIS PROSPECTUS.
EXCEPT AS OTHERWISE NOTED, ALL INFORMATION IN THIS PROSPECTUS: (i) REFLECTS
THE AUTOMATIC CONVERSION OF OUR OUTSTANDING SERIES A CONVERTIBLE PREFERRED STOCK
INTO COMMON STOCK UPON THE CLOSING OF THIS OFFERING; (ii) REFLECTS OUR
REINCORPORATION IN DELAWARE AND A 3-FOR-2 STOCK SPLIT OF OUR COMMON STOCK UPON
THE CLOSING OF THIS OFFERING; AND (iii) ASSUMES THAT THE UNDERWRITERS'
OVER-ALLOTMENT OPTION WILL NOT BE EXERCISED.
OUR COMPANY
We are a Web-based retailer of movies and videos in the digital versatile
disc format, commonly known as DVD. We operate our online store at
www.dvdexpress.com and offer interesting and informative content and community
features through our Web site at www.dvd.com. Our two Web sites are linked to
provide customers the ability to easily move between the sites. Our customers
benefit from our extensive product selection and availability, convenient
shopping experience, helpful customer service, competitive prices, informative
content and community. Our management's entertainment background, our
relationships with major and independent studios and our Hollywood location
provide a unique value to our customers. To enhance our brand recognition and
increase traffic to our online store, we have entered into strategic marketing
agreements with America Online, Infoseek Corporation (Go.com) and AltaVista as
well as other promotional agreements with several computer hardware and Internet
companies.
We maintain an inventory of nearly every title available in the DVD format
in our warehouse. Through our online store, we offer customers the convenience
and flexibility of shopping 24 hours a day, seven days a week. We ship our
products directly from our warehouse to the customer, usually on the same day
orders are received.
OUR MARKET OPPORTUNITY
We believe that we are well positioned to take advantage of the continued
growth of online shopping, the rapid adoption of the DVD format, the attractive
demographics of online consumers and the likelihood of DVD owners to shop
online. We believe that DVD will eventually become the standard format for home
video, music, games and software.
We also believe that many consumers find the video shopping experience,
especially at traditional retail outlets, to be time consuming and frustrating
due to inconvenient store hours, location and layout, as well as limited product
selection and inadequate customer service.
Our online store provides consumers with an enjoyable shopping experience
which offers a compelling alternative to traditional video retailing. The key
components of our solution include:
- A PREMIERE INTERNET ADDRESS
- EXTENSIVE PRODUCT SELECTION AND AVAILABILITY
- RAPID DELIVERY
- CONVENIENT SHOPPING EXPERIENCE
- INFORMATIVE CONTENT AND COMMUNITY
- COMMITMENT TO CUSTOMER SERVICE
- ADDITIONAL SERVICES
3
<PAGE>
OUR STRATEGY
Our goal is to enhance our position as a leading online retailer of DVDs and
related entertainment products and services. Our strategy includes the following
elements:
- BUILD BRAND RECOGNITION
- DEVELOP AND MAINTAIN STRATEGIC RELATIONSHIPS WITH THE MAJOR STUDIOS
- ESTABLISH OPERATIONS IN INTERNATIONAL MARKETS
- PURSUE WAYS TO INCREASE OUR REVENUES
- CONTINUOUSLY IMPROVE OUR CUSTOMERS' EXPERIENCE
THE OFFERING
The following information assumes that the underwriters do not exercise
their over-allotment option. The share numbers below exclude the following
options and warrants that will increase the shares outstanding if and when they
are exercised and further dilute your investment:
- 2,250,000 shares of common stock available for issuance under our stock
incentive plan, of which 1,124,250 shares were underlying outstanding
options as of the date of this prospectus at a weighted average exercise
price of $4.38 per share;
- 300,000 shares of common stock underlying options granted to Joan Abend,
Vice President of Operations, at an exercise price of $.0667 per share;
and
- 1,384,006 shares of common stock underlying a warrant granted to America
Online at an exercise price of $5.60 per share.
<TABLE>
<S> <C>
Common stock offered........................ 4,500,000 shares
Total shares outstanding after this
offering.................................. 22,206,427 shares
Use of proceeds............................. Expand marketing activities, payments to
America Online, fund international expansion,
repay credit lines, expand infrastructure and
for other general corporate purposes. See "Use
of Proceeds."
Proposed Nasdaq National Market symbol...... DVDS
</TABLE>
CONTROL BY OUR FOUNDER
Upon completion of this offering, our founder, Michael Dubelko, will
beneficially own approximately 67.1% of our outstanding shares of common stock
and will have the ability to control matters requiring the vote of the
stockholders.
CORPORATE INFORMATION
We were incorporated in California in 1996 and will be reincorporated in
Delaware upon the closing of this offering. Our executive offices are located at
7083 Hollywood Boulevard, Los Angeles, California 90028, and our telephone
number is (323) 465-1183. Information on our Web sites does not constitute part
of this prospectus.
4
<PAGE>
SUMMARY FINANCIAL DATA
The following summary financial data is derived from our financial
statements and related notes appearing elsewhere in this prospectus. You should
read the following summary financial data in conjunction with those financial
statements and notes.
Our operating expenses included sales and marketing expenses of $97,000 in
1997, $2.9 million in 1998, $127,000 for the three months ended March 31, 1998
and $3.2 million for the three months ended March 31, 1999. In addition, in 1998
and in the three months ended March 31, 1999, our operating expenses included
America Online warrant amortization expense of $1.2 million. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The pro forma statement of operations data reflects the termination of our S
corporation status and the impact of the automatic conversion of the Series A
Convertible Preferred Stock into common stock effective upon the closing of the
initial public offering as if the conversion had occurred on January 4, 1999,
the date of original issuance.
<TABLE>
<CAPTION>
OCTOBER 18
(INCEPTION)
TO YEARS ENDED THREE MONTHS ENDED
DECEMBER DECEMBER 31, MARCH 31,
31, -------------------- ----------------------
1996 1997 1998 1998 1999
----------- --------- --------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues........................ $ -- $ 1,269 $ 16,907 $ 1,645 $ 11,229
Cost of revenues................ -- 1,046 15,086 1,365 10,381
----------- --------- --------- ---------- ----------
Gross profit.................... -- 223 1,821 280 848
Operating expenses.............. 17 415 6,311 291 6,132
----------- --------- --------- ---------- ----------
Operating loss.................. (17) (192) (4,490) (11) (5,284)
Interest income (expense),
net........................... -- -- (74) -- 10
----------- --------- --------- ---------- ----------
Net loss........................ $ (17) $ (192) $ (4,564) $ (11) $ (5,274)
----------- --------- --------- ---------- ----------
----------- --------- --------- ---------- ----------
Loss before pro forma provision
for income taxes.............. $ (17) $ (192) $ (4,564) $ (11) $ (5,274)
Pro forma provision for income
taxes (unaudited)............. -- -- -- -- --
----------- --------- --------- ---------- ----------
Pro forma net loss
(unaudited)................... $ (17) $ (192) $ (4,564) $ (11) $ (5,274)
----------- --------- --------- ---------- ----------
----------- --------- --------- ---------- ----------
Basic and diluted loss per
common share.................. $ (0.00) $ (0.01) $ (0.30) $ (0.00) $ (0.35)
Weighted average shares
outstanding................... 15,000,000 15,000,000 15,000,000 15,000,000 15,114,000
Basic and diluted pro forma loss
per common share
(unaudited)................... $ (0.00) $ (0.01) $ (0.30) $ (0.00) $ (0.30)
Pro forma weighted average
shares outstanding
(unaudited)................... 15,000,000 15,000,000 15,000,000 15,000,000 17,599,713
</TABLE>
5
<PAGE>
The as adjusted column contained in the following balance sheet data table
reflects:
- the increase in stockholders' equity to reflect the receipt by us of the
net proceeds of this offering of 4,500,000 shares of common stock, which
are estimated to be $45.4 million;
- the automatic conversion of the 1,714,285 shares of Series A Preferred
Stock into 2,571,427 shares of common stock (post 3-for-2 stock split)
which has no impact of total stockholders' equity;
- the payment of additional prepaid advertising of $7 million to America
Online under our marketing agreement; and
- the repayment of $3 million outstanding under our credit lines which
reduces total debt to zero.
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................................................. $ 4,933 $ 40,318
Working capital........................................................................... 9,632 55,017
Total assets.............................................................................. 25,536 67,921
Total debt................................................................................ 3,000 --
Total stockholders' equity................................................................ 18,425 63,810
</TABLE>
6
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS BEFORE YOU DECIDE TO BUY
OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS,
FINANCIAL CONDITION OR RESULTS OF OPERATIONS WOULD LIKELY SUFFER. AS A RESULT,
THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR
PART OF THE MONEY YOU PAID TO BUY OUR COMMON STOCK.
OUR PROSPECTS ARE DIFFICULT TO FORECAST BECAUSE WE HAVE ONLY BEEN OPERATING OUR
BUSINESS SINCE APRIL 1997. IF WE FAIL TO MEET THE EXPECTATIONS OF PUBLIC
MARKET ANALYSTS AND INVESTORS, THE MARKET PRICE OF OUR COMMON STOCK MAY
DECLINE SIGNIFICANTLY.
We began selling DVD products in April 1997 and, accordingly, we have a very
limited operating history. You must consider our prospects in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stage of development, particularly companies in the new and rapidly
evolving online commerce market. These risks include, but are not limited to,
the inability to respond promptly to changes in a rapidly evolving and
unpredictable business environment and the inability to manage growth. To
address these risks, we must, among other things:
- expand our customer base;
- successfully implement our business and marketing strategies;
- continue to develop and upgrade our Web sites and transaction-processing
systems;
- provide superior customer service and order processing;
- respond to competitive developments; and
- attract and retain qualified personnel.
WE HAVE A HISTORY OF LOSSES AND WE EXPECT TO CONTINUE TO INCUR LOSSES FOR THE
FORESEEABLE FUTURE.
To date, we have not been profitable and aggregate losses from inception
through March 31, 1999 are $10 million. During 1998, we incurred net losses of
$4.5 million and for the three months ended March 31, 1999, we incurred losses
of $5.3 million. We intend to invest heavily in marketing and promotion, Web
site development and technology and the development of our administrative
organization. As a result, we expect to incur substantial operating losses for
the foreseeable future at rates significantly above current levels. Because our
gross margin is relatively low, achieving profitability depends upon our ability
to generate and sustain substantially higher revenues. We expect to use a
portion of the net proceeds from this offering to fund operating losses. If the
net proceeds from this offering, together with cash generated by operations,
cannot sufficiently fund future operating losses, we may be required to raise
additional funds. Additional financing may not be available in amounts or on
terms acceptable to us, if at all.
OUR FUTURE OPERATING RESULTS MAY FLUCTUATE AND ARE UNPREDICTABLE. IF WE FAIL TO
MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS AND INVESTORS, THE MARKET
PRICE OF OUR COMMON STOCK MAY DECLINE SIGNIFICANTLY.
Our limited operating history makes it difficult to forecast accurately our
revenues, operating expenses and operating results. As a result, we may be
unable to adjust our spending in a timely manner to compensate for any
unexpected revenue shortfall. We may also be unable to increase our spending and
expand our operations in a timely manner to meet customer demand should it
exceed our expectations.
7
<PAGE>
Our future operating results may fluctuate significantly due to a variety of
factors, many of which are outside of our control. These factors include, but
are not limited to:
- our ability to retain existing customers, attract new customers and
maintain customer satisfaction;
- the introduction of new or enhanced Web pages, services, products and
strategic alliances by us and our competitors;
- price competition or higher wholesale prices;
- the timing and popularity of future DVD releases and our access to those
releases;
- our ability to manage inventory levels;
- fluctuations in the amount of consumer spending on DVDs and related
products;
- decreases in the number of visitors to our Web sites or our inability to
convert visitors to our Web sites into customers;
- the termination of existing, or failure to develop new, strategic
marketing relationships through which we receive exposure to traffic on
third-party Web sites;
- increases in the cost of online or offline advertising;
- our ability to attract new personnel in a timely and effective manner or
retain existing personnel;
- unexpected increases in shipping costs or delivery times;
- government regulations related to use of the Internet for commerce;
- our ability to maintain, upgrade and develop our Web sites, transaction
processing systems or network infrastructure;
- technical difficulties, system downtime or Internet brownouts;
- the amount and timing of operating costs and capital expenditures relating
to expansion of our business, operations and infrastructure;
- the timing of promotions and sales programs; and
- general economic conditions and economic conditions specific to the
Internet and the DVD industry.
As a result of the factors listed above, our quarterly or annual results of
operations in future periods may not meet the expectations of securities
analysts or investors. This could result in a decline in the value of our common
stock.
BECAUSE OUR BUSINESS WILL PROBABLY BE AFFECTED BY SEASONAL BUYING PATTERNS, OUR
QUARTERLY OPERATING RESULTS WILL FLUCTUATE AND OUR SHARE PRICE MAY BE
ADVERSELY AFFECTED.
We believe that our revenues will be affected by seasonal consumer buying
patterns. Sales in the traditional video industry are highest in the fourth
quarter of each calendar year. To date, our limited operating history and rapid
growth make it difficult for us to determine what effect, if any, seasonality
has on our business. Shifts in seasonal sales cycles may occur due to changes in
the economy or other factors affecting the market for our products. These shifts
could cause our quarterly or annual results of operations in future periods to
fall below the expectations of securities analysts or investors. This could
result in a decline in the value of our common stock.
8
<PAGE>
IF WE DO NOT MAINTAIN ADEQUATE SYSTEMS CAPACITY TO SERVICE OUR CUSTOMERS, WE
COULD LOSE CUSTOMERS AND OUR REVENUES COULD BE REDUCED.
A key element of our strategy is to generate higher volumes of traffic on
our Web sites. Our reputation and ability to attract, retain and serve our
customers hinge upon the reliable performance of our Web sites, network
infrastructure and transaction-processing systems. Interruptions in these
systems could make our Web sites unavailable and hinder our ability to fill
orders, thereby reducing the volume of products we can sell. These interruptions
could also diminish the overall attractiveness of our product and service
offerings to existing and potential customers. If we experience a substantial
increase in traffic volume on our Web sites or in the number of orders placed by
customers, we will need to expand and upgrade our network infrastructure,
technology and transaction-processing systems by adding additional hardware and
software. We may not be able to project the rate of increase in traffic or order
volume on our Web sites. If we do not or are unable to make these improvements
on a timely basis, we may encounter:
- unanticipated system disruptions;
- slower response times;
- a decline in the quality of our customer service;
- reduced accuracy and/or speed of order fulfillment; and
- delays in reporting accurate financial information.
WE RELY ON PANDESIC LLC TO DEVELOP AND SERVICE THE COMMERCE SYSTEMS THAT OPERATE
OUR BUSINESS. OUR OPERATIONS COULD BE IMPAIRED IF THIS RELATIONSHIP IS
TERMINATED.
We depend on Pandesic LLC to develop and service our commerce systems,
including the software and hardware that operates our transaction-processing
systems. Our current agreement with Pandesic runs through May 2000. If Pandesic
terminates the agreement early or if the agreement is not renewed, we would be
forced to either enter into a relationship with another third-party provider or
undertake to develop and service our commerce systems internally. In either
event, we would have to incur additional expenses to convert our commerce
systems. Also, the new commerce system could be more expensive to maintain than
our current system and may not function as well.
WE FACE THE RISK OF SYSTEM FAILURES AND WE DO NOT MAINTAIN REDUNDANT FACILITIES.
THE OCCURRENCE OF A SYSTEM FAILURE COULD DAMAGE OUR REPUTATION AND IMPAIR OUR
OPERATING RESULTS.
Our ability to receive and process orders successfully and provide
high-quality customer service depends on the efficient and uninterrupted
operation of our computer and communications systems. Our systems and operations
are vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, earthquake and similar events. Our systems are also
vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions. We operate our business from and warehouse all of our inventory at
a single location. This facility may also be damaged by fire, flood, power loss,
telecommunications failure, break-ins, earthquake and similar events. We do not
presently have redundant systems or a formal disaster recovery plan and do not
carry sufficient business interruption insurance to compensate us for losses
that may occur.
IF WE ARE NO LONGER ABLE TO PURCHASE PRODUCTS DIRECTLY FROM MAJOR STUDIOS, OUR
GROSS PROFIT COULD BE REDUCED.
A key element of our strategy involves purchasing inventory directly from
major and independent studios. This allows us to buy product at lower prices
than can be obtained through distributors. We also rely on studios for joint
promotions and we believe our relationships with them may allow us to
9
<PAGE>
develop additional revenue sources. We do not have any long-term supply
agreements. If we are unable to maintain our relationships with the studios, we
would have to purchase our product from distributors and our profit margins
would be reduced.
BECAUSE OF THE RELATIVELY LOW COST OF LAUNCHING A WEB SITE AND THE LIMITED
BARRIERS TO ENTRY, COMPETITION IN THE ONLINE COMMERCE MARKET IS INTENSE. IF WE
ARE UNABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE COMPETITORS THAT
ENTER THE ONLINE COMMERCE MARKET, OUR REVENUES AND OPERATING RESULTS COULD BE
IMPAIRED.
The online commerce market is new, rapidly evolving and intensely
competitive, and we expect that competition could further intensify in the
future. Barriers to entry are limited, and current and new competitors can
launch Web sites at a relatively low cost. In addition, the broader retail video
industry is intensely competitive. We currently compete with a variety of online
vendors who specialize in DVDs and videos, as well as those who also sell books,
music and other entertainment products. We also compete with specialty video
retailers, mass merchandisers, consumer electronic stores, and non-store
retailers including mail-order video clubs. Many of these traditional retailers
also support or may introduce dedicated Web sites that compete directly with
ours. As the DVD rental market matures, we may also face increased competition
from DVD rental stores. New technologies and the expansion of existing
technologies may increase the competitive pressures on us. For example,
applications that rank specific titles from a variety of Web sites based on
price may channel customers to online retailers that compete with us.
We believe that the primary competitive factors in the online market are:
- brand recognition;
- product selection;
- ease of use;
- site content;
- speed of delivery;
- customer service; and
- price.
Many of our current and potential competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than us. Our competitors have
and may continue to utilize aggressive pricing or inventory availability
practices and devote substantially more resources to Web site and systems
development than us. Increased competition may result in reduced operating
margins, loss of market share and diminished brand recognition.
We may not be able to compete successfully against current and future
competitors. Further, as a strategic response to changes in the competitive
environment, we may from time to time make pricing, service, marketing decisions
or acquisitions that could have a material adverse effect on our business,
prospects, financial condition and results of operations.
IF WE ARE NOT ABLE TO MANAGE OUR GROWTH OR EXPANSION, OUR OPERATING RESULTS AND
ABILITY TO SUSTAIN GROWTH COULD BE IMPAIRED.
We have expanded rapidly since we commenced operations in April 1997. We
anticipate that further expansion of our operations will be required to address
any significant growth in our customer base and to take advantage of our market
opportunities. During 1998, we grew from seven to 72
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employees. As of March 31, 1999, we had 90 employees and several key members of
management have only recently joined us. We may choose to expand our operations
by:
- developing new Web sites;
- promoting new or complementary products or sales formats;
- expanding the breadth and depth of products and services offered; or
- expanding our market presence through relationships with third parties.
Any future expansion, internally or through acquisitions, may place
significant demands on our managerial, operational, administrative and financial
resources. Furthermore, any new business or product line we launch that is not
favorably received by our consumers could damage our reputation, brand name or
results of operations. Our future performance and profitability will depend in
part on our ability to recruit, motivate and retain qualified personnel and on
the implementation of enhancements to our operational and financial systems. We
cannot be certain that our systems, procedures or controls will be adequate to
support our expanding operations or that management will be able to respond
effectively to any growth in our business.
OUR GROWTH AND OPERATING RESULTS COULD BE IMPAIRED IF WE ARE UNABLE TO EXPAND
OUR WAREHOUSE AND ORDER PROCESSING CAPABILITIES.
We must increase the size of our warehouse and order processing operations
in order to accommodate increases in the total number of DVD titles available
for sale and any significant increase in the volume of customer orders. Our
current warehouse operations are not adequate to accommodate significant
increases in the number of DVD titles or in customer demand. We will have to
relocate some of our operations within the next twelve months, and we have
recently commenced a search for suitable locations. We may also be required to
automate order processing tasks that are currently performed manually. All of
these factors could adversely affect our business, prospects, financial
condition and results of operations.
OUR GROWTH AND OPERATING RESULTS WILL BE IMPAIRED IF THE INTERNET AND ONLINE
COMMERCE DO NOT CONTINUE TO GROW.
Our growth and operating results depend in part on widespread consumer
acceptance and use of the Internet as a way to buy products. This consumer
practice is at an early stage of development, and demand and continued market
acceptance is uncertain. We cannot predict the number of consumers that will be
willing to shift their purchasing habits from traditional to online retailers.
The Internet may not become a viable commercial marketplace due to
inadequate development of network infrastructure and enabling technologies that
address consumer concerns about:
- network performance;
- security;
- reliability;
- speed of access;
- ease of use; and
- bandwidth availability.
In addition, the Internet's viability as a commercial marketplace could be
adversely affected by increased government regulation. Changes in or
insufficient availability of telecommunications or other services to support the
Internet also could result in slower response times and adversely affect general
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<PAGE>
usage of the Internet. Also, negative publicity and consumer concern about the
security of transactions conducted on the Internet and the privacy of users may
also inhibit the growth of commerce on the Internet.
IF DVD TECHNOLOGY DOES NOT BECOME WIDELY ACCEPTED OR BECOMES OBSOLETE, OUR
REVENUES COULD BE REDUCED.
Consumers may not accept DVD technology on a widespread basis, or acceptance
may be delayed, due to:
- a reluctance by studios or others to release titles in the DVD format;
- consumer confusion because of competing DVD formats, including DIVX;
- potentially high switching costs from VHS to DVD; and
- the availability of pay-per-view and other forms of online transmission as
an alternative to DVD.
The foregoing factors could result in delays in the acceptance of DVD
technology. Also, the electronic online delivery of information, through
distribution media including the Internet, satellites or cable television,
competes with DVD technology. Recent and continuing developments in broadband
online data delivery have led to speculation regarding the decreasing viability
of physical media including DVD products. If DVD technology does not become
widely accepted or becomes obsolete, our revenues could be reduced and our
operating results could be impaired.
IF WE DO NOT RESPOND TO TECHNOLOGICAL CHANGE OUR SERVICES COULD BECOME OBSOLETE
AND WE COULD LOSE CUSTOMERS.
To remain competitive, we must continue to enhance and improve the
responsiveness, reliability, functionality and features of our online store. The
Internet and the online commerce industry are characterized by rapid
technological change, changes in user and customer requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices. These developments could
render our Web sites and proprietary technology and systems obsolete. Our growth
and operating results will depend, in part, on our ability to:
- enhance our existing services;
- develop new features, services and technology that address the
increasingly sophisticated and varied needs of prospective customers; and
- respond to technological advances and emerging industry standards and
practices on a cost-effective and timely basis.
Also, new technologies may make our existing features and services obsolete.
We believe that our growth and operating results will depend in part on our
ability to deliver products and services which meet changing technology and
customer needs.
OUR GROWTH AND OPERATING RESULTS DEPEND ON KEY PERSONNEL AND OUR ABILITY TO HIRE
ADDITIONAL PERSONNEL.
We depend substantially on the continued services and performance of our
senior management and other key employees, particularly Michael Dubelko, our
Chairman, Chief Executive Officer and President, and Andrew Crist, our Chief
Financial Officer. The loss of any of these officers or key
employees could disrupt our business. Both Mr. Dubelko's and Mr. Crist's
employment agreements are terminable at their discretion. In addition, we cannot
be certain that the key person life insurance that we maintain on Mr. Dubelko
will adequately compensate us for the loss of his services. Our future
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success also depends on our ability to identify, attract, hire, train, retain
and motivate other highly skilled technical, managerial, editorial,
merchandising, marketing and customer service personnel. Competition for
qualified personnel is intense, and we may not be able to successfully attract,
assimilate or retain sufficiently qualified personnel.
IF OUR ONLINE COMMERCE SECURITY MEASURES FAIL TO PROTECT CONSUMER INFORMATION,
OUR REPUTATION AND BRAND COULD BE DAMAGED AND WE COULD LOSE CUSTOMERS.
In the online commerce business, consumer confidence largely depends upon
the privacy of their activities and the secured transmission of confidential
information over public networks. To secure transmission of our customers'
confidential information, including their credit card numbers, we rely on
licensed encryption and authentication technology. However, our current security
measures may not be adequate. Advances in computer capabilities, new discoveries
in the field of cryptology or other developments may interfere with the methods
we use to secure customer transactions. Should someone circumvent our security
measures, he could misappropriate proprietary information and cause
interruptions in our operations. Security breaches could expose us to lawsuits
for failing to secure confidential customer information. As a result, we may be
required to expend a significant amount of money and other resources to protect
against security breaches or to alleviate any problems they may cause.
IF OUR STRATEGIC MARKETING ALLIANCES AND ONLINE AND TRADITIONAL ADVERTISING ARE
UNSUCCESSFUL, WE MAY BE UNABLE TO INCREASE OUR CUSTOMER BASE AND BRAND NAME
RECOGNITION.
We rely on strategic alliances and online and traditional advertising to
attract customers to our Web sites. We have entered into strategic marketing
agreements with America Online Inc., One Zero Media, Inc. (AltaVista) and
Infoseek Corporation (Go.com). Our ability to generate higher revenues will
largely depend on increased traffic and purchases through these agreements and
similar agreements we may enter into in the future. However, these marketing
agreements may not generate a sufficient number of new customers or revenues to
justify their costs. We cannot be sure that we will be able to renew or expand
successful advertising programs or our strategic alliances beyond their initial
terms or at acceptable terms. In addition, we commit substantial resources to
promoting our brand name through online, print and radio advertising campaigns.
However, we cannot be certain that these methods of advertising will
successfully attract additional customers to our Web sites.
IF WE ARE UNABLE TO PROTECT OUR DOMAIN NAMES, OUR REPUTATION AND BRAND COULD BE
IMPAIRED AND WE COULD LOSE CUSTOMERS.
We currently hold various domain names relating to our brand, including
DVDEXPRESS.COM and DVD.COM. The acquisition and maintenance of domain names
generally are regulated by governmental agencies and their designees. The
regulation of domain names in the United States and in foreign countries may
change in the near future. Governing bodies may establish additional top-level
domains, appoint additional domain name registrars or modify the requirements
for holding domain names. As a result, we may be unable to acquire or maintain
relevant domain names in all countries in which we conduct business.
Furthermore, the relationship between regulations governing domain names and
laws protecting trademarks and similar proprietary rights is unclear. We may be
unable to prevent third parties from acquiring domain names that are similar to,
infringe upon or otherwise decrease the value of our trademarks and other
proprietary rights.
IF WE ARE UNABLE TO PROTECT OUR TRADEMARKS AND PROPRIETARY RIGHTS, OUR
REPUTATION AND BRAND COULD BE IMPAIRED AND WE COULD LOSE CUSTOMERS.
We regard our trademarks, trade secrets and similar intellectual property as
critical to our business. We rely on trademark and copyright law, trade secret
protection and confidentiality and/or
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license agreements with employees, customers, partners and others to protect our
proprietary rights. We have pursued the registration of our trademarks in the
United States and internationally and have applied for the registration of
trademarks and service marks which are important to our business. Effective
trademark, service mark, copyright and trade secret protection may not be
available in every country where our products and service are made available
online. We cannot be certain that we have taken adequate steps to protect our
proprietary rights, especially in countries where the laws may not protect our
rights as fully as in the United States. In addition, third parties may infringe
upon or misappropriate our proprietary rights, and we could be required to incur
significant expenses in preserving them.
INTELLECTUAL PROPERTY CLAIMS AGAINST US COULD BE COSTLY AND RESULT IN THE LOSS
OF SIGNIFICANT RIGHTS.
Other parties may assert infringement or unfair competition claims against
us. In the past, other parties have sent us notice of claims of infringement of
proprietary rights, and we expect to receive other notices in the future. We
cannot predict whether third parties will assert claims of infringement against
us, or whether any past or future assertions or prosecutions will adversely
affect our business. If we are forced to defend against any infringement or
unfair competition claims, whether they are with or without merit or are
determined in our favor, then we may face costly litigation and diversion of
technical and management personnel. As a result of these disputes, we may have
to develop non-infringing property or enter into royalty or licensing
agreements. These royalty or licensing agreements, if required, may not be
available on acceptable terms, if at all.
OUR GROWTH AND OPERATING RESULTS COULD BE IMPAIRED IF WE ARE UNABLE TO EXPAND
OUR INTERNATIONAL SALES.
A significant component of our business strategy is to expand our
international sales. Although we currently sell products to international
customers from within the United States, we intend to establish a physical
presence in Europe and possibly other international markets in the future.
Conducting business in foreign countries involves inherent risks, including, but
not limited to:
- unexpected changes in regulatory requirements;
- export restrictions;
- tariffs and other trade barriers;
- difficulties in protecting intellectual property rights;
- difficulties in staffing and managing foreign operations;
- problems collecting accounts receivable;
- longer payment cycles;
- political instability;
- fluctuations in currency exchange rates; and
- potentially adverse tax consequences.
One or more of the foregoing factors could hinder our plans to expand our
international operations.
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OUR GROWTH AND OPERATING RESULTS COULD BE IMPAIRED IF WE ARE UNABLE TO MEET OUR
FUTURE CAPITAL REQUIREMENTS.
Based on our current operating plan, we anticipate that the net proceeds of
this offering, together with our available funds, will be sufficient to satisfy
our anticipated needs for working capital, capital expenditures and business
expansion for approximately the next 18 months. After that time, we may need
additional capital. Alternatively, we may need to raise additional funds sooner
in order to fund more rapid expansion, to develop new or enhanced services and
to respond to competitive pressures. If we raise additional funds by issuing
equity or convertible debt securities, the percentage ownership of our
stockholders will be diluted. Furthermore, any new securities could have rights,
preferences and privileges senior to those of our common stock.
We currently do not have any commitments for additional financing. We cannot
be certain that additional financing will be available when and to the extent
required or that, if available, it will be on acceptable terms. If adequate
funds are not available on acceptable terms, we may not be able to fund our
expansion, develop or enhance our products or services or respond to competitive
pressures.
WE MAY NOT BE ABLE TO SELL PRODUCTS HELD IN INVENTORY IF CONSUMER PREFERENCES
CHANGE.
The market for DVDs is impacted by rapidly changing trends in consumer
tastes. It is critical to our success that we accurately predict these trends
and stock sufficient amounts of popular titles and other products on a timely
basis and not overstock unpopular titles. Our failure to sufficiently stock
popular titles would adversely affect our operating results. The demand for
titles can change between the time we order products and the date we receive
them. In the event that one or more titles do not achieve widespread consumer
acceptance, we may be required to take significant inventory markdowns, which
would adversely affect our business. We believe that this risk will increase if
we enter new product categories due to our lack of experience in purchasing
products for these categories. In addition, to the extent that demand for our
products increases over time, we may be forced to increase inventory levels. Any
increase in our inventory levels would subject us to additional inventory risks.
BURDENSOME GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD IMPAIR OUR
RESULTS OF OPERATIONS.
It is possible that a number of laws and regulations may be adopted
concerning the Internet, relating to:
- user privacy;
- pricing;
- content;
- copyrights;
- distribution; and
- characteristics and quality of products and services.
The adoption of any additional laws or regulations may decrease the
popularity or expansion of the Internet. A decline in the growth of the Internet
could decrease demand for our products and services and increase our cost of
doing business. Moreover, the applicability of existing laws to the Internet is
uncertain with regard to many issues including property ownership, intellectual
property, export of encryption technology, sales tax, libel and personal
privacy. Our business, financial condition and results of operations could be
seriously harmed by any new legislation or regulation of these types. The
application of laws and regulations from jurisdictions whose laws do not
currently apply to our business, or the application of existing laws and
regulations to the Internet and other online services could also harm our
business.
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WE COULD FACE LIABILITY FOR PUBLISHING OR DISTRIBUTING CONTENT OVER THE
INTERNET.
We may be considered a publisher or distributor of both our own and
third-party content, and people may download or copy material from our Web sites
and distribute it to others. As a result, individuals may bring claims against
us for defamation, negligence, copyright or trademark infringement, invasion of
privacy and publicity, unfair competition or other theories based on the nature
and content of this material. For example, claims could be made against us if
material deemed inappropriate for viewing by young children could be accessed
through our Web sites. Our general liability insurance may not cover claims of
this type or may not adequately cover the costs we could incur in defending
potential claims. Further, our insurance may not fully indemnify us for all
liability that may be imposed. Our business, financial condition and operating
results could suffer if costs resulting from these claims are not covered by our
insurance or exceed our policy limits.
WE MAY BE LIABLE FOR SALES AND OTHER TAXES.
We currently collect sales or other similar taxes on the shipment of goods
only in the State of California. Tax authorities in many states are reviewing
the appropriate tax treatment of Internet and catalogue retail companies. Any
resulting state tax regulations could subject us to the assessment of sales and
income taxes in other states. Since our service is available over the Internet
in multiple states and in foreign countries, these jurisdictions may require us
to qualify to do business. If we fail to qualify in a jurisdiction that requires
us to do so, we could face expenditures for taxes and penalties.
THE RIGHTS OF OUR STOCKHOLDERS COULD BE ADVERSELY AFFECTED BECAUSE WE ARE
CONTROLLED BY MICHAEL DUBELKO, OUR FOUNDER.
Upon completion of this offering, our founder, Michael Dubelko, will
beneficially own approximately 67.1% of the outstanding shares of our common
stock. As a result, Michael Dubelko will have the ability to control matters
requiring the vote of the stockholders, including the election of our directors
and most of our corporate actions. His control could delay, defer or prevent
others from initiating a potential merger, takeover or other change in our
control, even if these events would benefit our stockholders and us. This could
adversely affect the voting and other rights of our other stockholders, and
could depress the market price of our common stock.
IF THE SOFTWARE, HARDWARE, COMPUTER TECHNOLOGY AND OTHER SYSTEMS AND SERVICES
THAT WE USE ARE NOT YEAR 2000 COMPLIANT, OUR OPERATING RESULTS, BRAND AND
REPUTATION COULD BE IMPAIRED AND WE COULD LOSE CUSTOMERS.
Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
upcoming change in the century. If not corrected, many computer software
applications could fail or create erroneous results by, at or beyond the year
2000. This could result in system failures or miscalculations causing
disruptions of operations, including, among others, a temporary inability to
process transactions, send invoices or engage in similar normal business
activities.
We use software, hardware, computer technology and other services that we
developed and or purchased from third-party vendors that may fail due to the
Year 2000 issue. We are dependent on financial institutions to process our
customers' credit card payments. We are also dependent on telecommunications
vendors to maintain our network and the United States Postal Service, Federal
Express and other third-party carriers to deliver orders to customers.
If Year 2000 issues prevent our customers from accessing the Internet,
accessing our Web sites, processing orders through our third party provided
systems or using their credit cards, or if we are unable to purchase product
from our suppliers or deliver product to our customers, our operations may be
materially adversely affected. We cannot currently predict how the Year 2000
issue will affect our
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computer systems, suppliers and shippers, including the United States Postal
Service and Federal Express, or the extent to which we would be vulnerable to
the failure to remedy any Year 2000 issues on a timely basis. Also, we cannot be
certain that our customers' credit card vendors and those organizations
responsible for maintaining and providing Internet access will rectify their
Year 2000 issues. Moreover, the costs related to Year 2000 compliance could be
significant. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Year 2000."
WE HAVE BROAD DISCRETION AS TO USE OF PROCEEDS AND MAY NOT USE THE PROCEEDS
EFFECTIVELY.
We estimate the net proceeds of this offering to be approximately $45.4
million. We expect to use the net proceeds to expand marketing activities,
satisfy contractual obligations with America Online, fund international
expansion, repay credit lines, expand our infrastructure and for working
capital. However, we may change the allocation of these proceeds in response to
economic or industry developments or changes. Accordingly, our management will
have broad discretion in applying the net proceeds of this offering. See "Use of
Proceeds."
NO PRIOR PUBLIC MARKET EXISTS FOR OUR COMMON STOCK AND NO ACTIVE TRADING MARKET
MAY DEVELOP.
Prior to this offering, there has been no public market for our common
stock. We cannot be sure that an active trading market for the common stock will
develop or continue as a result of this offering.
STOCK PRICES OF INTERNET-RELATED COMPANIES HAVE FLUCTUATED WIDELY IN RECENT
MONTHS AND THE TRADING PRICE OF OUR COMMON STOCK IS LIKELY TO BE VOLATILE,
WHICH COULD RESULT IN SUBSTANTIAL LOSSES TO INVESTORS.
The trading price of our common stock is likely to be volatile and could
fluctuate widely in response to factors including the following, some of which
are beyond our control:
- variations in our operating results;
- announcements of technological innovations or new services by us or our
competitors;
- changes in expectations of our future financial performance, including
financial estimates by securities analysts and investors;
- changes in operating and stock price performance of other Internet and
online companies similar to us;
- conditions or trends in the Internet industry;
- additions or departures of key personnel; and
- future sales of our common stock.
Domestic and international stock markets often experience significant price
and volume fluctuations. These fluctuations, as well as general economic and
political conditions unrelated to our performance may adversely affect the price
of our common stock. In particular, following initial public offerings, the
market prices for stocks of Internet and technology-related companies often
reach levels that bear no established relationship to the operating performance
of these companies. These market prices are generally not sustainable and could
vary widely. The market prices of the securities of Internet-related and online
companies have been especially volatile. If our common stock trades to high
levels following this offering, it could eventually experience a significant
decline.
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OUR OFFERING PRICE DOES NOT NECESSARILY RELATE TO ANY ESTABLISHED CRITERIA OF
VALUE, SO OUR STOCK MAY TRADE AT MARKET PRICES BELOW THE OFFERING PRICE.
Through negotiations with the underwriters, we determined the public
offering price of the shares of our common stock. This price does not
necessarily relate to our book value, assets, past operating results, financial
condition or other established criteria of value. As a result, the shares being
offered may trade at market prices below the initial public offering price.
SALES OF ADDITIONAL SHARES OF OUR COMMON STOCK INTO THE PUBLIC MARKET MAY CAUSE
OUR STOCK PRICE TO FALL.
Sales of substantial amounts of our common stock in the public market after
this offering could adversely affect the prevailing market price of our common
stock. Upon completion of this offering, we will have 22,206,427 shares of
common stock outstanding. The shares sold in this offering will be freely
tradable under the Securities Act unless purchased or held by our "affiliates,"
as that term is defined in Rule 144 under the Securities Act. As part of this
offering, our executive officers, directors and stockholders have agreed with
the underwriters that they will not offer or sell any shares of common stock for
a period of 180 days after the date of this prospectus without the prior written
consent of ING Baring Furman Selz LLC. ING Baring Furman Selz LLC may, in its
sole discretion, at any time and without notice, release all or any portion of
the shares of common stock under these agreements. Sales of substantial amounts
of common stock in the public market, or the perception that sales could occur,
could adversely affect the prevailing market price for the common stock and
could impair our ability to raise capital through a public offering of equity
securities.
PROVISIONS IN OUR CHARTER DOCUMENTS COULD DETER TAKEOVER EFFORTS WHICH COULD
DEPRESS OUR STOCK PRICE.
Provisions of our Certificate of Incorporation, Bylaws and Delaware law
could make it more difficult for a third-party to acquire us, even if doing so
would be beneficial to our stockholders. See "Description of Capital
Stock--Anti-Takeover Effects."
MINORITY STOCKHOLDERS MAY NOT BE ABLE TO ELECT ANY OF OUR DIRECTORS WHICH COULD
DETER A TAKEOVER EVEN IF BENEFICIAL TO OUR STOCKHOLDERS.
Our Certificate of Incorporation does not provide for cumulative voting. As
a result, it is more difficult for minority stockholders to obtain
representation on our Board of Directors, which may deter takeover attempts.
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CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that address:
- trends in online commerce, Internet usage and adoption of DVD technology;
- our strategies;
- use of proceeds;
- Year 2000; and
- our financial condition or results of operations.
These forward-looking statements may be found in "Prospectus Summary," "Risk
Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and elsewhere in this
prospectus. In some cases you can identify forward-looking statements by
terminology including "believes," "anticipates," "expects," "estimates," "may,"
"will," "should," "could," "plans," "predicts," "potential," "continue" or
similar terms.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. The forward-looking statements involve
known and unknown risks, uncertainties and other factors that may cause actual
results to be materially different from any future results expressed or implied
by the forward-looking statements. These factors include those listed under
"Risk Factors" and elsewhere in this prospectus. We undertake no duty to update
any of the forward-looking statements after the date of this prospectus, even if
new information becomes available or other events occur in the future. All
forward-looking statements contained in this prospectus are expressly qualified
in their entirety by this cautionary notice.
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TERMINATION OF S CORPORATION STATUS
From the time of our founding until December 31, 1998 we elected to be taxed
as a Subchapter S corporation. A Subchapter S corporation, unlike a Subchapter C
corporation, is taxed like a partnership, with the owners being taxed instead of
the business entity. As a result, our sole shareholder during this period,
Michael Dubelko, was liable for all federal and substantially all state taxes
levied on our earnings.
We terminated this election effective on January 1, 1999. No adjustment was
necessary to reflect income tax expense in our pro forma statements of
operations because we had not generated any taxable income. Further, no
adjustment was necessary to our net deferred income tax assets because their
realization was uncertain and we had valued them at zero.
We agreed with Mr. Dubelko that if any adjustment is made to our taxable
income for any period prior to January 1, 1999 that increases his tax liability,
we will reimburse him to the extent our tax liability is decreased. If an
adjustment during that period increases our tax liability, he will reimburse us
to the extent his tax liability is decreased. These reimbursements to Mr.
Dubelko must also compensate him for any taxes due as a result of our
reimbursement to him.
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USE OF PROCEEDS
We estimate the net proceeds from this offering to be approximately $45.4
million, or $52.3 million if the underwriters' exercise their over-allotment
option in full, assuming an initial public offering price of $11.00 per share
and after deducting the underwriting discounts and commissions and estimated
offering expenses.
We expect to use these net proceeds as follows:
<TABLE>
<S> <C>
Expand marketing activities........................................... $21.5 million
Pay amounts due to America Online..................................... 7.0 million
Fund international expansion.......................................... 5.0 million
Pay amounts due to other marketing partners........................... 3.5 million
Repay credit lines with Wells Fargo Bank.............................. 3.0 million
Expand infrastructure and other general corporate purposes............ 5.4 million
------------
$45.4 million
------------
------------
</TABLE>
Until the proceeds are used, we intend to invest the net proceeds in
interest-bearing investment grade instruments, certificates of deposit or direct
or guaranteed obligations of U.S. governmental agencies.
As noted above, we expect to use $3 million of the net proceeds to repay two
credit lines with Wells Fargo Bank, National Association. The $2 million line
bears interest at .25% below prime rate and expires on November 1, 1999. The $1
million line bears interest at .75% above the prime rate and expires on
September 1, 1999. The prime rate was 7.75% at March 31, 1999. These credit
lines were used for general corporate purposes. Michael Dubelko has personally
guaranteed the repayment of both credit lines.
Other than with respect to payments to America Online and Wells Fargo Bank,
we intend to maintain flexibility in our use of the remaining proceeds of this
offering. The amounts actually expended for each use are at our discretion and
may vary significantly depending upon a number of factors, including the
progress of our marketing programs, capital spending requirements and
developments in the DVD market and Internet commerce. Accordingly, we reserve
the right to reallocate the proceeds of this offering as we deem appropriate.
From time to time, in the ordinary course of business, we evaluate possible
acquisitions of, or investments in, businesses, products and technologies that
are complementary to our business. A portion of the net proceeds may be used to
fund acquisitions or investments. We currently have no arrangements, agreements
or understandings and are not engaged in active negotiations with respect to any
acquisitions or investments.
DIVIDEND POLICY
To date, we have not declared or paid any dividends on our common stock. We
do not intend to declare or pay dividends on our common stock in the foreseeable
future, but rather to retain any earnings to finance the growth of our business.
Any future determination to pay dividends will be at the discretion of our Board
of Directors and will depend on our results of operations, financial condition,
contractual and legal restrictions and other factors it deems relevant.
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CAPITALIZATION
The following table shows our capitalization as of March 31, 1999. Our
capitalization is presented on an actual basis and on an as adjusted basis to
reflect the receipt and application by us of the net proceeds of this offering,
which are estimated to be $45.4 million, as detailed in "Use of Proceeds," and
to give effect to the automatic conversion of the 1,714,285 shares of Series A
Convertible Preferred Stock into 2,571,427 shares of common stock upon the
closing of this offering, after giving effect to a 3-for-2 stock split. The
number of issued and outstanding shares in the following table excludes the
following options and warrants that could result in further dilution to new
investors:
- 2,250,000 shares of common stock available for issuance under our stock
incentive plan, of which 1,124,250 shares were subject to outstanding
options as of the date of this prospectus at a weighted average exercise
price of $4.38 per share;
- 300,000 shares of common stock underlying options granted to an employee
at an exercise price of $.0667 per share; and
- 1,384,006 shares of common stock underlying a warrant granted to America
Online at an exercise price of $5.60 per share.
As a result of our change from an S corporation, the accumulated deficit for
accounting purposes includes only losses since January 1, 1999.
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Long-term debt, less current portion...................................................... $ -- $ --
Stockholders' equity:
Preferred Stock, $.0001 par value; 10,000,000 shares authorized;
1,714,285 issued and outstanding; no shares issued and outstanding
on an as adjusted basis............................................................... -- --
Common Stock, $.0001 par value; 50,000,000 shares authorized;
15,135,000 shares issued and outstanding; 22,206,427 shares outstanding
on an as adjusted basis............................................................... 2 2
Additional paid-in capital.............................................................. 23,697 69,082
Accumulated deficit..................................................................... (5,274) (5,274)
--------- -----------
Total stockholders' equity................................................................ 18,425 63,810
--------- -----------
Total capitalization.................................................................. $ 18,425 $ 63,810
--------- -----------
--------- -----------
</TABLE>
22
<PAGE>
DILUTION
Purchasers of the common stock in this offering will experience an immediate
and substantial dilution in the pro forma net tangible book value of the common
stock from the initial public offering price. The pro forma net tangible book
value of the common stock as of March 31, 1999, was $18.2 million or $1.03 per
share. Pro forma net tangible book value per share is equal to our total assets
less intangible assets, less total liabilities, divided by the number of shares
of common stock outstanding, after giving effect to the automatic conversion of
the 1,714,285 shares of Series A Convertible Preferred Stock into 2,571,427
shares of common stock upon the closing of this offering, after giving effect
for a 3-for-2 stock split. After giving effect to the sale of 4,500,000 shares
of common stock in this offering at an assumed initial public offering price of
$11.00 per share and the receipt and application of the net proceeds as detailed
in "Use of Proceeds," our pro forma net tangible book value as of March 31, 1999
would have been $63.6 million or $2.87 per share. This represents an immediate
increase in net tangible book value of $1.84 per share to our current
stockholders and an immediate and substantial dilution of $8.13 per share to new
stockholders purchasing shares in this offering. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price....................................... $ 11.00
Pro forma net tangible book value as of March 31, 1999.................... $ 1.03
Increase attributable to new stockholders................................. 1.84
---------
Pro forma net tangible book value as of March 31, 1999 after this
offering.................................................................. 2.87
---------
Dilution to new stockholders................................................ $ 8.13
---------
---------
</TABLE>
The following table summarizes on a pro forma basis as of March 31, 1999,
the differences between the number of shares of common stock purchased, the
total consideration paid and the average price per share paid by the existing
stockholders and the new stockholders purchasing shares of common stock in this
offering.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- -------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders................................. 17,706,427 79.7% $ 14,130,000 22.2% $ 0.80
New stockholders...................................... 4,500,000 20.3 49,500,000 77.8 $ 11.00
------------ ----- ------------- -----
22,206,427 100.0% $ 63,630,000 100.0%
------------ ----- ------------- -----
------------ ----- ------------- -----
</TABLE>
The above tables and calculations assume no exercise of outstanding options
or warrants. At the date of this prospectus, 1,124,250 shares of common stock
were underlying outstanding options under our stock incentive plan at a weighted
average exercise price of $4.38 per share, up to 300,000 shares could be
purchased under an option granted to an employee at an exercise price of $.0667
per share and up to 1,384,006 shares of common stock could be purchased upon
exercise of the warrant granted to America Online. To the extent options or
warrants are exercised, there will be further dilution to new investors.
23
<PAGE>
SELECTED FINANCIAL DATA
The following table shows selected financial data of our business for the
periods indicated. The statement of operations data shown below with respect to
the period ended December 31, 1996, the years ended December 31, 1997 and 1998
(audited), the three months ended March 31, 1998 and 1999 (unaudited) and the
balance sheet data as of December 31, 1996, 1997 and 1998 (audited) and March
31, 1999 (unaudited) are derived from our financial statements and the related
notes appearing elsewhere in this prospectus. The following data should be read
in conjunction with our financial statements and related notes and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
OCTOBER 18
(INCEPTION) YEARS ENDED THREE MONTHS ENDED
TO DECEMBER 31, MARCH 31,
DECEMBER 31, -------------------------- --------------------------
1996 1997 1998 1998 1999
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................. $ -- $ 1,269 $ 16,907 $ 1,645 $ 11,229
Cost of revenues......................... -- 1,046 15,086 1,365 10,381
------------ ------------ ------------ ------------ ------------
Gross profit............................. -- 223 1,821 280 848
Operating expenses(1).................... 17 415 6,311 291 6,132
------------ ------------ ------------ ------------ ------------
Operating loss........................... (17) (192) (4,490) (11) (5,284)
Interest income (expense), net........... -- -- (74) -- 10
------------ ------------ ------------ ------------ ------------
Net loss................................. $ (17) $ (192) $ (4,564) $ (11) $ (5,274)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Loss before pro forma provision
for income taxes....................... $ (17) $ (192) $ (4,564) $ (11) $ (5,274)
Pro forma provision for income
taxes (unaudited)(2)................... -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Pro forma net loss (unaudited)(2)........ $ (17) $ (192) $ (4,564) $ (11) $ (5,274)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Basic and diluted loss per
common share(3)........................ $ (0.00) $ (0.01) $ (0.30) $ (0.00) $ (0.35)
Weighted average shares
outstanding............................ 15,000,000 15,000,000 15,000,000 15,000,000 15,114,000
Basic and diluted pro forma loss
per common share (unaudited)(3)........ $ (0.00) $ (0.01) $ (0.30) $ (0.00) $ (0.30)
Pro forma weighted average shares
outstanding (unaudited)................ 15,000,000 15,000,000 15,000,000 15,000,000 17,599,713
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF MARCH 31, 1999
------------------------------- ---------------------------
1996 1997 1998 ACTUAL AS ADJUSTED(4)
--------- --------- --------- ----------- --------------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.......................... $ 13 $ -- $ 905 $ 4,933 $ 40,318
Working capital.................................... 13 157 2,244 9,632 55,017
Total assets....................................... 13 310 19,489 25,536 67,921
Total debt......................................... -- -- 4,300 3,000 --
Total stockholders' equity......................... 13 191 11,823 18,425 63,810
</TABLE>
- ------------------------------
(1) Operating expenses included sales and marketing expenses (excluding America
Online warrant amortization expense) of $97,000 in 1997, $2.9 million in
1998, $127,000 for the three months ended March 31, 1998 and $3.2 million
for the three months ended March 31, 1999. In addition, we had America
Online warrant amortization expenses of $1.2 million in 1998 and $1.2
million for the three months ended March 31, 1999. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(2) We have been exempt from payment of federal income taxes and have paid state
income taxes at a reduced rate as a result of our S corporation election. As
of January 1, 1999, our S corporation status terminated. Pro forma statement
of income data reflect the income tax expense that would have been recorded
had we not been exempt from paying taxes under the S corporation election.
This pro forma expense would be zero as a result of our operating losses.
There are no additional deferred taxes based upon the increase in the
effective tax rate from our S corporation status to C corporation status to
be recorded as all net deferred tax assets have been fully offset by a
valuation allowance as their realizability is uncertain. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
and notes 2 and 8 to the financial statements.
(3) See notes to financial statements for an explanation of the calculation and
presentation of earnings (loss) per common share.
(4) As adjusted to reflect (i) the increase in stockholders' equity to reflect
the receipt by us of the net proceeds of this offering from the sale of
4,500,000 shares of common stock, which are estimated to be $45.4 million;
(ii) the automatic conversion of the 1,714,285 shares of Series A Preferred
Stock into 2,571,427 shares of common stock (post 3-for-2 stock split) which
has no impact on total stockholders' equity; (iii) the payment of additional
prepaid advertising of $7 million to America Online under our marketing
agreement; and (iv) the repayment of $3 million outstanding under our credit
lines which reduces total debt to zero.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS TOGETHER WITH THE FINANCIAL STATEMENTS AND THE RELATED
NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
We commenced our online activities in April 1997 and have since grown
rapidly. Our revenues were $11.2 million in the first quarter of 1999, up from
$1.6 million in the first quarter of 1998. We had revenues of $16.9 million in
1998 compared to $1.3 million in 1997.
Because of the early stage of our operations, we believe that
period-to-period comparisons of our operating results are not meaningful and
should not be relied upon as an indication of our future performance. We report
our results on an accrual basis and recognize revenue when we ship products to
our customers. Our revenues are received primarily from customer credit card
payments within three days of our shipments and concurrent billings.
We incurred net losses of $5.3 million for the first quarter of 1999, $4.6
million for the year ended December 31, 1998, $192,000 for the year ended
December 31, 1997 and $17,000 for the period ended December 31, 1996. At
December 31, 1998, we had an accumulated deficit of $4.8 million. As a result of
our change from an S corporation, the accumulated deficit for accounting
purposes includes only losses since January 1, 1999. These losses and
accumulated deficit resulted from a lack of substantial revenues, advertising
costs, the costs of the significant infrastructure and other costs incurred for
the development and initial rollout of our Web sites. Because of our aggressive
expansion plans, we expect to incur significant operating losses for the
foreseeable future. Although we have experienced revenue growth in recent
periods, this growth may not be sustainable and these recent periods should not
be considered indicative of future performance. We may never achieve significant
revenues or profitability, or if we achieve significant revenues, they may not
be sustained.
RESULTS OF OPERATIONS
QUARTERLY RESULTS.
The following tables show unaudited statement of operations data, in dollars
and as a percentage of revenues, for the last five quarters. They have been
prepared on the same basis as our annual information and, in our opinion,
include all adjustments necessary to present fairly the information for the
quarters presented.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------------
1998 1999
------------------------------------------------------- ------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
------------ ------------ ------------ ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues................................ $ 1,645 $ 2,623 $ 3,730 $ 8,909 $ 11,229
Cost of revenues........................ 1,365 2,297 3,309 8,115 10,381
------------ ------------ ------------ ------------- ------------
Gross profit............................ 280 326 421 794 848
Operating expenses:
Operating and development............. 102 225 298 684 1,177
Sales and marketing................... 127 205 433 2,146 3,246
AOL warrant amortization.............. -- -- -- 1,249 1,249
General and administrative............ 62 167 187 426 460
------------ ------------ ------------ ------------- ------------
Operating loss.......................... (11) (271) (497) (3,711) (5,284)
Interest income (expense), net.......... -- -- (16) (58) 10
------------ ------------ ------------ ------------- ------------
Net loss................................ $ (11) $ (271) $ (513) $ (3,769) $ (5,274)
------------ ------------ ------------ ------------- ------------
------------ ------------ ------------ ------------- ------------
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------
1998 1999
---------------------------------------------------------- -------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues........................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues................ 83.0 87.6 88.7 91.1 92.5
----- ----- ----- ----- -----
Gross profit.................... 17.0 12.4 11.3 8.9 7.5
Operating expenses:
Operating and development..... 6.2 8.6 8.0 7.7 10.5
Sales and marketing........... 7.7 7.8 11.6 24.1 28.9
AOL warrant amortization...... -- -- -- 14.0 11.1
General and administrative.... 3.8 6.3 5.1 4.8 4.1
----- ----- ----- ----- -----
Operating loss.................. (0.7) (10.3) (13.4) (41.7) (47.1)
Interest income (expense),
net........................... -- -- (0.4) (0.6) 0.1
----- ----- ----- ----- -----
Net loss........................ (0.7)% (10.3 )% (13.8 )% (42.3 )% (47.0 )%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</TABLE>
QUARTER ENDED MARCH 31, 1999 COMPARED TO QUARTER ENDED MARCH 31, 1998
REVENUES. Revenues for the first quarter of 1999 totaled $11.2 million
compared to $1.6 million for the first quarter of 1998. Revenues consist of the
selling price of DVD Video, DVD-ROM and other merchandise, net of sales
discounts, as well as shipping and handling charges. Revenues increased
approximately $9.6 million as a result of significant growth in our customer
base.
COST OF REVENUES AND GROSS PROFITS. Cost of revenues for the first quarter
of 1999 totaled $10.4 million compared to $1.4 million for the first quarter of
1998. Cost of revenues increased significantly as a result of our increase in
revenues. Cost of revenues consisted of the cost of merchandise, packaging and
shipping.
Over the last 12 months, some of our competitors have advertised and sold
DVDs at prices we believe to be at or below their cost. We believe more
discounting activity occurred during the first quarter of 1999 than during any
previous period. Our gross profit margins, as a percentage of revenues, declined
to 7.5% for the first quarter of 1999 from 17.0% for the first quarter of 1998.
We believe our competitors' discounting activities may decline as their or other
online retailers' margins are negatively impacted by their practices. Also,
during the first quarter of 1999, 44% of our cash purchases of DVDs were made
directly from studios. We expect this percentage to increase further as we
continue to expand our studio direct purchasing efforts. There can be no
assurance, however, that our gross profit margin will not continue to decline
for the foreseeable future.
OPERATING AND DEVELOPMENT EXPENSES: Operating and development expenses
totaled $1.2 million for the first quarter of 1999 compared to $0.1 million for
the first quarter of 1998 due to the growth of our business. Operating expenses
consisted primarily of the costs of purchasing, inventory management, order
processing and customer service, including related payroll, insurance and
depreciation expenses. Development expenses consisted primarily of the costs of
software acquisition and development, technical infrastructure, graphic design,
editorial and Web site content and related payroll. The increase resulted
primarily from additional website development costs of $492,000 and increased
payroll costs of $479,000. We anticipate that operating and development expenses
will increase in absolute dollars as we expand our customer base and product
offering, but gradually decline as a percentage of revenues.
SALES AND MARKETING EXPENSES: Sales and marketing expenses totaled $3.2
million for the first quarter of 1999 compared to $0.1 million for the first
quarter of 1998 due to the growth of our business as we expanded our efforts to
attract more customers and increase brand awareness. Sales and marketing
expenses consisted primarily of advertising and promotional expenses, bank and
other related transaction fees and payroll associated with personnel involved in
our advertising, marketing and public
27
<PAGE>
relations efforts. The increase resulted primarily from additional advertising
expenses of $1.7 million and bank and other related transaction fees of
$230,000. During the second half of 1998, we entered into three strategic
marketing agreements with America Online, One Zero Media (AltaVista) and
Infoseek Corporation (Go.com). Payments made under these agreements and the fair
value of other equity consideration are capitalized and amortized over the
expected useful life based upon the term of the agreement or the number of
impressions delivered by each company. We anticipate that sales and marketing
expenses will continue to increase as we expand our online and traditional
marketing programs.
AMERICA ONLINE WARRANT AMORTIZATION EXPENSE: The strategic marketing
agreement with America Online includes a warrant to purchase up to 1,384,006
shares of common stock. The value of the America Online warrant is being
amortized over the three-year term of the marketing agreement beginning on
October 1, 1998. Related amortization expense totaled $1.2 million for the first
quarter of 1999 compared to zero for the first quarter of 1998, because the
underlying America Online strategic marketing agreement was not effective until
the fourth quarter of 1998.
GENERAL AND ADMINISTRATIVE EXPENSE: General and administrative expenses
totaled $460,000 for the first quarter of 1999 compared to $62,000 for the first
quarter of 1998 due to the growth of our business. General and administrative
expenses consisted of executive management, accounting and administrative
personnel, facilities and other overhead costs. The increase resulted primarily
from additional payroll costs of $91,000, professional fees of $85,000, rent of
$71,000 and other overhead costs of $71,000. We anticipate that general and
administrative expenses will increase in absolute dollars as we expand our
executive management team and general staff but gradually decline as a
percentage of revenue. In addition, we believe we will incur additional costs
related to our growth and operation as a public company.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES. Revenues for 1998 totaled $16.9 million compared to $1.3 million
for 1997. Revenues increased approximately $14.0 million as a result of
significant growth in our customer base and increased approximately $1.6 million
due to three additional months of offering our products for sale online in 1998.
COST OF REVENUES AND GROSS PROFITS. Cost of revenues for 1998 totaled $15.1
million compared to $1.0 million for 1997. Cost of revenues increased
significantly as a result of the large increase in revenues.
Our gross profit margins, as a percentage of revenues, declined to 10.8% for
1998 from 17.6% for 1997. This decline resulted from our short-term tactical
decision to match some competitors' prices on certain products. We believe our
competitors' discounting activities may decline as their or other online
retailers' margins are negatively impacted by these practices. Also, during
1998, approximately 30% of our cash purchases of DVDs were made directly from
studios. We expect this percentage to further increase as we expand our studio
direct purchasing efforts. There can be no assurance that our gross profit
margins will not continue to decline for the foreseeable future.
OPERATING AND DEVELOPMENT EXPENSES. Operating and development expenses
totaled $1.3 million for 1998 compared to $177,000 for 1997 primarily reflecting
additional payroll costs of $792,000 and web site development costs of $214,000
due to the growth of our business.
SALES AND MARKETING EXPENSES. Sales and marketing expenses totaled $2.9
million for 1998 compared to $97,000 for 1997. Sales and marketing expenses
increased significantly as we expanded our efforts to attract more customers and
increase brand awareness, primarily reflecting additional advertising expenses
of $1.1 million and bank and other related transaction fees of $440,000. We
28
<PAGE>
anticipate that sales and marketing expenses will continue to increase as we
expand our online and traditional marketing programs. See "Business--Our
Strategy."
AMERICA ONLINE WARRANT AMORTIZATION EXPENSE. America Online warrant
amortization expense totaled $1.2 million for 1998 compared to zero for 1997.
This increase is due to the fact that we did not begin amortizing the value of
the America Online warrant until October 1, 1998, the date the underlying
strategic marketing agreement became effective.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
totaled $842,000 for 1998 compared to $141,000 for 1997. The increase resulted
primarily from additional professional fees of $315,000, rent of $140,000 and
other overhead costs of $73,000. Through December 31, 1998, no salary had been
paid to Michael Dubelko, our Chairman, Chief Executive Officer and President.
The value of his services of $50,000 per year has been reflected as both
contributed capital and salary expense for the years ended December 31, 1997 and
1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE PERIOD FROM OCTOBER 18 TO DECEMBER
31, 1996
We began operations on October 18, 1996, but did not offer products for sale
on our Web sites until April 1997. Accordingly, during the period from October
18 to December 31, 1996 we had less than three months of operations and no
revenues. We incurred $17,000 in general and administrative expenses related to
startup and corporate formation. Further comparison between 1996 and 1997 is not
meaningful.
LIQUIDITY AND CAPITAL RESOURCES
Net cash of $3.6 million was used for operating activities for 1998 and
$290,000 in 1997, primarily as a result of net losses generated during those
periods. Cash used in operations during 1998 included aggregate payments of $2.9
million under marketing agreements and increases in inventories of $1.6 million,
offset by an increase in payables of $3.0 million. Net cash of $6.3 million was
used for operating activities in the three months ended March 31, 1999,
primarily as a result of net losses of $5.3 million generated in the period.
Cash used in operations during the period also included an increase of $1.9
million in prepaid advertising, an increase of $666,000 in inventory offset in
part by an increase in payables of $744,000.
During the second half of 1998, we entered into three-year strategic
marketing agreements with America Online and One Zero Media (AltaVista) and a
two-year strategic marketing agreement with Infoseek Corporation (Go.com). These
agreements require aggregate payments of up to $26.9 million over the terms of
the agreements, of which $2.9 million was paid in 1998. See "Business--Strategic
Marketing Agreements." During the three months ended March 31, 1999 we made
payments of $3.2 million under these agreements.
Cash of $696,000 was used in investing activities for purchases of fixed
assets in 1998 and $42,000 in 1997. Cash of $201,000 was used in investing
activities for purchases of intangible domain names assets in 1998. During the
three months ended March 31, 1999, we used cash of $284,000 for purchases of
fixed assets.
Net cash provided by financing activities, consisting of capital
contributions, stockholder loans and advances on lines of credit, totaled $5.5
million for 1998 and $320,000 in 1997.
Before January 1999, we have funded our operations and capital expenditures
primarily through capital contributions and loans from our founder, Michael
Dubelko, as well as bank credit lines that Mr. Dubelko has guaranteed. At
December 31, 1998, we had a cash balance of $905,000. We have two credit lines
totaling $3 million with Wells Fargo Bank, N.A., which were fully utilized as of
December 31, 1998. The $2 million line bears interest at .25% below prime rate
(7.5% at March 31, 1999) and expires on November 1, 1999. The $1 million line
bears interest at .75% above the prime
29
<PAGE>
rate (8.5% at March 31, 1999) and expires on September 1, 1999. We plan to use a
portion of the proceeds of this offering to repay these lines. In addition, at
December 31, 1998, we owed Michael Dubelko $1.3 million as a result of loans he
made during 1998. These loans bore interest at 8.5% and were repaid in full
during the three months ended March 31, 1999.
During January 1999, we sold 1,714,285 shares of Series A Convertible
Preferred Stock to private investors for net proceeds of $11.2 million. The
1,714,285 shares of Series A Convertible Preferred Stock will convert into
2,571,427 shares of common stock upon the closing of this offering. In an
unrelated transaction, we sold 135,000 shares of common stock to three directors
for net proceeds of $630,000. A portion of the proceeds from these sales were
used to pay back the loans made by Michael Dubelko described in the preceding
paragraph and to pay amounts due under our marketing agreement with America
Online.
Although we expect negative cash flow from operations for the foreseeable
future as we continue to develop and market our operations, we believe that the
proceeds of this offering, together with our cash on hand will be sufficient to
finance our planned operations and capital expenditures for the next 18 months,
including a planned move to larger warehouse facilities, anticipated inventory
increases and increased selling, general and administrative expenses.
SEASONALITY
The demand for DVDs, like many other consumer products, will likely be
highest in the fourth quarter, concurrent with the holiday gift purchasing
season. Although our growth has mitigated the seasonal effects in our historic
quarterly results, in the future we expect that our fourth quarter will
generally be the strongest. See "Risk Factors."
YEAR 2000
Many existing computer systems and software are coded to accept only two
digit entries in the date code field and cannot distinguish 21st century dates
from 20th century dates. If not corrected, there could be system failures or
miscalculations causing disruptions of operations including, among other things,
a temporary inability to process transactions or engage in normal business
activities. As a result, many companies' software and computer systems may need
to be upgraded or replaced to comply with these "Year 2000" requirements.
OUR STATE OF READINESS. We are assessing the impact that the Year 2000
problem may have on our operations and we have identified the following two
areas of our business that may be affected:
FACILITY AND OPERATIONAL SYSTEMS. We have internally developed the
software for our Web sites that customers use to shop in our online store.
Since we developed our Web store software within the last 14 months, we
believe we constructed these systems around the Year 2000 problem and have
not conducted any formal assessment of this software. Our remaining
information technology systems include our purchased third-party hardware
and software, and the systems and software hosted by Pandesic LLC. Our Year
2000 assessment for these information technology systems is discussed below.
In addition to our information technology, our non-information
technology systems, including our heating and air conditioning, security
systems and other systems with embedded technology are vulnerable to Year
2000 risks. To date, we have not conducted, and do not intend to conduct,
any formal assessment of our non-information technology systems. We believe
that any problems with these systems resulting from Year 2000 failures will
be insignificant and can be repaired without a material delay in our
business.
30
<PAGE>
THIRD-PARTY SUPPLIERS. We depend on Pandesic LLC to service our
commerce systems, including the hardware and software that operate our
transaction-processing systems. We have received a Year 2000 readiness
disclosure statement from Pandesic LLC indicating the Year 2000 compliance
of their systems. We intend to rely on Pandesic LLC's Year 2000 readiness
disclosure statement and we do not intend to conduct any further assessment
of their systems and software. Pandesic LLC is obligated to maintain and
correct errors that cause a material loss in function in the servers and
software used to operate our business. As a result, we believe Pandesic LLC
will repair any Year 2000 problems in their systems and software. We have
not developed any plans in the event Pandesic LLC's systems are not Year
2000 compliant or become inoperable due to Year 2000 problems.
We use other third-party hardware and software that may or may not be
Year 2000 compliant. Consequently, our ability to address Year 2000 issues
is, to a large extent, dependent upon the Year 2000 readiness of these third
parties' hardware and software products. To date, we have not initiated
communication with these third parties to assess their Year 2000 compliance.
However, we plan to contact these suppliers to validate that their products
are Year 2000 compliant. We intend to complete our assessment of their
compliance by the end of July 1999. We currently do not have any back-up
systems in place in the event our third party hardware and software becomes
inoperable. If our current hardware and software products are not Year 2000
compliant by the end of July 1999, we intend to pursue other third party
solutions that are Year 2000 compliant.
We also depend on our distributors and major and independent studios to
provide the merchandise we sell in our online store. To date, we have not
initiated communications with these parties; however, we intend to commence
communications with all of our distributors and major and independent
studios to determine the extent to which we are vulnerable to those third
parties' Year 2000 issues. We intend to obtain Year 2000 readiness
disclosure statements from each of these distributors and studios by the end
of July 1999 to confirm that their systems are Year 2000 compliant. We
expect to resolve any significant Year 2000 issues with our distributors and
studios; however, in the event they do not achieve Year 2000 compliance, we
may have to seek alternative product suppliers.
We depend on the Year 2000 compliance of Wells Fargo, our credit card
processing agent, and CyberCash, our payment service provider. We also rely
on the United States Postal Service and Federal Express to ship our
products. Although we have not initiated formal communications with these
parties, we intend to obtain Year 2000 readiness disclosure statements from
each of these parties to verify the Year 2000 compliance of their systems.
We currently do not have any back-up systems in place in the event these
third-party systems become inoperable. However, we expect to complete our
assessment of these third-party systems by the end of July 1999, and we will
locate alternative sources to handle our outsourced systems if our
third-party suppliers do not become Year 2000 compliant.
COSTS OF ADDRESSING OUR YEAR 2000 ISSUES. We do not expect the cost of
addressing our Year 2000 issues to be material to our financial condition and
results of operations. To date, we have incurred less than $10,000 in connection
with identifying and evaluating Year 2000 compliance issues. These expenses have
generally related to the operational costs associated with time spent by our
employees in the evaluation process of Year 2000 compliance in general. We
anticipate that our costs will continue to include employee expenses, and we do
not estimate total future expenditures to exceed $25,000. However, if these
costs are substantially higher than we anticipate, it could have a material
adverse effect on our business.
RISKS ASSOCIATED WITH OUR YEAR 2000 ISSUES. If Year 2000 issues prevent our
customers from accessing the Internet, accessing our Web sites, processing
orders through our third-party provided systems or using their credit cards, or
if we are unable to purchase product from our suppliers or deliver product to
our
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customers, our operations may be materially adversely affected. We cannot
currently predict the extent to which the Year 2000 issue will affect our
computer systems, suppliers and shippers, including the United States Postal
Service and Federal Express, or the extent to which we would be vulnerable to
the failure to remedy any Year 2000 issues on a timely basis. Also, we cannot be
certain that our customers' credit card vendors and those organizations
responsible for maintaining and providing Internet access will rectify their
Year 2000 issues. Any failure of our third-party equipment, facility and
operational systems, third-party suppliers or shippers to operate properly could
cause, among other things:
- a decrease in our sales;
- an increase in our allocation of resources to address Year 2000 problems
without additional revenue commensurate with our dedication of resources;
and
- an increase in litigation costs relating to losses suffered by our
customers due to Year 2000 problems.
OUR CONTINGENCY PLANS. To date, we have not identified any of our
information technology systems or non-information technology systems as needing
remediation or replacement. However, we have identified our worst case scenario
as the interruption of our business resulting from Year 2000 failure of our
third-party systems to process our transactions, and the failure of our credit
card processing agent and payment service provider to process our orders. We
have not developed a contingency plan, but we expect to complete this plan by
the end of August 1999. Without a worst case scenario plan in place, we may be
unable to effectively respond to Year 2000 problems in a timely manner.
Furthermore, if we complete our contingency plan, we cannot be certain that the
plan would be adequate to meet our needs or that the plan would be successful.
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BUSINESS
OUR COMPANY
We are a Web-based retailer of movies and videos in the digital versatile
disc format, commonly known as DVD. We operate our online store at
www.dvdexpress.com and offer interesting and informative content and community
features through our Web site at www.dvd.com.
MARKET OVERVIEW
THE PROJECTIONS DISCUSSED IN THIS MARKET OVERVIEW SECTION ARE INDUSTRY
PROJECTIONS, AND ANY GROWTH RATES DISCUSSED ARE INDUSTRY GROWTH RATES AND MAY
NOT REFLECT OUR GROWTH RATES OVER THE SAME PERIOD.
ONLINE COMMERCE. The Internet is an increasingly significant global medium
for communications, content and commerce. International Data Corporation
estimates that the number of Web users worldwide grew to approximately 142
million by the end of 1998 and will grow to approximately 399 million by 2002.
We believe that growth in Internet usage has been fueled by a number of factors:
- the large and growing installed base of personal computers in the
workplace and homes;
- advances in the performance and speed of personal computers and modems;
- improvements in network infrastructure, security and bandwidth;
- easier and cheaper access to the Internet; and
- increased awareness of the Internet among businesses and consumers.
The increasing functionality, accessibility and overall usage of the
Internet and online services have made them an attractive commercial medium. The
Internet and other online services are evolving into a unique sales and
marketing channel, similar to retail stores, mail-order catalogs and television
shopping. Online retailers can interact directly with customers by frequently
adjusting their featured selections, editorial insights, shopping interfaces,
pricing and visual presentations. Online retailers can also easily obtain
demographic and behavioral data about customers, increasing opportunities for
targeted direct marketing and personalized services. We believe that the minimal
cost to publish on the Web, the ability to reach and serve a large and global
group of customers electronically from a central location, and the potential for
personalized low-cost customer interaction all provide additional economic
benefits for online retailers. According to International Data Corporation, the
number of Web buyers worldwide is estimated to increase from 30.8 million in
1998 to 133.9 million in 2002, which represents a compounded annual growth rate
of 44%.
An increasingly broad base of products is being sold successfully online,
including computers, travel services, brokerage services, automobiles, music,
videos and books. International Data Corporation estimates that the total value
of goods and services purchased worldwide over the Web grew from $296 million in
1995 to $50.4 billion in 1998, and will increase to $733.6 billion in 2002.
Unlike traditional retail channels, online retailers do not have the costs of
managing and maintaining a significant retail store infrastructure or the
continuous printing and mailing costs of catalog marketing. Because of these
advantages, we believe that online retailers have the potential to build large,
global customer bases quickly and cost effectively and to achieve superior
economic returns over the long term. Even though online retailers have
advantages over traditional retail channels, online retailers face a number of
challenges, including intense competition, timely product distribution and rapid
technological changes. See "Risk Factors."
HOME VIDEO BUSINESS. According to Paul Kagan Associates, the U.S. market
for both VHS and DVD videos combined will increase from $8.9 billion in 1998 to
$11.1 billion in 2002, which represents a compounded annual growth rate of 5.7%.
During those years, Paul Kagan Associates expects DVD video sales to increase
from $268 million in 1998 to $2.9 billion in 2002. Paul Kagan Associates expects
VHS sales to decrease from $8.6 billion in 1998 to $8.2 billion in 2002. Since
the introduction of the VCR over twenty years ago, renting and purchasing
pre-recorded home videos has become a
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mainstream form of entertainment. The emergence of the pre-recorded video
business has created a large and growing market for the thousands of older and
historic films. Each new generation represents potential new audiences for these
older motion pictures. We believe that substantial growth opportunities exist in
the retail online pre-recorded home video industry. We also believe that the
DVD-Video format will eventually replace the VHS format in the video market.
THE DVD FORMAT. DVD technology is similar in functionality to CD-ROM and
CD-Audio technology; however, a DVD, which is the same size as a CD, is able to
store substantially more data than a CD. A typical DVD can hold a 135-minute
motion picture with up to eight different spoken language tracks, thirty-two
foreign language subtitles and six-channel, digital-surround sound. Added
features, including the movie's soundtrack, director's notes, story-based games
and other CD-ROM applications are also possible with the higher storage capacity
afforded with DVDs. As a result, we believe the DVD format will be the first
medium to embrace and allow for cross-promotion between video, audio and
software products.
We believe DVDs will initially compete most directly with sales and rentals
of pre-recorded videotapes. DVD players have become more affordable and are
currently available from several manufacturers at retail prices generally
ranging from $250 to $1,000. Forrester Research reports that by the end of 1999,
less than three years since its launch, 4.3 million DVD players will be
installed in North American households, far outpacing the debut of both the CD
player and VCR in their first years. Paul Kagan Associates estimates that the
installed base of DVD players in U.S. households will increase from 1.1 million
in 1998 to 12.0 million in 2002, which represents a compounded annual growth
rate of 82%. We believe that as the installed base of DVD players increases, the
demand for DVD-Video titles will also increase. Currently, over 3,000 motion
picture titles are available on the DVD format and we expect that number to grow
rapidly as the format gains popularity. Paul Kagan Associates also estimates
that DVD-Video discs sold in the United States will increase from 13.4 million
discs in 1998 to approximately 159.6 million discs in 2002, which represents a
compounded annual growth rate of 86%. Paul Kagan Associates also estimates that
annual U.S. DVD-Video sales will be $661 million in 1999, $1.3 billion in 2000
and $2.9 billion in 2002. International Data Corporation predicts approximately
16.0 million DVD-ROM drives will be installed in personal computers in the
United States during 2000, up from an estimated 8.3 million DVD-ROM drives to be
installed in 1999. According to Paul Kagan Associates, during the same period
the number of VHS tapes sold in the United States is estimated to decrease from
609.2 million in 1998 to 556.5 million in 2002.
While DVDs are initially expected to serve as substitutes for video tapes,
they are also expected to eventually replace CD-Audio and CD-ROM. We anticipate
that the market for DVDs will eventually exceed that of CD-ROM and CD-Audio.
Microsoft's Windows 98 operating system supports DVD, and Intel Corporation has
started shipping a new DVD-compatible product. International Data Corporation
predicts that DVD-ROM drives sold for United States households will increase
from 2.9 million in 1998 to 27.3 million in 2002, which represents a compound
annual growth rate of 75%.
Another important advantage of the DVD format, which we believe will
accelerate its market penetration, is its backwards compatibility. DVD players
and DVD-ROM drives are designed to read CD-Audio and CD-ROMs, which we expect to
increase consumers' acceptance of this new technology. Unlike the introduction
of CDs, consumers will be able to acquire the new DVD technology without making
their music collections obsolete because DVD players will also be capable of
playing CD-Audio. We believe these factors will contribute to the DVD format
becoming the standard medium for home video, music, games and software
distribution.
TRADITIONAL VIDEO RETAIL INDUSTRY. We believe that traditional store-based
retailers face a number of challenges in providing a satisfying shopping
experience for consumers of video products. We believe these same challenges
apply to the sale of DVDs:
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- The amount of physical space available in the store limits the number of
titles and the amount of product inventory that a traditional store-based
retailer can carry in any one store. As a result, many traditional
store-based retailers focus their product selection on the most popular
products that produce the highest inventory turns, thereby further
limiting consumer selection.
- Store configuration constraints limit merchandising flexibility. As a
result, traditional retailers generally display products by category,
including action, comedy or drama, and cannot easily modify or reconfigure
these merchandising strategies.
- Traditional store-based retailers must open new stores to serve additional
geographic areas, resulting in significant investments in inventory, real
estate and the hiring and training of store personnel.
- Traditional store-based retailers face challenges in hiring, training and
retaining knowledgeable sales staff, thereby limiting the level of
customer service available to consumers.
In addition, we believe that many consumers find the video shopping
experience, especially at traditional mass market retail outlets, to be
time-consuming and frustrating due to factors including inconvenient store
hours, location and layout, as well as limited product selection and inadequate
customer service.
OUR MARKET OPPORTUNITY
Our online store provides consumers with an enjoyable shopping experience
which offers a compelling alternative to traditional video retailing. We believe
our focus on the DVD format and commitment to customer service, along with the
informational content and community on our Web sites, enable us to address the
needs and desires of our customers. The key components of our solution include:
PREMIERE INTERNET ADDRESS. We were an early entrant in the online DVD
market and acquired the exclusive rights to the Internet address www.dvd.com
which provides high visibility and easy access to our Web sites.
EXTENSIVE PRODUCT SELECTION AND AVAILABILITY. We offer and expect to
continue to offer nearly every title available in the DVD format. In addition,
we sell video and DVD-ROM games and accessories.
RAPID DELIVERY. We manage our inventory so that order shipment usually
occurs the same day orders are received, including weekends.
CONVENIENT SHOPPING EXPERIENCE. Our online store provides customers with an
easy-to-use shopping interface that is available 24 hours a day, seven days a
week from the convenience of a customer's home or office. Our online store
enables us to deliver a broad selection of titles to customers in locations that
do not have easy access to physical stores. We also make the shopping experience
convenient by categorizing our DVDs by movie genre. Our search technology makes
it easy for consumers to locate products efficiently based on pre-selected
criteria, including title, actor or other key words.
CONTENT AND COMMUNITY. Our Web sites educate and entertain visitors and
provide an interactive community for DVD enthusiasts. We offer reviews,
recommendations, news and information about new and existing titles and
products, answers to frequently asked questions and the opportunity to preview
over 700 movie previews. Our editorial staff maintains and updates our Web sites
daily to provide our visitors a comprehensive source of information, interaction
and commerce.
COMMITMENT TO CUSTOMER SERVICE. We provide comprehensive sales support via
e-mail and toll-free telephone service during extended hours. Once an order is
placed, a customer can view the status of his or her order on our Web site or
contact a customer service representative.
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ADDITIONAL SERVICES. Through our online store, we offer real-time inventory
status, order tracking and the ability to order titles up to two months in
advance of their release. In addition, our technology platform enables us to
provide specific recommendations based upon our customers' preferences.
OUR STRATEGY
Our goal is to enhance our position as a leading online retailer of DVDs and
related entertainment products and services. Our strategy includes the following
elements:
BUILD BRAND RECOGNITION. We intend to become a primary destination for
consumers of DVDs. We attempt to target purchasers of DVD products through our
Web sites, advertising and promotional activities. We use offline and online
marketing strategies to maximize customer awareness and enhance our brand
recognition:
- STRATEGIC MARKETING RELATIONSHIPS, ONLINE ADVERTISING AND PROMOTIONAL
ARRANGEMENTS. We have strategic marketing arrangements with America
Online, One Zero Media (AltaVista) and Infoseek Corporation (Go.com). We
also advertise regularly on sites including Yahoo!, AOL, AltaVista,
HotBot, Excite, Lycos, Go.com, MSN.com and VideoSeeker and have
promotional arrangements with Gateway, Toshiba, Compaq, Microsoft and NBC
Mutlimedia.
- OFFLINE ADVERTISING. We use offline advertising to promote both our brand
name and specific merchandising opportunities. Our advertising campaigns
utilize traditional print and radio media. We regularly advertise in
publications which serve our customers' demographic profile, including THE
WALL STREET JOURNAL and entertainment related publications including
ENTERTAINMENT WEEKLY, PREMIERE, MOVIELINE and HOME THEATER. We also
periodically run advertising campaigns in major radio markets, including
New York, Los Angeles and Chicago.
- DIRECT ONLINE MARKETING. In order to drive traffic and repeat purchases,
we deliver special offers, promotions and information to customers who
visit our Web sites or who elect to receive semimonthly e-mail messages.
DEVELOP AND MAINTAIN STRATEGIC RELATIONSHIPS WITH THE MAJOR STUDIOS. During
the three months ended March 31, 1999, we purchased approximately 44% of our
inventory directly from major and independent studios. We are able to buy
product from the studios at lower prices than are generally available from
distributors. Since we believe many of our competitors are not able to do so, we
believe we enjoy a cost advantage over them. Also, we regularly create
product-specific promotions, contests and giveaways funded by the studios. We do
not have any long-term supply agreement with any of the studios.
ESTABLISH OPERATIONS IN INTERNATIONAL MARKETS. We have taken several
definitive steps to establish distribution, marketing and service centers in
Europe and other international markets where we believe we can benefit from the
growth of the DVD format. An international physical presence should reduce our
overseas shipping costs and allow us to respond quickly to customer inquiries.
We anticipate opening a distribution, marketing and service center in Europe
later this year.
PURSUE WAYS TO INCREASE REVENUES. We are planning to offer complementary
products to our customers, including music and an expanded selection of games,
as well as the sale and auction of entertainment themed clothing and
memorabilia. In addition, we are also considering selling advertising and other
related services to interested parties. We believe these opportunities will
present additional revenue opportunities.
CONTINUOUSLY IMPROVE CUSTOMER EXPERIENCE. We promote customer loyalty and
build repeat purchase relationships with our customers by enhancing our service,
content and community offerings. Specifically, we are dedicated to customer
service, developing personalization features and programs,
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upgrading our user interface and increasing the automation and efficiency of our
supply chain and order processing activities.
OUR WEB SITES
We provide customers and other visitors with a compelling online experience
by combining commerce, content and community on our Web sites. Multiple links
provide for easy access between our online store (www.dvdexpress.com) and the
content and community driven Web site (www.dvd.com).
DVDEXPRESS.COM. We designed our online store to be intuitive and easy to
use, while providing a substantial amount of user features that enhance the
shopping experience. Consumers shopping on our Web site can, in addition to
ordering products, conduct targeted searches, view recommended products,
participate in promotions and check their order status. The following highlights
some of the key features of our online store:
- BROWSING. Our DVD EXPRESS online store offers visitors a variety of
highlighted subject areas and special features arranged in a simple,
easy-to-use layout intended to enhance product search and selection.
Customers can browse by category, including action, drama and comedy, or
use a keyword search in order to locate a specific title. Also, customers
can execute more sophisticated searches based on numerous pre-selected
criteria, including names of actors or directors, languages, price range,
year of release and video or audio format including Dolby Digital.
- PRODUCT INFORMATION. One of the unique advantages of an Internet retail
store is the ability to interweave product information and editorial
content. At our online store, customers can find detailed product
information, including reviews and recommendations of related titles and
view over 700 movie previews.
- ORDERING. We have designed our ordering system based on comments from our
customers. A customer simply clicks on the "order" button to add products
to his virtual shopping cart. A customer can add and subtract products
from his shopping cart as he browses in our store prior to making a final
purchase decision. During a shopping session at DVD EXPRESS, a customer
can click on a title and determine, in real-time, whether the item is in
stock at our warehouse. A customer can then put the item in his personal
shopping cart for immediate shipping, or if out of stock, to be shipped
upon availability. When the customer is ready to complete an order, he
simply proceeds to the checkout page, enters his name, shipping and
billing information, selects a shipping and payment method and completes
the transaction. If requested, we keep the customer's information in our
database, which facilitates repeat purchases by eliminating the need for
the customer to resubmit information on future orders.
- PAYING. Customers generally use a credit card or debit card which is
authorized during the checkout process and charged when the item is
shipped to the customer. Our online store uses an encryption technology
that works with the most common Internet browsers to prevent unauthorized
parties from reading information sent by our customers. Our system
automatically confirms receipt of each order via e-mail within minutes and
notifies the customer when we ship the order, which is usually on the same
day.
- GETTING HELP. From every page of our online store, a customer can click on
a "customer service" button to go to our customer service area. The
customer service area of our online store contains extensive information
for first-time and repeat visitors. In this area, we assist customers in
searching for, shopping for, ordering and returning our products. In
addition, we provide customers with information on our policies, answer
their most frequently asked questions and enable them to send us
suggestions via e-mail. Furthermore, our customer service representatives
are available to answer questions about products and the shopping process
during extended
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hours via our toll-free number, which is displayed in the customer service
area of our online store.
We provide an extensive selection of DVD titles that would be economically
impractical to stock in a traditional store. Unlike traditional store-based
retail formats, our online store provides us significant flexibility with regard
to the organization and presentation of our product selection without having to
alter the layout of a physical store.
To encourage purchases, we feature various rotating promotions and
continuously update our online recommendations. We also actively create and
maintain pages that are artistically designed to highlight titles. We believe
this strategy provides us with an excellent opportunity to promote impulse
purchases by customers.
DVD.com. We operate an information and entertainment Web site located at
www.dvd.com which is linked to our online store. This site educates and
entertains consumers and provides an interactive community for DVD enthusiasts.
Where specific movies are discussed or otherwise presented, we provide a link to
our online store so that the title can be easily reviewed and purchased. Our
site is maintained and updated regularly by our editorial staff to provide our
users with a comprehensive source of information and interaction, and is
organized into the following five distinct areas:
- SCOOP. Features the latest DVD news, reviews of the newest DVD releases
and original feature stories on digital entertainment trends. Scoop also
contains message boards where users can share information.
- LEARN. Displays features on home theater components, the latest
information on DVD technology, reasons why DVD is a superior format to VHS
or laserdisc and a "DVDictionary," which provides understandable
explanations of technical terms.
- FIX. Introduces DVD enthusiasts to "Doc DVD," a DVD specialist in hardware
functionality, software and player/disc compatibility issues. Doc DVD
personally responds to any DVD-related questions via e-mail, usually
within 24 hours. Doc DVD's answers to frequently asked questions about DVD
technology are also available on our Web site.
- SCHMOOZE. Takes users inside the DVD movie process. Each month, an
acclaimed director or filmmaker talks about technology's effect on the
industry. Schmooze also goes behind-the-scenes with the production teams
at various studios to get an insider's look at the film-making process.
- PLAY. Features product reviews and other information on personal digital
products, as well as articles and celebrity interviews, digital postcards
and DVD-specific reviews, which differentiate DVD movies from other
formats.
We believe that we are providing a valuable service to existing and
potential customers by making it quick and easy for visitors to become more
acquainted with new technologies and the benefits and features of the DVD
format.
SALES AND MARKETING
Our target market is DVD owners and online shoppers. Forrester Research
estimates that 47% of DVD owners have an online connection at home, 58% of these
consumers research products online and 40% shop online. In addition, Forrester
Research estimates that in 1998 U.S. households earning more than $50,000 a year
accounted for 74% of U.S. online spending, and that in 2003 this group will
account for 66% of U.S. online revenues. In addition, we believe there is a
large demand for DVDs internationally. For a geographic breakdown of our
revenues, see note 2 to the notes to our financial statements.
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We believe that our company will enjoy growth fueled by the rapid adoption
of the DVD format, the growth and acceptance of Internet commerce and the
attractive demographics of online consumers and DVD owners. The fundamental
elements of our sales and marketing strategy are as follows:
- build brand recognition;
- increase consumer traffic to our Web sites;
- add new customers and convert visitors into buyers; and
- build customer loyalty.
Like many other Internet retailers, we advertise on major search and
directory providers, as well as movie-specific sites. We have purchased
advertising on well-recognized search engines for the keyword "DVD." We believe
that this targeting strategy is more cost-effective than other methods of
advertising on the Internet. We regularly advertise on sites including Yahoo!,
AOL, AltaVista, HotBot, Excite, Lycos, Go.com, MSN.com and VideoSeeker. Except
for the strategic marketing agreements and promotional arrangements mentioned
below, we do not have any written advertising agreements with the companies that
operate these sites.
In addition to Internet-specific marketing and advertising, we also conduct
campaigns utilizing traditional print, outdoor and radio advertising. We
regularly advertise in publications which serve our customers' demographic
profile, including THE WALL STREET JOURNAL, and entertainment related
publications including ENTERTAINMENT WEEKLY, PREMIERE, MOVIELINE and HOME
THEATER. We also periodically advertise in several major radio markets,
including New York, Los Angeles and Chicago. We do not have any long term
advertising agreement with any publication or radio station.
We also currently have promotional arrangements with several other
companies, including Cowabunga Enterprises Inc., a wholly-owned subsidiary of
Gateway Inc., Toshiba America Consumer Products, Inc., Compaq Computer
Corporation, Microsoft Corporation and NBC Multimedia, Inc. These arrangements
are designed to promote our products as well as the other companies products.
Generally, these arrangements are non-exclusive and are for terms of one to two
years and may be renewed upon the consent of us and the other company.
Generally, we pay these companies based on sales generated from the arrangement.
As of the date of the prospectus, we have paid an aggregate of approximately
$102,000 under these arrangements.
In addition, in order to increase our exposure on the Internet and directly
generate sales, we are in the process of implementing an affiliate program.
Under this program, a person or entity with a web site may post our logos,
banners, or links on its web site and be compensated on all purchases made by
customers who enter our site through these links. We have received expressions
of interest from over 200 sites and expect the program to formally launch within
the next 30 to 60 days. These sites are in no way affiliated with DVD EXPRESS
and we will merely be linked with the sites.
We began selling DVDs shortly after the commercial introduction of the first
DVD players. As of May 1999, we had over 180,000 registered users in our e-mail
database to whom we regularly send information regarding new releases,
promotions and contests. We use this database to stimulate interest in new
releases and to keep the DVD EXPRESS brand name in the minds of customers. Since
we consider early adopters among the most active consumers in a product class,
we believe our database is a strategic asset for the growth of our business.
STRATEGIC MARKETING RELATIONSHIPS
We currently have the following strategic marketing agreements in place:
AMERICA ONLINE. In August 1998, we entered into a non-exclusive agreement
with America Online Inc. under which America Online will provide us with
promotions throughout the America
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Online service on AOL and America Online's Digital City. Specifically, during
the term of the agreement, America Online has agreed to provide us with
promotional placements and banner advertisements on various shopping and
entertainment areas of AOL. Furthermore, America Online has committed that its
users will access the online areas promoting DVD EXPRESS a specified number of
times. The initial term of the agreement ends in October 2001 and may be renewed
by America Online for additional one year terms. As part of our commitment to
the strategic relationship, we are required to provide a top quality,
comprehensive offering of DVD related products and related content. We also
provide promotions and special offers to America Online members and to users of
AOL. If we breach our obligations under this agreement, America Online may
either reduce the promotional support provided to us or terminate this
agreement. America Online may also terminate this agreement upon 30 days notice
if a company offering online services acquires control of DVD EXPRESS or if
there is a change of control of America Online. We have guaranteed payments
during the term to America Online of $15 million, and may be obligated to make
further payments if our quarterly revenues attributable to America Online member
traffic exceed specified amounts. We have paid $5 million of the guaranteed
payments to America Online through March 31, 1999 and upon completion of this
offering we are going to pay an additional $7 million of the guaranteed payments
to America Online. We have also granted to America Online a warrant to purchase
up to 1,384,006 shares of our common stock. See "Description of Capital
Stock--Warrants."
ONE ZERO MEDIA (ALTAVISTA). In September 1998, we entered into an agreement
with One Zero Media, Inc. One Zero Media is the exclusive producer and
aggregating partner for the "Entertainment Zone," the entertainment content area
within the "AltaVista" Web site. Under this agreement, we have been appointed as
the sole provider of the Entertainment Zone's DVD Store Area. The agreement also
contemplates promotional efforts on our behalf in both the Entertainment Zone
and on the Wild Wild Web syndicated television show. During the three-year term
of the agreement we are obligated to pay One Zero Media $6.6 million. Payments
are due in part based on the number of impressions provided by One Zero Media.
The agreement automatically renews unless we decide to terminate the agreement.
However, One Zero Media may terminate this agreement if we breach any of our
obligations, including our obligation to provide a fully operational DVD Store
Area.
INFOSEEK CORPORATION (GO.com). In October 1998, we entered into a
distribution agreement with Infoseek Corporation, commonly known as Go.com, an
information search and navigation service. Under this agreement, Go.com will
feature us on a semi-exclusive basis in its Entertainment Channel and various
other areas throughout the service. Go.com has agreed not to promote our
competitors that are named in the agreement. During the 24-month term of the
agreement, we are obligated to pay Infoseek a minimum of $5.3 million plus a
percentage of our revenues attributable to Go.com member traffic. Under this
agreement, we are obligated to provide DVD related content and services to
Go.com and have provided a non-exclusive, worldwide license to allow Go.com to
exploit such content throughout its services and sites. Go.com may terminate
this agreement if we do not meet performance standards relating to the
availability and functionality of the content and services we provide or if we
breach the agreement. Also, either party may terminate the agreement without
cause upon 60 days prior written notice to the other party. This agreement may
be extended for additional one year terms upon the mutual agreement of us and
Go.com.
SUPPLY ARRANGEMENTS; STUDIO RELATIONSHIPS
We purchase a substantial portion of our inventory directly from major and
independent studios. In addition, we receive cooperative advertising and market
development funds from several studios. To date, we have awarded premiums
including T-shirts and movie memorabilia to our customers. In the future, we
intend to use these funds to help pay for print and online advertising. We do
not have long-
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<PAGE>
term written supply agreements with any studio or other supplier. The following
table shows the breakdown of our historic purchases from our suppliers.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER ENDED
31, MARCH 31,
-------------------- --------------------
1997 1998 1998 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Primary distributors:
Valley Media, Inc.................................................... 0% 34% 3% 31%
Image Entertainment.................................................. 40% 19% 48% 11%
Norwalk Distributors, Inc............................................ 17% 14% 29% 11%
--------- --------- --------- ---------
Subtotal........................................................... 57% 67% 80% 53%
Studios................................................................ 13% 29% 13% 44%
Other sources.......................................................... 30% 4% 7% 3%
--------- --------- --------- ---------
Total.............................................................. 100% 100% 100% 100%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
PRODUCT DISTRIBUTION
We ship customer orders from our approximately 8,000 square foot warehouse
located in Hollywood, California. We currently stock over 3,000 different DVD
titles. Orders are communicated from our Web site to our warehouse through an
order processing system that controls the pick, pack and ship processes. This
system also provides our Web site with data on inventory activity and status,
which enables it to display individual product availability. Orders are usually
shipped on the same day they are received. Customers can select to have their
order shipped via Federal Express or the United States Postal Service. Shipping
costs are paid by the customer. We feel our rapid delivery contributes
substantially to the satisfaction of our customers.
CUSTOMER SERVICE
We believe that superior customer service and support is critical to
retaining and expanding our customer base. We provide timely and accurate
responses to both telephone and e-mail inquiries. Our customer service
representatives are available from 8:00 am until 6:00 pm, Pacific Time, seven
days a week. During 1999, we expect to increase the number of hours that we
provide telephone support. We currently have 20 full time customer service
representatives. Our customer service team is responsible for handling general
customer inquiries, answering customer questions about the ordering process,
investigating the status of orders, shipments and payments, as well as
processing customer orders. Our customer service representatives are a valuable
source of feedback regarding customer satisfaction. We use BizRate, an online
market research company, to compile customer comments on their experiences.
BizRate provides monthly reports that enable us to make improvements in response
to our customers' comments. Our online store site also contains a customer
service page that outlines store policies and provides answers to frequently
asked questions.
TECHNOLOGY
Since May 1998, we have been using an electronic commerce system owned by
Pandesic LLC to operate our Web site and process orders. Pandesic has licensed
its E-Business solutions software to us on a non-exclusive basis through May
2000. Pandesic, a joint venture between Intel and SAP AG, provides this system
and related computer hardware, management services and support. As one of
Pandesic's first customers, we have entered into an agreement by which, in
addition to receiving discounts on our fees owed to Pandesic, we assist Pandesic
in the development of new software features to enhance their system and provide
them with marketing support. In addition, Pandesic provides us with marketing
support and has agreed not to offer its services to any of our direct
competitors for
41
<PAGE>
which sales of DVDs account for more than 30% of these direct competitors'
revenues. Under the agreement, Pandesic has agreed to provide maintenance and
support for the licensed software and to provide us with upgrades to the
software. As of the date of this prospectus, we have paid approximately $410,000
under this agreement. The fees payable to Pandesic are based on a percentage of
our revenues. The agreement with Pandesic expires in May 2000. The agreement may
be extended for successive one-year terms unless either party notifies the other
party of its intent not to renew at least 90 days prior to the end of the term.
Pandesic may also immediately terminate the agreement if we breach any term of
the software license or attempt to assign the agreement.
With this system, customers have the ability to access their account
information, track their orders, preorder products, cancel and change orders and
receive credit card approvals online. They can also check the exact availability
of every product we display at our online store. Customers can elect to hold
orders until all items are available or generate multiple shipments as items
become available. Orders and invoices are automatically confirmed by e-mail as
they are processed.
We continue to extend and enhance the online features of our Web sites
through a combination of internal software development and the licensing of
third-party software, including that provided by Pandesic. We are focusing our
development efforts on features that appeal to our customers, including online
movie previews and customized product recommendations.
Our systems have been designed by Pandesic to reduce downtime in the event
of outages or catastrophic occurrences. Our system hardware is hosted at their
facility in Folsom, California which provides redundant communications lines and
emergency power backup.
COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive, and we expect that competition will further intensify in the
future. Barriers to entry are not extensive, and current and new competitors can
launch new sites at a relatively low cost. In addition, the broader retail video
industry is intensely competitive. We currently compete with a variety of online
vendors who specialize in DVDs and videos, as well as those who also sell books,
music and other entertainment products. We also compete with traditional
retailers, including specialty video retailers, mass merchandisers, department
and consumer electronics stores, as well as non-store retailers such as
mail-order video clubs. Many of these traditional retailers also support
dedicated Web sites that compete with us directly.
We believe that the principal competitive factors in the online market are
brand recognition, product selection, scope of services, ease of use, site
content, customer service and price. We believe that we compete favorably with
respect to brand recognition, product selection, scope of services, ease of use,
site content and customer service. We also believe that our prices are
reasonably competitive. Many of our current and potential competitors have
longer operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Some
of our competitors have adopted, and may continue to adopt, aggressive pricing
or inventory availability policies and devote substantial resources to Web site
and systems development. Increased competition may reduce our operating margins,
market share and brand recognition.
Many traditional store-based and online competitors have longer operating
histories, larger customer or user bases, greater brand recognition and
significantly greater financial, marketing and other resources than we do. Many
of these competitors can devote substantially more resources to Web site
development than we can. In addition, larger, well-established and well-financed
entities may join with online competitors or video, music, game and software
suppliers as the use of the Internet and other online services increases.
42
<PAGE>
Our competitors may also be able to secure products from vendors on more
favorable terms, fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than us. Traditional
store-based retailers also enable customers to see and feel products in a manner
that is not possible over the Internet. Some of our competitors, including Best
Buy, Musicland, Blockbuster, Wherehouse Entertainment, Hollywood Entertainment
and Tower Records, have significantly greater experience in selling video,
music, game or software products.
Our online competitors are particularly able to use the Internet as a
marketing medium to reach significant numbers of potential customers. Finally,
new technologies and the expansion of existing technologies, such as price
comparison programs, may increase competition.
INTELLECTUAL PROPERTY
We regard our trademarks, particularly "DVD EXPRESS," trade secrets and
similar intellectual property as critical to our success, and we rely on
trademark and trade secret protection and confidentiality and/or license
agreements with our employees, customers, partners and others to protect our
proprietary rights. We have registered our "DVD EXPRESS" trademark in the United
States and have applied for the registration of our "DVD EXPRESS" trademark
internationally. Effective trademark and trade secret protection may not be
available in every country where our products and service are available online.
DVD EXPRESS is our registered trademark. All other trademarks or services marks
used in this prospectus are the property of their respective holders.
EMPLOYEES
As of March 31, 1999, we had 90 full-time employees. We vary the number of
part-time and temporary employees to respond to fluctuating market demand for
our products. Our employees are not covered by a collective bargaining
agreement. We consider our relationships with our employees to be good.
PROPERTIES
Our executive offices, sales and marketing operations and warehouse are
located at 7083 Hollywood Boulevard, Los Angeles, California 90028, where we
lease approximately 18,800 square feet of space. The current monthly rental due
under this lease is approximately $30,600. A portion of the lease expires in
April 2001 with the remainder expiring in October 2003. We expect that we will
outgrow our current facilities and will have to relocate our distribution center
within the next 12 months. We currently are conducting a search for suitable
locations. We believe that suitable additional or alternative space will be
available on commercially reasonable terms.
LEGAL PROCEEDINGS
We are not involved in any pending, nor are we aware of any threatened,
legal proceedings which we believe could reasonably be expected to have a
material adverse effect on our business, operating results or financial
condition.
43
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table presents information with respect to the directors and
executive officers of DVD EXPRESS as of March 31, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------- --- --------------------------------------------------
<S> <C> <C>
Chairman of the Board, Chief Executive Officer and
Michael J. Dubelko........ 46 President
Chief Financial Officer, Chief Operating Officer
Andrew T. Crist........... 43 and Secretary
Joan A. Abend............. 40 Vice President of Operations
Alison I. Johns........... 38 Vice President and Executive Editor
Susan M. Daniher.......... 29 Vice President of Marketing
Jason L. Vagner........... 27 Vice President of Technology
Steven S. Antebi(1)....... 55 Director
Kimberly S. Eads(2)....... 32 Director
Norman J. Pattiz(1)....... 56 Director
Stephen J. Cannell........ 58 Director
Harold E. Hughes(2)....... 53 Director
</TABLE>
- ------------------------
(1) Member of the Compensation Committee.
(2) Member of Audit Committee.
MICHAEL J. DUBELKO has been our Chairman of the Board, Chief Executive
Officer and President since DVD EXPRESS was founded in October 1996. From
December 1986 through July 1995, Mr. Dubelko served as President of the Cannell
Studios; from May 1982 through November 1986, he was Executive Vice President of
Cannell. In his role at Cannell, he oversaw the production and distribution of
over 30 prime-time television series, developed the largest motion picture and
television studio in Canada and formed a broadcast group of independent
television stations. Under his direction, Cannell grew to become one of the
largest privately-held film entertainment companies, prior to its sale to New
World Entertainment in 1995, which was subsequently acquired by News Corp. From
July 1995 until he founded DVD EXPRESS in October 1996, Mr. Dubelko was
responsible for managing Cannell assets that were not acquired by New World
Entertainment. From October 1980 to April 1982, he was employed by Jess S.
Morgan & Co., an entertainment business management firm. From January 1974
through September 1980, Mr. Dubelko was employed by Touche Ross & Co. as a
certified public accountant. Mr. Dubelko received his B.B.A. in finance from
Cleveland State University.
ANDREW T. CRIST has served as our Chief Financial Officer, Chief Operating
Officer and Secretary since February 1999. Prior to joining us, Mr. Crist was
Vice President of Financial Operations/Mergers and Acquisitions with Blockbuster
Entertainment Corporation from September 1996 to February 1999. From 1987 to
1996, Mr. Crist was Executive Director of International Development and Senior
Director of Retail Product Management with Alamo Rent A Car, Inc. He began his
career with a seven-year tenure at KPMG Peat Marwick in 1979. Mr. Crist has an
M.B.A. degree with honors from The University of Michigan and a B.A. degree in
accounting from Duke University. He is a certified public accountant.
JOAN A. ABEND joined us in February 1997 as Vice President of Operations.
From September 1994 to January 1997, Ms. Abend was employed by Cannell Motion
Pictures as a development executive. From January 1987 to June 1994, Ms. Abend
was employed by The Education Group as Vice President of Operations. From
October 1986 to August 1988, Ms. Abend was employed by The MGM Store as its
Retail Manager.
44
<PAGE>
ALISON I. JOHNS joined us in June 1998 as Vice President and Executive
Editor. From September 1994 to July 1997, Ms. Johns was a Content Director in
Artdirect, Inc., a Web design studio. From March 1986 to June 1994, Ms. Johns
was employed by MILLIMETER, The Magazine of Motion Picture, Television and New
Media Production. During the last four years at MILLIMETER, she served as
Editor-in-Chief. Ms. Johns has been a journalist for over ten years covering
entertainment, technology and culture. Ms. Johns graduated from Rutgers College
with a B.A. in English Literature.
SUSAN M. DANIHER joined us in March 1998 as Vice President of Marketing.
From June 1992 to March 1998, Ms. Daniher was employed by Blockbuster
Entertainment Group in Washington, DC, Philadelphia and Dallas in various
marketing capacities, most recently as National Product Marketing Manager. From
June 1991 to May 1992, Ms. Daniher was employed by Marlo Furniture as its
Advertising Coordinator. Ms. Daniher received her B.A. in Advertising from the
University of Florida.
JASON L. VAGNER joined us in February 1998 as Vice President of Technology.
From September 1997 to January 1998, Mr. Vagner was an information security
analyst at Charles Schwab and Co. Mr. Vagner was employed by Strategic
Interactive Group from August 1996 to August 1997 as a Senior Unix
Administrator. From January 1996 to April 1996, Mr. Vagner was employed as a
senior systems administrator at Cape Internet. Mr. Vagner received his B.A. in
English from Arizona State University.
STEVEN S. ANTEBI has served as a Director since July 1998. Since 1998, Mr.
Antebi has been the Manager of Fontenelle LLC, a personal holding company
specializing in telecommunications and Internet investments. Since 1994, he has
also been the general partner of Maple Partners, a California partnership with
investments in equities. Since 1992, he has been the managing partner of JLA
Partners, a venture capital partnership specializing in late stage development
companies. Mr. Antebi is also President and Chairman of the Board of Novante
Communications, a Nevada corporation which invests in debt and equity marketable
securities. From March 1973 through June 1991, Mr. Antebi was employed by Bear
Stearns & Co. Inc., and from 1986 through 1991, served as a Managing Director.
From 1991 to 1993, Mr. Antebi was employed by Drake Capital. Mr. Antebi also
serves on the board of Nettaxi, a public company.
KIMBERLY S. EADS has served as a Director since January 1999. Since December
1998, Ms. Eads has been General Partner of Geocapital Partners, a venture
capital firm. From June 1997 to November 1998, she served as a Principal with
Geocapital Partners and from June 1995 to May 1997, she was an associate with
the firm. From August 1992 to March 1995, Ms. Eads was Vice President of Lease
Guarantee Corporation, a technology start-up that she co-founded. Ms. Eads
received her B.S. degree in Mechanical and Aeronautical Engineering from
Princeton University.
NORMAN J. PATTIZ has served as a Director since January 1999. Mr. Pattiz has
been the Chairman of the Board of Westwood One, Inc., a leading producer and
distributor of nationally sponsored radio programs and the nation's largest
radio network for the past five years. Mr. Pattiz founded Westwood One, Inc. in
1976 and was Chief Executive Officer until February 1994.
STEPHEN J. CANNELL has served as a Director since January 1999. Mr. Cannell
is the Emmy Award-winning creator and producer of over 35 television series, and
one of television's most prolific writers, with over 1,500 episodes to his
credit. He is also a national best-selling author of four novels. Mr. Cannell
was the founder, Chief Executive Officer and Chairman of the Board of the
Cannell Studios until its sale to New World Entertainment in July 1995. Since
July 1995, Mr. Cannell has been pursuing a career as an author.
HAROLD E. HUGHES has served as a Director since March 1999. Mr. Hughes is
the Chairman and Chief Executive Officer of Pandesic LLC. Pandesic is an
eCommerce software supplier owned jointly by Intel and SAP. Prior to joining
Pandesic in August of 1997, Mr. Hughes worked for 23 years at Intel Corporation
during which time he held a number of positions in financial and operational
management.
45
<PAGE>
His most recent assignments were as Vice President and Director of Planning and
Logistics and Chief Financial Officer. Prior to joining Intel, he served as an
Officer in the U.S. Army from 1968-1972. He received a B.A. from the University
of Wisconsin in 1968 and an M.B.A. from The University of Michigan in 1974. He
is on the boards of the London Pacific Group, Merant PLC and Hummingbird
Communications, each of which are public companies.
We have a staggered Board of Directors. Each Director holds office until the
annual meeting for the year in which his term expires or until his successor
shall be duly elected and qualified. Mr. Dubelko's and Mr. Antebi's terms expire
at the 2002 annual meeting. Mr. Cannell's and Mr. Pattiz's terms expire at the
2001 annual meeting. Ms. Eads' and Mr. Hughes' terms expire at the 2000 annual
meeting. Our Bylaws presently provide that the number of directors shall be
fixed at six. Vacancies on our Board of Directors may be filled only by a
majority vote of the remaining directors. In no case will our Board of Directors
reduce the number of directors to shorten the term of any incumbent director.
Executive officers are appointed and serve at the discretion of our Board of
Directors, except for Mr. Dubelko and Mr. Crist who have executed employment
agreements.
COMMITTEES OF OUR BOARD OF DIRECTORS
Our Board of Directors recently created a compensation committee and an
audit committee. The compensation committee will evaluate our compensation
policies and administer our stock option plan. The members of the compensation
committee are Steven Antebi and Norman Pattiz. The audit committee will review
the scope of our audits, the engagement of our independent auditors and their
audit reports. The audit committee will also meet with the financial staff to
review accounting procedures and reports. The members of the audit committee are
Harold Hughes and Kimberly Eads.
DIRECTOR COMPENSATION
We intend to pay non-employee directors fees of $1,000 for each meeting
attended. Directors are also eligible to receive options under our Stock
Incentive Plan. As of March 31, 1999, we had granted options to purchase an
aggregate of 187,500 shares of common stock to our directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
We did not have a compensation committee for the fiscal year ended December
31, 1998. For the fiscal year ended December 31, 1998, all decisions regarding
executive compensation were made by our Board of Directors. No interlocking
relationship exists between any of our executive officers or any member of our
compensation committee and any member of any other company's board of directors
or compensation committee.
EXECUTIVE COMPENSATION
The following table presents both the compensation paid or to be paid by us
to Michael Dubelko, our President and Chief Executive Officer, for services
rendered during 1998. No executive officer received compensation in excess of
$100,000 for 1998.
46
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
------------
ANNUAL COMPENSATION NUMBER OF
FISCAL YEAR ----------------------------- SECURITIES
ENDED OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION DECEMBER 31 SALARY BONUS COMPENSATION OPTIONS
- ---------------------------------------- ----------- ------ ----- ------------ ------------
<S> <C> <C> <C> <C> <C>
Michael J. Dubelko, Chairman, Chief
Executive Officer and President(1).... 1998 $ 0 $ 0 $ 0 0
</TABLE>
- ------------------------
(1) Michael Dubelko did not receive a salary during 1998. Mr. Dubelko will be
entitled to receive an annual base salary of $50,000 for 1999 under his
employment agreement. For a description of Mr. Dubelko's employment
agreement, see "Employment Agreements with Executive Officers," below. Mr.
Dubelko does not hold any options to purchase our common stock.
EMPLOYMENT AGREEMENTS WITH EXECUTIVE OFFICERS
Michael Dubelko has entered into a three-year employment agreement with us,
effective as of March 1, 1999, under which Mr. Dubelko will serve as our
Chairman, Chief Executive Officer and President. Under this agreement, Mr.
Dubelko will be entitled to a base salary of $50,000 per year. Mr. Dubelko may
also be paid a bonus at the discretion of the Board. The agreement also provides
for the reimbursement of employment related expenses and general employee
benefits, including medical insurance plans and paid vacation. The employment
agreement terminates on February 28, 2002, unless sooner terminated by its
terms. If Mr. Dubelko's employment is terminated without cause or as a result of
a change in control, he will be entitled to continue to receive his base salary
for a one-year period following his termination.
Andrew Crist has entered into a two-year employment agreement with us,
effective as of March 1, 1999, under which Mr. Crist will serve as our Chief
Financial Officer and Chief Operating Officer. Under this agreement, Mr. Crist
will be entitled to a base salary of $150,000 per year. Mr. Crist may also be
paid a bonus at the discretion of the Board. The agreement also provides for the
reimbursement of employment related expenses and general employee benefits,
including medical insurance plans and paid vacation. The employment agreement
terminates on February 28, 2001 unless sooner terminated by its terms. If Mr.
Crist's employment is terminated without cause or as a result of a change in
control, he will be entitled to continue to receive his base salary for a
one-year period following his termination.
Other than Michael Dubelko and Andrew Crist, officers are appointed by and
serve at the discretion of our Board of Directors.
STOCK INCENTIVE PLAN
We adopted a stock incentive plan in 1998. Each of our executive officers,
other employees, directors or consultants is eligible to be considered for the
grant of awards under our stock incentive plan. A maximum of 2,250,000 shares of
common stock may be issued under our stock incentive plan. Any shares of common
stock underlying an award which for any reason expires or terminates unexercised
are again available for issuance under our stock incentive plan.
Our stock incentive plan will be administered by our compensation committee.
The administrator will have full and final authority to select the executives
and other employees to whom awards will be granted, to grant the awards and to
determine the terms and conditions of the awards and the number of shares to be
issued.
47
<PAGE>
AWARDS. Our stock incentive plan authorizes the administrator to enter into
both incentive and non-statutory options. An award under the stock incentive
plan may permit the recipient to pay all of the purchase price of the shares by
delivering previously-owned shares of our capital stock.
DURATION. Our stock incentive plan became effective upon its adoption by
our Board of Directors and the stockholder in January 1998. As of the date of
this prospectus, our Board has granted options covering an aggregate of
1,124,250 shares of common stock to our directors, officers and employees, with
a weighted average exercise price of $4.38 per share. No options have been
exercised. However, any award that was duly granted on or prior to December 31,
2007 may be exercised or settled after that date in accordance with its terms.
No award may be granted on or after December 31, 2007.
AMENDMENTS. The administrator may amend or terminate our stock incentive
plan at any time and in any manner. However, no recipient of any option may be
deprived of any of his or her rights under the option as a result of any
amendment or termination without his or her consent. Stockholder approval is
required to increase the number of shares available for issuance under our stock
incentive plan.
FORM S-8 REGISTRATION. We intend to file a registration statement under the
Securities Act to register the 2,250,000 shares of common stock reserved for
issuance under our stock incentive plan, and the option to purchase 300,000
shares granted to Joan Abend, Vice President of Operations. This registration
statement is expected to be filed shortly following the date of this prospectus
and will become effective immediately upon filing with the Commission. Shares
issued under our stock incentive plan after the effective date of this
registration statement generally will be available for sale to the public
without restriction, except for the 180-day lock-up provisions and except for
shares issued to our affiliates, which will continue to be governed by the
volume and manner of sale limitations of Rule 144. See "Shares Eligible for
Future Sale."
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
Our Certificate of Incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:
- any breach of their duty of loyalty to the corporation or its
stockholders,
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law,
- unlawful payments of dividends or unlawful stock repurchases or
redemptions or
- any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies including injunctive relief or recession.
Our Certificate of Incorporation and Bylaws provide that we shall indemnify
our directors and executive officers and may indemnify our other officers and
employees and other agents to the fullest extent permitted by law. We believe
that indemnification under our Bylaws covers at least negligence and gross
negligence on the part of indemnified parties. Our Certificate of Incorporation
also permits us to secure insurance on behalf of any officer, director, employee
or other agent for any liability arising out of his or her actions in their
professional capacity, regardless of whether the provisions of law would permit
indemnification.
We plan to enter into agreements to indemnify our directors and executive
officers, in addition to the indemnification provided for in our Certificate of
Incorporation. These agreements provide for indemnification of our directors and
executive officers for expenses (including attorneys' fees), judgments, fines
and settlement amounts incurred by any of these people in any action or
proceeding,
48
<PAGE>
including any action by or in the right of DVD EXPRESS, arising out of these
people's services as a director or executive officer of DVD EXPRESS, any
subsidiary of DVD EXPRESS or any other company or enterprise to which the person
provides services at our request. We believe that these provisions and
agreements are necessary to attract and retain qualified persons as directors
and executive officers.
At present, we are not aware of any pending or threatened litigation or
proceeding involving a director, officer, employee or agent where
indemnification would be required or permitted. We are not aware of any
threatened litigation or proceeding that might result in a claim for
indemnification.
49
<PAGE>
RELATED PARTY TRANSACTIONS
Since January 1, 1998, there has not been, nor is there currently proposed,
any transaction or series of similar transactions to which we were or are to be
a party, in which the amount involved exceeded or will exceed $60,000 and in
which any director, executive officer, holder of more than 5% of our common
stock or any member of the immediate family of any of these people had or will
have a direct or indirect material interest other than:
- compensation agreements and other arrangements, which are described where
required in "Management;" and
- the transactions described below.
We have entered into a tax indemnification agreement with Michael Dubelko
relating to our respective income tax liabilities. See "Termination of S
Corporation Status."
On January 15, 1999, we sold an aggregate of 135,000 shares of our common
stock to three of our directors, Steven Antebi, Norman Pattiz and Stephen
Cannell, for a purchase price of $4.67 per share.
On January 4, 1999, we sold an aggregate of 1,714,285 shares of our Series A
Convertible Preferred Stock to Geocapital V, L.P., Geocapital IV, L.P. and
Broadview Partners Group for an aggregate purchase price of $12.0 million. The
1,714,285 shares of Series A Convertible Preferred Stock will convert into
2,571,427 shares of common stock upon the closing of this offering, after giving
effect to a 3-for-2 stock split. As a result of the Series A Convertible
Preferred Stock financing, Kimberly Eads, a general partner of Geocapital
Partners, was elected to our Board of Directors.
In December 1998, we borrowed $1.0 million from Michael Dubelko. The loan
was repayable upon demand and bore interest at 8.5%. Also, in December 1998, we
borrowed $300,000 from Michael Dubelko. This loan was also repayable upon demand
and bore interest at 8.5%. These loans were repaid in full during the first
quarter of 1999 for an aggregate amount of $1.3 million plus accrued interest of
$6,300.
Michael Dubelko has personally guaranteed the $2.0 million credit line and
the $1.0 million credit line we have with Wells Fargo Bank. We plan to repay
these credit lines with a portion of the net proceeds of this offering. Mr.
Dubelko's guarantees will terminate upon repayment of the credit lines. Mr.
Dubelko has also guaranteed the lease on our office space.
On March 25, 1998, we entered into an E-Business Solution Agreement with
Pandesic to provide our electronic commerce system. Harold Hughes is the
Chairman and Chief Executive Officer of Pandesic, and joined our Board of
Directors in March 1999. We have paid approximately $410,000 to Pandesic under
this agreement through March 31, 1999.
50
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table presents information regarding the beneficial ownership
of the common stock as of May 31, 1999, and as adjusted for our sale of
4,500,000 shares of common stock offered by this prospectus, for:
- each person who is known to us to be the beneficial owner of more than 5%
of the outstanding common stock;
- each of our directors;
- our Chief Executive Officer, no other officer received compensation in
excess of $100,000 for 1998; and
- all of our directors and executive officers as a group.
The address of each person listed is in care of us, at 7083 Hollywood
Boulevard, Los Angeles, California 90028, unless otherwise provided below the
person's name. All share numbers shown below reflect a 3-for-2 stock split of
our common stock that automatically will occur upon the closing of this
offering.
<TABLE>
<CAPTION>
PERCENTAGE BENEFICIALLY OWNED(1)
NUMBER OF SHARES ---------------------------------
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BEFORE OFFERING AFTER OFFERING
- ------------------------------------------------------- ------------------ --------------- ---------------
<S> <C> <C> <C>
Michael J. Dubelko(2).................................. 14,904,000 84.2% 67.1%
Geocapital V, L.P.
Two Executive Drive
Fort Lee, New Jersey 07024............................. 1,500,000 8.5% 6.8%
Geocapital IV, L.P.
Two Executive Drive
Fort Lee, New Jersey 07024............................. 1,056,427 6.0% 4.8%
America Online, Inc.
22000 AOL Way
Dulles, Virginia 20166(3).............................. 1,384,006 7.2% 5.9%
Broadview Partners Group
One Bridge Plaza
Fort Lee, New Jersey 07024............................. 15,000 * *
Steven S. Antebi....................................... 45,000 * *
Stephen J. Cannell..................................... 45,000 * *
Norman J. Pattiz....................................... 45,000 * *
Kimberly S. Eads(4).................................... -- * *
Harold E. Hughes....................................... -- * *
All of the directors and executive officers as a group
(11 persons)(4)(5)................................... 15,293,169 85.1% 68.1%
</TABLE>
- ------------------------
* Less than 1%.
(1) Percentage ownership is based on 17,706,427 shares outstanding as of May 31,
1999, including 2,571,427 shares of common stock issuable upon conversion of
all outstanding preferred stock upon the closing of this offering, but
excluding 1,384,006 shares of common stock which may be purchased upon the
exercise of the warrant granted to America Online. Shares of common stock
under options currently exercisable or exercisable within 60 days of May 31,
1999 are deemed outstanding for purposes of computing the percentage
ownership of the person holding such options but are not deemed outstanding
for computing the percentage ownership of any other person. Except as
provided under applicable community property laws or as indicated in the
footnotes to this table, each stockholder identified in the table possesses
sole voting and investment power with respect to all shares of common stock
shown as beneficially owned by that stockholder.
51
<PAGE>
(2) Includes 300,000 shares of common stock held in the Dubelko 1999 Children's
Trust dated January 1, 1999, of which Michael Dubelko is trustee.
(3) Represents shares of common stock which may be purchased upon exercise of a
warrant that is currently exercisable.
(4) Kimberly Eads is a General Partner of Geocapital V, L.P. and Geocapital IV,
L.P. Ms. Eads disclaims beneficial ownership of the shares held by
Geocapital V, L.P. and Geocapital IV, L.P.
(5) Includes 254,169 shares of common stock which may be purchased upon exercise
of options that are exercisable or will become exercisable within 60 days
from May 31, 1999.
52
<PAGE>
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue 50,000,000 shares of common stock, par value
$.0001 per share, and 10,000,000 shares of preferred stock, par value $.0001 per
share. As of the date of this prospectus, there were 17,706,427 shares of common
stock outstanding and there were 24 holders of record of the common stock. There
are 2,571,427 shares of preferred stock outstanding, all of which will convert
to common stock on the closing date of this offering. The following statements
are brief summaries of our capital stock.
COMMON STOCK
The holders of common stock are entitled to one vote for each share held of
record on all matters on which the holders of common stock are entitled to vote.
The holders of common stock are entitled to receive dividends in proportion to
their ownership when, as and if declared by our Board of Directors out of
legally available funds. In the event of our liquidation, dissolution or winding
up, the holders of common stock are entitled, subject to the rights of holders
of Preferred Stock issued by us, if any, to share proportionally in all assets
remaining available for distribution to them after payment of liabilities and
after provision is made for each class of stock, if any, having preference over
the common stock.
The holders of common stock have no preemptive or conversion rights, and
they are not liable for further calls or assessments by us. There are no
redemption or sinking fund provisions applicable to our common stock. The
outstanding shares of common stock are, and the common stock issuable in this
offering will be, when issued, fully paid and nonassessable.
PREFERRED STOCK
Our Board of Directors has the authority to issue the authorized and
unissued preferred stock in one or more series with designations, rights and
preferences as it may determine from time to time. Accordingly, our Board of
Directors is empowered, without stockholder approval, to issue preferred stock
with dividend, liquidation, conversion, voting or other rights superior to, or
which otherwise adversely affect, the voting power or other rights of the
holders of our common stock. In the event of issuance, our preferred stock could
be utilized as a way of discouraging, delaying or preventing an acquisition or
change in our control. After this offering, we will not have any shares of
preferred stock outstanding, and we do not presently intend to issue any shares
of preferred stock, although we may do so.
OPTIONS
As of the date of this prospectus, our Board of Directors has granted, under
our stock incentive plan, options covering an aggregate of 1,124,250 shares of
common stock to our directors, officers and employees, with a weighted average
exercise price of $4.38 per share. These options typically vest over a
three-year period.
In addition, on June 1, 1997, our Board of Directors granted stock options
to purchase up to 300,000 shares of common stock at $.0667 per share to Joan
Abend, Vice President of Operations. These options vest over a four-year period.
WARRANTS
On August 1, 1998, we granted a warrant to America Online, Inc., which was
subsequently amended, to purchase up to 1,384,006 shares of common stock at an
exercise price $5.60 per share. The America Online warrant is fully vested,
non-forfeitable and expires on August 1, 2008. The America Online warrant does
not have any voting rights, dividend rights or preferences before it is
exercised for shares of common stock.
53
<PAGE>
REGISTRATION RIGHTS
After this offering, Michael J. Dubelko, Geocapital V, L.P., Geocapital IV,
L.P. and Broadview Partners Group will be entitled to registration rights with
respect to their shares. These holders can require us to register all or part of
their shares at any time following 180 days after this offering. In addition,
these holders may also require us to include their shares in future registration
statements that we file and may require us to register their shares on Form S-3.
Upon registration, the registered shares are freely tradable in the public
market without restriction.
Also, America Online is entitled to registration rights with respect to the
shares of common stock that can be purchased upon exercise of its warrant. This
holder can similarly require us to register all or part of its shares at any
time following 180 days after this offering. In addition, this holder may also
require us to include its shares in future registration statements we file and
may require us to register its shares on Form S-3. Upon registration, the
registered shares are freely tradable in the public market without restriction.
ANTI-TAKEOVER EFFECTS
Delaware law and our Certificate of Incorporation and Bylaws could make our
acquisition and the removal of our incumbent officers and directors by means of
a tender offer, a proxy contest or otherwise more difficult. These provisions,
summarized below, are expected to discourage coercive takeover practices and
inadequate takeover bids and to encourage persons seeking to acquire control of
DVD EXPRESS to negotiate first with our management. We believe that the benefits
of increased protection of our potential ability to negotiate with the proponent
of an unfriendly or unsolicited proposal to acquire or restructure us outweigh
the disadvantages of discouraging these proposals because negotiation of these
proposals could result in an improvement of their terms.
We are governed by Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in an "business combination" with an "interested
stockholder" for a period of three years following the date the person became an
interested stockholder, unless the "business combination" or the transaction in
which the person became an interested stockholder is approved in a prescribed
manner. Generally, a "business combination" includes a merger, asset or stock
sale, or other transaction resulting in a financial benefit to the interested
stockholder. Generally, an "interested stockholder" is a person who, together
with affiliates and associates, owns or owned, within three prior years, 15% or
more of a corporation's voting stock. The existence of this provision would be
expected to have an anti-takeover effect with respect to transactions not
approved in advance by our Board of Directors, including discouraging attempts
that might result in a premium over the market price for the shares of Common
Stock held by stockholders.
Our Certificate of Incorporation and Bylaws, provide for a staggered Board
of Directors, do not provide for cumulative voting in the election of directors,
eliminate the right of stockholders to act by written consent and provides that
special meetings of the stockholders can only be called by our Board of
Directors, Chairman, Chief Executive Officer or President. Also, the
authorization of undesignated preferred stock makes it possible for our Board of
Directors to issue preferred stock with voting of other rights or preferences
that could impede the success of any attempt to change our control. These and
other provisions may have the effect of deterring hostile takeovers or delaying
changes in our control or management.
TRANSFER AGENT
Our transfer agent and registrar for our common stock is U.S. Stock Transfer
Corporation.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our common
stock. We cannot predict the effect, if any, that future sales of shares, or the
availability of shares for future sale, will have on the prevailing market price
for our common stock. Sales of substantial amounts of our common stock in the
public market following this offering, or the perception that these sales may
occur, could adversely affect the prevailing market prices for our common stock.
Upon completion of this offering, we will have 22,206,427 shares of common
stock outstanding. Of those shares, the shares sold in this offering will be
freely tradable without restriction or further registration under the Securities
Act, unless purchased or held by our "affiliates" as that term is defined in
Rule 144.
RULE 144. In general, under Rule 144 as currently in effect, beginning 90
days after the date of this prospectus any person who has beneficially owned
restricted securities for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- 1.0% of the then outstanding shares of common stock; or
- the reported average weekly trading volume during the four weeks preceding
the sale.
Sales under Rule 144 are also governed by manner of sale restrictions and
notice requirements and by the availability of current public information about
us. Commencing 180 days after the date of this prospectus, 14,904,000 shares of
common stock held by our affiliates will be eligible for sale under Rule 144.
However, these shares of common stock continue to be governed by Rule 144
restrictions and the restrictions imposed by the lock-up agreements described
below.
LOCK-UP AGREEMENTS. All of our officers, directors and stockholders, as
well as America Online, have signed lock-up agreements under which they agreed
not to sell or otherwise transfer, directly or indirectly, any shares of common
stock or any securities convertible into, or exercisable or exchangeable for any
shares of common stock for a period of 180 days after the date of this
prospectus. Transfers or dispositions can be made sooner with the prior written
consent of ING Baring Furman Selz LLC. These lock-up agreements do not prevent
us from granting additional options under our stock incentive plan or from
issuing shares under our stock incentive plan. This restriction will expire
after the 180-day period, and shares permitted to be sold under Rule 144 will be
eligible for sale. ING Baring Furman Selz LLC may, in its sole discretion, at
any time and without notice, release all or any portion of the securities
underlying these lock-up agreements.
STOCK OPTIONS. Within 90 days after the date of this prospectus, we intend
to file a registration statement on Form S-8 covering the 2,250,000 shares of
common stock that have been reserved for issuance under the stock incentive plan
and 300,000 shares of common stock that may be issued upon exercise of options
granted to an employee. Shares of common stock issued upon exercise of options
after the effective date of the Form S-8 will be available for sale in the
public market. However, these shares continue to be governed by Rule 144 volume
limitations applicable to our affiliates and to the lock-up agreements.
REGISTRATION RIGHTS. Upon completion of this offering, holders of
17,475,427 shares of our common stock and America Online will be entitled to
request that we register their shares under the Securities Act. These holders
can require us to register all or part of their shares at any time following 180
days after this offering. If holders of registration rights elect to register
and sell a large number of shares into the public market, these sales could have
an adverse effect on the market price of our common stock.
55
<PAGE>
UNDERWRITING
Under the terms and conditions of an underwriting agreement, the
underwriters named below, acting through their representatives, ING Baring
Furman Selz LLC, Friedman, Billings, Ramsey & Co., Inc. and Needham & Company,
Inc., have each agreed to purchase from us the number of shares of common stock
shown opposite their names below. Other than the shares covered by the
over-allotment option, the underwriters are obligated to purchase and accept
delivery of all the shares of common stock if any are purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
- ----------------------------------------------------------------------------------- -----------
<S> <C>
ING Baring Furman Selz LLC.........................................................
Friedman, Billings, Ramsey & Co., Inc..............................................
Needham & Company, Inc.............................................................
-----
Total..............................................................................
-----
-----
</TABLE>
The underwriters propose initially to offer the shares of common stock in
part directly to the public at the initial public offering price shown on the
cover page of this prospectus and in part to dealers, including the
underwriters, at this price less a discount not in excess of $ per share. The
underwriters may allow, and these dealers may re-allow other dealers, a discount
not in excess of $ per share.
The following table shows the underwriting discounts and commissions to be
paid to the underwriters by us. These amounts are shown assuming both no
exercise and full exercise of the underwriters' option to purchase additional
shares of common stock.
<TABLE>
<CAPTION>
EXERCISE NO EXERCISE FULL
- ------------------------------------------------------------------------ ------------- ---------
<S> <C> <C>
Per share............................................................... $ $
Total................................................................... $ $
</TABLE>
Other expenses of this offering, including the registration fees and the
fees and expenses of the financial printer, counsel and accountants, that are to
be paid by us are expected to be approximately $650,000.
OVER-ALLOTMENT. The underwriters have an option, exercisable within 30 days
after the date of this prospectus, to purchase up to an aggregate of 675,000
additional shares of common stock at the public offering price less the
underwriting discounts and commissions. The underwriters may exercise this
option solely to cover over-allotments, if any, made in this offering. If the
underwriters exercise this option, each underwriter will purchase shares in
approximately the same proportion as indicated in the table above.
INDEMNITY. We have agreed to indemnify the underwriters against some types
of liabilities, including liabilities under the Securities Act. We have also
agreed to contribute to payments that the underwriters may be required to make
in respect of any of those liabilities.
FUTURE SALES. DVD EXPRESS, its executive officers, directors and our
existing stockholders, have agreed not to offer, pledge, sell, hedge or
otherwise transfer or dispose of, directly or indirectly, any shares of common
stock or any securities convertible into or exercisable or exchangeable for
common stock for a period of 180 days from the date of this prospectus.
Transfers or dispositions can be made sooner with the prior written consent of
ING Baring Furman Selz LLC. Their consent may be given at any time without
public notice. During the 180-day period, we have agreed not to file any
registration statement with respect to any shares of our common stock. This
restriction does not apply to the
56
<PAGE>
registration statement on Form S-8 that we plan to file covering the 2,250,000
shares of common stock that have been reserved for issuance under our stock
incentive plan and the 300,000 shares of common stock that may be issued upon
exercise of options granted to Joan Abend, Vice President of Operations. In
addition, each of our executive officers, directors and all of our stockholders
with registration rights have agreed not to make any demand for, or exercise
these rights without the prior written consent of ING Baring Furman Selz LLC.
OFFERS IN OTHER JURISDICTIONS. Neither we nor the underwriters have taken
any action that would permit a public offering of the shares of common stock
offered by this prospectus in any jurisdiction other than the United States
where action for that purpose is required. The shares of common stock offered by
this prospectus may not be offered or sold, directly or indirectly, nor may this
prospectus or any other offering material or advertisements related to the offer
and sale of these shares of common stock be distributed or published, in any
jurisdiction, except under circumstances that will result in compliance with the
applicable rules and regulations of these jurisdictions. This prospectus is not
an offer to sell or a solicitation of an offer to buy any shares of common stock
offered hereby in any jurisdiction in which such an offer or solicitation is
unlawful.
ING Baring Furman Selz LLC has advised us that the underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.
STABILIZATION. During this offering, the underwriters may engage in
transactions on the Nasdaq National Market or the over-the-counter market or
otherwise that stabilize, maintain or otherwise affect the price of the common
stock. Specifically, the underwriters may overallot this offering, creating a
syndicate short position. In addition, the underwriters may bid for and purchase
shares of common stock in the open market to cover syndicate short positions or
to stabilize the price of the common stock. In addition, ING Baring Furman Selz
LLC, on behalf of the underwriters, may reclaim selling concessions allowed to
an underwriter or dealer if the underwriting syndicate repurchases shares
distributed by that underwriter or dealer. These activities may stabilize or
maintain the market price of the common stock above independent market levels.
The underwriters are not required to engage in these activities and may
discontinue any of these activities at any time.
NO PRIOR PUBLIC MARKET. Prior to this offering, there has been no public
market for our common stock. As a result, the initial public offering price for
the common stock has been determined by negotiations between us and the
underwriters. Among the factors considered in determining the public offering
price were:
- prevailing market conditions;
- our results of operations in recent periods;
- the present stage of our development;
- the market capitalizations and development stages of other companies that
we and the underwriters believe to be comparable to us; and
- estimates of our growth potential.
DIRECTED SHARE PROGRAM. At our request, the underwriters have reserved up
to 337,500 shares of common stock to be issued by us and offered for sale by
this prospectus, at the initial public offering price, to directors, officers,
employees, business associates and related persons of DVD EXPRESS. The number of
shares of common stock available for sale to the general public will be reduced
to the extent these individuals purchase these reserved shares. Any reserved
shares which are not so purchased will be offered by the underwriters to the
general public on the same basis as the other shares offered by this prospectus.
57
<PAGE>
LEGAL MATTERS
Our counsel, Troop Steuber Pasich Reddick & Tobey, LLP, Los Angeles,
California, has rendered an opinion that the common stock offered by us, upon
its sale, will be duly and validly issued, fully paid and non-assessable.
Brobeck, Phleger & Harrison, LLP, Irvine, California, has acted as counsel to
the underwriters of this offering.
EXPERTS
The financial statements included in this prospectus and elsewhere in the
registration statement have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their report with respect thereto, and are
included herein in reliance upon the authority of such firm as experts in giving
said reports.
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission in Washington,
D.C., a registration statement under the Securities Act with respect to this
offering. This prospectus does not contain all of the information set forth in
the registration statement and the related exhibits. With respect to any
contract or other document filed as an exhibit to the registration statement,
reference is made to the exhibit for a complete description of the matter
involved. For further information about us and the shares offered, please review
the registration statement and exhibits. A copy of the registration statement,
including the exhibits, may be inspected without charge at the Securities and
Exchange Commission's principal office in Washington, D.C., and copies of all or
any part of the registration statement may be obtained from the Public Reference
Section of the Securities and Exchange Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, upon payment of prescribed rates.
Upon completion of this offering, we will be governed by the informational
requirements of the Exchange Act and will file reports and other information
with the Securities and Exchange Commission in accordance with its rules. These
reports and other information concerning us may be inspected and copied at the
public reference facilities referred to above as well some of the regional
offices of the Securities and Exchange Commission.
The Securities and Exchange Commission maintains a Web site which contains
reports, proxy and information statements and other information regarding
issuers, including us, that file electronically with the Securities and Exchange
Commission at http://www.sec.gov.
58
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Balance Sheets as of March 31, 1999 (unaudited) and December
31, 1998 and 1997......................................... F-3
Statements of Operations for the Three Months Ended March
31, 1999 and 1998 (unaudited), the Years Ended December
31, 1998 and 1997 and for the Period From October 18
(inception) to December 31, 1996.......................... F-4
Statements of Stockholders' Equity for the Three Months
Ended March 31, 1999 (unaudited), the Years Ended December
31, 1998 and 1997 and for the Period From October 18
(inception) to December 31, 1996.......................... F-5
Statements of Cash Flows for the Three Months Ended March
31, 1999 and 1998 (unaudited), the Years Ended December
31, 1998 and 1997 and for the Period From October 18
(inception) to December 31, 1996.......................... F-6
Notes to the Financial Statements........................... F-7
</TABLE>
F-1
<PAGE>
After the reincorporation and the concurrent 3-for-2 stock split of each
outstanding share of common stock, as discussed in Note 9 of Notes to
Consolidated Financial Statements is effected, we expect to be in a position to
render the following audit report.
ARTHUR ANDERSEN LLP
Los Angeles, California
February 1, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE STOCKHOLDERS OF DVD EXPRESS, INC.:
We have audited the accompanying balance sheets of DVD EXPRESS, Inc. (a
California corporation, the "Company") as of December 31, 1998 and 1997, and the
related statements of operations, stockholders' equity, and cash flows for the
years ended December 31, 1998 and 1997 and the period from October 18
(inception) to December 31, 1996. 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 audits 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 DVD EXPRESS, Inc. as of
December 31, 1998 and 1997, and the results of its operations and its cash flows
for the years ended December 31, 1998 and 1997 and the period from October 18 to
December 31, 1996 in conformity with generally accepted accounting principles.
Los Angeles, California
February 1, 1999 (except with
regard to the matters discussed
in Note 9, as to which the date is
, 1999)
F-2
<PAGE>
DVD EXPRESS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------
1997 1998
----------- ------------- AS OF MARCH 31,
---------------
1999
---------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ 200 $ 904,865 $ 4,932,616
Accounts receivable................................................ 18,409 254,661 343,353
Inventories........................................................ 250,689 1,803,948 2,470,103
Prepaid advertising................................................ -- 6,884,901 8,534,237
Other assets....................................................... 6,037 61,269 462,706
----------- ------------- ---------------
Total current assets............................................. 275,335 9,909,644 16,743,015
Property and equipment, net.......................................... 34,653 646,528 850,423
Other assets:
Prepaid advertising................................................ -- 8,745,523 7,765,427
Intangible assets, net............................................. -- 187,015 176,814
----------- ------------- ---------------
Total assets..................................................... $ 309,988 $ 19,488,710 $ 25,535,679
----------- ------------- ---------------
----------- ------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................... $ 116,785 $ 3,082,334 $ 3,759,916
Accrued expense and other.......................................... 1,800 283,627 350,893
Advances under lines of credit..................................... -- 3,000,000 3,000,000
Stockholder loans.................................................. -- 1,300,000 --
----------- ------------- ---------------
Total current liabilities........................................ 118,585 7,665,961 7,110,809
----------- ------------- ---------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.0001 par value, 10,000,000 shares authorized,
none issued and outstanding at December 31, 1997 and 1998,
1,714,285 issued and outstanding at March 31, 1999............... -- -- 171
Share capital, $.0001 par value, 50,000,000 shares authorized,
15,000,000 issued and outstanding at December 31, 1997 and 1998,
15,135,000 issued and outstanding at March 31, 1999.............. 1,500 1,500 1,514
Additional paid-in capital......................................... 398,500 16,594,288 23,697,305
Accumulated deficit................................................ (208,597) (4,773,039) (5,274,120)
----------- ------------- ---------------
Total stockholders' equity....................................... 191,403 11,822,749 18,424,870
----------- ------------- ---------------
Total liabilities and stockholders' equity....................... $ 309,988 $ 19,488,710 $ 25,535,679
----------- ------------- ---------------
----------- ------------- ---------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
DVD EXPRESS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
OCTOBER 18 TO DECEMBER 31, MARCH 31,
DECEMBER 31, ----------------------------- -----------------------------
1996 1997 1998 1998 1999
------------- ------------- -------------- ------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues........................... $ -- $ 1,269,241 $ 16,906,630 $ 1,644,803 $ 11,229,350
Cost of revenues................... -- 1,046,112 15,085,763 1,365,294 10,381,086
------------- ------------- -------------- ------------- --------------
Gross profit................... -- 223,129 1,820,867 279,509 848,264
------------- ------------- -------------- ------------- --------------
Operating expenses:
Operating and development........ -- 177,051 1,309,232 102,197 1,176,839
Sales and marketing.............. -- 96,640 2,910,655 126,932 3,246,621
America Online warrant
amortization................... -- -- 1,249,360 -- 1,249,360
General and administrative....... 17,007 141,028 842,063 61,263 459,783
------------- ------------- -------------- ------------- --------------
Operating loss................. (17,007) (191,590) (4,490,443) (10,883) (5,284,339)
Interest expense................... -- -- (73,999) -- (46,128)
Interest income.................... -- -- -- -- 56,347
------------- ------------- -------------- ------------- --------------
Net loss........................... $ (17,007) $ (191,590) $ (4,564,442) $ (10,883) $ (5,274,120)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Loss before pro forma provision for
income taxes..................... $ (17,007) $ (191,590) $ (4,564,442) $ (10,883) $ (5,274,120)
Pro forma provision for income
taxes (unaudited)................ -- -- -- -- --
------------- ------------- -------------- ------------- --------------
Pro forma net loss (unaudited)..... $ (17,007) $ (191,590) $ (4,564,442) $ (10,883) $ (5,274,120)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Basic and diluted loss per common
share............................ $ (0.00) $ (0.01) $ (0.30) $ (0.00) $ (0.35)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Weighted average number of shares
(unaudited)...................... 15,000,000 15,000,000 15,000,000 15,000,000 15,114,000
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Basic and diluted pro forma loss
per common share (unaudited)..... $ (0.00) $ (0.01) $ (0.30) $ (0.00) $ (0.30)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Pro forma weighted average number
of shares (unaudited)............ 15,000,000 15,000,000 15,000,000 15,000,000 17,599,713
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
DVD EXPRESS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK
---------------------- ------------------------ ADDITIONAL TOTAL
NUMBER OF NUMBER OF PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT EQUITY
--------- ----------- ----------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Beginning balance.................... -- $ -- -- $ -- $ -- $ -- $ --
Capital contribution............... -- -- -- -- 30,000 -- 30,000
Net loss........................... -- -- -- -- -- (17,007) (17,007)
--------- ----- ----------- ----------- ------------ ------------ ------------
Balance, December 31, 1996........... -- -- -- -- 30,000 (17,007) 12,993
Issuance of common stock........... -- -- 15,000,000 1,500 318,500 -- 320,000
Fair value of services contributed
by original stockholder.......... -- -- -- -- 50,000 -- 50,000
Net loss........................... -- -- -- -- -- (191,590) (191,590)
--------- ----- ----------- ----------- ------------ ------------ ------------
Balance, December 31, 1997........... -- -- 15,000,000 1,500 398,500 (208,597) 191,403
Capital contribution............... -- -- -- -- 1,150,000 -- 1,150,000
Fair value of services contributed
by original stockholder.......... -- -- -- -- 50,000 -- 50,000
Fair value of options issued in
connection with purchase of
intangible assets................ -- -- -- -- 3,463 -- 3,463
Fair value of America Online
warrant.......................... -- -- -- -- 14,992,325 -- 14,992,325
Net loss........................... -- -- -- -- -- (4,564,442) (4,564,442)
--------- ----- ----------- ----------- ------------ ------------ ------------
Balance, December 31, 1998........... -- -- 15,000,000 1,500 16,594,288 (4,773,039) 11,822,749
Termination of S corporation
status........................... -- -- -- -- (4,773,039) 4,773,039 --
Issuance of preferred stock........ 1,714,285 171 -- -- 11,246,070 -- 11,246,241
Issuance of common stock........... -- -- 135,000 14 629,986 -- 630,000
Net loss........................... -- -- -- -- -- (5,274,120) (5,274,120)
--------- ----- ----------- ----------- ------------ ------------ ------------
Balance, March 31, 1999
(unaudited)........................ 1,714,285 $ 171 15,135,000 $ 1,514 $ 23,697,305 $(5,274,120) $18,424,870
--------- ----- ----------- ----------- ------------ ------------ ------------
--------- ----- ----------- ----------- ------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
DVD EXPRESS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED MARCH
OCTOBER 18 TO DECEMBER 31, 31,
DECEMBER 31, ------------------------ ------------------------
1996 1997 1998 1998 1999
------------- ---------- ------------ ---------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss................................... $ (17,007) $ (191,590) $ (4,564,442) $ (10,883) $ (5,274,120)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization............ -- 7,706 101,125 2,227 90,479
America Online warrant amortization...... -- -- 1,249,360 -- 1,249,360
Contributed services..................... -- 50,000 50,000 12,500 --
Changes in certain assets and
liabilities:
Increase in prepaid advertising........ -- -- (1,887,459) -- (1,918,600)
Increase in accounts receivable........ -- (18,409) (236,252) (87,870) (88,692)
Increase in inventories................ -- (250,689) (1,553,259) (271,000) (666,155)
Increase in other assets............... -- (6,037) (55,232) (21,353) (401,437)
Increase in accounts payable........... -- 116,785 2,965,549 108,539 677,582
Increase in accrued expenses and
other................................ -- 1,800 281,827 32,265 67,265
------------- ---------- ------------ ---------- ------------
Net cash used in operating
activities......................... (17,007) (290,434) (3,648,783) (235,575) (6,264,318)
------------- ---------- ------------ ---------- ------------
Cash flows from investing activities:
Additions to property and equipment........ -- (42,359) (695,999) (14,425) (284,172)
Purchase of intangible assets.............. -- -- (200,553) -- --
------------- ---------- ------------ ---------- ------------
Net cash used in investing
activities......................... -- (42,359) (896,552) (14,425) (284,172)
------------- ---------- ------------ ---------- ------------
Cash flows from financing activities:
Capital contributions...................... 30,000 320,000 1,150,000 250,000 --
Net proceeds from sale of common stock..... -- -- -- -- 630,000
Net proceeds from sale of preferred
stock.................................... -- -- -- -- 11,246,241
Advances on lines of credit................ -- -- 3,000,000 -- --
Stockholder loans.......................... -- -- 1,300,000 -- (1,300,000)
------------- ---------- ------------ ---------- ------------
Net cash provided by financing
activities......................... 30,000 320,000 5,450,000 250,000 10,576,241
------------- ---------- ------------ ---------- ------------
Net increase (decrease) in cash and cash
equivalents................................ 12,993 (12,793) 904,665 -- 4,027,751
Cash and cash equivalents, beginning of
period..................................... -- 12,993 200 200 904,865
------------- ---------- ------------ ---------- ------------
Cash and cash equivalents, end of period..... $ 12,993 $ 200 $ 904,865 $ 200 $ 4,932,616
------------- ---------- ------------ ---------- ------------
------------- ---------- ------------ ---------- ------------
Supplemental disclosures:
Interest paid.............................. $ -- $ -- $ 47,691 $ -- $ 72,436
Income taxes paid.......................... $ -- $ -- $ -- $ -- $ --
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
1. ORGANIZATION, BASIS OF PRESENTATION AND BUSINESS RISKS
DVD EXPRESS, Inc. is a specialty retail online video store which uses the
Internet as its primary channel of selling and marketing digital versatile disk
movies, games, and accessories. DVD EXPRESS was incorporated and commenced
principal operations on October 18, 1996.
RISKS OF BUSINESS
DVD EXPRESS has a limited operating history on which to base an evaluation
of its business. DVD EXPRESS will encounter numerous risks including, but not
limited to, the need to respond to changes in a rapidly evolving and
unpredictable business environment and the ability to manage growth effectively.
DVD EXPRESS must, among other things, expand its customer base, successfully
implement its business and marketing strategies, continue to develop and upgrade
its Web site and provide superior customer service. If DVD EXPRESS is not
successful in addressing such risks, it will be materially adversely affected.
LOSSES FROM OPERATIONS
DVD EXPRESS is an early stage enterprise and has incurred aggregate net
losses since its inception of approximately $9.9 million as of March 31, 1999.
To date, DVD EXPRESS has funded operations through the sale of its stock, bank
debt, and capital contributions and loans from the sole stockholder. There can
be no assurance that DVD EXPRESS will continue to be able to raise additional
capital as needed, which could have a material adverse effect on its business,
financial condition or results of operations. Additionally, there is no
assurance that DVD EXPRESS will attain profitability in the future. DVD EXPRESS'
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in the early stages of development,
particularly companies in new and rapidly evolving markets such as online
commerce.
DVD EXPRESS intends to continue investing heavily in marketing and
promotion, strategic alliances, Web site development and technology, and
development of its administrative organization. As a result, DVD EXPRESS
believes that it will continue to incur substantial operating losses for the
foreseeable future, and at rates significantly above current levels. Achieving
profitability depends upon DVD EXPRESS' ability to generate and sustain
substantially increased revenue levels. There can be no assurance that DVD
EXPRESS will be able to generate sufficient revenues or gross margins to achieve
or sustain profitability in the future.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
UNAUDITED INFORMATION AS OF MARCH 31, 1999 AND 1998
The accompanying financial statements as of March 31, 1999 and 1998 reflect
all adjustments which are, in the opinion of management, necessary for the fair
presentation of the financial statements
F-7
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
for such interim periods. Such adjustments consist only of normal recurring
items. Interim results are not necessarily indicative of results for a full
year.
CASH AND CASH EQUIVALENTS
DVD EXPRESS considers cash and cash equivalents to consist of all highly
liquid debt instruments purchased with an initial maturity of three months or
less.
ACCOUNTS RECEIVABLE
Accounts receivable consist primarily of credit card receivables. The
carrying amount of these receivables approximates realizable value.
INVENTORY
Inventories are comprised of DVD movies, videos and DVD-ROM software and are
stated at the lower of cost (first-in, first-out method) or market.
PREPAID ADVERTISING
DVD EXPRESS has entered into several long-term marketing agreements.
Payments made are capitalized as prepaid advertising. Prepaid advertising is
amortized over the expected useful life of the individual agreements based upon
the actual guaranteed impressions or click throughs if the information is
available or based upon the contractual guaranteed impressions or click throughs
as specified in the individual agreement if actual impressions or click throughs
have not yet been reported to DVD EXPRESS. See also Note 7. The carrying value
of the prepaid advertising is reviewed when events or circumstances indicate
that an impairment test is necessary (see Long Lived Assets).
INTANGIBLE ASSET
Intangible assets consist of cash amounts paid and the fair value of options
granted for domain names on the World Wide Web. DVD EXPRESS entered into an
agreement for the purchase of the following domain names: "dvd.com",
"hometheater.com", and "hometheater.net" for cash and the grant of stock options
to purchase 15,000 shares of common stock at an exercise price of $4.67 per
share. The options have been valued at a fair value of $3,463 using a
Black-Scholes Option Pricing Model.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is computed utilizing the straight-line method. These assets are
depreciable over the estimated useful lives as follows:
<TABLE>
<S> <C>
Furniture and equipment........................... 5 years
Computer equipment................................ 3 years
Leasehold improvements............................ Life of lease or asset life if shorter
</TABLE>
Major renewals and improvements are capitalized. Any maintenance and repairs
which do not improve or extend the life of the assets are expensed as incurred.
F-8
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The cost and accumulated depreciation for property and equipment sold,
retired or otherwise disposed of are relieved from the respective accounts and
resulting gains and losses are reflected in income.
LONG LIVED ASSETS
DVD EXPRESS had adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets to be Disposed of." This statement establishes accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles, and goodwill related to those assets to be held and used and for
long-lived assets and certain identifiable intangibles to be disposed of. The
carrying value of existing assets are reviewed when events or changes in
circumstances indicate that an impairment test is necessary in order to
determine if an impairment has occurred. When factors indicate that such assets
should be evaluated for possible impairment, DVD EXPRESS will estimate the
future cash flows expected to result from the use of the assets and their
eventual disposition, and compare the amounts to the carrying value of the
assets to determine if an impairment loss has occurred.
REVENUE RECOGNITION
Revenues, which consists primarily of DVD movies sold via the Internet,
include outbound shipping and handling charges and are recognized when the
products are shipped.
EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is calculated by dividing net income
(loss) available to common stockholders by the weighted average number of shares
outstanding for the period. Diluted earnings (loss) per share reflects the
potential dilution from the exercise of options or conversion of other
securities into common stock. Stock options to purchase and conversion of other
securities into 4,143,542, 309,658, 883,354, 174,913 and zero shares of common
stock outstanding for the three months ended March 31, 1999 and 1998, the years
ended December 31, 1998 and 1997, and the period ended December 31, 1996,
respectively, have not been included in the computation of diluted earnings
(loss) per share because to do so would have been antidilutive.
PRO FORMA EARNINGS (LOSS) PER COMMON SHARE
Pro forma earnings (loss) per common share is presented pursuant to
Statement of Financial Accounting Standards No. 128 "Earnings per share". Pro
forma earnings (loss) per share is computed using the weighted average number of
common shares outstanding, including the pro forma effects of the automatic
conversion of the Series A Convertible Preferred Stock into Common Stock
effective upon the closing of the initial public offering as if such conversion
had occurred on January 4, 1999, the date of original issuance.
F-9
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following table sets forth the computation of basic and pro forma
earnings (loss) per share:
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
OCTOBER 18 TO --------------------------- ---------------------------
DECEMBER 31, 1996 1997 1998 1998 1999
----------------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Numerator:
Net loss................ $ (17,007) $ (191,590) $ (4,564,442) $ (10,883) $ (5,274,120)
Denominator:
Weighted average number
of shares............. 15,000,000 15,000,000 15,000,000 15,000,000 15,114,000
----------------- ------------ ------------- ------------ -------------
Basic................... 15,000,000 15,000,000 15,000,000 15,000,000 15,114,000
Effect of:
Series A Convertible
Preferred Stock..... -- -- -- -- 2,485,713
----------------- ------------ ------------- ------------ -------------
Pro forma basic........... 15,000,000 15,000,000 15,000,000 15,000,000 17,599,713
----------------- ------------ ------------- ------------ -------------
</TABLE>
INCOME TAXES
DVD EXPRESS accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." SFAS 109
specifies an asset and liability approach, which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events which have been recognized in DVD EXPRESS' financial statements.
Through December 31, 1998, DVD EXPRESS elected to file federal and state
income tax returns as a S corporation and as a result, was not subject to
federal income tax but was subject to state income tax in certain states. In
accordance with the S corporation election, taxable income or loss of DVD
EXPRESS was included in the computation of adjusted gross income of DVD EXPRESS'
sole stockholder. As DVD EXPRESS reported losses since inception through
December 31, 1998 and paid only the minimum state tax required, no state income
tax provision was recorded.
As of January 1, 1999, DVD EXPRESS terminated its S corporation status and
recorded the effect of such termination in the first quarter of 1999 (see Note
8).
GOING CONCERN
The accompanying financial statements have been prepared assuming that DVD
EXPRESS will continue as a going concern. As shown in the accompanying balance
sheets, liabilities exceed assets at December 31, 1998; nevertheless, the
management of DVD EXPRESS intends to fund operations as necessary in order for
DVD EXPRESS to continue as a going concern through at least December 31, 1999.
F-10
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
COMPREHENSIVE INCOME
Aside from net loss, there are no other comprehensive income items for three
months ended March 31, 1999 and 1998, the years ended December 1998 and 1997 and
the period from October 18, 1996 to December 31, 1996.
SEGMENT REPORTING
DVD EXPRESS adopted SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information" in 1998. This statement requires companies
to report certain information about operating segments in a financial statement
and information about their products and services, the geographic areas in which
they operate, and their major customers. DVD EXPRESS has adopted SFAS 131 in
1998. As DVD EXPRESS has only one reportable operating segment of its business
there is no segment information to report for the three months ended March 31,
1999 and 1998, the years ended December 1998 and 1997 and the period from
October 18 to December 31, 1996, other than the following geographic
information. DVD EXPRESS has no assets outside the United States and all
transactions are denominated in United States dollars.
Revenues from product shipments to geographic areas for the three months
ended March 31, 1999 and 1998, and the years ended December 31, 1998 and 1997
were approximately as follows: United States and possessions $5,300,000,
$800,000, $9,300,000, and $710,000; Europe $2,700,000, $400,000, $3,500,000, and
$250,000; and rest of world $1,700,000, $200,000, $2,100,000, and $160,000,
respectively.
Revenues from total worldwide shipping charges for the three months ended
March 31, 1999 and 1998, and the years ended December 31, 1998 and 1997 were
approximately $1,500,000, $200,000, $2,000,000, and $150,000, respectively.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1998
----------------- ----------------- MARCH 31, 1999
--------------
(UNAUDITED)
<S> <C> <C> <C>
Furniture and equipment................ $ 8,168 $ 270,869 $ 377,619
Computer equipment..................... 34,191 221,652 327,410
Leasehold improvements................. -- 245,837 317,500
------- -------- --------------
42,359 738,358 1,022,529
Less: Accumulated depreciation......... (7,706) (91,830) (172,106)
------- -------- --------------
$ 34,653 $ 646,528 $ 850,423
------- -------- --------------
------- -------- --------------
</TABLE>
4. BANK AND OTHER DEBT
LINES OF CREDIT
In July 1998, DVD EXPRESS entered into a revolving line of credit with Wells
Fargo Bank National Association aggregating $1,000,000. The interest expense is
computed at a rate of .75% above
F-11
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
4. BANK AND OTHER DEBT (CONTINUED)
prime rate (8.5% at December 31, 1998 and at March 31, 1999) beginning on
September 1, 1998. The revolving line of credit expires on September 1, 1999.
In October 1998, DVD EXPRESS entered into an additional revolving line of
credit with Wells Fargo Bank National Association aggregating $2,000,000. The
interest expense is computed at a rate of .25% below prime rate (7.5% at
December 31, 1998 and at March 31, 1999) beginning on October 1, 1998. The
revolving line of credit expires on November 1, 1999.
The credit lines are both fully utilized as of December 31, 1998 and March
31, 1999.
5. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
Management believes, based upon the advice of legal counsel, that there are
no proceedings, either threatened or pending, against DVD EXPRESS that could
result in a material adverse effect on the results of operations or the
financial condition of DVD EXPRESS.
LETTERS OF CREDIT
On February 11, 1998, DVD EXPRESS entered into an agreement expiring on
September 1, 1999 under which Wells Fargo Bank, National Association will issue
standby letters of credit not to exceed $750,000. As of December 31, 1998 and
March 31, 1999, DVD EXPRESS had no letters of credits outstanding.
OPERATING LEASE AGREEMENTS
Prior to April 1998, DVD EXPRESS occupied business premises subject to a
month to month lease. DVD EXPRESS entered into a three-year operating lease
agreement for office space on April 1, 1998, which was amended to include
additional premises on August 5, 1998. Total rent expense for the three months
ended March 31, 1999 and 1998, the years ended December 31, 1998 and 1997, and
the period from October 18 to December 31, 1996 was $88,818, $17,925, $159,598,
$18,267, and $0, respectively.
Future minimum lease payments at December 31, 1998, relating to DVD EXPRESS'
non-cancelable operating leases, are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
- ----------------------------------------------------------------------------------
<S> <C>
1999.............................................................................. $ 324,842
2000.............................................................................. 324,842
2001.............................................................................. 91,319
----------
$ 741,003
----------
----------
</TABLE>
F-12
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
MARKETING AGREEMENTS, STRATEGIC ALLIANCES AND SYSTEM PROVIDERS
AMERICA ONLINE AGREEMENT
In August 1998, DVD EXPRESS entered into an agreement with America Online
Inc. pursuant to which America Online will provide DVD EXPRESS with promotions
throughout the America Online service on AOL and America Online's Digital City.
The initial term of the agreement runs from October 1, 1998 to October 1, 2001.
DVD EXPRESS has guaranteed payments during the term to America Online of $15
million. As partial consideration, DVD EXPRESS granted a warrant to purchase
1,384,006 shares of its common stock to America Online. (See also Note 7).
INFOSEEK AGREEMENT
In October 1998, DVD EXPRESS entered into a distribution agreement with
Infoseek Corporation (commonly known as Go.com) pursuant to which Go.com will
feature us in its Entertainment Channel and various other areas throughout the
service. During the 24-month term of the agreement, DVD EXPRESS is obligated to
pay Infoseek a minimum of $5.3 million plus a percentage of our revenues
attributable to Go.com member traffic.
ONE ZERO MEDIA AGREEMENT
In September 1998, DVD EXPRESS entered into an agreement with One Zero
Media, Inc. One Zero Media is the exclusive producer and aggregating partner for
the "Entertainment Zone," the entertainment content area within the "AltaVista"
Web site. Pursuant to the agreement, DVD EXPRESS has been appointed as the sole
provider of the Entertainment Zone's DVD Store Area. The agreement also
contemplates promotional efforts on behalf of DVD EXPRESS in both the
Entertainment Zone and on the Wild Wild Web syndicated television show. DVD
EXPRESS pays One Zero Media based on the amount of traffic originating from
AltaVista.
SYSTEM PROVIDERS
DVD EXPRESS depends on Pandesic LLC to develop and service its commerce
systems, including the software that operates the transaction-processing
systems. The current agreement with Pandesic runs through May, 2000 and requires
minimum payments plus a percentage of revenues to be made. If Pandesic
terminates the agreement early or if the agreement is not renewed, DVD EXPRESS
would be forced to either enter into a relationship with another third-party
provider or undertake to develop and service its commerce systems internally.
DVD EXPRESS is required to pay aggregate minimum fees under marketing
agreements, strategic alliances and system providers as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
- -------------------------------------------------------------------------------
<S> <C>
1999........................................................................... $ 13,942,575
2000........................................................................... 7,839,394
2001........................................................................... 2,475,000
-------------
$ 24,256,969
-------------
-------------
</TABLE>
Many of DVD EXPRESS' agreements, including the America Online, Infoseek, and
One Zero Media Agreements, contain provisions which may require additional
payments to be made by DVD
F-13
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
EXPRESS based on factors such as click-throughs and new customers generated.
Such payments are expensed as incurred. DVD EXPRESS will continue to evaluate
the realizability of assets recorded, if any, related to the America Online,
Infoseek, One Zero Media and other agreements, and, if necessary, write down the
assets to realizable value.
6. RELATED PARTY TRANSACTIONS
In December 1998, DVD EXPRESS entered into two agreements to borrow a total
of $1,300,000 from its sole stockholder. All borrowings were repaid by DVD
EXPRESS in January 1999. Through December 31, 1998, the sole stockholder has not
drawn a salary for his services. The value of his services of $50,000 per year
has been reflected as both contributed capital and salary expense for the years
ended December 31, 1997 and 1998.
7. SHARE CAPITAL
DVD EXPRESS has authorized 50,000,000 $.0001 par value shares of Common
Stock and 10,000,000 $.0001 par value shares of Preferred Stock. The original
stockholder purchased 15,000,000 shares of Common Stock for $320,000 in 1997.
The original stockholder also contributed additional capital of $30,000 during
1996 and $1,150,000 during 1998 to fund operating expenses.
On January 4, 1999, DVD EXPRESS entered into a Series A Convertible
Preferred Stock Purchase Agreement with Geocapital IV, L.P., Geocaptial V, L.P.
and Broadview Partners Group. DVD EXPRESS sold 1,714,285 shares of its Series A
Convertible Preferred Stock for $12,000,000 less offering costs of $754,000. The
shares are convertible into Common Stock at the rate of 3-for-2 upon completion
of DVD EXPRESS' initial public offering. On January 15, 1999, DVD EXPRESS sold
135,000 shares of Common Stock for net proceeds of $630,000.
AMERICA ONLINE WARRANT
On August 1, 1998, DVD EXPRESS granted a warrant to America Online, Inc. to
purchase up to 1,384,006 shares of Common Stock at an exercise price of $5.60
per share. The America Online warrant is fully vested and non-forfeitable. The
America Online warrant expires on August 1, 2008. The AOL warrant does not have
any voting rights, dividend rights or preferences until such time as it is
exercised for shares of Common Stock. This warrant was granted as partial
compensation for the marketing agreement entered into with America Online (see
also Note 5). The America Online warrant was valued at a fair value of
$14,992,325 using the Black-Scholes Option Pricing Model using the following
assumptions: risk-free interest rate of 5.71%, expected life of 10 years,
dividend yield of 0% and volatility of 80%. The fair value of the America Online
warrant is included as prepaid advertising and is being amortized on a
straight-line basis over the term of the America Online marketing agreement.
STOCK OPTION PLAN
DVD EXPRESS adopted a stock incentive plan during 1998. The stock incentive
plan allows for the granting of up to 2,250,000 stock options to certain
employees, officers or consultants at a price not less than 100% of the market
value of DVD EXPRESS' Common Stock or issue nonqualified stock options pursuant
to the stock incentive plan. Options issued to consultants and non-employees are
valued at the fair value of the consideration received or the fair value of the
options issued. The fair
F-14
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
7. SHARE CAPITAL (CONTINUED)
value of options issued to non-employees is valued using the Black-Scholes
Option Pricing Model. The stock incentive plan prescribes general terms for the
exercise of options and option periods subject to the condition that all options
terminate not more than ten years from the date of grant. Options granted are at
the discretion of the Board of Directors, however, in no event shall any option
vest at a rate of less than 20% per year over five years from the grant date.
DVD EXPRESS accounts for the stock incentive plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees". Under APB Opinion No. 25,
compensation cost is not recognized for options issued at market value of the
Common Stock at the date of the grant. Had compensation cost for the stock
incentive plan and the other grants to employees been determined consistent with
SFAS 123, DVD EXPRESS' net loss would have been increased to the following pro
forma amounts:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1998
------------- ---------------
<S> <C> <C>
Net loss--as reported............................. $(191,590) $(4,564,442)
Net loss--pro forma............................... $(192,740) $(4,656,730)
</TABLE>
The fair value of each option grant was estimated on the date of grant using
the minimum value method with the following weighted average assumptions for
grants during 1998 and in 1997, respectively: risk-free interest rates of 5.47%
and 6.44%, expected lives of four years, zero volatility and payments of no
dividends.
The weighted average grant date fair value of options granted during 1998
was $0.80 per share.
No stock options were awarded under the stock incentive plan prior to 1998.
Information regarding stock options awarded under the stock incentive plan are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
----------------------------
WTD AVG.
SHARES EX. PRICE
------------- ----------
<S> <C> <C>
Options outstanding at beginning of
year.................................. -- $ --
Granted............................... 591,000 2.83
Exercised............................. -- --
Canceled.............................. (9,000) 4.00
------------- -----
Options outstanding at end of year...... 582,000 $ 2.81
------------- -----
------------- -----
</TABLE>
The following summarizes the number of shares exercisable and the exercise
price at December 31, 1998 for the stock incentive plan:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
OPTIONS REMAINING CONTRACTUAL OPTIONS
EXERCISE PRICE OUTSTANDING LIFE EXERCISABLE
- -------------------------------------------------------------------- ----------- --------------------- -----------
<S> <C> <C> <C>
$1.33............................................................... 150,000 9.16 41,781
$1.67............................................................... 108,750 9.25 27,213
$3.34............................................................... 70,500 9.42 43,919
$4.00............................................................... 237,750 9.64 49,312
$4.67............................................................... 15,000 9.62 15,000
----------- --- -----------
582,000 9.42 177,225
----------- --- -----------
----------- --- -----------
</TABLE>
F-15
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
7. SHARE CAPITAL (CONTINUED)
DVD EXPRESS also granted options to purchase 300,000 shares of common stock
to an employee at an exercise price of $.0667 per share during 1997 with an
average grant date fair value of $0.15 per share. As of December 31, 1998,
118,767 of these shares are exercisable. The weighted average remaining
contractual life of these outstanding options at December 31, 1998, was 8.4
years.
During the period from January 1, 1999 to May 31, 1999, DVD EXPRESS granted
options (excluding those that were also forfeited) under the stock incentive
plan to employees and directors to purchase an additional 549,000 shares of
common stock at a weighted average price of $6.03.
8. INCOME TAXES
Prior to January 1, 1999, DVD EXPRESS operated as an S corporation, and
therefore was not subject to federal income taxes and only to state income taxes
at a reduced rate. As an S corporation, DVD EXPRESS' stockholders were subject
to federal and state taxes based on DVD EXPRESS' earnings. As a result of
terminating DVD EXPRESS' S corporation status on January 1, 1999, DVD EXPRESS
was required to record a one-time, non-cash charge against historical earnings
for additional deferred taxes based upon the increase in the effective tax rate
from DVD EXPRESS' S corporation status to C corporation status. The deferred
taxes are a result of timing differences, principally depreciation expense,
operating losses and other accrued expenses between amounts deducted for tax
purposes as compared to financial statement purposes. This charge was zero as
all net deferred tax assets have been fully offset by a valuation allowance as
their realization is uncertain. DVD EXPRESS also offset its accumulated deficit
as of December 31, 1998 as a charge against DVD EXPRESS' additional paid in
capital. The following pro forma tax information is presented as if DVD EXPRESS
was a C corporation since inception.
Under SFAS 109, deferred tax assets may be recognized for temporary
differences that will result in deductible amounts in future periods and for
loss carryforwards. A valuation allowance is recognized if, based on the weight
of available evidence, it is more likely than not that some portion or all of
the deferred tax asset will not be realized.
The tax effects of temporary differences which give rise to deferred tax
assets (liabilities) for 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1998
----------------- -----------------
<S> <C> <C>
Deferred tax assets:
Depreciation and amortization........................ $ -- $ 25,993
Accrued expenses and other........................... -- 8,082
Net operating loss................................... 64,977 1,904,153
-------- -----------------
Subtotal gross tax (assets)........................ 64,977 1,938,228
Valuation allowance.................................. (64,977) (1,938,228)
-------- -----------------
Net deferred tax assets............................ $ -- $ --
-------- -----------------
-------- -----------------
</TABLE>
F-16
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
8. INCOME TAXES (CONTINUED)
The pro forma provision for income taxes for the years ended December 31,
1998, 1997 and for the period from October 18 to December 31, 1996 follows:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
OCTOBER 18 TO -------------------------
DECEMBER 31, 1996 1997 1998
----------------- ---------- -------------
<S> <C> <C> <C>
Current
Federal....................................... $ (5,952) $ (49,557) $ (1,599,117)
State......................................... (1,021) (8,447) (274,134)
------- ---------- -------------
(6,973) (58,004) (1,873,251)
Deferred........................................ 6,973 58,004 1,873,251
------- ---------- -------------
Pro forma provision for income taxes.......... $ -- $ -- $ --
------- ---------- -------------
------- ---------- -------------
</TABLE>
The following is a summary reconciliation of the effective tax rate to the
assumed federal tax rate:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
OCTOBER 18 TO ------------------------
DECEMBER 31, 1996 1997 1998
--------------------- ----- -----
<S> <C> <C> <C>
Assumed federal tax rate on pre-tax book loss............. 35% 35% 35%
State taxes............................................... 6% 6% 6%
Valuation allowance....................................... (41)% (41)% (41)%
-- -- --
Effective pro forma tax rate.............................. 0% 0% 0%
-- -- --
-- -- --
</TABLE>
9. SUBSEQUENT EVENT--REINCORPORATION AND STOCK SPLIT
On (BLANK DATE), 1999, DVD EXPRESS reincorporated in Delaware and effected a
concurrent 3-for-2 stock split of each outstanding share of Common stock. All
share, stock option and warrant data have been restated to reflect the stock
split.
F-17
<PAGE>
[PICTURES OF COMPANY PRODUCTS]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN
THIS PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR THE SALE OF COMMON
STOCK MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE
DATE OF THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH
THE OFFER OR SOLICITATION IS UNLAWFUL.
--------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 7
Cautionary Notice Regarding Forward-Looking Statements.................... 19
Termination of S Corporation Status....................................... 20
Use of Proceeds........................................................... 21
Dividend Policy........................................................... 21
Capitalization............................................................ 22
Dilution.................................................................. 23
Selected Financial Data................................................... 24
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 26
Business.................................................................. 33
Management................................................................ 44
Related Party Transactions................................................ 50
Principal Stockholders.................................................... 51
Description of Capital Stock.............................................. 53
Shares Eligible For Future Sale........................................... 55
Underwriting.............................................................. 56
Legal Matters............................................................. 58
Experts................................................................... 58
Additional Information.................................................... 58
Index to Financial Statements............................................. F-1
</TABLE>
------------------------
UNTIL , 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
THAT BUY, SELL OR TRADE THESE SHARES OF COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
4,500,000 SHARES
[LOGO]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
ING BARING FURMAN SELZ LLC
FRIEDMAN BILLINGS RAMSEY
NEEDHAM & COMPANY, INC.
JUNE , 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table itemizes the expenses we incurred in connection with
this offering, other than underwriting discounts. All the amounts shown are
estimates except the Securities and Exchange Commission registration fee and the
NASD filing fee.
<TABLE>
<S> <C>
Registration fee--Securities and Exchange Commission.............. $ 15,985
NASD filing fee................................................... 6,250
Nasdaq National Market fee........................................ 50,000
Accounting fees and expenses...................................... 175,000
Legal fees and expenses (other than blue sky)..................... 250,000
Blue sky fees and expenses, including legal fees.................. 5,000
Printing; stock certificates...................................... 100,000
Transfer agent and registrar fees................................. 5,000
Miscellaneous..................................................... 42,765
---------
Total........................................................... $ 650,000
---------
---------
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Our Certificate of Incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for (i) any breach of
their duty of loyalty to the corporation or its stockholders, (ii) acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) unlawful payments of dividends or unlawful stock
repurchases or redemptions, or (iv) any transaction from which the director
derived an improper personal benefit. Such limitation of liability does not
apply to liabilities arising under the federal securities laws and does not
affect the availability of equitable remedies such as injunctive relief or
recession.
Our Certificate of Incorporation and Bylaws provide that we shall indemnify
our directors and executive officers and may indemnify our other officers,
employees and other agents to the fullest extent permitted by law. We believe
that indemnification under our Bylaws covers at least negligence and gross
negligence on the part of indemnified parties. Our Certificate of Incorporation
also permits us to secure insurance on behalf of any officer, director, employee
or other agent for any liability arising out of his or her actions in such
capacity, regardless of whether the provisions of law would permit such
indemnification.
In addition to the indemnification provided for in our Certificate of
Incorporation, we plan to enter into agreements to indemnify our directors and
executive officers. These agreements, among other things, provide for
indemnification of our directors and executive officers for certain expenses
(including attorneys' fees), judgments, fines and settlement amounts incurred by
any such person in any action or proceeding, including any action by or in the
right of DVD EXPRESS, arising out of such person's services as a director or
executive officer of DVD EXPRESS, any subsidiary of DVD EXPRESS or any other
company or enterprise to which the person provides services at our request. We
believe that these provisions and agreements are necessary to attract and retain
qualified persons as directors and executive officers.
At present, we are not aware of any pending or threatened litigation or
proceeding involving a director, officer, employee or agent in which
indemnification would be required or permitted. We are
II-1
<PAGE>
not aware of any threatened litigation or proceeding that might result in a
claim for such indemnification.
Section 8 of the Underwriting Agreement filed as Exhibit 1.1 hereto sets
forth certain provisions with respect to the indemnification of certain
controlling persons, directors and officers against certain losses and
liabilities, including certain liabilities under the Securities Act.
We plan to obtain director and officer liability insurance.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers and controlling persons pursuant to
the foregoing provisions, or otherwise, we have been advised that in the opinion
of the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
Reference is made to the following documents filed as exhibits to this
Registration Statement regarding relevant indemnification provisions described
above and elsewhere herein:
<TABLE>
<CAPTION>
DOCUMENT EXHIBIT NUMBER
- ----------------------------------------------------------------------------- -----------------
<S> <C>
Proposed form of Underwriting Agreement...................................... 1.1
Registrant's Certificate of Incorporation.................................... 3.3
Registrant's Bylaws.......................................................... 3.4
Registrant's Form of Indemnification Agreement............................... 10.4
Tax Agreement................................................................ 10.5
</TABLE>
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
On June 1, 1997, we issued stock options to purchase up to 300,000 shares of
Common Stock at $.0667 per share to Joan Abend. The issuance and sale of these
securities is exempt from the registration requirements of the Securities Act
pursuant to Section 4(2) of the Securities Act as a transaction not involving
any public offering, and also pursuant to Rule 701 because the offer and sale of
the securities was pursuant to a compensatory benefit plan relating to
compensation.
On March 1, 1998, we issued pursuant to the stock incentive plan stock
options to purchase up to 150,000 shares of Common Stock at $1.33 per share to
Jason Vagner. The issuance and sale of these securities is exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) of the
Securities Act as a transaction not involving any public offering, and also
pursuant to Rule 701 because the offer and sale of the securities was pursuant
to a compensatory benefit plan relating to compensation.
On April 1, 1998, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 108,750 shares of Common Stock at $1.67 per
share to four of our employees. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant to Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to compensation.
On June 1, 1998, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 70,500 shares of Common Stock at $3.34 per
share to eight of our employees. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant to Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to compensation.
On August 1, 1998, we issued pursuant to the stock incentive plan stock
options to purchase up to 112,500 shares of Common Stock at $4.00 per share to
Steven Antebi. The issuance and sale of these
II-2
<PAGE>
securities is exempt from the registration requirements of the Securities Act
pursuant to Section 4(2) of the Securities Act as a transaction not involving
any public offering, and also pursuant to Rule 701 because the offer and sale of
the securities was pursuant to a compensatory benefit plan relating to
compensation.
On August 1, 1998, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 93,750 shares of Common Stock at $4.00 per
share to seven of our employees. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant to Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to compensation.
On August 1, 1998, we granted a warrant to purchase up to 1,384,006 shares
of Common Stock at $5.60 per share to America Online, Inc. The issuance and sale
of these securities is exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) of the Securities Act as a transaction
not involving any public offering.
On August 15, 1998, we issued pursuant to the stock incentive plan stock
options to purchase up to 15,000 shares of Common Stock at $4.67 per share to
Tushar Patel. The issuance and sale of these securities is exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) of the
Securities Act as a transaction not involving any public offering, and also
pursuant to Rule 701 because the offer and sale of the securities was pursuant
to a compensatory benefit plan relating to compensation.
On December 1, 1998, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 33,750 shares of Common Stock at $4.00 per
share to six of our employees. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant to Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to compensation.
On January 4, 1999, we sold an aggregate of 1,714,285 shares of our Series A
Convertible Preferred Stock to Geocapital V, L.P., Geocapital IV, L.P. and
Broadview Partners Group for an aggregate offering price of $12 million less
offering costs of $754,000. The 1,714,285 shares of Series A Convertible
Preferred Stock will convert into 2,571,427 shares of common stock (post 3-for-2
stock split) upon the closing of this offering. Post conversion and stock split,
the purchase price of the Series A Convertible Preferred Stock is effectively
$4.67 per share. The issuance and sale of these securities is exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) and
Rule 506 of the Securities Act as a transaction not involving any public
offering.
On January 15, 1999, we sold an aggregate of 135,000 shares of our Common
Stock to three directors, Steve Antebi, Norman Pattiz and Stephen Cannell, for a
purchase price of $4.67 per share. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) and Rule 506 of the Securities Act as a transaction not involving
any public offering. On January 15, 1999, we also issued pursuant to the stock
incentive plan options to purchase an aggregate of 75,000 shares of Common Stock
at $4.67 per share to each of Mr. Pattiz and Mr. Cannell. The issuance and sale
of these securities is exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) of the Securities Act as a transaction
not involving any public offering, and also pursuant to Rule 701 because the
offer and sale of the securities was pursuant to a compensatory benefit plan
relating to compensation.
On February 1, 1999, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 225,000 shares of Common Stock at $4.00 per
share to two of our employees. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act
II-3
<PAGE>
pursuant to Section 4(2) of the Securities Act as a transaction not involving
any public offering, and also pursuant to Rule 701 because the offer and sale of
the securities was pursuant to a compensatory benefit plan relating to
compensation.
On February 1, 1999, we issued pursuant to the stock incentive plan stock
options to purchase up to 78,750 shares of Common Stock at $4.67 per share to 13
of our employees. The issuance and sale of these securities is exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) of the
Securities Act as a transaction not involving any public offering, and also
pursuant to Rule 701 because the offer and sale of the securities was pursuant
to a compensatory benefit plan relating to compensation.
On March 1, 1999, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 22,500 shares of Common Stock at $8.00 per
share to two of our employees. The issuance and sale of these securities is
exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant to Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to compensation.
On May 25, 1999, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 154,500 shares of Common Stock at $10.00 per
share to seventeen of our employees. The issuance and sale of these securities
is exempt from the registration requirements of the Securities Act pursuant to
Section 4(2) of the Securities Act as a transaction not involving any public
offering, and also pursuant to Rule 701 because the offer and sale of the
securities was pursuant to a compensatory benefit plan relating to compensation.
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement.*
3.1 Amended and Restated Articles of Incorporation of the Registrant's predecessor.*
3.2 Amended and Restated Bylaws of the Registrant's predecessor.*
3.3 Certificate of Incorporation of Registrant.*
3.4 Bylaws of Registrant.*
4.1 Specimen Stock Certificate of Common Stock of Registrant.
5.1 Opinion and Consent of Troop Steuber Pasich Reddick & Tobey, LLP.
10.1 1998 Stock Incentive Plan.*
10.2 Form of Registrant's Stock Option Agreement (Non-Statutory Stock Option).*
10.3 Form of Registrant's Stock Option Agreement (Incentive Stock Option).*
10.4 Form of Director and Officer Indemnification Agreement.*
10.5 Tax Indemnification Agreement, dated March 1, 1999, between Registrant and Michael Dubelko.*
10.6 Employment Agreement, dated March 1, 1999, between the Registrant and Michael Dubelko.*
10.7 Employment Agreement, dated March 1, 1999, between the Registrant and Andrew Crist.*
10.8 Office Space Lease, dated January 16, 1998, between the Registrant and Jahra Investments, N.V., as
amended by the First Amendment to Office Building Lease dated August 5, 1998.*
10.9 Interactive Marketing Agreement, dated August 1, 1998, between the Registrant and America Online, Inc.,
as amended by the First Amendment to Interactive Marketing Agreement, dated as of May 1, 1999.+*
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
10.10 Amended and Restated Common Stock Subscription Warrant, dated August 1, 1998, between the Registrant and
America Online, Inc.*
10.11 Affiliate Agreement, dated September 1, 1998, between the Registrant and One Zero Media, Inc.+*
10.12 Distribution Agreement, dated October 13, 1998, between the Registrant and Infoseek Corporation.+*
10.13 E-Business Solution Agreement, dated March 25, 1998, between the Registrant and Pandesic, LLC, as
amended on April 9, 1999.+*
10.14 Purchase Agreement for DVD.COM, dated August 3, 1998, between the Registrant and Tushar Patel.*
10.15 Revolving Line of Credit Note, dated July 23, 1998, between the Registrant and Wells Fargo Bank,
National Association, as amended by the Addendum to Promissory Note dated July 23, 1998, and the
Continuing Guaranty to Wells Fargo Bank, National Association, dated January 23, 1998, executed by
Michael J. Dubelko.*
10.16 Revolving Line of Credit Note, dated October 1, 1998, between the Registrant and Wells Fargo Bank,
National Association, as amended by the Addendum to Promissory Note dated October 1, 1998, and the
Continuing Guaranty to Wells Fargo Bank, National Association, dated October 1, 1998, executed by
Michael J. Dubelko.*
10.17 Letter of Credit, dated February 11, 1998, issued by Wells Fargo Bank, National Association to the
Registrant.
10.18 Registration Rights Agreement, dated December 31, 1998, between the Registrant, Michael Dubelko,
Geocapital V, L.P., Geocapital IV, L.P. and Broadview Partners Group.*
10.19 Option Agreement, dated June 1, 1997, between the Registrant and Joan Abend.*
23.1 Consent of Troop Steuber Pasich Reddick & Tobey, LLP (included in its opinion filed as Exhibit 5.1
hereto).
23.2 Consent of Arthur Andersen LLP.+
23.3 Consent of Paul Kagan Associates, Inc.
23.4 Consent of International Data Corporation.
24.1 Power of Attorney (included on signature page).*
27.1 Financial Data Schedule.*
</TABLE>
- ------------------------
* Previously filed.
+ To be filed concurrently with the effectiveness of the offering.
+ Confidential treatment requested as to certain portions of this exhibit.
ITEM 17. UNDERTAKINGS.
(a) The undersigned Registrant hereby undertakes to provide to the
underwriters at the closing specified in the underwriting agreements,
certificates in such denominations and registered in such names as required by
the underwriters to permit prompt delivery to each purchaser.
(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers, and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act
II-5
<PAGE>
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer of controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by a controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(c) The undersigned registrant hereby undertakes that:
(1) For the purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and contained
in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1)
or (4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and this offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-1 and has duly caused this Amendment No. 2 to
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Los Angeles, State of California, on June 18,
1999.
<TABLE>
<S> <C> <C>
DVD EXPRESS, INC.
By: /s/ MICHAEL J. DUBELKO
-----------------------------------------
Michael J. Dubelko, CHAIRMAN OF THE BOARD,
CHIEF EXECUTIVE OFFICER AND PRESIDENT
</TABLE>
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to Registration Statement has been signed by the following persons in the
capacities and on the dates stated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ MICHAEL J. DUBELKO Chairman of the Board,
- ------------------------------ Chief Executive Officer June 18, 1999
Michael J. Dubelko and President
Chief Financial Officer,
/s/ ANDREW T. CRIST Chief Operating Officer
- ------------------------------ and Secretary (Principal June 18, 1999
Andrew T. Crist Financial and Accounting
Officer)
*
- ------------------------------ Director June 18, 1999
Steven S. Antebi
*
- ------------------------------ Director June 18, 1999
Kimberly S. Eads
*
- ------------------------------ Director June 18, 1999
Norman J. Pattiz
*
- ------------------------------ Director June 18, 1999
Stephen J. Cannell
*
- ------------------------------ Director June 18, 1999
Harold E. Hughes
</TABLE>
* Power of Attorney
<TABLE>
<S> <C> <C> <C>
By: /s/ MICHAEL J. DUBELKO
-------------------------
Michael J. Dubelko
ATTORNEY IN FACT
</TABLE>
II-7
<PAGE>
[LOGO]
Number Shares
C-
CUSIP 23334K 10 4
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
SEE REVERSE FOR
THIS CERTIFIES THAT CERTAIN DEFINITIONS
IS THE OWNER OF
FULLY PAID AND NON-ASSESSABLE SHARES, OF THE PAR VALUE
OF $.0001 PER SHARE, OF COMMON STOCK OF
DVD EXPRESS
transferred on the books of the Corporation by the holder hereof in person or
by duly authorized attorney upon surrender of this Certificate properly
endorsed or accompanied by a proper assignment. This Certificate is not valid
unless countersigned by this Transfer Agent and registered by the Registrar.
WITNESS the facsimile seal of the Corporation and facsimile signatures of
its duly authorized officers.
Dated:
[COMPANY CORPORATE SEAL]
COUNTERSIGNED AND REGISTERED:
U.S. Stock Transfer Corporation
CHAIRMAN TRANSFER AGENT
BY
PRESIDENT AUTHORIZED SIGNATURE
<PAGE>
EXHIBIT 5.1
[LETTERHEAD]
June 18, 1999
DVD Express, Inc.
7083 Hollywood Boulevard.
Los Angeles, California 90028
Ladies/Gentlemen:
At your request, we have examined the Registration Statement on Form S-1
(the "Registration Statement") to which this letter is attached as Exhibit
5.1 filed by DVD Express, Inc., a Delaware corporation (the "Company"), in
order to register under the Securities Act of 1933, as amended (the "Act"),
4,500,000 shares of Common Stock, par value $0.0001 per share, of the
Company, and an additional 675,000 shares of Common Stock, par value $0.0001
per share, of the Company subject to the underwriters' over-allotment option,
and any additional shares of Common Stock of the Company which may be
registered pursuant to Rule 462(b) under the Act (collectively, the "Shares").
We are of the opinion that the Shares have been duly authorized and upon
issuance and sale of the Shares in conformity with and pursuant to the
Registration Statement, the Shares will be validly issued, fully paid and
non-assessable.
We consent to the use of this opinion as an exhibit to the Registration
Statement and to use of our name in the Prospectus constituting a part
thereof.
Respectfully submitted,
TROOP STEUBER PASICH REDDICK & TOBEY, LLP
<PAGE>
Beverly Hills Private Client Services
9600 Santa Monica Blvd.
Beverly Hills, CA 90210
February 11, 1998
Michael J. Dubelko
1125 Tower Road
Beverly Hills, CA 90210
Dear Mr. Dubelko:
This letter is to confirm that Wells Fargo Bank, National Association
("Bank"), subject to all terms and conditions contained herein, has agreed to
make available to Michael J. Dubelko ("Borrower") a commitment under which
Bank will issue standby letters of credit for the account of Borrower (each,
a "Letter of Credit" and collectively, "Letters of Credit") from time to time
up to and including February 15, 1999, not to exceed at any time the maximum
principal amount of Seven Hundred Fifty Thousand Dollars ($750,000.00)
("Letter of Credit Line").
I. CREDIT TERMS:
1. LETTER OF CREDIT LINE:
(a) LETTERS OF CREDIT. Letters of Credit shall be issued under the
Letter of Credit Line to guaranty delivery of goods to DVD Express, Inc. by
its suppliers; provided however, that the form and substance of each Letter
of Credit shall be subject to approval by Bank, in its sole discretion; and
provided further, that the aggregate of all undrawn amounts, and all amounts
drawn and unreimbursed, under any Letters of Credit issued by Bank under the
Letter of Credit Line shall not at any time exceed the maximum principal
amount available thereunder, as set forth above. Each Letter of Credit shall
be issued for a term not to exceed 365 days, as designated by Borrower;
provided, however, that no Letter of Credit shall have an expiration date
subsequent to February 15, 2000. Each Letter of Credit shall be subject to
the additional terms of the Application and Agreement for Standby Letter of
Credit Agreement and related documents, if any, required by Bank in
connection with the issuance thereof (each, a "Letter of Credit Agreement"
and collectively, "Letter of Credit Agreements").
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 2
(b) REPAYMENT OF DRAFTS. Each draft paid by Bank under any Letter of
Credit shall be repaid by Borrower in accordance with the provisions of the
applicable Letter of Credit Agreement.
II. INTEREST/FEES:
1. INTEREST. The amount of each draft paid by Bank under any Letter of
Credit shall bear interest from the date such draft is paid by Bank to the
date such amount is fully repaid by Borrower at a rate per annum three
quarters of one percent (0.75%) above the Prime Rate in effect from time to
time.
2. COMPUTATION AND PAYMENT. Interest shall be computed on the basis of
a 360-day year, actual days elapsed. Interest shall be payable at the times
and place set forth in the Letter of Credit Agreement.
3. LETTER OF CREDIT FEES. Borrower shall pay to Bank (a) fees upon the
issuance of each Letter of Credit equal to one and one half of one percent
(1.5%) per annum (computed on the basis of a 360-day year, actual days
elapsed) of the face amount thereof, and (b) fees upon the payment or
negotiation by Bank of each draft under any Letter of Credit and fees upon
the occurrence of any other activity with respect to any Letter of Credit
(including without limitation, the transfer, amendment or cancellation of any
Letter of Credit) determined in accordance with Bank's standard fees and
charges then in effect for such activity.
III. REPRESENTATIONS AND WARRANTIES:
Borrower makes the following representations and warranties to Bank,
which representations and warranties shall survive the execution of this
letter and shall continue in full force and effect until the full and final
payment, and satisfaction and discharge, of all obligations of Borrower to
Bank subject to this letter.
1. LEGAL STATUS. Borrower is qualified or licensed to do business in
all jurisdictions in which such qualification or licensing is required or in
which the failure to so qualify or to be so licensed could have a material
adverse effect on Borrower.
2. AUTHORIZATION AND VALIDITY. This letter, Letter of Credit
Agreement, and each other document, contract or instrument deemed necessary
by Bank to evidence any extension of credit to Borrower pursuant to the terms
and conditions hereof, or now or at any time hereafter required by or
delivered to Bank in connection with this letter (collectively, the "Loan
Documents")
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 3
have been duly authorized, and upon their execution and delivery in accordance
with the provisions hereof will constitute legal, valid and binding
agreements and obligations of Borrower or the party which executes the same,
enforceable in accordance with their respective terms.
3. NO VIOLATION. The execution, delivery and performance by Borrower
of each of the Loan Documents do not violate any provision of any law or
regulation, or result in a breach of or constitute a default under any
contract, obligation, indenture or other instrument to which Borrower is a
party or by which Borrower may be bound.
4. LITIGATION. There are no pending, or to the best of Borrower's
knowledge threatened, actions, claims, investigations, suits or proceedings
by or before any governmental authority, arbitrator, court or administrative
agency which could have a material adverse effect on the financial condition
or operation of Borrower other than those disclosed by Borrower to Bank in
writing prior to the date hereof.
5. CORRECTNESS OF FINANCIAL STATEMENT. The financial statement of
Borrower dated February 5, 1998, a true copy of which has been delivered by
Borrower to Bank prior to the date hereof, (a) is complete and correct and
presents fairly the financial condition of Borrower, (b) discloses all
liabilities of Borrower that are required to be reflected or reserved against
under generally accepted accounting principles, whether liquidated or
unliquidated, fixed or contingent, and (c) has been prepared in accordance
with generally accepted accounting principles consistently applied. Since the
date of such financial statement there has been no material adverse change in
the financial condition of Borrower, nor has Borrower mortgaged, pledged,
granted a security interest in or otherwise encumbered any of its assets or
properties except in favor of Bank or as otherwise permitted by Bank in
writing.
6. INCOME TAX RETURNS. Borrower has no knowledge of any pending
assessments or adjustments of its income tax payable with respect to any year.
7. NO SUBORDINATION. There is no agreement, indenture, contract or
instrument to which Borrower is a party or by which Borrower may be bound
that requires the subordination in right of payment of any of Borrower's
obligations subject to this letter to any other obligation of Borrower.
8. PERMITS, FRANCHISES. Borrower possesses, and will hereafter
possess, all permits, consents, approvals, franchises
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 4
and licenses required and all rights to trademarks, trade names, patents and
fictitious names, if any, necessary to enable it to conduct the business in
which it is now engaged in compliance with applicable law.
9. ERISA. Borrower is in compliance in all material respects with all
applicable provisions of the Employee Retirement Income Security Act of 1974,
as amended or recodified from time to time ("ERISA"); Borrower has not
violated any provision of any defined employee pension benefit plan (as
defined in ERISA) maintained or contributed to by Borrower (each, a "Plan");
no Reportable Event, as defined in ERISA, has occurred and is continuing with
respect to any Plan initiated by Borrower; Borrower has met its minimum
funding requirements under ERISA with respect to each Plan; and each Plan
will be able to fulfill its benefit obligations as they come due in
accordance with the Plan documents and under generally accepted accounting
principles.
10. OTHER OBLIGATIONS. Borrower is not in default on any obligation
for borrowed money, any purchase money obligation or any other material
lease, commitment, contract, instrument or obligation.
11. ENVIRONMENTAL MATTERS. Except as disclosed by Borrower to Bank in
writing prior to the date hereof, Borrower is in compliance in all material
respects with all applicable federal or state environmental, hazardous waste,
health and safety statutes, and any rules or regulations adopted pursuant
thereto, which govern or affect any of Borrower's operations and/or
properties, including without limitation, the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, the Superfund Amendments
and Reauthorization Act of 1986, the Federal Resource Conservation and
Recovery Act of 1976, and the Federal Toxic Substances Control Act, as any of
the same may be amended, modified or supplemented from time to time. None of
the operations of Borrower is the subject of any federal or state
investigation evaluating whether any remedial action involving a material
expenditure is needed to respond to a release of any toxic or hazardous waste
or substance into the environment. Borrower has no material contingent
liability in connection with any release of any toxic or hazardous waste or
substance into the environment.
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 5
IV. CONDITIONS:
1. CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of Bank
to extend any credit contemplated by this letter is subject to fulfillment to
Bank's satisfaction of all of the following conditions:
(a) DOCUMENTATION. Bank shall have received each of the Loan
Documents, duly executed and in form and substance satisfactory to Bank.
(b) FINANCIAL CONDITION. There shall have been no material adverse
change, as determined by Bank, in the financial condition or business of
Borrower, nor any material decline, as determined by Bank, in the market
value of any collateral required hereunder or a substantial or material
portion of the assets of Borrower.
2. CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of Bank to
make each extension of credit requested by Borrower hereunder shall be
subject to the fulfillment to Bank's satisfaction of each of the following
conditions:
(a) COMPLIANCE. The representations and warranties contained herein
and in each of the other Loan Documents shall be true on and as of the date
of the signing of this letter and on the date of each extension of credit by
Bank pursuant hereto, with the same effect as though such representations and
warranties had been made on and as of each such date, and on each such date,
no default hereunder, and no condition, event or act which with the giving of
notice of the passage of time or both would constitute such a default, shall
have occurred and be continuing or shall exist.
(b) DOCUMENTATION. Bank shall have received all additional documents
which may be required in connection with such extension of credit.
V. COVENANTS:
Borrower covenants that so long as Bank remains committed to extend
credit to Borrower pursuant hereto, or any liabilities (whether direct or
contingent, liquidated or unliquidated) of Borrower to Bank under any of the
Loan Documents remain outstanding, and until payment in full of all
obligations of Borrower subject hereto, Borrower shall, unless Bank otherwise
consents in writing:
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 6
1. PUNCTUAL PAYMENT. Punctually pay all principal, interest, fees or
other liabilities due under any of the Loan Documents at the times and place
and in the manner specified therein.
2. ACCOUNTING RECORDS. Maintain adequate books and records in
accordance with generally accepted accounting principles consistently
applied, and permit any representative of Bank, at any reasonable time, to
inspect, audit and examine such books and records, to make copies of the
same, and inspect the properties of Borrower.
3. FINANCIAL STATEMENTS. Provide to Bank all of the following, in
form and detail satisfactory to Bank:
(a) not later than each February 15th, a financial statement of
Borrower, prepared by Borrower, to include balance sheet and income
statement, and within 45 days after filing, but in no event later than each
February 15th, copies of Borrower's filed federal income tax returns for such
year;
(b) from time to time such other information as Bank may reasonably
request.
4. COMPLIANCE. Preserve and maintain all licenses, permits,
governmental approvals, rights, privileges and franchises necessary for the
conduct of its business; and comply with the provisions of all documents
pursuant to which Borrower is organized and/or which govern Borrower's
continued existence and with the requirements of all laws, rules, regulations
and orders of a governmental agency applicable to Borrower and/or its
business.
5. INSURANCE. Maintain and keep in force insurance of the types and
in amounts customarily carried in lines of business similar to that of
Borrower, including but not limited to fire, extended coverage, public
liability, flood, property damage and workers' compensation, with all such
insurance carried with companies and in amounts satisfactory to Bank, and
deliver to Bank from time to time at Bank's request schedules setting forth
all insurance then in effect.
6. FACILITIES. Keep all properties useful or necessary to Borrower's
business in good repair and condition, and from time to time make necessary
repairs, renewals and replacements thereto so that such properties shall be
fully and efficiently preserved and maintained.
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 7
7. TAXES AND OTHER LIABILITIES. Pay and discharge when due any and
all indebtedness, obligations, assessments and taxes, both real or personal,
including without limitation federal and state income taxes and state and
local property taxes and assessments, except (a) such as Borrower may in good
faith contest or as to which a bona fide dispute may arise, and (b) for which
Borrower has made provision, to Bank's satisfaction, for eventual payment
thereof in the event that Borrower is obligated to make such payment.
8. LITIGATION. Promptly give notice in writing to Bank of any
litigation pending or threatened against Borrower with a claim in excess of
$100,000.00.
VI. DEFAULT, REMEDIES:
1. DEFAULT, REMEDIES. Upon the violation of any term or condition of
any of the Loan Documents, or upon the occurrence of any default or defined
event of default under any of the Loan Documents: (a) all indebtedness of
Borrower under each of the Loan Documents, any term thereof to the contrary
notwithstanding, shall at Bank's option and without notice become immediately
due and payable without presentment, demand, protest or notice of dishonor,
all of which are expressly waived by Borrower; (b) the obligation, if any, of
Bank to extend any further credit under any of the Loan Documents shall
immediately cease and terminate; and (c) Bank shall have all rights, powers
and remedies available under each of the Loan Documents, or accorded by law,
including without limitation the right to resort to any or all security for
any credit extended by Bank to Borrower under any of the Loan Documents and
to exercise any or all of the rights of a beneficiary or secured party
pursuant to the applicable law. All rights, powers and remedies of Bank may
be exercised at any time by Bank and from time to time after the occurrence
of any such breach or default, are cumulative and not exclusive, and shall be
in addition to any other rights, powers or remedies provided by law or equity.
2. NO WAIVER. No delay, failure or discontinuance of Bank in
exercising any right, power or remedy under any of the Loan Documents shall
affect or operate as a waiver of such right, power or remedy; nor shall any
single or partial exercise of any such right, power or remedy preclude, waive
or otherwise affect any other or further exercise thereof or the exercise of
any other right, power or remedy. Any waiver, permit, consent or approval of
any kind by Bank of any breach of or default under any of the Loan Documents
must be in writing and shall be effective only to the extent set forth in
such writing.
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 8
VII. MISCELLANEOUS:
1. NOTICES. All notices, requests and demands which any party is
required or may desire to give to any other party under any provision of this
letter must be in writing delivered to each party at its address first set
forth above, or to such other address as any party may designate by written
notice to all other parties. Each such notice, request and demand shall be
deemed given or made as follows: (a) if sent by hand delivery, upon delivery;
(b) if sent by mail, upon the earlier of the date of receipt or three (3)
days after deposit in the U.S. mail, first class and postage prepaid; and (c)
if sent by telecopy, upon receipt.
2. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay to Bank
immediately upon demand the full amount of all payments, advances, charges,
costs and expenses, including reasonable attorneys' fee (to include outside
counsel fees and all allocated costs of Bank's in-house counsel), expended or
incurred by Bank in connection with (a) the negotiation and preparation of
this letter and the other Loan Documents, Bank's continued administration
hereof and thereof, and the preparation of amendments and waivers hereto and
thereto, (b) the enforcement of Bank's rights and/or the collection of any
amounts which become due to Bank under any of the Loan Documents, and (c) the
prosecution or defense of any action in any way related to any of the Loan
Documents, including without limitation, any action for declaratory relief,
whether incurred at the trial or appellate level, in an arbitration
proceeding or otherwise, and including any of the foregoing incurred in
connection with any bankruptcy proceeding (including without limitation, any
adversary proceeding, contested matter or motion brought by Bank or any other
person) relating to any Borrower or any other person or entity.
3. SUCCESSORS, ASSIGNMENT. This letter shall be binding upon and
inure to the benefit of the heirs, executors, administrators, legal
representatives, successors and assigns of the parties; provided however,
that Borrower may not assign or transfer its interest hereunder without
Bank's prior written consent. Bank reserves the right to sell, assign,
transfer, negotiate or grant participations in all or any part of, or any
interest in, Bank's rights and benefits under each of the Loan Documents. In
connection therewith Bank may disclose all documents and information which
Bank now has or hereafter may acquire relating to any credit extended by Bank
to Borrower, Borrower or its business, or any collateral required hereunder.
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 9
4. ENTIRE AGREEMENT; AMENDMENT. This letter and the other Loan
Documents constitute the entire agreement between Borrower and Bank with
respect to any extension of credit by Bank subject hereto and supersede all
prior negotiations, communications, discussions and correspondence concerning
the subject matter hereof. This letter may be amended or modified only in
writing signed by each party hereto.
5. NO THIRD PARTY BENEFICIARIES. This letter is made and entered into
for the sole protection and benefit of the parties hereto and their
respective permitted successors and assigns, and no other person or entity
shall be a third party beneficiary of, or have any direct or indirect cause
of action or claim in connection with, this letter or any other of the Loan
Documents to which it is not a party.
6. SEVERABILITY OF PROVISIONS. If any provision of this letter shall
be prohibited by or invalid under applicable law, such provision shall be
ineffective only to the extent of such prohibition or invalidity without
invalidating the remainder of such provision or any remaining provisions of
this letter.
7. GOVERNING LAW. This letter shall be governed by and construed in
accordance with the laws of the State of California.
8. ARBITRATION.
(a) ARBITRATION. Upon the demand of any party, any Dispute shall be
resolved by binding arbitration (except as set forth in (e) below) in
accordance with the terms of this letter. A "Dispute" shall mean any action,
dispute, claim or controversy of any kind, whether in contract or tort,
statutory or common law, legal or equitable, now existing or hereafter
arising under or in connection with, or in any way pertaining to, any of the
Loan Documents, or any past, present or future extensions of credit and other
activities, transactions or obligations of any kind related directly or
indirectly to any of the Loan Documents, including without limitation, any of
the foregoing arising in connection with the exercise of any self-help,
ancillary or other remedies pursuant to any of the Loan Documents. Any party
may by summary proceedings bring an action in court to compel arbitration of
a Dispute. Any party who fails or refuses to submit to arbitration following
a lawful demand by any other party shall bear all costs and expenses incurred
by such other party in compelling arbitration of any Dispute.
(b) GOVERNING RULES. Arbitration proceedings shall be administered by
the American Arbitration Association ("AAA") or such other administrator as
the parties shall mutually agree upon
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 10
in accordance with the AAA Commercial Arbitration Rules. All Disputes
submitted to arbitration shall be resolved in accordance with the Federal
Arbitration Act (Title 9 of the United States Code), notwithstanding any
conflicting choice of law provision in any of the Loan Documents. The
arbitration shall be conducted at a location in California selected by the
AAA or other administrator. If there is any inconsistency between the terms
hereof and any such rules, the terms and procedures set forth herein shall
control. All statutes of limitation applicable to any Dispute shall apply to
any arbitration proceeding. All discovery activities shall be expressly
limited to matters directly relevant to the Dispute being arbitrated.
Judgment upon any award rendered in an arbitration may be entered in any
court having jurisdiction; provided however, that nothing contained herein
shall be deemed to be a waiver by any party that is a bank of the protections
afforded to it under 12 U.S.C. Section 91 or any similar applicable state law.
(c) NO WAIVER; PROVISIONAL REMEDIES, SELF-HELP AND FORECLOSURE. No
provision hereof shall limit the right of any party to exercise self-help
remedies such as setoff, foreclosure against or sale of any real or personal
property collateral or security, or to obtain provisional or ancillary
remedies, including without limitation injunctive relief, sequestration,
attachment, garnishment or the appointment of a receiver, from a court of
competent jurisdiction before, after or during the pendency of any
arbitration or other proceeding. The exercise of any such remedy shall not
waive the right of any party to compel arbitration or reference hereunder.
(d) ARBITRATOR QUALIFICATIONS AND POWERS; AWARDS. Arbitrators must be
active members of the California State Bar or retired judges of the state or
federal judiciary of California, with expertise in the substantive law
applicable to the subject matter of the Dispute. Arbitrators are empowered to
resolve Disputes by summary rulings in response to motions filed prior to the
final arbitration hearing. Arbitrators (i) shall resolve all Disputes in
accordance with the substantive law of the state of California, (ii) may
grant any remedy or relief that a court of the state of California could
order or grant within the scope hereof and such ancillary relief as is
necessary to make effective any award, and (iii) shall have the power to
award recovery of all costs and fees, to impose sanctions and to take such
other actions as they deem necessary to the same extent a judge could
pursuant to the Federal Rules of Civil Procedure, the California Rules of
Civil Procedure or other applicable law. Any Dispute in which the amount in
controversy is $5,000,000 or less shall be decided by a single arbitrator who
shall not render an award of greater than $5,000,000 (including damages,
costs, fees
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 11
and expenses). By submission to a single arbitrator, each party expressly
waives any right or claim to recover more than $5,000,000. Any Dispute in
which the amount in controversy exceeds $5,000,000 shall be decided by
majority vote of a panel of three arbitrators; provided however, that all
three arbitrators must actively participate in all hearings and deliberations.
(e) JUDICIAL REVIEW. Notwithstanding anything herein to the contrary,
in any arbitration in which the amount in controversy exceeds $25,000,000,
the arbitrators shall be required to make specific, written findings of fact
and conclusions of law. In such arbitrations (i) the arbitrators shall not
have the power to make any award which is not supported by substantial
evidence or which is based on legal error, (ii) an award shall not be binding
upon the parties unless the findings of fact are supported by substantial
evidence and the conclusions of law are not erroneous under the substantive
law of the state of California, and (iii) the parties shall have in addition
to the grounds referred to in the Federal Arbitration Act for vacating,
modifying or correcting an award the right to judicial review of (A) whether
the findings of fact rendered by the arbitrators are supported by substantial
evidence, and (B) whether the conclusions of law are erroneous under the
substantive law of the state of California. Judgment confirming an award in
such a proceeding may be entered only if a court determines the award is
supported by substantial evidence and not based on legal error under the
substantive law of the state of California.
(f) REAL PROPERTY COLLATERAL; JUDICIAL REFERENCE. Notwithstanding
anything herein to the contrary, no Dispute shall be submitted to arbitration
if the Dispute concerns indebtedness secured directly or indirectly, in whole
or in part, by any real property unless (i) the holder of the mortgage, lien
or security interest specifically elects in writing to proceed with the
arbitration, or (ii) all parties to the arbitration waive any rights or
benefits that might accrue to them by virtue of the single action rule
statute of California, thereby agreeing that all indebtedness and obligations
of the parties, and all mortgages, liens and security interests securing such
indebtedness and obligations, shall remain fully valid and enforceable. If
any such Dispute is not submitted to arbitration, the Dispute shall be
referred to a referee in accordance with California Code of Civil Procedure
Section 638 et seq., and this general reference agreement is intended to be
specifically enforceable in accordance with said Section 638. A referee with
the qualifications required herein for arbitrators shall be selected pursuant
to the AAA's selection procedures.
<PAGE>
Michael J. Dubelko
February 11, 1998
Page 12
Judgment upon the decision rendered by a referee shall be entered in the
court in which such proceeding was commenced in accordance with California
Code of Civil Procedure Sections 644 and 645.
(g) MISCELLANEOUS. To the maximum extent practicable, the AAA, the
arbitrators and the parties shall take all action required to conclude any
arbitration proceeding within 180 days of the filing of the Dispute with the
AAA. No arbitrator or other party to an arbitration proceeding may disclose
the existence, content or results thereof, except for disclosures of
information by a party required in the ordinary course of its business, by
applicable law or regulation, or to the extent necessary to exercise any
judicial review rights set forth herein. If more than one agreement for
arbitration by or between the parties potentially applies to a Dispute, the
arbitration provision most directly related to the Loan Documents or the
subject matter of the Dispute shall control. This arbitration provision shall
survive termination, amendment or expiration of any of the Loan Documents or
any relationship between the parties.
Your acknowledgment of this letter shall constitute acceptance of the
foregoing terms and conditions. Bank's commitment to extend any credit to
Borrower pursuant to the terms of this letter shall terminate on March 15,
1998, unless this letter is acknowledged by Borrower and returned to Bank on
or before that date.
Sincerely,
WELLS FARGO BANK,
NATIONAL ASSOCIATION
By: /s/ KATIE MILLER
-----------------------------------
Katie Miller
Vice President
Acknowledged and accepted as of 2/26/98.
-------
/s/ MICHAEL J. DUBELKO
- ------------------------------
MICHAEL J. DUBELKO
<PAGE>
STANDBY LETTER OF CREDIT AGREEMENT
In consideration of Wells Fargo Bank, National Association, at the request and
for the account of Applicant issuing a standby letter of credit pursuant to
the Application for Standby Letter of Credit on the front of this Agreement
and pursuant to the terms and conditions of this Agreement, Applicant hereby
agrees that the terms and conditions hereinafter set forth shall apply to the
Application, to the Credit issued by Wells Fargo pursuant to the Application,
to the issuance of the Credit, and to transactions under the Application, the
Credit and this Agreement.
SECTION 1. DEFINITIONS. As used in this Agreement, the following terms
shall have the meanings set forth after each term: "Agreement" shall mean
this Standby Letter of Credit Agreement as it may be revised or amended from
time to time pursuant to its terms. "Applicant" shall mean the person or
persons or the entity or entities signing the Application. "Application"
shall mean the Application for Standby Letter of Credit on the front of this
Agreement and/or an application for amendment of the Credit or any
combination of such applications, as the context may require. "Beneficiary"
shall mean the person or entity named on the Application as the beneficiary
or any person or entity who is the transferee of such beneficiary.
"Collateral" shall mean the Property, together with the proceeds of such
Property, securing any or all the obligations and liabilities of Applicant to
Wells Fargo at any time existing under or in connection with any Letter of
Credit Document and/or any Loan Document. "Commission Fee" shall mean the
fee, computed at the commission fee rate specified by Wells Fargo, charged
by Wells Fargo at the time or times specified by Wells Fargo on the amount of
the Credit and on the amount of each increase in the Credit for the time
period the Credit is outstanding. "Credit" shall mean an instrument or
document titled "Irrevocable Standby Letter of Credit" or "Irrevocable
Standby Credit", or an instrument or document whatever it is titled or
whether or not it is titled functioning as a standby letter of credit, issued
under or pursuant to the Application, and all renewals, extensions and
amendments of such instrument or document. "Demand" small mean any draft,
electronic or telegraphic transmission or other written demand drawn or made,
or purported to be drawn or made, under or in connection with the Credit.
"Document" shall mean any instrument, statement, certificate or other
document referred to in or related to the Credit or required by the Credit to
be presented with any Demand. "Dollars" shall mean the lawful currency at any
time for the payment of public or private debts in the United States of
America. "Event of Default" shall mean any of the events set forth in Section
13 of this Agreement. "Expiration Date" shall mean the date the Credit
expires. "Guarantor" shall mean any person or entity guaranteeing the payment
and/or performance of any or all the obligations of Applicant to Wells Fargo
under or in connection with any Letter of Credit Document and/or any Loan
Document. "Holding Company" shall mean any company or other entity
controlling Wells Fargo. "Letter of Credit Document" shall mean this
Agreement, the Application, the Credit and each Demand. "Loan Document" shall
mean each and any promissory note, credit agreement, loan agreement, security
agreement, pledge agreement, guarantee or other agreement or writing signed
by Wells Fargo and/or Applicant and/or any Guarantor relating to, evidencing
or guaranteeing any loan or other extension of credit made by Wells Fargo to
Applicant under or in connection with any Letter of Credit Document.
"Negotiation Fee" shall mean the fee, computed at the negotiation fee rate
specified by Wells Fargo, charged by Wells Fargo on the amount of each Demand
when each Demand is honored. "Payment Office" shall mean such office of Wells
Fargo specified by Wells Fargo as the office where reimbursements and other
payments under or in connection with any Letter of Credit Documents are to be
made by Applicant. "Prime Rate" shall mean the rate of interest most recently
announced at Wells Fargo's principal office in San Francisco, California as
its Prime Rate, with the understanding that the Prime Rate is one of Wells
Fargo's base rates and serves as the basis upon which effective rates of
interest are calculated for these loans making references thereto, and is
evidenced by the recording thereof after its announcement in such internal
publication or publications as Wells Fargo may designate. "Property" shall
mean all forms of property, whether tangible or intangible, real, personal or
mixed. "Rate of Exchange" shall mean Wells Fargo's then current selling rate
of exchange in San Francisco, California for sales of currency of payment of
any Demand, or of any fees or expenses or other amounts payable under this
Agreement, for cable transfer to the country of which such currency is the
legal tender. "UCP" shall mean the Uniform Customs and Practice for
Documentary Credits, an international Chamber of Commerce publication or any
substitution therefor or replacement thereof. "Unpaid and Undrawn Balance"
shall mean at any time and from time to time the entire amount which has not
been paid by Wells Fargo under the Credit, including, but not limited to, the
amount of each Demand on which Wells Fargo has not yet effected payment as
well as the amount undrawn under the Credit. "Wells Fargo" shall mean Wells
Fargo Bank, National Association, a national banking association.
SECTION 2. HONORING DEMANDS AND DOCUMENTS. Applicant agrees that Wells
Fargo may receive, accept and honor, as complying with the terms of the
Credit, any Demand and any Documents accompanying such Demand; provided,
however, that (a) such Demand and accompanying Documents appear on their face
to comply substantially with the provisions of the Credit, and (b) such
Demand and accompanying Documents are, or appear on their face to be, signed
or issued by (i) a person or entity authorized under the Credit to draw, sign
or issue such Demand and such accompanying Documents, or (ii) an
administrator, executor, trustee in bankruptcy, debtor in possession,
assignee for the benefit of creditors, liquidator, receiver or other legal
representative or successor in interest by operation of law of any such
person or entity.
SECTION 3. REIMBURSEMENT FOR PAYMENT OF DEMANDS. Applicant agrees to
reimburse Wells Fargo for all amounts paid by Wells Fargo on each Demand,
including, but not limited to, all amounts paid by Wells Fargo on each Demand
to any paying, negotiating or other bank. If in connection with the issuance
of the Credit, Wells Fargo agrees to pay any other bank the amount of any
payment or negotiation made by such other bank under the Credit upon receipt
by Wells Fargo of a cable, telex or other written telecommunication advising
Wells Fargo of such payment or negotiation, or authorizes any other bank to
debit Wells Fargo's account for the amount of such payment or negotiation,
Applicant agrees to reimburse Wells Fargo for all such amounts paid by Wells
Fargo, or debited to Wells Fargo's account with such other bank, even if any
Demand or Document specified in the Credit fails to arrive in whole or in
part or if, upon the arrival of any such Demand or Document, the terms of the
Credit have not been complied with or such Demand or Document does not
conform to the requirements of the Credit or is not otherwise in order.
SECTION 4. FEES AND EXPENSES. Applicant agrees to pay to Wells Fargo
(a) all Commission Fees, Negotiation Fees, cable fees, amendment fees,
non-issuance fees and cancellation fees of, and all out-of-pocket expenses
incurred by, Wells Fargo under or in connection with any Letter of Credit
Document and (b) all fees and charges of banks other than Wells Fargo under
or in connection with any Letter of Credit Document if the Application (i)
does not indicate who will pay such fees and charges, (ii) indicates that
such fees and charges are to be paid by Applicant, or (iii) indicates that
such fees and charges are to be paid by the Beneficiary and the Beneficiary
does not, for any reason whatsoever, pay such fees or charges. There shall be
no refund of any portion of any Commission Fee in the event the Credit is
used, reduced, amended, modified or terminated before its Expiration Date.
SECTION 5. DEFAULT INTEREST. Unless otherwise specified in any Loan
Document or on the Application and agreed to by Wells Fargo, all amounts to
be reimbursed by Applicant to Wells Fargo pursuant to Section 3 of this
Agreement and all fees and expenses to be paid by Applicant to Wells Fargo
pursuant to Section 4 of this Agreement, and all other amounts due from
Applicant to Wells Fargo under or in connection with the Letter of Credit
Documents, will bear interest (to the extent permitted by law), payable on
demand, from the date Wells Fargo paid the amounts to be reimbursed or the
date such fees, expenses and other amounts were due until such amounts are
reimbursed in full or such fees, expenses and other amounts are paid in full,
at that interest rate per annum, calculated for the actual days elapsed in a
year of 360 days, which is two percent (2%) above the Prime Rate in effect
from time to time.
SECTION 6. TIME AND METHOD OF REIMBURSEMENT AND PAYMENT. Unless
otherwise specified in this Section 6, in any Loan Document or on the
Application and agreed to by Wells Fargo, all amounts to be reimbursed by
Applicant to Wells Fargo pursuant to Section 3 of this Agreement, all fees
and expenses to be paid by Applicant to Wells Fargo pursuant to Section 4 of
this Agreement, all interest due to Wells Fargo pursuant to Section 5 of this
Agreement, and all other amounts due to Wells Fargo from Applicant under or
in connection with the Letter of Credit Documents will be reimbursed or paid
at the Payment Office in Dollars in immediately available funds without
setoff or counterclaim on demand or, at Wells Fargo's option, by Wells Fargo
debiting any of Applicant's accounts with Wells Fargo without presentment,
protest, demand for reimbursement or payment, notice of dishonor or any other
notice whatsoever all of which are hereby expressly waived by Applicant. Such
debit will be made (a) at the time each Demand is paid by Wells Fargo or, if
earlier, at the time each amount is paid by Wells Fargo to any paying,
negotiating or other bank, (b) at the time each fee and expense referenced in
Section 4 of this Agreement is to be paid, (c) at the time interest is due to
Wells Fargo pursuant to Section 5 of this Agreement, and (d) at the time each
other amount is due under or in connection with the Letter of Credit
Documents. If any Demand or any fee, expense, interest or other amount
payable under or in connection with the Letter of Credit Documents is payable
in a currency other than Dollars, Applicant agrees to reimburse Wells Fargo
for all amounts paid by Wells Fargo on such Demand, and/or to pay Wells Fargo
all such fees, expenses, interest and other amounts, in one of the three
following ways, as determined by Wells Fargo in its sole discretion in each
case, (i) at such place as Wells Fargo shall direct, in such other currency,
or (ii) at the Payment Office in the Dollar equivalent of the amount of such
other currency calculated at the Rate of Exchange on the date determined by
Wells Fargo in its sole discretion, or (iii) at the Payment Office in the
Dollar equivalent, as determined by Wells Fargo (which determination shall be
deemed correct absent manifest errors) of such fees, expenses, interest or
other amounts or of the actual cost to Wells Fargo of paying such Demand.
SECTION 7. AGREEMENTS OF APPLICANT. Applicant agrees that (a) unless
otherwise specifically provided in any Loan Document, Wells Fargo shall not
be obligated to issue any other letter of credit for the account of Applicant
or to make other extensions of credit to Applicant or in any other manner to
extend any financial consideration to Applicant; (b) Wells Fargo may, as
Wells Fargo deems appropriate, modify or alter and use in the Credit the
terminology contained on the Application; (c) Wells Fargo has not given
Applicant any legal or other advice with regard to any Letter of Credit
Document or Loan Document; (d) if Wells Fargo at any time discusses with
Applicant the wording for the Credit, any such discussion will not constitute
legal or other advice by Wells Fargo or any representation or warranty of
Wells Fargo that any wording or the Credit will satisfy Applicant's needs;
(e) Applicant is responsible for the wording of the Credit, including, but
not limited to, any drawing conditions, and will not rely on Wells Fargo in
any way in connection with the wording of the Credit or the structuring of
any transaction related to the Credit; (f) Applicant and not Wells Fargo is
responsible for entering into the contracts relating to the Credit between
Applicant and the Beneficiary and for causing the Credit to be issued; (g)
unless the Application specifies whether the Documents to be presented with a
Demand under the Credit must be sent to Wells Fargo in one parcel or in two
parcels or may be sent to Wells Fargo in any number of parcels, Wells Fargo
may, if it so desires, make such determination and specify in the Credit
whether such Documents must be sent in one parcel or two parcels or may be
sent in any number of parcels; (h) Wells Fargo shall not be deemed the agent
of Applicant, the Beneficiary or any other user of the Credit, and neither
Applicant nor the Beneficiary nor any other user of the Credit shall be
deemed an agent of Wells Fargo; (i) Applicant will promptly examine all
Documents and the Credit if and when they are delivered to Applicant by Wells
Fargo and, in the event of any claim of noncompliance of any Documents or the
Credit with Applicant's instructions or the Application, or in the event of
any other irregularity, will promptly notify Wells Fargo in writing of such
noncompliance or irregularity, Applicant being conclusively deemed to have
waived any such claim of noncompliance or irregularity unless such notice is
given promptly; (j) all directions and correspondence relating to any Letter
of Credit Document are to be sent at the risk of Applicant; (k) if the Credit
has a provision concerning the automatic extension of the Expiration Date of
the Credit, Wells Fargo may, at its sole option, give notice of nonrenewal of
the Credit and if Applicant does not at any time want the Credit to be
renewed Applicant will so notify Wells Fargo at least fifteen (15) calendar
days before Wells Fargo is to notify the Beneficiary of the Credit or any
advising bank of such nonrenewal pursuant to the terms of the Credit; (l)
Applicant will not seek to obtain, apply for, or acquiesce in any temporary
restraining order, restraining order, preliminary injunction, permanent
injunction or any type of pretrial or permanent injunctive relief or any
similar relief, however named, restraining, prohibiting or enjoining Wells
Fargo, any of Wells Fargo's correspondents or any advising, confirming,
negotiating, paying or other bank from paying or negotiating any Demand or
honoring any other obligation under or in connection with the Credit; and (m)
except for any of Applicant's obligations which are specifically affected by
the actions referred to in subsection (vi) of this Section 7(m), Applicant's
obligations under or in connection with each Letter of Credit Document and
each Loan Document shall be absolute, unconditional and irrevocable, and
shall be performed strictly in accordance with the terms of each such Letter
of Credit Document and each such Loan Document under all circumstances
whatsoever, including, but not limited to, the following circumstances and the
circumstances listed in Section 12(b) through (s) of this Agreement: (i) any
lack of validity or enforceability of any Letter of Credit Document, any Loan
Document, any Document or any agreement relating to any Letter of Credit
Document, any Loan Document, or any Document; (ii) any amendment of or waiver
relating to, or any consent to or departure from, any Letter of Credit
Document, any Loan Document, or any Document; (iii) any release or
substitution at any time of any Property which may be held as Collateral;
(iv) the existence of any claim, set-off, defense or other right which
Applicant may have at any time against Wells Fargo or the Beneficiary (or any
person or entity for whom the Beneficiary may be acting or any other person
or entity, whether under or in connection with any Letter of Credit Document,
any Loan Document, any Document or any Property referred to in or
<PAGE>
related to any Letter of Credit Document, any Loan Document or any Document
or under or in connection with any unrelated transaction; (v) any breach of
contract or other dispute between or among any two or more of Applicant,
Wells Fargo, the Beneficiary, any transferee of the Beneficiary, any person
or entity for whom the Beneficiary or any transferee of the Beneficiary may
be acting, or any other person or entity; or (vi) any delay, extension of
time, renewal, compromise or other indulgence granted or agreed to by Wells
Fargo with or without notice to, or approval by, Applicant in respect of any
of Applicant's Indebtedness or other obligations to Wells Fargo under or in
connection with any Letter of Credit Document or any Loan Document.
SECTION 8. COMPLIANCE WITH LAWS AND REGULATIONS. Applicant represents and
warrants to Wells Fargo that the Application, the Credit and the transactions
under the Application and/or the Credit will not contravene any law or
regulation of the government of the United States or any state thereof.
Applicant agrees (a) to comply with all federal, state and foreign exchange
regulations and other government laws and regulations now or hereafter
applicable to any Letter of Credit Document, to any payments under or
in connection with any Letter of Credit Document, or to each transaction
under or in connection with any Letter of Credit Document, and (b) to
reimburse Wells Fargo for such amounts as Wells Fargo may be required to
expend as a result of such laws or regulations, any change in such laws or
regulations or any change in the interpretation of such laws or regulations
by any court or administrative or government authority charged with the
administration of such laws or regulations.
SECTION 9. TAXES, RESERVES AND CAPITAL ADEQUACY REQUIREMENTS. In addition
to, and notwithstanding, any other provision of any Letter of Credit Document
or any Loan Document, in the event that any law, treaty, rule, regulation,
guideline, request, order, directive or determination (whether or not having
the force of law) of or from any government authority, including, but not
limited to, any court, central bank or government regulatory authority, or
any change therein or in the interpretation or application thereof, (a) does
or shall subject Wells Fargo to any tax of any kind whatsoever with respect
to the Letter of Credit Documents or the Loan Documents, or change the basis
of taxation of payments to Wells Fargo of any amount payable thereunder
(except for changes in the rate of tax on the net income of Wells Fargo); or
(b) does or shall impose, modify or hold applicable any reserve, special
deposit assessment, compulsory loan, Federal Deposit Insurance Corporation
insurance or similar requirement against assets held by, deposits or other
liabilities in or for the account of, advances or loans by, other credit
extended by or any other acquisition of funds by, any office of Wells Fargo;
or (c) does or shall impose, modify or hold applicable any capital adequacy
requirements (whether or not having the force of law); or (d) does or shall
impose on Wells Fargo any other condition; and the result of any of the
foregoing is (i) to increase the cost to Wells Fargo of issuing or
maintaining the Credit or of performing any transaction under any Letter of
Credit Document or any Loan Document, or (ii) to reduce any amount receivable
by Wells Fargo under any Letter of Credit Document or any Loan Document, or
(iii) to reduce the rate of return on the capital of Wells Fargo or the
Holding Company to a level below that which Wells Fargo or the Holding
Company could have achieved but for any imposition, modification or
application of any capital adequacy requirement (taking into consideration
the policy of Wells Fargo or the Holding Company, as the case may be, with
respect to capital adequacy), and any such increase or reduction is material
(as determined by Wells Fargo in its sole discretion); then, in any such
case, Applicant agrees to pay to Wells Fargo such amount or amounts as may be
necessary to compensate Wells Fargo or the Holding Company for (1) any such
additional cost, (2) any reduction in the amount received by Wells Fargo
under any Letter of Credit Document or any Loan Document, or (3) to the
extent allocable (as determined by Wells Fargo in its sole discretion) to any
Letter of Credit Document or any Loan Document, any reduction in the rate of
return on the capital of Wells Fargo or the Holding Company.
SECTION 10. COLLATERAL. In addition to, and not in substitution for, any
Property delivered, conveyed, transferred or assigned to Wells Fargo under
any Loan Document as security for any or all of the obligations and
liabilities of Applicant to Wells Fargo at any time existing under or in
connection with any Letter of Credit Document or any Loan Document, Applicant
grants to Wells Fargo a security interest in and to the following Collateral,
whether or not any such Collateral is in Wells Fargo's possession or control
or in the possession or control of Wells Fargo's agents or correspondents or
in transit to, or set apart for, Wells Fargo or any of Wells Fargo's agents
or correspondents, until such time as all the obligations and liabilities of
Applicant to Wells Fargo at any time existing under or in connection with
each Letter of Credit Document and each Loan Document have been fully paid
and discharged, all as security for such obligations and liabilities: (a) all
the property, claims, demands, right, title and interest of Applicant in and
to the balance of every deposit account of Applicant with Wells Fargo now or
at any time hereafter existing, and all evidences of such deposit accounts,
(b) all Property belonging to Applicant or in which Applicant may have an
interest, now or at any time hereafter delivered, conveyed, transferred,
assigned, pledged or paid to Wells Fargo or its agents or correspondents in
any manner whatsoever, whether as security or for safekeeping or otherwise,
including, but not limited to, any items received for collection or
transmission, and the proceeds of such items, whether or not such Property is
in whole or in part released to Applicant on trust or bailee receipt or
otherwise, and (c) where more than one person or entity is an Applicant, all
right, title and interest of each Applicant in and to all the Property which
any Applicant may now or hereafter obtain as security for the obligations of
the other Applicants or Applicant to such Applicant arising under or in
connection with the transaction to which the Credit relates. Further, in
addition to, and not in substitution for, any Property delivered, conveyed,
transferred or assigned to Wells Fargo under any Loan Document as security
for any or all of the obligations and liabilities of Applicant to Wells Fargo
at any time existing under or in connection with any Letter of Credit
Document or any Loan Document, Applicant agrees to deliver, convey, transfer
and assign to Wells Fargo, on demand, as security, Property of a value and
character satisfactory to Wells Fargo (x) if Wells Fargo at any time feels
insecure about Applicant's ability or willingness to repay any amounts which
Wells Fargo has paid or may pay in the future on any Demand or in honoring
any other obligation of Wells Fargo under or in connection with the Credit, or
(y) without limiting the generality of the foregoing subsection (x), if any
temporary restraining order, restraining order, preliminary injunction,
permanent injunction or any type of pretrial or permanent injunctive relief
or any similar relief, however named, is obtained restraining, prohibiting or
enjoining Wells Fargo, any of Wells Fargo's correspondents or any advising,
confirming, negotiating, paying or other bank from paying or negotiating any
Demand or honoring any other obligation under or in connection with the
Credit. Applicant agrees that the receipt by Wells Fargo or any of Wells
Fargo's agents or correspondents at any time of any kind of security,
including, but not limited to, cash, shall not be deemed a waiver of any of
Wells Fargo's rights or powers under this Agreement. Applicant agrees to sign
and deliver to Wells Fargo on demand of Wells Fargo all such deeds of trust,
security agreements, financing statements and other documents as Wells Fargo
shall at any time request which are necessary or desirable (in the sole
opinion of Wells Fargo) to grant to Wells Fargo an effective and perfected
security interest in and to any or all of the Collateral. Applicant agrees to
pay all filing and recording fees related to the perfection of any security
interest granted to Wells Fargo in accordance with this Section 10. Applicant
hereby agrees that any or all of the Collateral may be held and disposed of
by Wells Fargo as provided in this Agreement. Upon any transfer, sale,
delivery, surrender or endorsement of any Document or Property which is or
was part of the Collateral, Applicant will indemnify and hold Wells Fargo and
Wells Fargo's agents and correspondents harmless from and against each and
every claim, demand, action or suit which may arise against Wells Fargo or
any such agent or correspondent by reason of such transfer, sale delivery,
surrender or endorsement.
SECTION 11. INDEMNIFICATION. Except to the extent caused by Wells
Fargo's lack of good faith, and notwithstanding any other provision of this
Agreement, Applicant agrees to reimburse and indemnify Wells Fargo for (a)
all amounts paid by Wells Fargo to the Beneficiary under or in connection
with any guarantee or similar undertaking issued by the Beneficiary to a
third party at the request of Applicant, whether such request is communicated
directly by Applicant or through Wells Fargo to the Beneficiary, and (b) all
damages, losses, liabilities, actions, claims, suits, penalties, judgments,
obligations, costs or expenses, of any kind whatsoever and howsoever caused,
including, but not limited to, attorneys' fees and interest, paid, suffered
or incurred by, or imposed upon, Wells Fargo directly or indirectly arising
out of or in connection with (i) any Letter of Credit Document, any Loan
Document, any Document or any Property referred to in or related to the
Credit; (ii) the issuance of the Credit; (iii) any transfer of the Credit;
(iv) any guarantee or similar undertaking, or any transactions thereunder,
issued by the Beneficiary to a third party at the request of Applicant,
whether such request is communicated directly by Applicant or through Wells
Fargo to the Beneficiary; (v) any communication made by Wells Fargo, on the
instructions of Applicant, to the Beneficiary requesting that the Beneficiary
issue a guarantee or similar undertaking to a third party or the issuance of
any such guarantee or similar undertaking; (vi) the collection of any amounts
owed to Wells Fargo by Applicant under or in connection with any Letter of
Credit Document or any Loan Document; (vii) the foreclosure against, or other
enforcement of, any Collateral; (viii) the protection, exercise or
enforcement of Wells Fargo's rights and remedies under or in connection with
any Letter of Credit Document or any Loan Document; (ix) any court decrees or
orders, including, but not limited to, temporary restraining orders,
restraining orders, preliminary injunctions, permanent injunctions or any
type of pretrial or permanent injunctive relief or any similar relief,
however named, restraining, prohibiting or enjoining or seeking to restrain,
prohibit or enjoin Wells Fargo, any of Wells Fargo's correspondents or any
advising, confirming, negotiating, paying or other bank from paying or
negotiating any Demand or honoring any other obligation under or in
connection with the Credit; or (x) the Credit being governed by laws or rules
other than the UCP in effect on the date the Credit is issued. The indemnity
provided in this Section 11 will survive the termination of this Agreement
and the expiration or cancellation of the Credit.
SECTION 12. LIMITATION OF LIABILITY. Notwithstanding any other
provision of this Agreement, neither Wells Fargo nor any of its agents or
correspondents will have any liability to Applicant for any action, neglect or
omission, if done in good faith, under or in connection with any Letter of
Credit Document, Loan Document or the Credit, including, but not limited to,
the issuance or any amendment of the Credit, the failure to issue or amend
the Credit, or the honoring or dishonoring of any Demand under the Credit,
and such good faith action, neglect or omission will bind the Applicant.
Notwithstanding any other provision of any Letter of Credit Document, in no
event shall Wells Fargo, its officers or directors be liable or responsible,
regardless of whether any claim is based on contract or tort, or (a) any
special, consequential, indirect or incidental damages, including, but not
limited to, lost profits, arising out of or in connection with the issuance
of the Credit or any action taken by Wells Fargo in connection with any
Letter of Credit Document, any Loan Document or any Document or Property
referred to in or related to the Credit; (b) the honoring of any Demand in
accordance with any order or directive of any court or government or
regulatory body or entity requiring such honor despite any temporary
restraining order, restraining order, preliminary injunction, permanent
injunction or any type of pretrial or permanent injunctive relief or any
similar relief, however named, restraining, prohibiting or enjoining such
honor; (c) the uses which may be made of the Credit; (d) the validity of any
purported transfer of the Credit or the identity of any purported transfers
of the Beneficiary; (e) any acts or omissions of the Beneficiary or any other
user of the Credit; (f) the form, validity, sufficiency, correctness,
genuineness or legal effect of any Demand or any Document, or of any
signatures or endorsements on any Demand or Document, even if any Demand or
any Document should in fact prove to be in any or all respects invalid,
insufficient, fraudulent or forged; (g) the honoring by Wells Fargo of any
Demand when the Demand and any Documents which accompany such Demand appear
on their face to comply substantially with the terms of the Credit or
dishonor by Wells Fargo of any Demand when the Demand and any Documents
which accompany such Demand do not strictly comply on their face with the
terms of the Credit; (h) the failure of any Demand or Document to bear any
reference or adequate reference to the Credit; (i) the failure of any
Document to accompany any Demand; (j) the failure of any person or entity to
note the amount of any Demand on the Credit or on any Document; (k) the
failure of any person or entity to surrender or take up the Credit; (l) the
failure of the Beneficiary to comply with the terms of the Credit or to meet
the obligations of the Beneficiary to Applicant; (m) the failure of any
person or entity to send or forward Documents if and as required by the terms
of the Credit; (n) any errors, inaccuracies, omissions, interruptions or
delays in transmission or delivery of any messages, directions or
correspondence by mail, cable, telegraph, wireless or otherwise, whether or
not they are in cipher; (o) any notice of nonrenewal of the Credit sent by
Wells Fargo not being received on time by the Beneficiary; (p) any
inaccuracies in the translation of any messages, directions or
correspondence; (q) the Beneficiary's use of the proceeds of any Demand; (r)
the Beneficiary's failure to repay to Wells Fargo or Applicant the proceeds
of any Demand if the terms of the Credit require such repayment; (s) any act,
error, neglect, default, negligence, gross negligence, omission, willful
misconduct, lack of good faith, insolvency or failure in business of any of
Wells Fargo's agents or correspondents or of any advising, confirming,
negotiating, paying or other bank. The occurrence of any one or more of the
contingencies referred to in the preceding sentence shall not affect, impair
or prevent the vesting of any of Wells Fargo's rights or powers under this
Agreement or any Loan Document or Applicant's obligation to make
reimbursement or payment to Wells Fargo under this Agreement or any Loan
Document. The provisions of this Section 12 will survive the termination of
this Agreement and any Loan Documents and the expiration or cancellation of
the Credit.
<PAGE>
SECTION 13. EVENTS OF DEFAULT. Applicant agrees that each of the
following shall constitute an Event of Default under this Agreement: (a)
Applicant's or any Guarantor's failure to pay any principal, interest, fee or
other amount when due under or in connection with any Letter of Credit
Document or any Loan Document; (b) Applicant's failure to deliver to Wells
Fargo Property of a value and character satisfactory to Wells Fargo at any
time Wells Fargo has demanded security from Applicant pursuant to Section 10
of this Agreement; (c) the occurrence and continuance of any default or
defined event of default under any Loan Document or any other agreement,
document or instrument signed or made by Applicant or any Guarantor in favor
of Wells Fargo; (d) Applicant's or any Guarantor's failure to perform or
observe any term, covenant or agreement contained in this Agreement or any
Loan Document (other than those referred to in subsections (a), (b) and (c)
of this Section 13), or the breach of any other obligation owed by Applicant
or any Guarantor to Wells Fargo, and any such failure or breach shall be
impossible to remedy or shall remain unremedied for thirty (30) calendar days
after such failure or breach occurs; (e) any representation, warranty or
certification made or furnished by Applicant or any Guarantor under or in
connection with any Letter of Credit Document, any Loan Document or any
Collateral, or as an inducement to Wells Fargo to enter into any Letter of
Credit Document or any Loan Document or to accept any Collateral, shall be
materially false, incorrect or incomplete when made; (f) any material
provision of this Agreement or any Loan Document shall at any time for any
reason cease to be valid and binding on Applicant or any Guarantor, or shall
be declared to be null and void, or the validity or enforceability thereof
shall be contested by Applicant or any Guarantor or any government agency or
authority, or Applicant or any Guarantor shall deny that it has any or
further liability or obligation under this Agreement or any Loan Document;
(g) Applicant's or any Guarantor's failure to pay or perform when due any
indebtedness or other obligation of Applicant or such Guarantor to any person
or entity other than Wells Fargo if such failure gives the payee of such
indebtedness or the beneficiary of the performance of such obligation the
right to accelerate the time of payment of such indebtedness or the
performance of such obligation; (h) any guarantee of, or any security
covering, any indebtedness of Applicant to Wells Fargo arising under or in
connection with any Letter of Credit Document or any Loan Document fails to
be in full force and effect at any time; (i) any adverse change deemed
material by Wells Fargo occurs in the financial condition of Applicant or any
Guarantor; (j) Applicant or any Guarantor suspends the transaction of its
usual business or is expelled or suspended from any exchange; (k) Applicant
or any Guarantor dies or is incapacitated; (l) Applicant or any Guarantor
dissolves or liquidates; (m) Applicant or any Guarantor is generally not
paying its debts as they become due; (n) Applicant or any Guarantor becomes
insolvent, however such insolvency may be evidenced, or makes any general
assignment for the benefit of creditors; (o) a petition is filed by or
against Applicant or any Guarantor seeking the liquidation or reorganization
of Applicant or Guarantor under the Bankruptcy Reform Act, Title 11 of the
United States Code, as amended or recodified from time to time, or a similar
action is brought by or against Applicant or any Guarantor under any federal,
state or foreign law; (p) a proceeding is instituted by or against Applicant
or any Guarantor for any relief under any bankruptcy, insolvency or other law
relating to the relief of debtors, reorganization, readjustment or extension
of indebtedness or composition with creditors; (q) a custodian or a receiver
is appointed for, or a writ or order of attachment, execution or garnishment
is issued, levied or made against, any of the Property or assets of Applicant
or any Guarantor; (r) an application is made by any judgment creditor of
Applicant or any Guarantor for an order directing Wells Fargo to pay over
money or to deliver other Property of Applicant or such Guarantor; or (s) any
government authority or any court takes possession of any substantial part of
the Property or assets of Applicant or any Guarantor or assumes control over
the affairs of Applicant or any Guarantor.
SECTION 14. REMEDIES. Upon the occurrence and continuance of any Event
of Default, all amounts paid by Wells Fargo on any Demand which have not
previously been repaid to Wells Fargo, together with all interest on such
amounts, and the Unpaid and Undrawn Balance, if any, shall automatically be
owing by Applicant to Wells Fargo and shall be due and payable by Applicant
on demand. Applicant agrees that upon payment of the Unpaid and Undrawn
Balance to Wells Fargo Applicant shall have no further legal or equitable
interest therein, and that Wells Fargo will not be required to segregate on
its books or records the Unpaid and Undrawn Balance paid by Applicant. After
Wells Fargo receives the Unpaid and Undrawn Balance, Wells Fargo agrees to
pay to Applicant, upon termination of all of Wells Fargo's liability under
the Credit and all the Demands, a sum equal to the amount which has not been
drawn under the Credit less all amounts due and owing to Wells Fargo from
Applicant under or in connection with the Letter of Credit Documents and the
Loan Documents. Further, upon the occurrence and continuance of any Event of
Default, Wells Fargo may sell immediately, without demand for payment,
advertisement or notice to Applicant, all of which are hereby expressly
waived, any and all Collateral, received or to be received, at private sale
or public auction or at brokers' board or upon any exchange or otherwise, at
Wells Fargo's option, in such parcel or parcels, at such time or times, at
such place or places, for such price or prices and upon such terms and
conditions as Wells Fargo may deem proper, and Wells Fargo may apply the net
proceeds of such sale or sales, together with any deposit balances and any
sums credited by or due from Wells Fargo to Applicant in a general account or
otherwise, to the payment of any and all obligations and liabilities due to
Wells Fargo by Applicant under or in connection with the Letter of Credit
Documents and the Loan Documents, all without prejudice to the rights of
Wells Fargo against Applicant with respect to any and all such obligations
and liabilities which may be or remain unpaid. If any sale pursuant to the
preceding sentence be at brokers' board or at public auction or upon any
exchange, Wells Fargo may itself be a purchaser at such sale free from any
right of redemption, which Applicant hereby expressly waives and releases.
All rights and remedies of Wells Fargo existing under the Letter of Credit
Documents and the Loan Documents are in addition to, and not exclusive of,
any rights or remedies otherwise available to Wells Fargo under applicable
law.
SECTION 15. SETOFF. In addition to any rights now or hereafter granted
under applicable law, and not by way of limitation of any such rights, upon
the occurrence and continuance of any Event of Default, Wells Fargo is hereby
authorized by Applicant at any time or from time to time, without notice to
Applicant or to any other person (any such notice being hereby expressly
waived by Applicant) to set off and to appropriate and to apply any and all
deposits (general or special, including, but not limited to, indebtedness
evidenced by certificates of deposit), whether matured or unmatured, and any
other indebtedness at any time held or owing by Wells Fargo to or for the
credit or the account of Applicant, against and on account of the obligations
and liabilities of Applicant to Wells Fargo under or in connection with any
of the Letter of Credit Documents or the Loan Documents, irrespective of
whether or not Wells Fargo shall have made any demand for payment of any or
all such obligations and liabilities or declared any or all such obligations
and liabilities to be due and payable, and although any or all such
obligations and liabilities shall be contingent or unmatured.
SECTION 16. WAIVERS. Applicant agrees that no delay, extension of
time, renewal, compromise or other indulgence which may occur or be granted
by Wells Fargo under any Letter of Credit Document or any Loan Document from
time to time shall impair Wells Fargo's rights or powers under this Agreement
or the Application. Wells Fargo shall not be deemed to have waived any of its
rights under this Agreement or the Application unless such waiver is in
writing signed by an authorized representative of Wells Fargo. No such
waiver, unless expressly provided in such waiver, shall be effective as to
any transactions which occur subsequent to the date of such waiver, or as to
any continuance of any Event of Default after such waiver. No amendment or
modification of this Agreement shall be effective unless such amendment or
modification is in writing signed by authorized representatives of Wells
Fargo and Applicant.
SECTION 17. AMENDMENTS AND MODIFICATIONS TO THE CREDIT. At the request
or with the consent of Applicant, and without affecting the obligations of
Applicant under this Agreement, Wells Fargo may, but will not be obligated
to, (a) increase the amount of the Credit, (b) extend the time for, and
amend or modify the terms and conditions governing, the making and honoring
of any Demand or Document or any other terms and conditions of the Credit, or
(c) waive the failure of any Demand or Document to comply with the terms of
the Credit. No amendment to, or modification of, the terms of the Credit will
become effective if the Beneficiary or any confirming bank objects to such
amendment or modification. If the Credit is amended or modified in accordance
with this Section 17, Applicant shall be bound by, and obligated under, the
provisions of this Agreement with respect to the Credit as so amended or
modified and any action taken by Wells Fargo or any advising, confirming,
negotiating, paying or other bank in accordance with such amendment or
modification.
SECTION 18. SUCCESSORS AND ASSIGNS. Applicant agrees that the terms
and conditions of this Agreement and the Application shall bind the heirs,
executors, administrators, successors and assigns of Applicant, and that all
rights, benefits and privileges conferred on Wells Fargo under or in
connection with each Letter of Credit Document and each Loan Document shall
be and hereby are extended to, conferred upon and may be enforced by the
successors and assigns of Wells Fargo. Applicant will not assign this
Agreement or Applicant's obligations or liabilities under or in connection
with any Letter of Credit Document or any Loan Document to any person or
entity without the prior written approval of Wells Fargo.
SECTION 19. GOVERNING LAW. This Agreement and the Application, and the
performance by Applicant and Wells Fargo under this Agreement and the
Application, shall be governed by and be construed in accordance with the
laws of the State of California. Unless Wells Fargo otherwise specifically
agrees in writing, the Credit, even if it is not a documentary credit, the
opening of the Credit, the performance by Wells Fargo under the Credit, and
the performance by the Beneficiary and any advising, confirming, negotiating,
paying or other bank under the Credit, shall be governed by and be construed
in accordance with the UCP in force on the date of issuance of the Credit.
SECTION 20. JURISDICTION AND SERVICE OF PROCESS. Any suit, action or
proceeding against Applicant under or with respect to any Letter of Credit
Document may, at Wells Fargo's sole option, be brought in (a) the courts of
the State of California, (b) the United States District Courts in California,
(c) the courts of the jurisdiction of Applicant's incorporation or principal
office, or (d) the courts of the jurisdiction where the Beneficiary, any
advising, confirming, negotiating, paying or other bank, or any other person
or entity has brought any suit, action or proceeding against Wells Fargo with
respect to the Credit or any Demand, and Applicant hereby submits to the
nonexclusive jurisdiction of such courts for the purpose of any such suit,
action, proceeding or judgment and waives any other preferential jurisdiction
by reason of domicile. Applicant further agrees that it will accept joinder
in any suit, action or proceeding brought in any court or jurisdiction
against Wells Fargo by the Beneficiary, any advising, confirming, negotiating,
paying, or other bank or any other person or entity with respect to the
Credit or any Demand. Applicant irrevocably waives trial by jury and any
objection, including, but not limited to, any objection of the laying of venue
or any objection based on the grounds of FORUM NON CONVENIENS, which
Applicant may now or hereafter have to the bringing of any such action or
proceeding. Applicant further waives any right to transfer or change the
venue of any suit, action or proceeding brought against Applicant by Wells
Fargo under or in connection with any Letter of Credit Document. Applicant
irrevocably consents to the service of process in any action or proceeding in
any court by the mailing of copies thereof by registered or certified mail,
postage prepaid, to Applicant at its address specified on the Application or
at such other address as Applicant shall have notified to Wells Fargo in
writing, such service to be effective ten (10) days after such mailing.
SECTION 21. JOINT APPLICANTS. If the Application is signed by more
than one person or entity, each Applicant agrees that this Agreement and the
Application shall be the joint and several agreement of all such Applicants
and that all references to Applicant in this Agreement and the Application
shall refer to all such Applicants jointly and severally.
SECTION 22. SEVERABILITY. Any provision of any Letter of Credit
Document which is prohibited or unenforceable in any jurisdiction shall be,
only as to such jurisdiction, ineffective to the extent of such prohibition or
unenforceability, but all the remaining provisions of such Letter of Credit
Document and all the other Letter of Credit Documents shall remain valid.
SECTION 23. HEADINGS. The headings used in this Agreement are for
convenience of reference only and shall not define or limit the provisions of
this Agreement.
SECTION 24. COMPLETE AGREEMENT. This Agreement and the Application
contain the entire agreement of Wells Fargo and Applicant with respect to the
Credit; provided, however, that such entire agreement will also include any
written document or instrument signed by Wells Fargo and/or Applicant and
approved by Wells Fargo, which specifically references this Agreement, the
Application or the Credit. Except as specifically provided in this Agreement,
in the Application or in any written document or instrument referred to in
the preceding sentence, no statements or representations not contained in
this Agreement, the Application or such written document or instrument shall
have any force or effect on this Agreement, the Application or such written
document or instrument.
<PAGE>
EXHIBIT 23.3
[Logo] June 2, 1999
PAUL KAGAN ASSOCIATES, INC.
126 CLOCK TOWER PLACE
CARMEL, CALIFORNIA 93923 8746
(831) 624 1536
VIA FAX
Danny Meidan
Friedman, Billings, Ramsey & Co., Inc.
1001 Nineteenth Street North, 18th Floor
Arlington, Virginia 22209
RE: Our 3/29/99 letter
Your 6/2/99 fax
Dear Mr. Meidan:
This letter constitutes Paul Kagan Associates, Inc. permission to use
selected PKA materials, derived from a 9/2/98 document dealing with DVDs
purchased from Baseline, in a Friedman, Billings, Ramsey & Co. filing with
the SEC. Specifically, you may use the five bullet points as presented in the
referenced facsimile and forwarded for our review on June 2, 1999.
It is understood this is a one-time approval, and this material may not be
used/disseminated for any other purpose without our prior consent. Thank you
for seeking prior approval to use our information.
Sincerely,
/s/ Dwight W. Beach
Dwight W. Beach
Vice President of Operations
<PAGE>
EXHIBIT 23.4
June 9, 1999
To Whom It May Concern:
This letter serves as permission for Friedman, Billings, Ramsey & Co. Inc. to
use the following data points from IDC for a prospectus.
International Data Corporation estimates that the number of Web users
worldwide grew to approximately 142 million by the end of 1998 and will grow
to approximately 399 million by 2002.
According to International Data Corporation, the number of Web buyers
worldwide is estimated to increase from 30.8 million in 1998 to 133.9
million in 2002, which represents a compound annual growth rate of 44%.
International Data Corporation estimates that the total value of goods and
services purchased worldwide over the Web grew from $296 million in 1995 to
$50.4 billion in 1998, and will increase to $733.6 billion in 2002.
International Data Corporation predicts approximately 16.0 million DVD-ROM
drives will be installed in personal computers in the United States during
2000, up from an estimated 8.3 million DVD-ROM drives to be installed in 1999.
International Data Corporation predicts that DVD-ROM drives sold for United
States households will increase from $2.9 million in 1998 to 27.3 million in
2002, which represents a compound annual growth rate of 75%.
Tony Picardi
Senior Vice President
5 Speen Street - Framingham, MA 01701
-------------------------------------
(508) 872-8200 - Fax (508) 935-4015
[Logo]
http://www.idc.com
