<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 24, 1999
REGISTRATION NO. 333-76121
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 4
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 24, 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 and 282,000 shares were underlying options
granted at an exercise price equal to the initial public offering price;
- 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 expense of $426,000 and $1.6 million, respectively. 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 5,488 291 6,479
----------- --------- --------- ---------- ----------
Operating loss.................. (17) (192) (3,667) (11) (5,631)
Interest income (expense),
net........................... -- -- (74) -- 10
----------- --------- --------- ---------- ----------
Net loss........................ $ (17) $ (192) $ (3,741) $ (11) $ (5,621)
----------- --------- --------- ---------- ----------
----------- --------- --------- ---------- ----------
Loss before pro forma provision
for income taxes.............. $ (17) $ (192) $ (3,741) $ (11) $ (5,621)
Pro forma provision for income
taxes (unaudited)............. -- -- -- -- --
----------- --------- --------- ---------- ----------
Pro forma net loss
(unaudited)................... $ (17) $ (192) $ (3,741) $ (11) $ (5,621)
----------- --------- --------- ---------- ----------
----------- --------- --------- ---------- ----------
Basic and diluted loss per
common share.................. $ (0.00) $ (0.01) $ (0.25) $ (0.00) $ (0.37)
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) $ (0.25) $ (0.00) $ (0.32)
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 increases in stockholders' equity of $12.5 million, current prepaid
advertising of $5 million and long term prepaid advertising of $7.5
million to reflect the fair value of the America Online warrant, which
becomes non-forfeitable and fully vested upon closing of this offering;
- 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........................................................................... 4,635 55,020
Total assets.............................................................................. 13,042 67,927
Total debt................................................................................ 3,000 --
Total stockholders' equity................................................................ 5,931 63,816
</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 $9.6 million. During 1998, we incurred net losses of
$3.7 million and for the three months ended March 31, 1999, we incurred losses
of $5.6 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.
21
<PAGE>
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," the
increase in additional paid-in capital of $12.5 million, to reflect the fair
value of the America Online warrant, which becomes non-forfeitable and fully
vested upon closing of this offering, 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 and 282,000 shares were underlying options
granted at an exercise price equal to the initial public offering price;
- 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.............................................................. 12,038 69,923
Unamortized deferred compensation....................................................... (488) (488)
Accumulated deficit..................................................................... (5,621) (5,621)
--------- -----------
Total stockholders' equity................................................................ 5,931 63,816
--------- -----------
Total capitalization.................................................................. $ 5,931 $ 63,816
--------- -----------
--------- -----------
</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 $5.8 million or $.32 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, the receipt and application of the net proceeds as detailed in
"Use of Proceeds," and the increase in stockholders' equity of $12.5 million to
reflect the fair value of the America Online warrant, which becomes non-
forfeitable and fully vested upon closing of this offering, 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
$2.54 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.................... $ .32
Increase attributable to new stockholders................................. 2.55
---------
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, 282,000 shares of common stock were
underlying outstanding options under our stock incentive plan at an exercise
price equal to the initial public offering price, 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 5,488 291 6,479
------------ ------------ ------------ ------------ ------------
Operating loss........................... (17) (192) (3,667) (11) (5,631)
Interest income (expense), net........... -- -- (74) -- 10
------------ ------------ ------------ ------------ ------------
Net loss................................. $ (17) $ (192) $ (3,741) $ (11) $ (5,621)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Loss before pro forma provision
for income taxes....................... $ (17) $ (192) $ (3,741) $ (11) $ (5,621)
Pro forma provision for income
taxes (unaudited)(2)................... -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Pro forma net loss (unaudited)(2)........ $ (17) $ (192) $ (3,741) $ (11) $ (5,621)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Basic and diluted loss per
common share(3)........................ $ (0.00) $ (0.01) $ (0.25) $ (0.00) $ (0.37)
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) $ (0.25) $ (0.00) $ (0.32)
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 (deficit).......................... 13 157 (2,754) 4,635 55,020
Total assets....................................... 13 310 5,746 13,042 67,927
Total debt......................................... -- -- 4,300 3,000 --
Total stockholders' equity (deficit)............... 13 191 (1,920) 5,931 63,816
</TABLE>
- ------------------------------
(1) Operating expenses included sales and marketing expenses (excluding America
Online warrant 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
expenses of $426,000 in 1998 and $1.6 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 increases in stockholders' equity of $12.5 million, current prepaid
advertising of $5 million and long term prepaid advertising of $7.5 million,
to reflect the fair value of the America Online warrant, which becomes
non-forfeitable and fully vested upon closing of this offering; (iii) 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; (iv) the payment of additional
prepaid advertising of $7 million to America Online under our marketing
agreement; and (v) 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 $5.6 million for the first quarter of 1999, $3.7
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 $3.9 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 expense................... -- -- -- 426 1,596
General and administrative............ 62 167 187 426 460
------------ ------------ ------------ ------------- ------------
Operating loss.......................... (11) (271) (497) (2,888) (5,631)
Interest income (expense), net.......... -- -- (16) (58) 10
------------ ------------ ------------ ------------- ------------
Net loss................................ $ (11) $ (271) $ (513) $ (2,946) $ (5,621)
------------ ------------ ------------ ------------- ------------
------------ ------------ ------------ ------------- ------------
</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 expense........... -- -- -- 4.8 14.2
General and administrative.... 3.8 6.3 5.1 4.8 4.1
----- ----- ----- ----- -----
Operating loss.................. (0.7) (10.3) (13.4) (32.5) (50.2)
Interest income (expense),
net........................... -- -- (0.4) (0.6) 0.1
----- ----- ----- ----- -----
Net loss........................ (0.7)% (10.3 )% (13.8 )% (33.1 )% (50.1 )%
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</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 EXPENSE: The strategic marketing agreement with
America Online includes a warrant to purchase up to 1,384,006 shares of common
stock. Related expense totaled $1.6 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. Should DVD EXPRESS be successful in closing its initial public offering
during the second quarter of 1999 at $11 per share, this expense is expected to
increase to approximately $1.7 million in the second quarter of 1999 and would
be approximately $1.2 million in each quarter for the remaining life of the
marketing agreement through September 30, 2001.
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
28
<PAGE>
advertising expenses of $1.1 million and bank and other related transaction fees
of $440,000. We 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 EXPENSE. America Online warrant expense totaled
$426,000 for 1998 compared to zero for 1997. This increase is due to the fact
that we did not incur any expense 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 $5.6 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.
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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. 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. 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. On August 1, 1999, America Online will have an
additional right to terminate this agreement upon 30 days notice. If America
Online exercises this right, we will not be obligated to make further payments
to them under the agreement. However, this right expires upon completion of this
offering. We have also granted to America Online a warrant to purchase up to
1,384,086 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
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future, we intend to use these funds to help pay for print and online
advertising. We do not have long-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
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with marketing support and has agreed not to offer its services to any of our
direct competitors for 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.
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<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.
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<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
Kevin M. Vargo............ 35 Vice President and Chief Information Officer
Vice President Strategic Planning/Business
Jonas E. Gray............. 32 Development
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.
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<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.
KEVIN M. VARGO joined us in June 1999 as Vice President and Chief
Information Officer. From July 1998 to February 1999, Mr. Vargo served as Senior
Vice President and Chief Information Officer of J. Crew Group, Inc. From August
1997 to June 1998, Mr. Vargo was employed by Books-A-Million, Inc. as Vice
President and Chief Information Officer. From March 1993 to July 1997, Mr. Vargo
was employed by The Limited, Inc., where he served as a director and manager of
systems development and as a project manager of data and technology. Mr. Vargo
received his B.S. in Computer Science from the DeVry Institute of Technology.
JONAS E. GRAY joined us in June 1999 as Vice President Strategic
Planning/Business Development. Prior to joining us, Mr. Gray was employed by
N2K, Inc., where he served in various marketing capacities, most recently as
Senior Director of International Marketing. From 1995 to 1996, Mr. Gray served
as a promotions and public relations consultant for Polygram Classics and Jazz.
From 1993 to 1995, Mr. Gray was employed by The Walker Group as a Marketing
Manager and previously as a Project Management Administrator. Mr. Gray received
his B.M. in Applied Music from the University of Rochester.
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.
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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. 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
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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.
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.
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<PAGE>
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.
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. Also, our Board has
granted options covering 282,000 shares of common stock to our officers and
employees at an exercise price equal to the initial public offering price. 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
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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, 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.
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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 and options covering an aggregate of 282,000
shares of common stock to our officers and employees at an exercise price equal
to the initial public offering price. 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 becomes
non-forfeitable and vests fully on the closing of this offering and
53
<PAGE>
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.
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 (Deficit) 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>
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 (deficit), 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.
/s/ ARTHUR ANDERSEN LLP
Los Angeles, California
February 1, 1999 (except with
regard to the matters discussed
in Note 9, as to which the date is
June 18, 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................................................ -- 1,887,459 3,536,797
Other assets....................................................... 6,037 61,269 462,706
----------- ------------- ---------------
Total current assets............................................. 275,335 4,912,202 11,745,575
Property and equipment, net.......................................... 34,653 646,528 850,423
Other assets:
Prepaid advertising................................................ -- -- 269,262
Intangible assets, net............................................. -- 187,015 176,814
----------- ------------- ---------------
Total assets..................................................... $ 309,988 $ 5,745,745 $ 13,042,074
----------- ------------- ---------------
----------- ------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
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 (deficit):
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 2,028,041 12,038,480
Unamortized deferred compensation.................................. -- -- (487,913)
Accumulated deficit................................................ (208,597) (3,949,757) (5,620,987)
----------- ------------- ---------------
Total stockholders' equity (deficit)............................. 191,403 (1,920,216) 5,931,265
----------- ------------- ---------------
Total liabilities and stockholders' equity (deficit)............. $ 309,988 $ 5,745,745 $ 13,042,074
----------- ------------- ---------------
----------- ------------- ---------------
</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 expense... -- -- 426,078 -- 1,596,227
General and administrative....... 17,007 141,028 842,063 61,263 459,783
------------- ------------- -------------- ------------- --------------
Operating loss................. (17,007) (191,590) (3,667,161) (10,883) (5,631,206)
Interest expense................... -- -- (73,999) -- (46,128)
Interest income.................... -- -- -- -- 56,347
------------- ------------- -------------- ------------- --------------
Net loss........................... $ (17,007) $ (191,590) $ (3,741,160) $ (10,883) $ (5,620,987)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Loss before pro forma provision for
income taxes..................... $ (17,007) $ (191,590) $ (3,741,160) $ (10,883) $ (5,620,987)
Pro forma provision for income
taxes (unaudited)................ -- -- -- -- --
------------- ------------- -------------- ------------- --------------
Pro forma net loss (unaudited)..... $ (17,007) $ (191,590) $ (3,741,160) $ (10,883) $ (5,620,987)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
Basic and diluted loss per common
share............................ $ (0.00) $ (0.01) $ (0.25) $ (0.00) $ (0.37)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
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) $ (0.25) $ (0.00) $ (0.32)
------------- ------------- -------------- ------------- --------------
------------- ------------- -------------- ------------- --------------
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 (DEFICIT)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK TOTAL
---------------------- ----------------------- ADDITIONAL UNAMORTIZED STOCKHOLDERS'
NUMBER OF NUMBER OF PAID-IN DEFERRED ACCUMULATED EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION DEFICIT (DEFICIT)
--------- ----------- ---------- ----------- ----------- ------------- ------------ --------------
<S> <C> <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 vested
portion of America
Online warrant..... -- -- -- -- 426,078 -- -- 426,078
Net loss............. -- -- -- -- -- -- (3,741,160) (3,741,160)
--------- ----- ---------- ----------- ----------- ------------- ------------ --------------
Balance, December 31,
1998................. -- -- 15,000,000 1,500 2,028,041 -- (3,949,757) (1,920,216)
Termination of S
corporation
status............. -- -- -- -- (3,949,757) -- 3,949,757 --
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
Deferred
compensation....... -- -- -- -- 487,913 (487,913) -- --
Fair value of vested
portion of America
Online warrant..... -- -- -- -- 1,596,227 -- -- 1,596,227
Net loss............. -- -- -- -- -- -- (5,620,987) (5,620,987)
--------- ----- ---------- ----------- ----------- ------------- ------------ --------------
Balance, March 31, 1999
(unaudited).......... 1,714,285 $ 171 15,135,000 $ 1,514 $12,038,480 $ (487,913) $(5,620,987) $ 5,931,265
--------- ----- ---------- ----------- ----------- ------------- ------------ --------------
--------- ----- ---------- ----------- ----------- ------------- ------------ --------------
</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) $ (3,741,160) $ (10,883) $ (5,620,987)
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 expense........... -- -- 426,078 -- 1,596,227
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 $9.6 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 contractual guaranteed impressions or click throughs as specified in the
individual agreement. DVD EXPRESS believes that this amortization method results
in appropriate matching of amortization and expected benefits of services to be
provided under the individual agreements. 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.
UNAMORTIZED DEFERRED COMPENSATION
Unamortized deferred compensation represents employee option related
compensation expense which is to be amortized over the three year vesting
periods of the related options.
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) $ (3,741,160) $ (10,883) $ (5,620,987)
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. This warrant was granted as partial compensation for the marketing
agreement entered into with America Online (see also Note 5). The America Online
warrant vests over the term of the marketing agreement, however, it becomes
non-forfeitable and vests fully on the closing of an initial public offering.
The America Online warrant expires on August 1, 2008. The America Online warrant
does not have any voting rights, dividend rights or preferences until such time
as it is exercised for shares of common stock. The vested portion of the America
Online warrant has been valued using the Black-Scholes Option Pricing Model at
each balance sheet date using the following assumptions as of December 31, 1998
and March 31, 1999 respectively: underlying stock price of $4.00 and $8.72,
risk-free interest rates of 4.96% and 5.65%, expected lives of 9.59 years and
9.34 years, 80% volatility and payments of no dividends. As of December 31, 1998
and March 31, 1999, approximately 133,000 and 266,000 shares had vested
respectively, and have been valued at $426,078 and $2,022,305, respectively.
Such fair values, less amounts expensed to date, are reflected as operating
expenses in the statements of operations.
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
F-14
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
7. SHARE CAPITAL (CONTINUED)
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 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) $(3,741,160)
Net loss--pro forma............................... $(192,740) $(3,833,448)
</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>
F-15
<PAGE>
DVD EXPRESS, INC.
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1999, DECEMBER 31, 1998 AND 1997
7. SHARE CAPITAL (CONTINUED)
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>
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. In June 1999, DVD EXPRESS
also granted options under its stock incentive plan to employees to purchase an
additional 282,000 shares of common stock at an exercise price equal to the
initial public offering price.
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.
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 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>
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 June 18, 1999, DVD EXPRESS filed a certificate of ownership and merger
with the Delaware secretary of state to effect its reincorporation in Delaware
and a concurrent 3-for-2 stock split of each outstanding share of Common stock
upon the closing of this offering. 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........................................ 90,000
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..................................................... 2,765
---------
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.
On June 15, 1999, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 132,000 shares of Common Stock at a price
equal to the initial public offering price. 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.
On June 22, 1999, we issued pursuant to the stock incentive plan stock
options to purchase an aggregate of 150,000 shares of Common Stock at a price
equal to the initial public offering price. 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.
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).*
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
10.3 Form of Registrant's Stock Option Agreement (Incentive Stock Option).*
<C> <S>
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.+*
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.
+ Portions of this exhibit have been omitted and filed separately with the
Commission under a request for confidential treatment.
II-5
<PAGE>
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 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. 4 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 24,
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. 4 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 24, 1999
Michael J. Dubelko and President
Chief Financial Officer,
/s/ ANDREW T. CRIST Chief Operating Officer
- ------------------------------ and Secretary (Principal June 24, 1999
Andrew T. Crist Financial and Accounting
Officer)
*
- ------------------------------ Director June 24, 1999
Steven S. Antebi
*
- ------------------------------ Director June 24, 1999
Kimberly S. Eads
*
- ------------------------------ Director June 24, 1999
Norman J. Pattiz
*
- ------------------------------ Director June 24, 1999
Stephen J. Cannell
*
- ------------------------------ Director June 24, 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>
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
reports (and to all references to our Firm) included in or made a part of this
Registration Statement No. 333-76121 on Form S-1.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Los Angeles, California
June 23, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1997 JAN-01-1998 JAN-1-1999
<PERIOD-END> DEC-31-1997 DEC-31-1998 MAR-31-1999
<CASH> 0 905 4,933
<SECURITIES> 0 0 0
<RECEIVABLES> 18 255 343
<ALLOWANCES> 0 0 0
<INVENTORY> 251 1,804 2,470
<CURRENT-ASSETS> 275 9,910 11,746
<PP&E> 42 738 1,023
<DEPRECIATION> 8 92 172
<TOTAL-ASSETS> 310 19,489 13,042
<CURRENT-LIABILITIES> 119 7,666 7,111
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 350 16,496 12,040
<OTHER-SE> 0 0 0
<TOTAL-LIABILITY-AND-EQUITY> 310 19,489 13,042
<SALES> 0 0 0
<TOTAL-REVENUES> 1,269 16,907 11,229
<CGS> 1,046 15,086 10,381
<TOTAL-COSTS> 415 5,488 6,479
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 0 74 46
<INCOME-PRETAX> 192 3,741 5,621
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> 192 3,741 5,621
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 192 3,741 5,621
<EPS-BASIC> (0.01) (0.25) (0.37)
<EPS-DILUTED> (0.01) (0.25) (0.32)
</TABLE>
