EMACHINES INC /DE/, 424B4, 2000-03-24

EMACHINES INC /DE/
424B4, 2000-03-24
ELECTRONIC COMPUTERS

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FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-86219

20,000,000 Shares

[LOGO OF EMACHINES APPEARS HERE]

Common Stock
------------

Prior to this offering, there has been no public market for our common
stock. Our common stock has been approved for listing on The Nasdaq Stock
Market's National Market under the symbol "EEEE."

The underwriters have an option to purchase a maximum of 3,000,000
additional shares to cover over-allotments of shares.

Investing in our common stock involves risks. See "Risk Factors" on page 6.

<TABLE>
<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public Commissions eMachines
------------- ------------- -------------
<S> <C> <C> <C>
Per Share.................................. $9.00 $0.63 $8.37
Total...................................... $180,000,000 $12,600,000 $167,400,000
</TABLE>

Delivery of the shares of common stock will be made on or about March 29,
2000.

Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.

Credit Suisse First Boston

Chase H&Q

Robertson Stephens

Salomon Smith Barney

The date of this prospectus is March 24, 2000.
<PAGE>

Emachines Artwork Description
- -----------------------------

Set forth at the center of the inside front cover page are blocks of text
arrayed around a color picture depicting, from left to right, a computer
keyboard, color computer monitor, computer processing unit, computer pointing
mouse, and a pair of audio speakers. The Computer monitor is displaying a
Windows operating system format desktop featuring an advertising banner and pop-
ups set against a stylized lower case letter "e".

Centered at the top of the page above the picture is the heading "emachines",
with a stylized initial letter "e", and centered below that is the text
"changing the way you think about computing".

The blocks of text arrayed around the picture, clockwise from the bottom left
corner, read as follows:

. the heading "Banner Advertising & Pop-ups", and below that the text "We
provide advertisers with several opportunities to display banners within eWare
or pop up offers on the eMachines desktop. Ads and offers can be targeted by
demographic and psychographic variables." Lines connect the text to the picture
of the computer monitor pictured at center;

. the heading "Desktop Icons", and below that the text "Icons link directly
to pre-installed programs and online services, including discount coupons for
online and offline purchase and online comparison shopping services." A line
connects the text to the picture of the computer monitor pictured at center;

. the heading "eWare", and below that the text "Our desktop Internet surfing
assistant gives users quick access to hundreds of popular Web sites and lets
them customize their PC desktop with logo touch-tiles that provide one-click
access to their favorites." A line connects the text to the picture of the
computer monitor pictured at center;

. the heading "High Value PCs", and below that the text "We offer a wide
range of desktop PCs priced from $399 to $1199 and one of the first sub-$1000
notebook PCs offered through major U.S. retailers. At every price point, we
strive to provide greater features and functions than any other leading brand of
PC." A line connects the text to the picture of the computer processing unit
pictured at center;

. the heading "Internet Access", and below that the text "We offer customers
immediate access to a range of Internet service providers, including AOL,
CompuServe and e-machines.net.";

. the heading "In-box Coupons & Brochures", and below that the text
"Advertisers and sponsors can introduce their brands to users before they go
online. Nearly half of eMachines customers are first-time PC buyers!";

. the heading "Opt-in E-mail", and below that the text "Over 70% of our
registered users consistently sign up to receive offers. In the coming years,
this will allow us to make brand introductions to millions of consumers.";

. the heading "eBoard", and below that the text "Our newest keyboard, which
we expect to begin shipping in the second quarter of 2000, includes 19 keys that
provide users with one-touch access to our sponsors' Web sites." A line
connects the text to the picture of the computer keyboard pictured at center.

Below these text boxes, in the bottom left portion of the page, is a magnified
inset of the computer keyboard pictured at center. A line connects the inset to
the text describing the computer keyboard.

<PAGE>

------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
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<S> <C>
Prospectus Summary....................................................... 2

Risk Factors............................................................. 6

Special Note Regarding Forward-Looking Statements........................ 22

Use of Proceeds.......................................................... 22

Dividend Policy.......................................................... 22

Capitalization........................................................... 23

Dilution................................................................. 24

Selected Financial Data.................................................. 26

Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 27

Business................................................................. 36
</TABLE>

<TABLE>
<CAPTION>
Page
----
<S> <C>
Management................................................................. 49

Related Party Transactions................................................. 56

Principal Stockholders..................................................... 62

Description of Capital Stock............................................... 64

Shares Eligible for Future Sale............................................ 68

Underwriting............................................................... 69

Notice to Canadian Residents............................................... 71

Legal Matters.............................................................. 72

Experts.................................................................... 72

Additional Information..................................................... 72

Index to Financial Statements.............................................. F-1
</TABLE>

------------

You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.

Dealer Prospectus Delivery Obligation

Until April 18, 2000 (25 days after the commencement of this offering), all
dealers that effect transactions in these securities, 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 an underwriter and with respect to unsold allotments or subscriptions.

1
<PAGE>

PROSPECTUS SUMMARY

This summary highlights information described more fully elsewhere in this
prospectus. This summary is not complete and does not contain all the
information you should consider before investing in our common stock.

eMachines, Inc.

In November 1998, we introduced the first branded sub-$400 PC to the U.S.
retail market. We have sold over two million PCs to date. We sold the third
largest number of desktop PCs through U.S. retailers in 1999, according to PC
Data, and sold the largest number of sub-$600 PCs, the low-priced PC market,
through U.S. retailers in July 1999, according to Ziff Davis' InfoBeads. In
1999, our products won prestigious awards in the low-priced PC desktop
category, including PC Computing's Most Valuable Product, number one on Windows
Magazine's "WinList 100" and CNET.com's Editors' Choice award.

We intend to aggressively pursue recurring revenue generating opportunities
that extend beyond the purchase of the PC or other Internet connected devices.
To this end, in January 2000, we acquired FreePC, Inc., a Bill Gross' idealab!
company that was one of the first companies to subsidize the purchase price of
the PC and Internet access with advertising sponsorships. Our acquisition of
FreePC's expertise, relationships, technology and technical experience is a key
element of our strategy to enhance our Internet revenues. We offer multiple,
integrated advertising programs, including our eWare and eBoards, that we
believe an Internet advertiser may combine into a powerful campaign capable of
dramatically increasing the effectiveness of its offer.

Our computing and Internet advertising offerings create an integrated PC and
Internet-based service that includes links to selected Web sites and other
Internet resources. This combination extends a Web-based portal business model
to the hardware itself. We intend to lead this new business category by:

. increasing penetration of the consumer market by providing low-priced,
high-quality integrated computing and Internet offerings;

. using our PC business to cost-effectively acquire Internet consumers;

. enhancing recurring Internet revenues through opportunities such as
Internet service payments, e-commerce and Web-based advertising;

. leveraging our established brand to broaden our PC line and to introduce
Internet appliances and Internet-connected peripheral products; and

. continuing to strengthen our strategic relationships with leading
retailers to capture and retain prime shelf space.

We were incorporated in Delaware in September 1998. Our principal executive
offices are located at 14350 Myford Road, Suite 100, Irvine, California 92606
and our telephone number is (714) 481-2828. Our Web site is located at
"www.e4me.com." Information contained on our Web site does not constitute a
part of this prospectus.

-----------

E-MACHINES(R) is our registered United States trademark. The "e" logo,
eMachines(TM), eTower(TM), eView(TM), eOne(TM), eSlate(TM), AdOptimizer(TM),
FreePC(TM) and FreePC Network(TM) are also our trademarks. This prospectus
contains other trademarks and trade names of other companies.

2
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The Offering

<TABLE>
<S> <C>
Common stock offered............................ 20,000,000 shares

Common stock to be outstanding after this
offering....................................... 144,690,425 shares

Use of proceeds................................. General corporate purposes, including
working capital and capital
expenditures.

Nasdaq National Market symbol................... EEEE
</TABLE>

The total number of shares of our common stock to be outstanding after this
offering is based on:

. 82,777,170 shares of common stock and 41,913,255 shares of preferred
stock outstanding as of January 31, 2000;

. 41,913,255 shares of common stock issuable upon automatic conversion of
outstanding shares of preferred stock referred to above upon completion
of this offering; and

. 20,000,000 shares of common stock offered in this offering.

The above information excludes:

. 1,532,200 shares of common stock issuable upon exercise of options
outstanding as of January 31, 2000, at a weighted average exercise price
of $5.85 per share, which options were issued under our 1998 stock plan,
3,467,800 additional shares authorized to be issued under our 1998 stock
plan plus an automatic annual increase to be added on the first day of
our fiscal year beginning in 2001;

. 360,297 shares of common stock issuable upon exercise of options
outstanding as of January 31, 2000, at a weighted average exercise price
of $2.40 per share, issued outside of our 1998 stock plan;

. 2,062,394 shares of common stock issuable upon exercise of options
assumed by us in connection with the FreePC acquisition and warrants to
purchase 883,843 shares of common stock issuable upon the exercise of
these assumed options at a warrant exercise price of $17.13 per share as
of January 31, 2000;

. 9,596,404 shares of common stock issuable upon exercise of warrants
issued in connection with the FreePC acquisition at a warrant exercise
price of $17.13 per share;

. up to 1,566,219 shares of common stock issuable to America Online upon
exercise of its warrants. See "Related Party Transactions--Relationship
with America Online, Inc." for a discussion of the America Online
warrants;

. 300,000 shares of common stock to be authorized for issuance under our
2000 employee stock purchase plan plus an annual increase to be added on
the first day of our fiscal year beginning in 2001; and

. 2,000,000 shares of common stock issuable upon exercise of an option
granted on March 19, 2000, to Stephen A. Dukker, our President and Chief
Executive Officer, with an exercise price of $9.00 per share.

3
<PAGE>

Summary Financial Information

The pro forma FreePC acquisition statement of operations data below gives
effect to our acquisition of FreePC as if it had taken place on January 1,
1999. The pro forma FreePC acquisition balance sheet data below gives effect to
the FreePC acquisition as if it had taken place on December 31, 1999. The pro
forma statement of operations data reflects $49.0 million of amortization of
intangible assets arising from the acquisition. The pro forma data is presented
for illustrative purposes only and is not necessarily indicative of the
operating results or financial position that would have resulted if the
acquisition had been in effect during the periods presented, nor is it
necessarily indicative of future operating results or financial position. For
an explanation of the calculation of pro forma amounts see Notes to the
Unaudited Pro Forma Condensed Combined Financial Information included elsewhere
in this prospectus.

During 1999, FreePC's business model included distributing free PCs and free
Internet access to its customers. The costs related to these activities in 1999
approximated $21.2 million. Subsequent to our acquisition of FreePC we have
ceased distributing free computers and will cease providing free Internet
service and, accordingly, expect these costs and associated revenues to
decrease substantially.

We restated our financial statements for 1998 and 1999. See Note 11 of Notes
to Financial Statements.

<TABLE>
<CAPTION>
Year Ended Dec. 31,
1999
Period From ------------------------
Sept. 18, 1998 Pro Forma
(inception) to FreePC
Dec. 31, 1998 Actual Acquisition
-------------- ----------- -----------
(in thousands, except share and per
share data)
<S> <C> <C> <C>
Statements of Operations Data:
Net revenues.......................... $ 58,283 $ 814,317 $ 815,518
Cost of revenues...................... 58,088 780,945 784,265
----------- ---------- ----------
Gross profit.......................... 195 33,372 31,253
Loss before amortization of intangible
assets............................... (1,913) (1,842) (32,491)
Amortization of intangible assets..... 49,000
----------- ---------- ----------
Loss from operations.................. (1,913) (1,842) (81,491)
----------- ---------- ----------
Net loss.............................. $ (2,802) $ (5,728) $ (84,515)
=========== ========== ==========
Net loss per common share:
Basic and diluted................... $ (0.05) $ (0.14) $ (1.21)
=========== ========== ==========
Basic and diluted-pro forma......... $ (0.07) $ (0.85)
========== ==========
Shares used to compute net loss per
share:
Basic and diluted................... 57,600,000 68,933,254 72,928,887
=========== ========== ==========
Basic and diluted-pro forma......... 77,913,294 99,542,813
========== ==========
<CAPTION>
Dec. 31, 1999
---------------------------------------
Pro forma
Pro Forma FreePC
FreePC Acquisition
Actual Acquisition As Adjusted
-------------- ----------- -----------
(in thousands)
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............. $ 114,823 $ 125,762 $ 292,077
Short-term investments................ 19,897 19,897 19,897
Working capital....................... 140,166 141,257 307,572
Total assets.......................... 331,713 495,587 661,902
Long-term obligations................. 1,903 3,131 3,131
Redeemable convertible preferred
stock................................ 150,014 150,014 --
Total stockholders' equity
(deficiency)......................... (7,736) 142,264 458,593
</TABLE>

4
<PAGE>

See Note 2 of Notes to Financial Statements for an explanation of the
determination of the number of shares used in computing per share data.

The pro forma FreePC acquisition information reflects:

. 3,995,633 shares of common stock and 17,633,886 shares of convertible
preferred stock issued in connection with the FreePC acquisition
completed in January 2000; and

. 2,891,275 shares of common stock issuable upon exercise of options
assumed by us in connection with the FreePC acquisition and warrants to
purchase 1,239,067 shares of common stock issuable upon the exercise of
these assumed options at a warrant exercise price of $17.13.

The pro forma FreePC acquisition as adjusted data includes the pro forma
FreePC acquisition information and:

. the conversion of all outstanding shares of preferred stock into
41,913,255 shares of common stock automatically upon completion of this
offering; and

. the issuance of 20,000,000 shares of common stock offered in this
offering.

Unless otherwise specifically stated, information throughout this prospectus
reflects the eight-for-one stock split of our common stock effected on August
13, 1999 (all share and per share amounts of our common stock have been
retroactively restated to reflect the stock split).

5
<PAGE>

RISK FACTORS

You should carefully consider the following risks before making an
investment decision. The risks described below are intended to highlight risks
that are specific to us and are not the only ones that we face. Additional
risks and uncertainties, such as those that generally apply to our industry or
to companies undertaking initial public offerings, may also impair our business
operations. You should also refer to the other information in this prospectus,
including the discussions in "Special Note Regarding Forward-Looking
Statements," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," as well as our Financial Statements and
the related Notes.

Risks Related to Our Combined Business

Because we have operated for a very limited period of time and our business is
still rapidly changing, you have limited information upon which to evaluate our
business.

We were incorporated in September 1998 and sold our first PC in November
1998. To date, most of our revenues have been derived from the sale of PCs and
monitors, and from the provision of customer support and other technical
services related to those PC products. The acquisition of FreePC in January
2000 has allowed us to accelerate our strategy of extending our historical
business as a high-quality, low-priced PC provider to offering computing and
Internet advertising offerings. As a result, we expect to derive a larger
portion of our revenues from Internet advertising sales and recurring Internet
revenues in the future, although our ability to generate significant revenue
from this business is unproven. Our limited operating history and the limited
operating history of FreePC and our evolving businesses make it difficult to
evaluate or predict our future business prospects. You should consider our
business and prospects in light of the risks and difficulties typically
encountered by companies in the early stages of development, particularly those
in the rapidly changing PC and Internet commerce markets.

We have incurred significant losses and expect to incur additional losses in
the future.

We have incurred net losses, and at December 31, 1999, we had an accumulated
deficit of $12.3 million. Although we experienced a period of rapid revenue
growth from PC sales following our inception and reported a profit in our most
recently completed quarter, we may not be able to maintain this revenue growth
and we expect to incur losses in the future. Further, FreePC has incurred
significant losses since its inception. In connection with the FreePC
acquisition, we will record a significant amount of intangible assets the
amortization of which will adversely affect our earnings and profitability in
2000 and through 2002. We expect to record intangible assets of approximately
$147 million, to be amortized over a period of three years. In addition, our
operating costs have increased significantly as a result of the FreePC
acquisition. We have not yet generated significant revenue from our Internet
business and we expect to experience operating losses before amortization in
that business in the future. As a result, we expect to report losses on an
operating basis before amortization of intangible assets in our combined
business for at least the next several quarters.

Our quarterly operating results are subject to fluctuations and seasonality
that make it difficult to predict our future performance.

We expect our quarterly operating results to fluctuate significantly in the
future due to a number of factors. Because our PC business currently generates
low operating margins, a trend that we expect to continue for the foreseeable
future, slight variations in the prices of our PCs, component or manufacturing
costs or operating costs could significantly affect our operating results in
future periods. In addition, the Internet advertising and e-commerce market is
highly competitive and subject to rapid change and our ability to generate any
significant revenue from that business is unproven. Some of the other factors
that could affect our quarterly operating results include:

. the timing and amount of Internet advertising and e-commerce activity
generated through our hot-key enabled keyboards that provide one-touch
access to selected Web sites, our desktop client software and other
initiatives;

6
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. acceptance by consumers of computing devices that include our Internet
offerings;

. continued acceptance and growth of the Internet as a medium for buying
and selling goods and services;

. acceptance by advertisers of the Internet as an efficient means for
reaching consumers;

. our ability or our suppliers' ability to effectively develop and support
new PC models;

. reductions in the prices of PC products, and new product or Internet
service announcements and introductions, by us or our competitors;

. fluctuations in the amount of, and the number of our PC buyers claiming
product rebates;

. popularity of the PCs and monitors we sell, and changes in our mix of
products;

. achieving and maintaining a low-cost business model in our PC business
and managing the third-party relationships necessary to do so;

. the cost of our PC products, including our key suppliers' component
costs and ability to obtain sufficient supply; and

. our key suppliers' ability to manufacture sufficient quantities of our
PC products, and maintain the quality of our PC products.

In addition, our limited operating history makes it difficult for us to
accurately identify all of the possible factors and plan our operations
accordingly. Furthermore, because our operating expenses are based on our
expectations of future revenues and we have recently significantly increased
our operating expenses as a result of our acquisition of FreePC, unexpected
quarterly fluctuations in revenue or a failure to generate significant revenue
from our Internet business could significantly harm our operating results. If
our operating results in any future quarter do not meet the expectations of
securities analysts or investors, the price of our common stock could
significantly decline.

Seasonal fluctuations may also affect our quarterly operating results.
Historically, demand for PCs and PC-related services and consumer retail sales
have been significantly stronger in the fourth quarter of each year and weaker
in the first and second quarter of each year. We believe this seasonal impact
on our business of these cycles will increase to the extent that PCs continue
to become more consumer-oriented or entertainment-driven products and e-
commerce continues to gain broader acceptance. As a result, we expect our net
revenues generally to be greater in the fourth quarter and lower in the first
and second quarters of each year from both our PC business and our Internet
business.

We have experienced a period of rapid growth, and if we are unable to manage
this growth successfully, we may not be able to manage our business and as a
result our business could be significantly harmed.

Our net revenues increased from $58.3 million for the period from our
inception to December 31, 1998, to $814.3 million for the year ended December
31, 1999. Our total number of employees has grown from 10 at December 31, 1998,
to 162 at January 31, 2000. As a result of our acquisition of FreePC, we added
98 employees. Our growth has placed, and will continue to place, a significant
strain on our management systems, infrastructure, resources and planning and
management processes.

As we grow, we will also need to continue to assimilate new employees, as
well as expand, train and manage our workforce. Several key members of our
management team have joined us recently in connection with our acquisition of
FreePC. These individuals must spend a significant amount of time learning our
management systems and our historical business model and helping us extend that
model to offering integrated computing and Internet solutions, in addition to
performing their regular duties. Further, our senior management team has
limited experience in the management and administration of a public company. If
our senior

7
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management team is unable to effectively integrate themselves into our business
or work together as a management team, we may be unable to manage our business
causing substantial harm to our business.

We are subject to risks associated with acquisitions, in general, and with our
acquisition of FreePC, in particular.

In January 2000, we acquired FreePC. We may not successfully integrate the
additional personnel, operations, technology and products of FreePC into our
business, or retain key personnel. In particular, with the acquisition of
FreePC, we have extended our historical business as a high-quality, low-priced
PC provider to include integrated computing and Internet advertising offerings.
We may not realize the expected benefits from these offerings. The acquisition
may also strain our existing financial and managerial controls and reporting
systems and procedures.

We intend to continue to make investments in complementary companies,
products or technologies. If we buy a company, we could have difficulty in
integrating that company's personnel and operations. In addition, the key
personnel may decide not to work for us. If we make other types of
acquisitions, we could have difficulty integrating the acquired technology or
products into our operations. These difficulties could disrupt our ongoing
business, distract our management and employees and increase our expenses. In
addition, as a result of future acquisitions, we may increase our debt or
dilute our existing stockholders if we issue equity securities to pay for the
acquisition.

If we do not maintain our reputation and expand our name recognition, we may
lose consumer and advertising customers.

Developing and maintaining awareness of our "eMachines" brand name is
critical to achieving widespread acceptance of our computing and Internet
advertising offerings. Promotion and enhancement of our brand will depend
largely on whether we cost-effectively provide reliable and desired products
and services to consumers and advertisers and the effectiveness of our
marketing efforts. Currently, retailers are our first point of contact with
consumers. If these retailers reduce or cease advertising our products, we may
need to increase our own sales and marketing expenses to create and maintain
brand awareness among potential consumers. If consumers do not perceive our
products to be of high quality, our brand name and reputation could be
significantly harmed. Also, if advertisers do not perceive our reputation among
consumers to be good, they may not be willing to offer as much for our
services. Furthermore, the importance of brand recognition will increase as
competition in the PC and Internet advertising markets increases. If we fail to
successfully promote our brand name or if we incur significant expenses
promoting and maintaining our brand name, we may lose PC and Internet
advertising sales.

If we do not continually introduce new products and services to keep pace with
rapid technological change, we may not be competitive and could experience a
decline in sales and loss of market share.

The PC and Internet advertising markets are both characterized by rapid
ongoing technological change, changes in user requirements and preferences,
frequent new service introductions embodying new processes and technologies and
evolving industry standards and practices that could render our existing
products and services obsolete. We must regularly introduce new products,
including new PC configurations, and enhanced Internet services to maintain
retailer, consumer and advertiser interest in our products and services. Any
new PC or other Internet access devices or Internet services that we introduce
may not be successful. In addition, the successful introduction of new products
or services by us or our competitors may significantly harm the sale of, or
gross margins on, our existing products or services. We may not be able to
quickly adapt to future changes in the PC and Internet access device industry,
in particular, because we do not maintain a PC or Internet access device
research and development group. Currently, we work closely with TriGem
Computer, one of our principal stockholders and the manufacturer of all of our
eTower PCs, to evaluate the latest developments in PC-related technology. If we
do not have access to new technology in the future, we may not be able to
successfully incorporate new technology into our products or deliver new
products or features in a timely and cost-effective manner.

8
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If we lose key personnel or are unable to attract and retain additional
personnel when needed, we may not be able to successfully operate our business.

Our future success depends on the skills, experience and performance of our
senior management and key personnel, especially that of our President and Chief
Executive Officer, Stephen A. Dukker. Additionally, the FreePC management team
is key to the success of our Internet business. We must retain these
individuals and be able to attract and retain additional key personnel when
needed in the future. Competition in the PC and Internet and e-commerce markets
for these types of individuals with business and technical expertise is high.
All of our senior management and key personnel are at-will employees and may
terminate their employment with us at any time without warning. Further, we do
not maintain "key man" life insurance with respect to any of our employees. If
we lose key personnel, especially Mr. Dukker, or if we are not able to attract
and retain additional personnel when needed, we may be unable to successfully
introduce new products and services or otherwise implement our business
strategy.

We are involved in litigation that may be costly and time-consuming.

In July 1999, Compaq Computer Corporation filed a complaint against us,
TriGem Computer, TriGem America and Korea Data Systems as defendants in the
U.S. District Court for the Southern District of Texas based on the defendants'
alleged infringement of 13 patents held by Compaq related to improved system
processing speed, enhanced video graphics, peripheral compatibility and overall
system architecture. The complaint seeks an accounting, treble damages, a
preliminary and permanent injunction from further alleged infringement,
attorneys' fees and other unspecified damages. We filed a response in September
1999, seeking declaratory judgment of noninfringement and invalidity of
Compaq's patents and asserting counterclaims against Compaq that included false
and misleading advertising under the Lanham Act, business disparagement and
unfair competition under Texas common law. The case is currently in the early
stages of discovery. As a result, we are currently unable to estimate total
expenses, possible loss or range of loss that may be ultimately connected with
these allegations. We are indemnified against liability under the terms of our
PC supply agreement. We cannot assure you that Compaq will not succeed in
obtaining monetary damages or an injunction against the production of our PC
products. Our defense of the claims could result in significant expenses and
diversion of management's attention and other resources. Although we believe
our direct financial exposure is limited under our indemnification
arrangements, the results of complex litigation of this sort are inherently
uncertain and difficult to predict and we cannot assure you that the results of
this litigation would not result in our business being significantly harmed,
particularly if it affects production of our PCs.

Packard Bell filed a complaint on October 6, 1999 in Federal District Court
for the Eastern District of California, alleging patent infringement on Packard
Bell patents which it asserts relates to (i) graphics controller, (ii) parallel
port controller, and (iii) bus interface of our eTower machine. We filed a
response in January 2000 disputing infringement and asserting that the patents
at issue are invalid. We are in the early stages of discovery. As a result, we
are currently unable to estimate total expenses, possible loss or range of loss
that may be ultimately connected with these allegations. We are indemnified
against liability under the terms of our PC supply agreement. We cannot assure
you that Packard Bell will not succeed in obtaining monetary damages or an
injunction against the production of our PC products. Our defense of the claims
could result in significant expenses and diversion of management's attention
and other resources. Although we believe our direct financial exposure is
limited under our indemnification arrangements, the results of complex
litigation of this sort are inherently uncertain and difficult to predict and
we cannot assure you that the results of this litigation would not result in
our business being significantly harmed, particularly if it affects production
of our PCs.

In October 1999, David Packard on behalf of a putative nationwide class,
filed a complaint against us as a defendant in the U.S. District Court for the
Eastern District of Texas based on our alleged sale of defective goods.
Essentially identical complaints were filed contemporaneously against Compaq,
Hewlett-Packard and Packard Bell. The complaints claim that a chip in the
defendants' respective PC products contains a defect which may cause an error
to occur when information is written to a floppy disk. The complaint seeks

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unspecified monetary damages, injunctive relief and declaratory relief. The
lawsuit against us is in the early stages of discovery and we have not yet
filed a response. Although we believe that we have meritorious defenses and
intend to vigorously defend ourselves in this action, these types of litigation
are inherently complex and unpredictable. We cannot assure you that the suit
will not succeed in obtaining unspecified monetary damages, injunctive and
declaratory relief against the production of our PC products. Our defense of
the claims could result in significant expenses and diversion of management's
attention and other resources. In addition, we cannot assure you that the
results of this litigation would not result in our business being significantly
harmed.

Various other lawsuits, claims and proceedings have been or may be asserted
against us, including those related to product liability, intellectual
property, Internet content, privacy, safety and health and employment matters.
Litigation is expensive and time consuming regardless of the merits of the
claim and could divert management's attention from our business. Moreover, we
cannot predict the outcome of any litigation. Some lawsuits, claims or
proceedings may be disposed of unfavorably to us.

We may not be able to compete effectively if we are not able to protect our
intellectual property.

We rely on a combination of trademark, trade secret, patent and copyright
law and contractual restrictions to protect our intellectual property. e-
machines is our registered trademark in the United States. We have also applied
to register several trademarks including eMachines and the "e" logo in the
United States. We have also applied to register marks in the European
Community, the United Kingdom, Brazil, Japan, Taiwan, China, Canada and Mexico.
We also have a United States patent application currently pending. If we are
not successful in obtaining the patent protection we seek, our competitors may
be able to replicate our ad optimization technology and compete more
effectively against us. The legal protections described above, even if
successful, would afford only limited protection. Unauthorized parties may
attempt to copy aspects of our products, services, or otherwise attempt to
obtain and use our intellectual property. Enforcement of trademark rights
against unauthorized use, particularly over the Internet and in other
countries, may be impractical or impossible and could generate confusion and
diminish the value of the mark. Litigation may be necessary to enforce our
intellectual property rights, to protect our trade secrets and to determine the
validity and scope of the proprietary rights of others. Any litigation could
result in substantial costs and diversion of our resources and could seriously
harm our business and operating results. In addition, our inability to protect
our intellectual property may harm our business and financial prospects.

We may be subject to claims that intellectual property used in our products
infringes the rights of third parties and we could incur significant costs
defending ourselves.

It is common for a company in the PC and software industries to receive
communications from time to time from other parties asserting that they possess
patent rights, copyrights, trademark rights or other intellectual property
rights that cover the company's products. We receive notices from time to time
that the intellectual property used in our products allegedly infringes
intellectual property rights held by others. Assertions of this nature may
subject us to legal proceedings and claims in the ordinary course of our
business. For example, in July 1999, Compaq filed a lawsuit against us alleging
that our PC products infringe a number of its patents. In addition, in October
1999, Packard Bell filed a lawsuit against us alleging infringement of patents
relating to graphics controller, parallel port controller and the bus interface
of our eTower machine. For a discussion of these lawsuits, see the risk factor
"We are involved in litigation that may be costly and time-consuming" above. If
the final judgment of any legal action is decided against us, our business
could be significantly harmed. Intellectual property litigation is expensive
and time consuming regardless of the merits of the claim, and could divert our
management's attention from our business. Any potential intellectual property
litigation could also force us to do one or more of the following:

. stop using the challenged intellectual property or selling our products
or services that incorporate it;

. obtain, if possible, a license to use the challenged intellectual
property or to sell products or services that incorporate it, although a
license may not be available on reasonable terms, or at all; or

. redesign those products or services that are based on or incorporate the
challenged intellectual property.

If we are forced to take any of the foregoing actions, we may be unable to sell
our products or services and our business would be significantly harmed.

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Products that contain, or are rumored to contain, defects could result in
significant costs to us, decrease in sales of our products, damage to our brand
and lawsuits.

The design and production of PC components is highly complex. Since we do
not design or produce our own PC products, we rely on suppliers and component
manufacturers to provide us with high-quality products. If any of our PC
products contain defective components, we could experience delays in shipment
of these products and increased costs. Further, the design of software is
highly complex, and software often contains defects that may be undiscovered
for long periods of time. If we are not successful in designing this software,
or if defects in our software or in our PC products are discovered after we
have shipped our affected software or PC products in volume, we could be harmed
in the following ways:

. upgrades, replacements or recalls could impose substantial costs on us;

. rumors, false or otherwise, could be circulated by the press and other
media which could cause a decrease in sales of our products and
significant damage to our brand; and

. our PC buyers could file suits against us alleging damages caused by
defective products.

For example, in October 1999, David Packard on behalf of a putative nationwide
class, filed complaints against us, Hewlett-Packard and Compaq in the U.S.
District Court for the Eastern District of Texas based on alleged sale of
defective goods. The complaint alleges that a chip in the respective
defendants' PC products contains a defect which causes an error to occur when
information is written to a floppy disk. For a discussion of these complaints
and the risks associated with the lawsuit against us, see the risk factor "We
are involved in litigation that may be costly and time-consuming" above.

If demand for Internet access devices, in general, and PCs, in particular, does
not continue to grow, we could have excessive inventories which could result in
write-offs.

The future success of our business model is dependent on the continued
strong demand for Internet access devices, generally, and for PCs, in
particular. Although we currently focus our efforts on high-quality, low-priced
PC products, we expect consumer demand for more powerful PCs and other Internet
access devices to increase with advances in technology and declines in prices.
To meet these demands, we must successfully gauge the level and timing of
consumer demand for PCs and other Internet access devices and match the supply
of each. The PC and Internet access device markets are characterized by rapid
new product and technology introductions and generally declining prices for
existing products. Demand for PCs and other Internet access devices might be
significantly reduced if consumers perceive little technological advantage in
new products or believe that the price of a new product is not worth the
perceived technical advantage. Further, if consumers view anticipated changes
as significant, such as the introduction of a new operating system or
microprocessor architecture, overall market demand for PCs and other Internet
access devices may decline because potential consumers may postpone their
purchases until release of the new product or in anticipation of lower prices
on existing products following the introduction of new models. Reduced demand
could result in excessive inventories that could lead to write-offs of some or
all of the excess inventories and could take several quarters to correct.

Misappropriation by others of our trademarks and other proprietary rights could
harm our reputation, affect our competitive position and cause us to incur
significant costs to defend our rights.

We rely on a combination of copyright, trademark, patent and trade secret
law and contractual restrictions to establish and protect our technology and
proprietary rights and information. We require employees and consultants to
sign confidentiality agreements. We own only one trademark registration in the
United States and

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have filed for only one patent application. Nonetheless, we may not be able to
deter misappropriation of our proprietary information and material in light of
the following risks:

. nonrecognition or inadequate protection of our proprietary rights in
certain foreign countries;

. undetected misappropriation of our proprietary information or materials;
and

. unenforceability of confidentiality agreements entered into by our
employees.

We also seek to limit access to our proprietary information and our third-
party licensors' proprietary information. If we are unable to protect our
trademarks and other proprietary rights against unauthorized use by others, our
reputation and brand name would be damaged and our competitive position would
be significantly harmed.

Risks Principally Related to Our Internet Business

The Internet advertising market is new and unproven and may not continue to
develop.

The Internet has not been used as an advertising medium for a sufficient
period of time to demonstrate its effectiveness. Our business would be
adversely affected if the Internet advertising market fails to develop. Most of
our current or potential advertising customers have not devoted a significant
portion of their advertising expenditures to Internet advertising and may not
find Internet advertising to be effective for promoting their products and
services relative to advertising using traditional media.

Currently, there are no widely accepted standards for measuring the
effectiveness of Internet advertising. We cannot be certain that such standards
will develop to sufficiently support Internet advertising as a significant
advertising medium. Advertisers may not accept our or third-party measurements
of impressions or click-throughs on Web sites utilizing our services. In
addition, the effectiveness of Internet advertising depends on the accuracy of
information contained in the databases used to target advertisements. We cannot
be certain that the information in our databases will be accurate or that
advertisers will be willing to have advertisements targeted by any database
containing such potential inaccuracies. Actual or perceived ineffectiveness of
online advertising in general, or accuracy of measurements or database
information in particular, could limit the long-term growth of online
advertising.

The advertising links that we provide using our hot-key-enabled keyboards
and client software and the banner advertisements that we serve may not be
effective advertising methods. Other forms of Internet advertising may be more
effective or gain wider acceptance; nonetheless, we may not be able to take
advantage of these other forms of advertising. Moreover, "filter" software
programs that limit advertising from being delivered to a user's computer are
currently available. The Internet advertising market and our business could be
adversely affected if use of filter software becomes widespread.

Adoption of online direct marketing, particularly by those entities that
have historically relied upon traditional means of direct marketing, such as
telemarketing and direct mail, requires the broad acceptance of a new and
substantially different approach to direct marketing. Intensive marketing and
sales efforts may be necessary to educate prospective advertisers regarding the
uses and benefits of our direct marketing services to generate demand for such
services. Enterprises may be reluctant or slow to adopt a new approach that may
replace, limit, or compete with their existing systems. In addition, since
online direct marketing is emerging as a new and distinct market apart from
online advertising, potential adopters of online direct marketing services will
increasingly demand functionality tailored to their specific requirements.

Our ability to generate Internet-based revenues is unproven and we may never
achieve profitability in the Internet segment of our business.

We first began bundling the eWare desktop client software with our PCs
during December 1999 and did not begin production of our first keyboard with
Internet hot-keys until January 2000. Given our limited history

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offering these Internet-based services, evaluating our performance is
difficult. In addition, although FreePC had relationships with a large number
of advertisers, our business model is significantly different than FreePC's,
and these advertisers may not continue to do business with us as we have
discontinued the distribution of free computers and expect to cease providing
free Internet access service. You should consider the uncertainties that we may
encounter as we develop our Internet business in this rapidly evolving market,
such as:

. consumer demand for, and acceptance of, our eWare Internet client and
hot-key-enabled keyboards;

. our ability to create user-friendly applications that appeal to
consumers;

. our ability to contract with content providers who will furnish
information that our users find attractive;

. our ability to support a large number of users;

. our ability to anticipate and adapt to a developing market and to
rapidly changing technologies;

. our unproven and evolving business model; and

. our need to expand significantly our internal resources to support
growth of our product and service offerings.

If we are unable to address successfully these issues, we will be unable to
expand our Internet business, compete effectively or achieve profitability in
the Internet segment of our business.

Our Internet-based revenues will suffer if consumers do not use the hot-keys,
desktop client software and other Internet-related services that we provide
them.

We expect to generate future revenues from sources such as Internet
advertising, sponsorships, e-commerce and Internet application services. The
success of our Internet operations depends upon the use by our consumers of the
hot-keys on our keyboards and our desktop client software to reach selected
advertisers' Web sites. Many of our potential consumers have never purchased
Internet access service, used the Internet, e-mail or other Internet-based
applications or engaged in e-commerce transactions. Potential users must
utilize our desktop client software and hot-keys as part of their Internet and
e-commerce experience in order for us to receive recurring Internet revenues.
Because these keys and the menu bar have only been operational for a limited
period of time and because they are new methods of accessing Web sites and
Internet-based services, whether enough users of our PCs will use these
features to create a sufficiently large audience to attract advertisers is
uncertain. In addition, use of the hot-keys and our desktop client software
depends on the appeal to our consumers of the linked Web sites. We rely on
market research to determine the categories of products and services in which
consumers are likely to be interested. Should our reliance on this research
prove to be misguided, we may fail to select relevant categories of interest to
consumers or fail to adequately provide links to superior content within these
categories. In addition, we have no control over the experience that our
consumers have while visiting these Web sites. Consumers who are not satisfied
with their experience may decide not to use our hot-keys or desktop client
software. Should this occur, our ability to generate advertising revenue will
be significantly harmed.

We face risks related to expanding into new services and business areas, in
particular, e-commerce.

To increase our revenues, we will need to expand our operations by promoting
new or complementary products and by expanding the breadth and depth of our
services. Specifically, our future success will depend, in part, on obtaining
revenues from the facilitation of e-commerce transactions with online and
traditional retailers. The market for e-commerce services is extremely
competitive. Because we have limited experience in this market, we may have
limited success. If we expand our operations in this manner, we will require
significant resources for additional development and such expansion may strain
our management, financial and operational resources. Our expansion into new
product and service offerings may not be timely or may not generate sufficient
revenues to offset their cost. If this occurs, our business will be seriously
harmed.

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If we are unable to compete successfully for users, we could experience a loss
of revenues and market share.

The markets for PCs, Internet appliances and Internet advertising are
intensely competitive, evolving and subject to rapid technological change.
These markets are characterized by an increasing number of entrants. We compete
for users, and consequently for potential electronic commerce and advertising
revenue, directly or indirectly, with the following categories of competitors:

. vendors of personal computers, such as Apple, Compaq, Dell, Gateway,
Hewlett-Packard and IBM;

. vendors of stand-alone Internet appliances, such as InfoGear, Netpliance
and WebTV;

. Internet service providers, such as America Online, EarthLink,
Mindspring, Microsoft and NetZero;

. Internet portals, such as Excite@Home, Lycos and Yahoo!; and

. providers of Internet advertising services, such as 24/7 Media,
DoubleClick and Engage Technologies.

Virtually all of our current and potential competitors have longer operating
histories, significantly greater financial, technical, marketing and other
resources, significantly greater name recognition and a substantially larger
installed base of customers than we do. In addition, many of our competitors
have nationally known brands or well-established relationships and have
extensive knowledge of our industry. Moreover, our current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products to
address consumer needs or to combine hardware product and Internet service
offerings.

If we are unable to sell America Online's Internet access services to our PC
buyers, our revenues and profits would be reduced.

Our future success depends in part on our ability to sell Internet access
services to our PC buyers. The PC industry and the Internet industry are
currently evolving and converging. We believe that this convergence will result
in the PC becoming the Internet appliance that attracts consumers to enter into
multi-year Internet access service contracts. In addition, since we receive
bounty payments and other revenues from America Online depending on the service
our PC buyers choose, our business would be harmed if the reputation of America
Online or the popularity of America Online's AOL Classic or CompuServe 2000
suffer and a significant number of buyers do not also purchase Internet access
service from America Online. If Internet access services fees decline
significantly or become free, an ISP rebate program would be unattractive to
consumers and our revenues and profits would be reduced.

Our future growth depends on the continued use of the Internet.

We believe a significant number of our PC buyers are purchasing our products
and services as a means of connecting to the Internet. As a result, our future
success is substantially dependent upon continued growth in Internet use. The
adoption of the Internet medium for commerce and communications generally
requires the understanding and acceptance of a new way of purchasing goods and
exchanging information. The use and acceptance of the Internet may not increase
for a number of other reasons, including the following:

. actual or perceived lack of security of information, such as credit card
numbers, which are transmitted over the Internet;

. high cost or lack of availability of access;

. congestion of traffic or other usage delays on the Internet;

. inconsistent quality of service;

. possible outages due to damage to the Internet;

. uncertainty regarding intellectual property ownership; and

. government regulation of the Internet.

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Capacity constraints caused by growth in the use of the Internet may impede
further development of the Internet to the extent that users experience delays,
transmission errors and other difficulties. If the necessary infrastructure,
products, services or facilities are not developed to mitigate the effects of
these factors, or if the Internet does not become a viable and widely used
commercial and communication medium, our products and services would be less
attractive and our future growth would be impaired.

If software we develop or software developed by, or licensed from, third
parties, has any unanticipated defects or becomes unavailable, we could
experience service interruptions that could increase our repair costs or reduce
our revenues.

We have developed and are further developing two-way client software as well
as other applications that will be bundled with our PCs. Some of our Internet-
based services rely on software provided by third parties that is bundled with
our PCs. We have no control over the quality of this software. Our software and
this third- party supplied software may contain undetected errors, defects or
bugs. These defects could cause service interruptions that could damage our
reputation or increase our product repair costs, prevent us from delivering
advertisements, cause us to lose revenue, delay market acceptance of our
Internet-based services or divert our development resources, any of which could
cause our business to suffer. If these problems cannot be fixed in a timely
manner, we may be unable to fulfill our obligations to our advertising
customers, which could significantly harm our business.

If we are unable to cope with significant increases in traffic to our servers,
we may lose user confidence.

Currently, users who use the hot-keys on our keyboards and our eWare client
software to reach our advertisers' Web sites are first directed to our servers
and then re-directed to our advertisers' Web sites. We may experience
significant increases in traffic on our servers for a variety of reasons,
including an increase in sales of our PCs or keyboards. We expect the number of
users of our Internet-enhanced PC products to increase rapidly over time.
Accordingly, our servers must accommodate a high volume of traffic, often at
unexpected times. Our servers have in the past, and may in the future,
experience slower response times than usual or other problems for a variety of
reasons. These events could cause our users to perceive our servers as not
functioning properly and, therefore, cause them to use other methods to access
and use the Internet. If this occurs, our business could be seriously harmed.

Our servers are located at a single site and, in the event of a natural
disaster, our client software would not operate.

We depend on the efficient and uninterrupted operations of our Web servers
and other hardware systems. Our Web servers and other hardware systems are
located in Sunnyvale, California. Our Web servers and other hardware systems
are vulnerable to damage from earthquakes, fire, floods, power loss,
telecommunications failures, and similar events. If any of these events result
in damage to our Web servers or other hardware systems, we may be unable to
deliver Internet advertising and other related Internet services for our
customers until the damage is repaired. If this occurs, we may lose customers,
users of our client software and revenue, and may incur substantial costs in
repairing any damage.

Online security breaches could result in a loss of consumer confidence in e-
commerce, which could lessen our ability to implement our business strategy.

Because many of our advertisers encourage people to use the Internet to
purchase goods and services, our business could be seriously harmed if Internet
users reduce their use of the Internet because of security concerns. We
currently ask consumers to provide us with registration and other information
and we rely on encryption and authentication technology to securely transmit
this confidential information. In addition, a party that is able to circumvent
the security of our server systems could steal proprietary information or cause
interruptions in our operations. Our efforts to protect our server systems may
not be successful. Any well-publicized compromise of confidential information,
whether during the transmission of data or while it is stored

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on our servers, could damage our reputation, expose us to a risk of loss,
litigation or liability, and deter people from using the Internet. Our
insurance policies may not be adequate to reimburse us for losses caused by
security breaches.

We could be exposed to liability or increased costs if new case law is decided,
or new government regulation is enacted, regarding the Internet.

The law relating to our Internet business and operations is evolving, and no
clear legal precedents have been established. For example, tax authorities in a
number of states are currently reviewing the appropriate tax treatment of
companies engaged in e-commerce, and new state tax regulations may subject us
to additional state sales or other taxes. The adoption of any new Internet laws
and regulations or the application of existing laws and regulations to the
Internet and e-commerce could decrease the demand for our products and services
or increase the cost of doing business. In addition, the applicability to the
Internet of existing laws in various jurisdictions governing issues such as
property ownership, sales and other taxes, libel and personal privacy is
uncertain and may take years to resolve. If we were alleged to have violated
federal, state or foreign civil or criminal law, even if we could successfully
defend such claims, it could occupy significant amounts of management's time,
harm our business reputation and negatively affect our operating results and
financial condition.

We may face claims for activities of our customers that could expose us to
liability and negatively impact our operating results.

Our customers' promotion of their products, services and software may not
comply with federal, state and local laws. A wide variety of laws and
regulations govern the content of advertisements and regulate the sale of
products and services. There is also uncertainty as to the application of these
laws to the emerging world of advertising on the Internet. We cannot predict
whether our role in facilitating these marketing activities would expose us to
liability under these laws. We may face civil or criminal liability for
unlawful advertising or other activities of our customers. If we are exposed to
this kind of liability, we could be required to pay substantial fines or
penalties, redesign our business methods, discontinue some of our services or
otherwise expend resources to avoid liability. Any costs incurred as a result
of that liability or asserted liability could negatively impact our operating
results.

Risks Principally Related to Our PC Business

Because our business depends on outsourcing a substantial portion of our PC
operations, if we were unable to do so in the future, we could incur
significantly higher costs which would reduce our revenues and our profits.

Historically, we have had relatively low manufacturing and operating costs
because we outsource most of our operating and manufacturing functions,
including system assembly, warehouse labor, distribution, research, product
design, warranty services and customer support. In addition, we have had
relatively low distribution costs because we distribute our products primarily
through a limited number of large retailers. We may not be successful in
managing our relationships with any of these third parties, and if existing
third-party suppliers cannot provide these services at commercially reasonable
prices, or at all, and we are not able to find suitable alternative suppliers,
our business would be significantly harmed. Moreover, we may not be able to
monitor or control effectively the quality of the PCs and monitors manufactured
by our suppliers. Low-quality products, poor customer service, or similar
inadequacies may harm our brand name, which would reduce our revenues and
profits.

Because we currently depend solely on three manufacturers for our PCs and
monitors, if supply is reduced or discontinued, our growth rate would decline
which would harm our business and financial results.

TriGem Computer currently manufactures all of our eTower and eMonster PCs.
Korea Data Systems Co. manufactures our eOne PCs, eSlate notebooks and,
together with the Jean Company, a Taiwanese manufacturer, all of our monitors.
We have no obligation to order, take minimum delivery or purchase products at

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pre-negotiated prices from TriGem Computer, Korea Data Systems Co. or Jean
Company. Additionally, other than in the case of TriGem Computer as described
below, absent a purchase order submitted by us, Korea Data Systems and Jean
Company have no contractual obligation to supply us with PCs and monitors.
Further, TriGem Computer's PC production facility in Korea is currently
operating at full capacity. In order to meet anticipated demand for our
products and the products of other customers, TriGem Computer recently entered
into an outsourcing manufacturing agreement for a facility in Xiamen, China and
opened a new facility in Shenyang, China. The Xiamen facility currently has
production capacity of approximately 90,000 PC units per month. The Shenyang
facility is a final-assembly plant with production capacity of approximately
150,000 PC units per month. Under the terms of our supply agreement, TriGem
Computer has agreed to reserve a portion of its manufacturing capacity at its
facilities to meet our supply requirements. TriGem Computer, Korea Data Systems
Co. and Jean Company provide other vendors with PCs and monitors. As a result,
we may not benefit from any increased production capacity. If we are unable to
obtain a sufficient supply of PCs or monitors to meet the demand for our
products, our growth rate would decline which could reduce our sales, revenue
and market share.

Our suppliers depend on a limited number of key suppliers for microprocessors
and other components used in our products.

Our suppliers generally use standard parts and components available from a
number of vendors. However, our suppliers are dependent on Intel Corporation
and Advanced Micro Devices, Inc. for their supply of microprocessors. If, in
the future, our suppliers are unable to obtain sufficient quantities of
microprocessors from Intel or Advanced Micro Devices, or if these companies
stop producing microprocessors that meet our needs, our suppliers could
experience increases in component costs or delays in product shipments that
would significantly harm our business. Even where multiple vendors are
available, our suppliers' strategy has been to concentrate purchases from a
single source to obtain favorable pricing. Our profit margins may decline and
our business would be significantly harmed if supply shortages led to price
increases or production delays for our products.

Because average selling prices of PCs decline rapidly, if we fail to properly
manage our inventory we may be unable to meet consumer demand or we could have
excess inventories.

The average selling prices of PCs are subject to rapid declines. To address
the problems created by excess inventory in the face of rapid price decreases,
PC vendors must carefully manage their inventory. Additionally, due to our
narrow margins, we must manage our inventory more efficiently than traditional
PC vendors. From time to time in the past, our inventory has been limited by
the capacity of our manufacturers and may be limited in the future. We may be
unsuccessful in managing the supply of our PCs and monitors to meet demand in
the future. Our business is dependent on our ability to quickly sell our PC
products through the retail channel. We must carefully monitor market demand
for, and supply of, our products in an effort to match supply to consumer
demand. If we overestimate the supply needed to meet consumer demand, we could
have excess inventory. If we underestimate needed supply or otherwise maintain
too little inventory, we may not be able to react quickly to sudden increases
in market demand for a given product.

In connection with the introduction of new products, we may be required to
discount prices of existing products or to give other sales incentives to
retailers. As a result, we may experience price protection adjustments to a
significant degree in the future. For example, in the second quarter of 1999,
we offered a significant price protection to certain retailers in connection
with the introduction of our next generation of products. In addition,
retailers generally have the right to return a portion of excess inventory
purchased in the prior quarter within a limited period of time. Increased
inventory levels in our distribution channels, whether due to a decrease in
consumer demand for our products, lower-than-anticipated demand for PCs in
general, problems in managing product transitions or component pricing
movements could significantly harm our profitability. Production delays at the
beginning of a new PC product cycle could affect our sales of newer products
and how we manage the sale of older PC product inventory held by retailers. If
we are unable to sell our aging products at anticipated prices, our margins
would be reduced. In managing our supply chain, we must

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accurately forecast consumer demand for our products. The amount we establish
as reserves for price adjustments in the event we must credit a retail customer
for a price decrease may be insufficient and any future returns or price
protection charges may reduce our operating results.

The international operations of our suppliers of PCs and monitors expose us to
currency, trade, regulatory, political and other risks.

All of our PCs and monitors are currently being manufactured in Korea, China
and Malaysia by TriGem Computer, Korea Data Systems Co. and Jean Company. These
suppliers' operations, and in turn our operating results, are subject to a
number of risks associated with international operations including:

. fluctuations in currency values;

. export duties, import controls and trade barriers;

. restrictions on the transfer of funds;

. political and economic instability; and

. compliance with foreign laws.

Our success depends on our ability to compete successfully in the PC industry.

The PC industry is highly competitive and we expect this competition to
increase significantly, particularly in the low-priced PC market. We have been
able to gain market share by selling high-quality PCs at prices significantly
lower than those offered by established PC vendors. We expect pricing pressures
in the PC market to continue, particularly as more vendors combine Internet
access with the purchase of a PC. PC vendors may continue to reduce their
prices to compete with us at our low price points. Large PC vendors such as
Compaq, Gateway, Hewlett-Packard and IBM have significantly greater financial,
marketing and technical resources than we do and may decide to accept lower
margins or losses on a sustained basis on their low-priced PC sales to regain
market share. The introduction of low-priced PCs combined with the brand
strength, extensive distribution channels and financial resources of the larger
PC vendors may cause us to lose market share.

Most major PC vendors have begun to offer Internet access services. Some PC
vendors are trying to increase their sales of higher-priced PCs by offering
additional services, such as free Internet access for a limited period of time.
In addition, other PC vendors are adopting programs similar to ours that rebate
a portion of the purchase price of PCs in exchange for entering into multi-year
Internet access service contracts. There are relatively few barriers preventing
competitors from entering this market. As a result, new market entrants pose a
threat to our business. We do not own any patented technology that precludes or
inhibits competitors from entering the low-priced PC market. Existing or future
competitors may develop or offer products or services that are comparable or
superior to ours at a lower price, which could erode our competitive position.
For example, in the last quarter of 1999 one retailer began offering its own
branded, low-priced PCs in conjunction with Internet access service from
America Online. Our PC and monitor suppliers either are not contractually bound
or have only limited obligations to meet our demand for products and can divert
some or all of their output to others, including our competitors, or sell
directly to the retail channel. If any of these events were to occur, our
market share could be reduced unless we were able to successfully compete with
these parties and source high-quality PCs and monitors from other low-cost
manufacturers.

The future of our PC business depends on PCs remaining the predominant Internet
access device.

The future of our PC business depends on PCs remaining the predominant
Internet access device. Internet services are currently accessed primarily by
PCs. However, television set-top boxes, hand-held products and other non-PC
devices may increasingly be used to access the Internet. Television set-top
boxes equipped with modems and cable modems allow users to transmit data at
substantially faster speeds than the analog modems currently incorporated in
our PCs. If consumers prefer this or any other alternative devices to PCs to
access the Internet, sales of our PCs may slow.

18
<PAGE>

Because we depend on licenses of intellectual property from third parties to
produce our PC products, the loss of any of these licenses would significantly
harm our financial results.

We are required to obtain licenses from software providers in order to
market and sell our products and services. In particular, we currently pre-
install Windows 98 and Microsoft Works on our PCs pursuant to a license.
However, if we are unable to maintain these licenses, or obtain the necessary
licenses in the future, we may be forced to market products without these
technological features or software. We may also be forced to discontinue sales
of our products that incorporate allegedly protected technology for which we
have no license or defend legal actions taken against us relating to our use of
the allegedly protected technology. Our inability to obtain licenses on
competitive terms necessary to sell our PCs at a profit would significantly
harm our financial results.

If we do not maintain and strengthen our relationships with our retailers, our
ability to generate revenues will suffer.

We depend substantially on retailers to sell our PCs and monitors. Since
inception, we have derived a significant portion of our gross revenues from
sales of our PCs and monitors to a limited number of large retailers. For the
year ended December 31, 1999, approximately 68% of our gross revenues were from
sales of PCs and monitors to Best Buy, Office Depot, Circuit City and
MicroCenter, our four largest retail customers. We expect to continue to derive
a large percentage of our gross revenues from sales of PCs and monitors to a
limited number of leading retailers. However, our retail customers are not
contractually committed to future purchases of our products and could
discontinue carrying our products at any time. In addition, we compete with an
increasing number of companies for access to limited shelf space with these
retailers. Generally, these retailers limit the number of PC brands they carry
and may stop carrying our PCs at any time. Any significant disruption of our
relationship with any of our major retailers, or any significant reduction in
purchases by them, could affect our ability to generate revenues.

If we are unable to monitor and manage our product rebate programs, our
revenues could decrease.

We currently offer product rebates to buyers of our PCs. We have limited
historical data to assist us in determining what percentage of consumers will
claim these product rebates. At the same time, we must approximate future
product rebate redemptions in order to price our products effectively. If an
unexpectedly large number of our PC buyers redeemed the product rebates to
which they were entitled, the effective average selling price of our products
would be reduced below the level we anticipated and our revenues would
decrease.

We rely on the availability of rebates offered by Internet service providers to
sell our PCs, and if such rebates are discontinued, our sales could decrease.

To help sell PCs, we rely on the availability of rebates offered by Internet
service providers to purchasers of new computers who subscribe for their
Internet access services. These rebates reduce the effective price of our PC
models, making them more affordable for consumers. If these rebates were
discontinued, the effective prices of our PCs would increase, which likely
would reduce sales of our PCs. A significant decrease in sales of PCs would
harm our business.

We operate under a verbal agreement with one of our suppliers, the terms of
which may be changed in a manner adverse to us.

We currently operate under a verbal agreement with KDS USA, the supplier of
our monitors and certain other of our products. Under this agreement, our
inventory trade payable terms are extended out to 90 days with a cash discount
on PC purchases proportional to the number of days we pay early. This verbal
agreement is described in more detail under "Related Party Transactions." Since
this agreement is not in written form, we may not be able to continue to
operate our business under these terms and these terms may be subject to future
change. If we are unable to continue to operate under this agreement or it is
changed in a manner adverse to us, our business could be significantly harmed.

19
<PAGE>

If we extend credit to retailers that do not repay us, or that pay late, we may
have unexpected losses.

We extend credit to our retailers, which exposes us to credit risk. Most of
our outstanding accounts receivable are from a limited number of large
retailers. As of December 31, 1999, our four highest outstanding accounts
receivable balances totaled $78.8 million, representing 63% of our gross
accounts receivable, with one customer accounting for $44.7 million,
representing 36% of our gross accounts receivable. In the event that we fail to
monitor and manage effectively the resulting credit risk and a material portion
of our accounts receivable is not paid in a timely manner or becomes
uncollectible, we could incur a significant loss associated with any
outstanding accounts receivable.

Risks Related to this Offering

Our principal stockholders can exercise a controlling influence over our
business and affairs.

Immediately after the offering, our four principal stockholders, TriGem
Corporation, Korea Data Systems America, Stephen A. Dukker and Bill Gross and
his affiliated entities, will own approximately 51% of our common stock
(approximately 50% if the underwriters' over-allotment option is exercised in
full). If these stockholders acted or voted together, they would have the power
to elect our directors and to exercise a controlling influence over our
business and affairs, including:

. any determinations over whether to change the source of our supply of
PCs and monitors;

. the appointment of new management;

. any determinations with respect to mergers, acquisitions or other
business combinations;

. future issuances of debt and equity securities; and

. the approval of any action requiring the consent of the stockholders,
including amendments to our certificate of incorporation.

In addition, this concentration of ownership could prevent a change in control
that might otherwise be beneficial to stockholders.

We may have potential conflicts of interest with our principal stockholders
that could be resolved in a manner that is inconsistent with other
stockholders' interests.

Conflicts of interest may arise between us and our principal stockholders in
a number of areas relating to our present and ongoing relationships, which
could be resolved in a manner that is inconsistent with our other stockholders'
interests. Conflicts of interests that may arise include:

. the ongoing supply relationships between us and our principal corporate
stockholders that may result in terms that are not as favorable to us as
arrangements we could negotiate at arm's length between unrelated
parties;

. potential competitive business activities;

. potential acquisitions or financing transactions;

. sales or other dispositions by these principal stockholders of shares of
our common stock, including through the exercise of their registration
rights; and

. tax and intellectual property matters.

20
<PAGE>

Substantial future sales of our common stock in the public market may depress
our stock price.

Our current stockholders hold a substantial number of shares of our common
stock that they will be able to sell in the public market in the future. Sales
of a substantial number of shares of our common stock after this offering could
cause our stock price to fall. In addition, the sale of these shares could
impair our ability to raise capital through the sale of additional stock. You
should read "Shares Eligible for Future Sale" for a full discussion of shares
that may be sold in the public market in the future.

Our management has broad discretion over the use of the proceeds from this
offering.

Our management has broad discretion over the use of the proceeds of this
offering. Accordingly, it is possible that our management may allocate the
proceeds differently than investors in this offering would have preferred, or
that we will fail to maximize our return on the proceeds. See "Use of Proceeds"
for a more complete description of our current intention regarding the net
proceeds of this offering.

As a new investor you will experience immediate and substantial dilution.

If you purchase common stock in this offering, you will pay more for your
shares than the amount paid by existing stockholders who acquired shares before
this offering. As a result, the value of your investment based on the value of
our net tangible assets, as recorded on our books, will be less than the amount
you pay for shares of common stock in this offering. In addition, the total
amount of our capital will be less than what it would have been had all the
existing stockholders and optionees paid the same amount per share of common
stock as you will pay in this offering. See "Dilution" for a more complete
description of the dilution of your investment in our common stock upon the
completion of this offering.

Our charter documents and Delaware law could make it more difficult for a third
party to acquire us and discourage a takeover.

Our certificate of incorporation and bylaws are designed to make it
difficult for a third party to acquire control of us, even if a change in
control would be beneficial to stockholders. For example, our amended and
restated certificate of incorporation to be filed upon completion of this
offering, authorizes our board of directors to issue up to 35,000,000 shares of
preferred stock without previously designated rights and privileges. Without
stockholder approval, the board of directors has the authority to attach
special rights, including voting and dividend rights, to this preferred stock.
With these rights, preferred stockholders could make it more difficult for a
third party to acquire our company, including takeover attempts that might
result in a premium over the market price for shares of our common stock.

Our charter documents will, subject to appropriate corporate action,
eliminate the right of stockholders to call a special meeting of stockholders
and eliminate the ability of stockholders to take action by written consent. As
a Delaware corporation, we are also subject to the Delaware anti-takeover
statute contained in Section 203 of the Delaware General Corporation Law. See
"Description of Capital Stock--Delaware Anti-Takeover Law and Certain Charter
and Bylaw Provisions" for a more complete description of Section 203 of the
Delaware General Corporation Law. These provisions could make it more difficult
for a third party to acquire us, even if doing so would be beneficial to our
stockholders.

Our stock price may be volatile.

Prior to this offering, there has not been a public market for our common
stock. We cannot predict the extent to which investor interest in eMachines
will lead to the development of a trading market or how liquid that market
might become. The initial public offering price for our shares has been
determined by negotiations between us and the representatives of the
underwriters and may not be indicative of prices that will prevail in the
trading market.

In addition, the stock markets in general, and The Nasdaq National Stock
Market and technology companies in particular, have experienced extreme price
and volume fluctuations that have often been unrelated or disproportionate to
the operating performance of such companies. The trading prices of many
comparable technology companies' stocks are at or near historical highs. These
trading prices are substantially above historic levels and may not be
sustained. These broad market and industry factors may seriously impact the
market price of our common stock, regardless of our actual operating
performance.

21
<PAGE>

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that relate to future
events or our future financial performance. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"intend," "potential" or "continue" or the negative of such terms or other
comparable terminology. These forward-looking statements include, but are not
limited to, statements about our plans, objectives, expectations and intentions
and other statements contained in the prospectus that are not historical facts.
These statements are only predictions. We cannot guarantee future results,
levels of activity, performance or achievements. We undertake no obligation to
publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise. Our actual results could differ
materially from those anticipated in these forward-looking statements as a
result of various factors, including the risk outlined under "Risk Factors" and
elsewhere in this prospectus.

USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the 20,000,000
shares of common stock offered will be approximately $166.3 million
(approximately $191.4 million if the underwriters' over-allotment option is
exercised in full), less underwriting discounts and commissions and estimated
offering expenses.

The principal purposes of this offering are to increase our working capital,
to create a public market for our common stock, to facilitate our future access
to public equity markets, and to provide us with increased visibility and
credibility. We presently have no specific plans for use of the net proceeds of
this offering. However, we intend to use the net proceeds primarily for general
corporate purposes, including working capital, expansion of our sales and
marketing organization, and capital expenditures. We may, when and if the
opportunity arises, use an unspecified portion of the net proceeds to acquire
or invest in complementary businesses, products and technologies. We have no
present understandings, commitments or agreements with respect to any material
acquisition of, or investment in, third parties. We believe that our existing
capital resources, combined with the net proceeds of this offering, will be
sufficient to meet our presently anticipated cash requirements through at least
the next 12 months. There can be no assurance that we will not be required to
raise additional financing prior to such time, that additional financing will
be available when needed or that, if available, such financing will be
available on terms favorable to us and our stockholders. Pending use of the net
proceeds for the above purposes, we intend to invest such funds in interest
bearing, investment grade securities.

DIVIDEND POLICY

We have never declared or paid any dividends on our capital stock. We
currently expect to retain future earnings for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in
the foreseeable future.

22
<PAGE>

CAPITALIZATION

The following table sets forth our unaudited capitalization as of December
31, 1999 on an actual, pro forma FreePC acquisition and pro forma as adjusted
basis. The actual column reflects our capitalization as of December 31, 1999 on
a historical basis, without any adjustments to reflect subsequent events. The
pro forma FreePC acquisition information reflects the issuance of 3,995,633
shares of common stock and 17,633,886 shares of convertible preferred stock
issued in connection with the FreePC acquisition completed in January 2000.

The pro forma as adjusted data includes the pro forma FreePC acquisition
information and:

. the conversion of all outstanding shares of preferred stock into
41,913,255 shares of common stock automatically upon completion of the
offering;
. the issuance of 20,000,000 shares of common stock offered in this
offering; and
. an increase of 10,000,000 in the number of shares of preferred stock
that our board of directors will be authorized to issue pursuant to an
amended and restated certificate of incorporation to be filed upon
completion of this offering.

<TABLE>
<CAPTION>
December 31, 1999
---------------------------------
Pro Forma
FreePC Pro Forma
Actual Acquisition As Adjusted
-------- ----------- -----------
(in thousands, except share
data)
<S> <C> <C> <C>
Long-term obligations........................ $ 1,903 $ 3,131 $ 3,131
Redeemable convertible preferred stock, $0.01
par value: 25,000,000 shares authorized
(actual and pro forma FreePC acquisition)
and 35,000,000 shares authorized (pro forma
as adjusted); 24,279,369 shares issued and
outstanding (actual and pro forma FreePC
acquisition); no shares issued and
outstanding (pro forma as adjusted)......... 150,014 150,014 --
Stockholders' equity (deficiency):
Convertible preferred stock, $0.01 par
value: 25,000,000 shares authorized (actual
and pro forma FreePC acquisition) and
35,000,000 shares authorized (pro forma as
adjusted); no shares issued and outstanding
(actual); 17,633,886 shares issued and
outstanding (pro forma FreePC acquisition);
no shares issued and outstanding (pro forma
as adjusted)............................... -- 110,551 --
Common stock, $0.0000125 par value:
250,000,000 shares authorized (actual and
pro forma FreePC acquisition) and
350,000,000 shares authorized (pro forma as
adjusted); 78,019,538 shares issued and
outstanding (actual); 82,015,171 shares
issued and outstanding (pro forma FreePC
acquisition); 143,928,426 shares issued and
outstanding (pro forma as adjusted)........ 1 1 2
Additional paid-in capital................... 6,582 46,031 472,910
Unearned stock compensation.................. (1,550) (1,550) (1,550)
Notes receivable from stockholders........... (500) (500) (500)
Accumulated deficit.......................... (12,269) (12,269) (12,269)
-------- -------- --------
Total stockholders' equity (deficiency)...... (7,736) $142,264 458,593
-------- -------- --------
Total capitalization...................... $144,181 $295,409 $461,724
======== ======== ========
</TABLE>

The above information excludes:

. 858,400 shares of common stock issuable upon exercise of options
outstanding as of December 31, 1999, at a weighted average exercise
price of $4.15 per share, which options were issued under our 1998 stock
plan, 4,141,600 additional shares authorized to be issued under our 1998
stock plan plus an automatic annual increase to be added on the first
day of our fiscal year beginning in 2001;
. 357,897 shares of common stock issuable upon exercise of options
outstanding as of December 31, 1999, at a weighted average exercise
price of $2.39 per share, issued outside of our 1998 stock plan;
. 2,891,275 shares of common stock issuable upon exercise of options
assumed by us in connection with the FreePC acquisition and warrants to
purchase 1,239,067 shares of common stock issuable upon the exercise of
these assumed options at a warrant exercise price of $17.13;
. 9,269,834 shares of common stock issuable upon exercise of warrants
issued in connection with the FreePC acquisition at a warrant exercise
price of $17.13 per share;
. up to 1,566,219 shares of common stock issuable to America Online upon
exercise of its warrants. See "Related Party Transactions--Relationship
with America Online, Inc." for a discussion of the America Online
warrants;
. 300,000 shares of common stock to be authorized for issuance under our
2000 employee stock purchase plan plus an annual increase to be added on
the first day of our fiscal year beginning in 2001; and
. 2,000,000 shares of common stock issuable upon exercise of an option
granted on March 19, 2000, to Stephen A. Dukker, our President and Chief
Executive Officer, with an exercise price of $9.00 per share.

23
<PAGE>

DILUTION

As of December 31, 1999, after giving pro forma effect to the acquisition of
FreePC and the conversion of 41,913,255 shares of convertible preferred stock
outstanding as of January 31, 2000, into 41,913,255 shares of common stock
automatically upon completion of this offering, the pro forma net tangible book
value of our outstanding common stock was $145.3 million, or approximately
$1.17 per share. Pro forma net tangible book value per share represents the
amount of our total tangible assets less total liabilities after giving effect
to the FreePC acquisition, divided by 123,928,426 shares of common stock
outstanding, which reflects:

. 78,019,538 shares of our common stock outstanding as of December 31,
1999;

. 3,995,633 shares of common stock issued in connection with the FreePC
acquisition completed in January 2000; and

. 41,913,255 shares of common stock issuable upon the automatic conversion
upon completion of this offering of 24,279,369 shares of our redeemable
convertible preferred stock outstanding as of December 31, 1999, and
17,633,886 shares of our convertible preferred stock issued in
connection with the FreePC acquisition in January 2000.

Dilution in pro forma net tangible book value per share represents the
difference between the amount per share paid by purchasers of shares of common
stock in this offering and the net tangible book value per share of common
stock immediately after completion of this offering. After giving effect to the
sale of the 20,000,000 shares of common stock in this offering at an initial
public offering price of $9.00 per share (less underwriting discounts and
commissions and estimated offering expenses), our pro forma net tangible book
value as of December 31, 1999 would have been $311.6 million or $2.17 per
share. This represents an immediate increase in net tangible book value of
$1.00 per share to existing stockholders and an immediate dilution in net
tangible book value of $6.83 per share to new investors of common stock in this
offering, or 75.9% of the initial public offering price of $9.00 per share. The
following table illustrates this dilution:

<TABLE>
<S> <C> <C>
Initial public offering price per share........................ $9.00
Pro forma net tangible book value per share as of December 31,
1999......................................................... $1.17
Increase per share attributable to new investors.............. $1.00
-----
Pro forma net tangible book value per share after this
offering...................................................... $2.17
-----
Dilution per share to new investors............................ $6.83
=====
</TABLE>

The following table sets forth, as of December 31, 1999, the differences
between the number of shares of common stock purchased from us, the total
consideration paid and the average price per share paid by existing holders of
common stock (on a pro forma basis to reflect the issuance of 3,995,633 shares
of common stock and 17,633,886 shares of convertible preferred stock issued in
connection with the FreePC acquisition completed in January 2000, and
41,913,255 shares of common stock issuable upon automatic conversion of
outstanding convertible preferred stock upon completion of this offering) and
by new investors, before deducting underwriting discounts and commissions and
estimated offering expenses, at an initial public offering price of $9.00 per
share.

<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------- -------------------- Average Price
Number Percent Amount Percent Per Share
----------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders... 123,928,426 86.1% $292,603,000 61.9% $2.36
New investors........... 20,000,000 13.9 180,000,000 38.1 $9.00
----------- ----- ------------ -----
Total................. 143,928,426 100.0% $472,603,000 100.0%
=========== ===== ============ =====
</TABLE>

24
<PAGE>

The foregoing discussion and table assume no exercise of the underwriters'
over-allotment option and excludes the effect of:

. 357,897 shares of common stock issuable upon exercise of options
outstanding as of December 31, 1999, at a weighted average exercise
price of $2.39 per share, issued outside of our 1998 stock plan;

. 2,891,275 shares of common stock issuable upon exercise of options
assumed by us in connection with the FreePC acquisition and warrants to
purchase 1,239,067 shares of our common stock issuable upon the exercise
of these assumed options at a warrant exercise price of $17.13 per
share;

. 9,269,834 shares of common stock issuable upon exercise of warrants
issued in connection with the FreePC acquisition at a warrant exercise
price of $17.13 per share;

25
<PAGE>

SELECTED FINANCIAL DATA

You should read the selected financial data set forth below in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our Financial Statements and related Notes included
elsewhere in this prospectus. The financial data and other operating
information as of and for the period from inception to December 31, 1998 and as
of and for the year ended December 31, 1999 are derived from audited financial
statements included elsewhere in this prospectus.

The pro forma financial data gives effect to the FreePC acquisition
completed in January 2000. You should read the pro forma data in conjunction
with the audited Consolidated Financial Statements and related Notes of FreePC
included elsewhere in this prospectus. The pro forma data below is presented
for illustrative purposes only and is not necessarily indicative of the
operating results or financial position that would have resulted if the
acquisition had been in effect during the periods presented, nor is it
necessarily indicative of future operating results or financial position. For
example, the pro forma financial data includes the cost of distributing free
computers and providing free Internet access. We do not expect to distribute
free computers or provide free Internet access in the foreseeable future. Also,
our expenses significantly increased during the year. We expect that our future
expenses will significantly increase as we continue to invest in technology,
infrastructure, and sales and marketing. We intend to hire more technological
and infrastructure support personnel, and also intend to invest in sales and
marketing programs. For an explanation of the calculation of pro forma amounts
see Notes to the Unaudited Pro Forma Condensed Combined Financial Information.

<TABLE>
<CAPTION>
Year Ended Dec. 31, 1999
---------------------------------
Sept. 18, 1998 Pro Forma
(inception) to FreePC
Dec. 31, 1998(4) Actual(4) Acquisition(4)
------------------ --------------- ----------------
Statements of Operations
Data: (in thousands, except share and per share data)
<S> <C> <C> <C>
Net revenues:
Hardware.................. $ 58,283 $ 812,233 $ 812,233
Internet.................. 2,084 3,285
--------------- --------------- ---------------
Net revenues............ 58,283 814,317 815,518
Cost of revenues:
Hardware.................. 58,088 780,859 780,859
Internet.................. 86 3,406
--------------- --------------- ---------------
Cost of revenues........ 58,088 780,945 784,265
--------------- --------------- ---------------
Gross profit............ 195 33,372 31,253
Operating expenses:
Sales and marketing (1)... 840 16,451 37,206
Customer service and
technical support........ 269 9,049 9,049
General and
administrative (2)....... 999 9,714 13,610
Research and
development.............. 2,938
Amortization of
intangible assets........ 49,000
Write-down of assets held
for sale................. 941
--------------- --------------- ---------------
Total operating
expenses............... 2,108 35,214 112,744
--------------- --------------- ---------------
Loss from operations...... (1,913) (1,842) (81,491)
Financing charges and
interest expense, net.... (889) (3,886) (3,024)
--------------- --------------- ---------------
Net loss.................. $ (2,802) $ (5,728) $ (84,515)
=============== =============== ===============
Net loss per common
share(3):
Basic and diluted......... $ (0.05) $ (0.14) $ (1.21)
=============== =============== ===============
Basic and diluted--pro
forma.................... $ (0.07) $ (0.85)
=============== =============== ===============
Shares used to compute net
loss per share(3):
Basic and diluted......... 57,600,000 68,933,254 72,928,887
=============== =============== ===============
Basic and diluted--pro
forma.................... 77,913,294 99,542,813
=============== ===============
</TABLE>
- ------------------
(1) Included in sales and marketing expenses was $1,153 of non-cash stock-based
compensation expense for the year ended December 31, 1999 (actual).
(2) Included in general and administrative expenses was $11 and $179 of non-
cash stock-based compensation expense for the period from September 18,
1998 (inception) to December 31, 1998 and the year ended December 31, 1999
(actual), respectively.
(3) See Note 2 of Notes to Financial Statements for an explanation of the
determination of the weighted average common and common equivalent shares
used to compute net loss per share.
(4) As restated, see Note 11 of Notes to Financial Statements.

<TABLE>
<CAPTION>
Dec. 31, 1999
----------------------
Pro Forma
FreePC
Dec. 31, 1998 Actual Acquisition
------------- --------- -----------
Balance Sheet Data: (in thousands)
<S> <C> <C> <C>
Cash and cash equivalents................. $ 3,791 $ 114,823 $ 125,762
Short-term investments.................... 19,897 19,897
Working capital (deficiency).............. (1,311) 140,166 141,257
Total assets.............................. 60,011 331,713 495,587
Long-term obligations..................... 560 1,903 3,131
Redeemable convertible preferred stock ... -- 150,014 150,014
Total stockholders' equity (deficiency)... (1,351) (7,736) 142,264
</TABLE>

26
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This prospectus contains forward-looking statements the accuracy of which
involves risks and uncertainties. We use words such as "anticipate," "believe,"
"plan," "expect," "future" and "intend" and similar expressions to identify
forward-looking statements. Prospective investors should not place undue
reliance on these forward-looking statements, which apply only as of the date
of this prospectus. Our actual results could differ materially from those
anticipated in these forward-looking statements for many reasons, including the
risks we face described in "Risk Factors" and elsewhere in this prospectus.

Overview

We sell high-quality, low-priced personal computers, or PCs, to develop
ongoing Internet-based consumer relationships designed to provide us with a
continuous stream of advertising and related revenues. We provide Internet
advertisers with an integrated approach to building their online brands that
includes our client-server software, promotional materials packaged with our
PCs and keyboards that provide one-touch access to selected Web sites. We were
incorporated in September 1998 and sold our first PC in November 1998. We
intend to aggressively pursue recurring revenue generating opportunities that
extend beyond the purchase of the PC or other Internet connected devices. To
this end, in January 2000, we acquired FreePC, Inc., a Bill Gross' idealab!
company that was one of the first companies to subsidize the purchase price of
the PC and Internet access with advertising sponsorships. Our acquisition of
FreePC's expertise and technical experience is a key element of our strategy to
enhance our Internet revenues.

We outsource the design and manufacturing of our PCs and monitors as well as
technical support, warehouse staffing, inspection, repair and repackaging of
returned PCs, and administration of our rebate program to third parties. As a
result, we have a relatively small internal organization that consisted of
162 employees as of January 31, 2000. Our hardware outsourcing strategy enables
us to minimize capital investment, maintain a low product cost structure and
respond quickly to market changes. As a result of our acquisition of FreePC, we
added 98 employees, significantly expanding our expertise in Internet-related
technologies, marketing and sales.

To date, we have derived substantially all of our revenues from the sales of
PCs and monitors to a limited number of large retailers. For the year ended
December 31, 1999, approximately 68% of our gross revenues were from sales of
PCs and monitors to our four largest retail customers. We expect to continue to
derive a significant percentage of our gross revenues from sales of PCs and
monitors to a limited number of leading retailers, as well as an increasing
portion from Internet-related activities.

We operate primarily in the United States. To date, all of our sales and
substantially all of our purchases from our suppliers have been made in U.S.
dollars. As a result, changes in currency exchange rates do not generally have
a direct effect on our financial position. However, we do face foreign
business, political and economic risks because our supply of PCs and monitors
are manufactured outside of the United States. In addition, changes in currency
exchange rates may affect the cost of the PCs and monitors we purchase from our
foreign suppliers, thereby indirectly affecting consumer demand for our
products and our net revenues. We intend to expand our sales outside of North
America.

Our gross margins on hardware are affected by fluctuations in demand for our
products, the mix of products sold, the timing of new product implementations,
new product introductions by us and our competitors, changes in our pricing
policies and those of our competitors and component costs. In the future, our
gross margins may also be affected by fluctuations in demand for our Internet-
related services.

Our founding stockholders were Stephen A. Dukker, our Chief Executive
Officer, President and a member of our board of directors, and two wholly-owned
U.S. subsidiaries of Korean PC and monitor manufacturers--TriGem Corporation
and Korea Data Systems America. TriGem Computer, the parent corporation of
TriGem Corporation, manufactures all of our eTower PCs and eMonster PCs. Korea
Data Systems Co. Ltd., the parent corporation of Korea Data Systems America,
manufactures our eOne PCs, eSlate notebook PCs and, together with the Taiwanese
manufacturer Jean Company, all of our monitors. Historically, we purchased
substantially all of our PCs and monitors from KDS USA, a company wholly-owned
by Lap Shun Hui, which in turn

27
<PAGE>

purchased them from these manufacturers. Mr. Hui is a member of our board of
directors and one of our stockholders. On January 24, 2000, we entered into a
supply agreement with TriGem Computer pursuant to which we will purchase all of
our TriGem-manufactured PCs directly from TriGem Computer. In the future, we
may establish supply relationships with other PC and monitor manufacturers.

In connection with our acquisition of FreePC, Inc., we issued 3,995,633
shares of our common stock and 17,633,886 shares of our convertible preferred
stock for all of the outstanding shares of capital stock of FreePC. In
addition, we issued warrants to purchase 9,269,834 shares of common stock and
we assumed options exercisable for 2,891,275 shares of common stock and for
warrants to purchase 1,239,067 shares of common stock in connection with the
acquisition. As a result of the acquisition, each share of FreePC capital stock
issued or subject to an option to purchase FreePC common stock was exchanged
for approximately 1.10 shares of our common stock and a warrant to purchase
approximately 0.47 shares of our common stock. We accounted for the acquisition
using the purchase method. In connection with the FreePC acquisition, we will
record a significant amount of intangible assets, the amortization of which
will adversely affect our earnings and profitability in 2000 through 2002. We
expect to record intangible assets of approximately $147 million, to be
amortized over a period of three years. In addition, our operating costs have
increased significantly as a result of the FreePC acquisition. We have not yet
generated significant revenue from our Internet business and we expect to
experience operating losses before amortization expenses in that business in
the future. As a result, we expect to report losses on an operating basis
before amortization of intangible assets in our combined business for at least
the next several quarters.

Hardware Revenues, net

To date all of our hardware revenue has been derived from sales of our PCs
and monitors. We sell a variety of PC configurations and monitor models to our
retail customers. When appropriate, we have introduced and intend to continue
to introduce enhanced configurations of our PCs, new PC models and new Internet
devices. Generally, our lowest-priced PC model carries significantly lower
gross margins than our other PC models. We do not require retail customers to
buy PCs and monitors as a bundled package. To date, we have sold substantially
more PCs than monitors.

We recognize revenues from PC and monitor sales at the time products are
shipped to our retail customers. Revenues are recorded net of outbound shipping
costs, returns, price protection and estimated costs for sales incentive
programs. Price protection represents discounts offered to our retail customers
as an incentive to lower their sales prices on specific eMachines products held
in their inventory. Generally, our policy is to avoid the use of price
protection and customers are not entitled to automatic price protection. Since
we began operations, price protection has only been offered by us once, during
the second quarter of 1999, resulting in a $7.7 million charge to net revenues.
Sales incentive programs consist primarily of cash rebates offered by us to our
PC buyers. In general, we offer a product rebate during a redemption period
which extends for up to thirty days after the PC is purchased. We rely on
historical data to forecast the percentage of our PC buyers who will redeem
their product rebates. If in a given period these redemptions exceed our
expectations, our gross margin and operating results will be adversely
impacted. In addition, we intend to modify from time to time our product rebate
programs in response to changing market conditions. These modifications may
affect the mix of PCs sold, our gross margin and the percentage of rebates
redeemed.

We also derive limited revenues from the sale of extended service contracts
and technical support provided on an as-needed basis. We offer these services
through Sykes Enterprises, Inc., a third-party customer service provider. Our
PC buyers receive free technical support for fifteen days following their
initial support call under our technical support program. After this period,
our PC buyers who require additional support can choose to enter into an
extended service contract or pay on a per incident basis until the issue is
resolved. We recognize revenues from extended service contracts ratably over
the contract period and from technical support calls outside the initial
fifteen-day period of free support as the services are performed.

28
<PAGE>

Internet Revenues

We began to earn and report Internet revenues in the third quarter of 1999
under our marketing agreement with America Online. Under the agreement, America
Online provides Internet service provider, or ISP, rebates to our PC buyers to
significantly reduce the net effective price of our PCs. To obtain an ISP
rebate, our PC buyers must enter into an agreement with America Online to
subscribe to America Online's CompuServe Internet access service over a
predetermined period of time at a stated monthly fee. In addition to the rebate
provisions, the agreement also provides that we include America Online's
software on our PCs. America Online pays us recurring revenue or a one-time fee
depending on which service or plan a PC buyer elects. We recognize these
revenues when reported to us by America Online.

In the fourth quarter of 1999, we deployed our private label Internet access
service, e-machines.net, for consumers. We provide Internet access service
through our Internet service provider agreement with UUNET.

In December 1999, we began pre-installing desktop client software on our
PCs. We generate Internet revenues from our client software and, in the future,
expect revenue from our client software to increase as we expand our Internet
business. We also expect to generate Internet revenue from sales to advertisers
related to our hot-key enabled keyboard, in-box promotions and other Internet
services.

We expect future Internet revenues to be derived primarily from advertising
generated by our keyboard buttons, our desktop client software, pre-loaded
software offerings and other Internet-related services. As a result, we expect
Internet revenues to increase as a percentage of our total revenues. We believe
that the revenue we derive from these services likely will depend upon our
satisfaction of specified performance criteria. Depending upon the type of
service offered and the performance criteria specified, we may recognize
revenue as PCs are shipped to our retail customers, as impressions are
displayed, as click-throughs occur, or as otherwise may be appropriate. To the
extent performance criteria are not met we may defer recognition of some or all
of the corresponding revenues.

29
<PAGE>

Results of Operations

Because of our limited operating history, the recent acquisition of FreePC
and the rapidly evolving nature of our business, we believe that year-to-year
period comparisons and quarter-to-quarter period comparisons are not meaningful
and should not be relied upon as an indication of future performance. The
following results of operations does not include results of operations of
FreePC. Our expenses significantly increased during fiscal 1999. We expect that
these expenses will significantly increase as we continue to invest in
technology, infrastructure, and sales and marketing. We also expect expenses to
increase as a result of the acquisition of FreePC. We intend to hire more
technological and infrastructure support personnel, and invest in sales and
marketing programs. We also expect cost of sales to increase as our sales
increase. The following table presents our operating results for the period
from September 18, 1998 (inception) to December 31, 1998 and each of the four
quarters in the year ended December 31, 1999, and the year ended December 31,
1999.

<TABLE>
<CAPTION>
Period from
Sept. 18, 1998 Quarter Ended
(inception) to -------------------------------------------------------- Year Ended
Dec. 31, 1998 Mar. 31, 1999 June 30, 1999 Sept. 30, 1999 Dec. 31, 1999 Dec. 31, 1999
-------------- ------------- ------------- -------------- ------------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Statements of Operations
Data:
Net revenues:
Hardware............... $58,283 $137,434 $213,879 $155,282 $305,638 $812,233
Internet............... -- -- -- 611 1,473 2,084
------- -------- -------- -------- -------- --------
Net revenues.......... 58,283 137,434 213,879 155,893 307,111 814,317
------- -------- -------- -------- -------- --------
Cost of revenues:
Hardware............... 58,088 131,101 207,689 150,119 291,950 780,859
Internet............... -- -- -- -- 86 86
------- -------- -------- -------- -------- --------
Cost of revenues..... 58,088 131,101 207,689 150,119 292,036 780,945
------- -------- -------- -------- -------- --------
Gross profit........ 195 6,333 6,190 5,774 15,075 33,372
Operating expenses:
Sales and
marketing(1).......... 840 2,719 2,814 3,823 7,095 16,451
Customer service and
technical support..... 269 949 1,573 3,245 3,282 9,049
General and
administrative(2)..... 999 1,147 2,270 2,627 3,670 9,714
------- -------- -------- -------- -------- --------
Total operating
expenses............. 2,108 4,815 6,657 9,695 14,047 35,214
------- -------- -------- -------- -------- --------
Income (loss) from
operations............ (1,913) 1,518 (467) (3,921) 1,028 (1,842)
Financing charges and
interest
expense, net.......... (889) (2,390) (2,570) (113) 1,187 (3,886)
------- -------- -------- -------- -------- --------
Net income (loss)..... $(2,802) $ (872) $ (3,037) $ (4,034) $ 2,215 $ (5,728)
======= ======== ======== ======== ======== ========
</TABLE>
- ------------------
(1) Included in sales and marketing expenses was $16, $1,126, $11 and $1,153 of
non-cash stock-based compensation expense for the quarters ended June 30,
1999, September 30, 1999, December 31, 1999 and the year then ended,
respectively.

(2) Included in general and administrative expenses was $11, $41, $83, $55 and
$179 of non-cash stock-based compensation expense for the period from
September 18, 1998 (inception) to December 31, 1998, the quarters ended
March 31, 1999, June 30, 1999, September 30, 1999 and the year ended
December 31, 1999, respectively.

<TABLE>
<CAPTION>
Period from
Sept. 18, 1998 Quarter Ended
(inception) to -------------------------------------------------------- Year Ended
Dec. 31, 1998 Mar. 31, 1999 June 30, 1999 Sept. 30, 1999 Dec. 31, 1999 Dec. 31, 1999
-------------- ------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
As a Percentage of Net
Revenues:
Net revenues:
Hardware............... 100.0% 100.0% 100.0% 99.6% 99.5% 99.7%
Internet............... -- -- -- 0.4 0.5 0.3
----- ----- ----- ----- ----- -----
Net revenues.......... 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- ----- -----
Cost of revenues:
Hardware............... 99.7 95.4 97.1 96.3 95.1 95.9
Internet............... -- -- -- -- -- --
----- ----- ----- ----- ----- -----
Cost of revenues...... 99.7 95.4 97.1 96.3 95.1 95.9
----- ----- ----- ----- ----- -----
Gross profit......... 0.3 4.6 2.9 3.7 4.9 4.1
Operating expenses:
Sales and marketing.... 1.4 2.0 1.3 2.4 2.3 2.0
Customer service and
technical support..... 0.5 0.7 0.7 2.1 1.1 1.1
General and
administrative........ 1.7 0.8 1.1 1.7 1.2 1.2
----- ----- ----- ----- ----- -----
Total operating
expenses............ 3.6 3.5 3.1 6.2 4.6 4.3
----- ----- ----- ----- ----- -----
Income (loss) from
operations............ (3.3) 1.1 (0.2) (2.5) 0.3 (0.2)
Financing charges and
interest
expense, net.......... (1.5) (1.7) (1.2) (0.1) 0.4 (0.5)
----- ----- ----- ----- ----- -----
Net income (loss).... (4.8)% (0.6)% (1.4)% (2.6)% 0.7% (0.7)%
===== ===== ===== ===== ===== =====
</TABLE>

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<PAGE>

Inception to December 31, 1998 and Year Ended December 31, 1999

Net Revenues

Hardware Revenues, Net

Our hardware revenues, net increased from $58.3 million for the period from
inception to December 31, 1998 to $812.2 million for the year ended December
31, 1999. This increase was due to increased unit shipments at each price point
and the expansion into higher price points. In the second quarter of 1999,
hardware revenues, net were negatively impacted by the Company's recording of
$7.7 million in price protection charges. In the third quarter of 1999, we
introduced our eOne PCs priced at $799 and $899 (after product rebates). In the
fourth quarter of 1999, we introduced our eMonster PC for $899 and eSlate
notebook PC for $999 (after product rebates). Net revenue from extended service
contracts and technical support calls during these periods was minimal and
reported with hardware revenues.

Internet Revenues

We recognized total Internet revenues of $2.1 million for the year ended
December 31, 1999. These revenues resulted from the launch of our Internet-
related services including our marketing agreement with America Online. As a
result of the FreePC acquisition, we expect revenues from Internet-related
activities to increase.

Cost of Revenues

Cost of revenues primarily consists of the cost of PCs and monitors,
Microsoft licensing costs, inbound shipping costs, inventory valuation reserves
and costs of providing Internet access through e-machines.net. Cost of revenues
increased from $58.1 million for the period from inception to December 31, 1998
to $780.9 million for the year ended December 31, 1999. This increase was due
to increases in unit shipments and expansion into higher cost products. Gross
margin increased from 0.3% for the period from inception to December 31, 1998
to 4.1% for the year ended December 31, 1999. This increase was due to
increased sales of higher margin products. Our historical gross margins may not
be indicative of our future results of operations. Inventory valuation reserves
are calculated and recorded monthly based on a lower of cost or market analysis
performed each month. Inventory valuation reserves charged to operations in the
year ended December 31, 1999 totalled approximately $533,000.

Operating Expenses

Sales and Marketing

Sales and marketing expenses consist primarily of cooperative advertising
incentives paid to retail customers, net of cooperative advertising credits
earned by us from component suppliers, and marketing development funds given by
us to certain retail customers. Cooperative advertising discounts are given to
retail customers at time of product invoicing as a reduction of net invoice
price. Sales and marketing expenses also include payroll expenses for sales and
marketing personnel. Included in sales and marketing expenses for the year
ended December 31, 1999 was approximately $700,000 of bonus expense paid to our
President and Chief Executive Officer pursuant to an employment agreement we
entered into with him. The provisions of the agreement requiring a cash bonus
to him was terminated effective June 30, 1999, and no further bonus expense
pursuant to this agreement is expected. Also included in sales and marketing
expenses for the year ended December 31, 1999 was $1.2 million of non-cash
stock-based compensation expense, of which $1.1 million was recorded as a one-
time charge in the quarter ended September 30, 1999, in connection with an
employment agreement with our president and chief executive officer. Stock-
based compensation arises when an option to purchase stock, with an exercise
price less than the fair value of the underlying stock, is granted to an
employee. The amount of compensation equals the spread between the exercise
price and the fair value of the underlying common stock. Stock-based
compensation is considered earned, and we recognize the related

31
<PAGE>

expense, as the options vest. Sales and marketing expenses have increased from
approximately $840,000 for the period from inception to December 31, 1998 to
$16.5 million for the year ended December 31, 1999. As a percentage of net
revenues, sales and marketing costs increased from 1.4% for the period from
inception to December 31, 1998 to 2.0% for the year ended December 31, 1999.
These increases were primarily due to increased commission expenses,
cooperative advertising costs and marketing development funds associated with
increased sales volumes and non-cash stock-based compensation expense. Our
sales and marketing expenses in absolute dollars will increase as sales
increase and as we increase the number of our sales representatives. As a
result of the FreePC acquisition, our in-house sales force increased from five
to 24, of which 19 are primarily devoted to Internet-related activities and of
which five are primarily devoted to our PC business. We expect sales and
marketing expenses to increase as we expand our Internet-related activities.

Customer Service and Technical Support

Customer service and technical support expenses consist primarily of the
cost of technical support provided for us by Sykes to buyers of our PCs as well
as subscribers to e-machines.net. For either of these services, Sykes charges
on a per minute basis for each support call they receive. We expect customer
service and technical support expenses to increase to the extent our sales
volumes increase. Customer service and technical support expenses increased
from approximately $269,000 for the period from inception to December 31, 1998
to $9.0 million for the year ended December 31, 1999. We expect our customer
service and technical support expenses to increase as we expand our Internet-
related activities.

General and Administrative

General and administrative expenses consist primarily of payroll and related
expenses for management and administrative personnel, outsourced warehousing
activities, facilities expenses, professional service fees, travel and other
general corporate expenses. Included in general and administrative expenses for
the year ended December 31, 1999 was $179,000 of non-cash stock-based
compensation expense. General and administrative expenses increased from
approximately $999,000, or 1.7% of net revenues, for the period from inception
to December 31, 1998, to approximately $9.7 million, or 1.2% of net revenues,
for the year ended December 31, 1999. We anticipate that general and
administrative expenses will increase in absolute dollars due to increased
expenses associated with the addition of personnel and additional professional
fees, including costs associated with being a public company. In addition, we
anticipate that general and administrative expenses may increase in future
periods as a result of our acquisition of FreePC and litigation costs
associated with legal proceedings. For a discussion of these proceedings, see
"Business--Legal Proceedings."

Intangible Assets

In connection with the FreePC acquisition, we will record a significant
amount of intangible assets the amortization of which will adversely affect our
earnings and profitability in 2000 through 2002. We expect to record intangible
assets of approximately $147.0 million, to be amortized over a period of three
years.

Financing Charges and Interest Expense, Net

Financing charges and interest expense, net consists primarily of interest
on trade payables and interest income from cash equivalents and short-term
investments. Financing charges and interest expense, net increased from
$889,000, for the period from inception to December 31, 1998, to $3.9 million
for the year ended December 31, 1999. Finance charges and interest expense
related to trade payable financing increased from approximately $889,000, or
1.5% of net revenues, for the period from inception to December 31, 1998 to
approximately $6.5 million, or 0.8% of net revenues, for the year ended
December 31, 1999. This increase in absolute dollars was due to increases in
trade payable financing associated with greater inventory purchases, resulting
from higher sales volumes. On August 18, 1999, we completed a private placement
of 24,279,369 shares of our Series A preferred stock providing us with net
proceeds of approximately $146.3 million, which

32
<PAGE>

enabled us to establish vendor payment terms of net thirty days, eliminating
most interest on trade payables for the remainder of 1999. In addition, we
invested the private placement proceeds in cash equivalents and other interest
bearing short-term investments, resulting in $2.6 million of interest income in
1999.

Liquidity and Capital Resources

To date, we have financed our operations by extended payment terms on trade
payables, issuance of common and preferred stock, and issuance of subordinated
notes payable to stockholders. The private placement of 24,279,369 shares of
our Series A preferred stock on August 18, 1999 provided us with net proceeds
of approximately $146.3 million. A portion of the proceeds from the issuance of
our Series A preferred stock was used to reduce trade payables. As of December
31, 1999, our sources of liquidity consisted of $114.8 million in cash and cash
equivalents, and $19.9 million in short-term investments. As of December 31,
1999, trade payables were $131.9 million with terms of net 30 days. As of
December 31, 1999, we had outstanding $560,000 of long-term subordinated notes
payable to stockholders, which bear interest at 5.79% and mature on June 7,
2004.

Net cash provided by operating activities was $2.1 million for the period
from inception to December 31, 1998. Net cash used in operating activities was
$13.5 million for the year ended December 31, 1999. Cash provided by operating
activities for these periods consisted primarily of increases in trade
payables-related party. Cash used in operating activities for these periods
consisted primarily of increases in accounts receivable and inventories.

Net cash used in investing activities was approximately $298,000 for the
period from inception to December 31, 1998, and approximately $21.7 million in
the year ended December 31, 1999. Net cash used in investing activities for
these periods consisted primarily of purchases of property and equipment and
short-term investments.

Net cash provided by financing activities was $2.0 million for the period
from inception to December 31, 1998. Net cash provided by financing activities
for the year ended December 31, 1999, was $146.3 million and consisted of the
proceeds from the issuance of preferred stock.

We currently anticipate that the net proceeds of this offering, together
with our available funds as of December 31, 1999, will be sufficient to meet
our anticipated needs for at least the next 12 months. If additional funds are
required, financing may not be available on acceptable terms, if at all, and
may be dilutive to our stockholders.

Year 2000 Issues

Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
change in the century. We have designed our products to be year 2000 compliant.
We are not aware of any errors that have occurred since the turn of the
century. To date, the amount spent on year 2000 preparations has been
immaterial. If any errors or defects become evident, we may incur costs to
resolve them, however, we do not expect to make any material expenditures
related to year 2000 compliance issues in the future.

Quantitative and Qualitative Discussion of Market Risk

We are exposed to fluctuations in interest rates and market values of our
investments. Our exposure to fluctuations in interest rates and market values
of our investments relates primarily to our short-term investment portfolio,
which is included in cash and cash equivalents and short-term investments. We
have not used derivative financial instruments in our investment portfolio. We
invest our excess cash in highly liquid commercial paper and U.S. Government
debt securities with maturities of less than one year, and, by policy, we limit
the amount of credit exposure to any one issuer. Due to the short-term nature
of our investments, the impact of interest rate changes would not be expected
to have a significant impact on the value of these investments. The effect of
interest rate and investment risk on us has not been significant.

33
<PAGE>

Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may
have their fair market value adversely impacted due to a rise in interest
rates, while floating rate securities may produce less income than expected if
interest rates fall. Our fixed rate debt consists of $560,000 in notes payable,
bearing interest at 5.79 percent, from various stockholders.

We have limited our investments to short-term, highly rated, fixed income
facilities such as repurchase agreements collateralized by government
securities and A-1/P-1 commercial paper. We intend to maintain our current
investment policy, which is designed to preserve principal while at the same
time maximizing the after-tax income we receive from our investments without
significantly increasing risk. Some of the securities that we may invest in may
be subject to market risk. This means that a change in prevailing interest
rates may cause the principal amount of the investment to fluctuate. For
example, if we hold a security that was issued with a fixed interest rate at
the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline. To minimize this risk
in the future, we generally intend to maintain our portfolio of cash
equivalents and short-term investments in a variety of securities, including
commercial paper, money market funds, government and non-government debt
securities. However, we may invest up to $15 million in companies that offer
products and services that support our business strategy. Such investments may
be illiquid for an indefinite period of time, or otherwise subject to greater
risk than that allowed for our remaining cash assets. To the extent any of our
investments are in foreign securities, we may be subject to foreign currency
exchange rate risks.

We currently have no floating rate indebtedness, hold no derivative
instruments and do not earn significant foreign sourced income. Accordingly,
changes in interest rates or currency exchange rates do not generally have a
direct effect on our financial position. In addition, we have primarily
operated in the United States and Canada and all purchases and sales to date
have been made in U.S. dollars. Foreign currency exchange rates, however, may
affect the cost of our PCs and monitors purchased from our foreign suppliers,
thereby indirectly affecting consumer demand for our products and our net
revenues. In addition, to the extent that changes in interest rates and
currency exchange rates affect general economic conditions, we would also be
affected by such changes.

Quarterly Fluctuations

We have a limited operating history upon which you can base an evaluation of
our business and prospects. Our prospects must be considered in light of the
risks, expenses, and difficulties encountered by companies in their early stage
of development. It is likely that in some future quarter our operating results
may fall below the expectations of securities analysts and investors. In this
event, the trading price of our common stock may fall significantly. See "Risk
Factors" for a more complete description of the risks we face. We believe that
the factors influencing quarterly variability include the following:

. the overall growth in the computer industry;

. shifts in short-term demand for our products resulting, in part, from
the introduction of new products or updates of existing products;

. the intensity of price competition among us and our competitors as
influenced by various factors;

. the fact that virtually all sales in a given quarter result from orders
booked in that quarter; and

. the popularity of, and seasonal or other fluctuations in demand for,
Internet services generally and e-machines.net in particular.

Traditionally, computer sales in the fourth quarter are historically higher
than in the previous three quarters. We believe that this pattern of higher
fourth quarter sales is partially due to customer buying patterns relating to
calendar year-end business and holiday purchases.

34
<PAGE>

Results of Operations--FreePC

Since inception, FreePC had incurred significant operating losses. For the
year ended December 31, 1999, FreePC had a net loss of $29.8 million. In
addition, at December 31, 1999, FreePC had an accumulated deficit of $30.4
million. During the year ended December 31, 1999, FreePC incurred operating
expenses of $28.5 million. During the year ended December 31, 1999, FreePC
recorded net revenues of $1.2 million, primarily from the sale of banner
advertisements and from revenues generated from its start page. In particular,
for the year ended December 31, 1999, FreePC generated approximately $211,000,
or 17.6% of its total revenues, from its start page. For the year ended
December 31, 1999, FreePC also generated approximately $1 million, or 82.4% of
its total revenues, from banner advertisements sold through its own
proprietary client software. Of the total cost of revenues, $3.1 million
consisted of Internet service provider costs to support FreePC's users. FreePC
sales and marketing expenses consisted primarily of expenditures associated
with its distribution of free computers. Of the total sales and marketing
expenses, approximately $18.1 million consisted of costs incurred by FreePC to
acquire users. During 1999, FreePC's business model included distributing free
personal computers and free Internet access to their customers. The costs
related to these activities in 1999 approximated $21.2 million. Subsequent to
our acquisition of FreePC we have ceased distributing free computers, and we
will cease providing free Internet service and, accordingly, expect these
costs and associated revenues to decrease substantially. Sales and marketing
expenses also include the salaries of a direct sales force. Product
development expenses primarily represents compensation paid to software
engineers and programmers. General and administrative expense primarily
represents compensation paid to management and administrative personnel and
professional and consulting expense.

Effects of Recent Accounting Pronouncements

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income," which requires an enterprise to report, by major components and as a
single total, the change in its net assets during the period from non-owner
sources, and SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information," which establishes annual and interim reporting standards
for an enterprise's business segments and related disclosures about its
products, services, geographic areas and major customers. We had no
comprehensive income items to report for the period from inception to December
31, 1998 and the year ended December 31, 1999. We currently operate one
reportable segment under SFAS No. 131. Adoption of these statements at our
inception did not impact our financial position, results of operations or cash
flows.

In June 1998, SFAS No 133 "Accounting for Derivative Instruments and
Hedging Activities" was released. The statement requires the recognition of
all derivatives as either assets or liabilities in the balance sheet and the
measurement of those instruments at fair value. The accounting for changes in
the fair value of a derivative depends on the planned use of the derivative
and the resulting designation. We are required to implement the statement in
the first quarter of fiscal 2001. We have not used derivative instruments and
believe the impact of adoption of this statement will not have a significant
effect on the financial statements.

35
<PAGE>

BUSINESS

Overview

We sell high-quality, low-priced personal computers, or PCs, to develop
ongoing Internet-based consumer relationships designed to provide us with a
continuous stream of advertising and related revenues. We introduced the first
branded sub-$400 PC in the U.S. retail market. Since the sale of our first PC
in November 1998, we have sold over two million PCs. We sold the third largest
number of desktop PCs through U.S. retailers in 1999, according to PC Data, and
sold the largest number of sub-$600 PCs sold through U.S. retailers in July
1999, according to Ziff Davis's InfoBeads. In 1999, our products won
prestigious awards in the low-priced desktop PC category, including PC
Computing's Most Valuable Product (MVP), number one on Windows Magazine's
"WinList 100" and CNET.com's Editors' Choice award.

Our affordable PCs and the variety of Internet access options that we offer
make the Internet experience available to a broader spectrum of consumers.
Approximately half of our consumers are first-time PC buyers who may have
limited experience using the Internet and whose first-point of contact with the
Internet is our PC. We believe that these first-time PC buyers represent
significant opportunities for Internet advertisers to reach Internet users who
are not likely to have established Internet brand loyalties.
We intend to aggressively pursue recurring revenue generating opportunities
that extend beyond the purchase of the PC or other Internet connected devices.
To this end, in January 2000, we acquired FreePC, Inc., a Bill Gross' idealab!
company that was one of the first companies to subsidize the purchase price of
the PC and Internet access with advertising sponsorships. Our acquisition of
FreePC's expertise, relationships, technology and technical experience is a key
element of our strategy to enhance our Internet revenues. We offer multiple,
integrated advertising programs, including our eWare and eBoards, that we
believe an Internet advertiser may combine into a powerful campaign that is
capable of dramatically increasing the effectiveness of its offer. Our
computing and Internet advertising offerings create an integrated PC and
Internet marketing service that includes links to selected Web sites and other
Internet resources. This combination extends a Web-based portal business model
to the hardware itself. By offering, through our hardware and desktop software,
portal functionality similar to that provided by AOL, Yahoo! and Excite, we can
create an interface and entry point for all online activity regardless of the
user's ultimate choice of Internet service provider. This position allows us to
create programs and relationships that benefit both advertisers and consumers.

Industry Background

The Internet has emerged as a global platform that allows millions of people
to share information, communicate and conduct business. International Data
Corporation, or IDC, estimates that there were approximately 144 million
Internet users worldwide at the end of 1998 and that the number of users will
grow to approximately 602 million by the end of 2003. The increased
availability of compelling media content on the Internet has enabled the
Internet to compete with traditional media such as television and radio for the
attention of consumers and serve as an effective channel for marketing goods
and services.

The PC is the primary means by which consumers access the Internet.
According to IDC, PCs accounted for approximately 95% of the access devices
connected to the Internet in the United States at the end of 1998. We believe
that PCs and other devices that offer an architecture sufficiently flexible to
run most applications and accommodate frequently changing Internet technologies
are ideally suited for accessing the Internet because they provide consumers
with an affordable, media-rich Internet experience. In addition, many of the
most popular PC software applications, such as those used for personal finance,
games and education, have been enhanced through the addition of Internet-
enabled features.

We believe the price of PCs had historically been a limiting factor to broad
penetration of the consumer market. This factor was dramatically reduced in
November 1998 when we introduced the first branded sub-$400 PC sold through
U.S. retailers. In July 1999, Microsoft, Prodigy and America Online introduced
rebates of up to $400 when PC buyers entered into multi-year contracts for
Internet access, or ISP rebates. The

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combination of these low-priced PCs and ISP rebates reduced the effective up-
front cost of accessing the Internet with a PC to as low as zero. This has
contributed to a dramatic increase in the number of PCs sold with Internet
access.

The significant increase in sales of PCs priced at less than $600
precipitated market share consolidation in the retail PC industry. According to
Ziff Davis' InfoBeads, sales of sub-$600 PCs increased as a percentage of the
total retail market from 5% in March 1999 to 41% in July 1999. Several retail
PC vendors were unable to compete successfully at these prices primarily due to
the need for economies of scale in both production and component costs,
component shortages and limited retail shelf space. This led to a significant
increase in market share amongst the top three providers of retail PCs.
According to PC Data, retail/mail order sales for desktop computers by Compaq,
Hewlett-Packard and eMachines combined represented 79% unit volume for December
1999.

The increase in the number of people with Internet access that was enabled
by the proliferation of lower-priced PCs has fueled the growth of Internet
shopping, or e-commerce. An October 1999 Dataquest survey indicated that 52% of
Internet users have made at least one Internet purchase. Recent data continues
to illustrate the increasing use of the Internet for e-commerce. A study
conducted by Shop.org, an Internet retailers' organization, and the Boston
Consulting Group estimates that total Internet retail sales increased from
$14.9 billion in 1998 to $36.6 billion in 1999.

To take advantage of this large and increasingly active commercial audience,
companies are accelerating the deployment of marketing initiatives aimed at
Internet users. Many companies have established Web sites to market or sell
products and services over the Internet. The growth of competition on the
Internet, however, has increased the costs of acquiring and retaining
consumers. For example, customer acquisition costs among online brokerage
competitors during 1999 ran as high as $500, according to the New York Times.
In addition, major Internet service providers, such as America Online and
Microsoft Network, have recently been paying up to $400 per customer to attract
PC buyers through popular rebate programs. Companies continue to invest heavily
in advertising and marketing programs to differentiate their services and
establish brand loyalty that will transcend price competition.

Today, companies are using Internet and traditional advertising in order to
build their Internet brands. In 1998, according to Jupiter Communications,
companies in the United States spent a total of $160 billion in advertising, of
which $2.1 billion was spent in Internet advertising. Currently, large
aggregated audiences make Internet portals one of the predominant channels of
Internet advertising. Internet portals are Web sites or online services that
offer a broad array of resources and services, including Web searching and
links to other Web sites. Advertisers are increasingly questioning the
efficiency of this channel. Because the leading portals attract a large
percentage of the Internet population, demand, and consequently prices, for key
ad slots is high. In addition, we believe that a large portion of the leading
portals' audience consists of long-term Internet users who have already
established Internet purchasing brand loyalties. Finally, like traditional
advertising, Internet advertising has been limited in its ability to target a
specific audience.

These inefficiencies are prompting companies to search for better Internet
advertising solutions. According to an October 1999 Jupiter analyst note by
Marissa Gluck regarding capturing the consumer early, the key to acquiring new
users is grabbing their attention and loyalty as early as possible. As a
result, the computer and its components (i.e., the keyboard, mouse and desktop)
have become the new prime real estate. A new solution is needed to enable
Internet advertisers and e-commerce providers to cost-effectively connect with
consumers who do not have pre-existing Internet brand loyalties.

The eMachines Solution

We combine the distribution of affordable PCs with the delivery of Internet
marketing programs, including keyboards that provide one-touch access to
selected Web sites and other Internet resources, desktop software

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and promotional materials packaged with our PCs. Our integrated computing and
Internet offering is designed to enable consumers to easily gain access to and
use the Internet and allow us to enable advertisers to cost-effectively reach a
significant base of first-time PC buyers. Our Internet marketing programs are
designed to enable advertisers to continuously communicate with our growing
base of consumers. Our two-way client-server software is designed to allow us
to automatically deliver updated marketing offers, system software upgrades and
provide other useful functions. This tightly integrated offering effectively
replicates the most desirable features of popular Web-based portals in the PC
hardware and desktop software markets, providing benefits to both advertisers
and consumers.

Benefits to Consumers

Our solution offers consumers the following benefits:

High-quality, low-priced PCs. We are the leading provider of PCs in the
$399-$599 price range (after product rebates), making PCs and the Internet
experience affordable to a broader spectrum of consumers. Due to our unit
volume and because of our established relationships with national retailers and
our low-cost, outsourced business model, we have been able to consistently
offer high-quality PCs at attractive prices and configurations. In 1999, our
products won prestigious awards in the low-priced desktop PC category,
including PC Computing's Most Valuable Product (MVP), Windows Magazine's
"WinList 100" and the CNET.com Editors' Choice award.

Easy access to the Internet. We offer consumers a variety of Internet access
options, including AOL Classic, CompuServe 2000 with rebates up to $400 for
multi-year service contracts, and our e-machines.net service--all pre-installed
for easy activation. In addition, through our retail partners, rebates of up to
$400 are available on our PCs in connection with MSN, Prodigy and other major
Internet access service providers.

An enhanced Internet experience. We enhance our PC hardware and software to
eliminate the need for consumers to navigate through portals and search engine
Web pages. These enhancements include:

. Our Internet keyboard. Our eBoard improves upon typical portal functions
by offering one-touch access to popular content categories such as
shopping, travel and finance, and selected Web sites.

. Our desktop client software. Our desktop client software encourages and
facilitates Internet navigation with e-commerce, content and
informational links organized for easy one- and two-click access, a
multi-engine search box and a tray of "touch-tiles" from which users can
choose. This surfing assistant also permits the delivery of banner ads
targeted to users' interests. In addition, our desktop client software
is designed to continuously provide consumers with customer support
information and periodic updates to system and utilities software.

. Exclusive offers. In addition to promotional offers packaged with our
PCs, we provide a variety of exclusive Web-based and e-mail offers to
our consumers that they can use for discounts on various Internet
products and services.

Benefits to Advertisers

Our solution provides advertisers the following benefits:

Direct link to a large number of first-time PC buyers. Since November 1998,
we have sold over two million PCs, of which approximately 960,000 were to
first-time buyers. We believe first-time buyers present significant
opportunities for Internet advertisers since it is likely they have not yet
established their Internet brand loyalties. Our solution enables our
advertisers to reach a growing base of Internet users at their first point of
contact, the PC.

Multiple integrated advertising programs. We offer a full suite of
advertising and marketing opportunities for e-commerce providers to communicate
offers to consumers. These include:

. Direct-access keyboard keys--allowing one-touch access to an
advertiser's Web site;

. Desktop icons--providing on-screen, branded, click-based links to
sponsors' content;

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. Pre-loaded software applications;

. Printed or electronic brochures, coupons and other merchandise or
service offers packaged with our PCs;

. Desktop banner advertising--delivered through our desktop client
software; and

. Targeted e-mail--enabling advertisers to reach consumers who have
requested offers relating to their specified areas of interest.

Our solution allows Internet advertisers to combine these delivery methods into
a powerful way to reach consumers. For example, an Internet brokerage firm
might provide a link to its Web site, an in-box brochure and a preloaded
commercial, supported by an e-mail campaign--a combination that has the
potential to dramatically increase the impact of the offer.

Continuous access to the consumer. Our Internet marketing solution is
designed to allow advertisers to continuously communicate with consumers. Our
two-way client-server desktop software is designed to allow us to automatically
deliver updated marketing offers, system software upgrades and other consumer
utilities when a consumer connects with the Internet. Branded keyboard keys and
desktop icons allow continuous visibility of an advertiser's brand and message
whether or not the user is on the Internet. In addition, we offer our
advertisers the opportunity to reach our users through targeted e-mail
campaigns. Taken together, these programs allow us to provide advertisers with
the opportunity to update and enhance their message and communicate with the
same group of consumers over a long period of time.

The eMachines Strategy

We plan to leverage our strong relationship with consumers, key retailers
and Internet advertisers to increase PC sales and generate significant
recurring Internet revenue. Our strategy includes the following core elements:

Increase penetration of the consumer market. We intend to increase our
market share by continuing to offer low-priced, high-quality integrated
computing and Internet solutions, continuing to drive down consumer price
points as they become cost effective. We plan to expand our penetration of the
retail space by continuing to work with retailers, America Online and other
Internet service providers to continue programs designed to significantly
reduce the effective, up-front price of our PCs to the consumer when a PC buyer
subscribes to Internet access services. We believe that our economies of scale,
low-cost business model and recurring Internet revenue create significant
competitive barriers to entry in the retail PC market, particularly at lower PC
price points. We believe that our hot-key enabled keyboard, desktop software
and targeted exclusive marketing offers, combined with our low-priced PCs, will
increase consumer purchases of our PCs and Internet-related recurring revenue.

Use low-cost PC business to cost-effectively acquire Internet consumers. We
intend to use our low-cost PC business to cost-effectively acquire Internet
consumers who will provide us with an opportunity to generate growing recurring
revenue from Internet advertisers. This provides us with a significant
competitive advantage over other Internet companies whose business strategy
requires them to incur substantial up-front costs to acquire Internet
consumers. Our PC business model allows us to offer high-quality, low-priced
PCs by outsourcing to established industry providers most of our major
operating and manufacturing functions, including system assembly, warehouse
labor, distribution, research and development, product design, warranty and
customer support. We intend to maintain low PC distribution, sales, marketing
and administrative costs by continuing to distribute and advertise our PC
products primarily through a limited number of large retailers.

Enhance recurring Internet revenue opportunities. We intend to aggressively
pursue recurring revenue-generating opportunities. These include Internet
service payments, e-commerce and Web-based advertising. We are creating a
series of desktop client software programs designed to provide consumers with a
wide variety of useful functionality with minimal invasiveness to encourage
access to selected e-commerce sites from which

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we will receive marketing payments and sales commissions. These programs will
be intentionally "ISP-agnostic"--meaning consumers can use them and we receive
Internet revenue no matter which Internet service provider they choose--
enabling us to have a direct and continuing relationship with our PC buyers who
choose AOL Classic, CompuServe 2000, MSN, e-machines.net or any other service
provider. We also intend to further enhance our Internet revenues by
introducing a keyboard with 19 more buttons than a standard keyboard in the
second quarter of 2000, which buttons will be available to sell or "rent" to
Internet advertisers.

Leverage our established brand to broaden our product family. We intend to
leverage our brand and strong distribution channels to:

. Broaden our PC line. We are expanding our market position from being the
leading brand in sub-$600 PCs to being a leading supplier of high value
PCs at a broader range of price points. For example, in October 1999, we
introduced the eMonster 500 at $899, delivering the first 500 Mhz
Pentium III, DVD-equipped desktop PC for under $1,000. In December, we
also introduced the eSlate 400, one of the first sub-$1,000 notebook PCs
offered through major U.S. retailers. In the fourth quarter of 1999,
approximately 24% of our total units sold were at or above $799 (after
product rebates). When appropriate, we intend to introduce new, high-
value products at varying price points.

. Introduce Internet appliances. We intend to develop and introduce
various Internet appliance products. Internet appliances offer a natural
downward extension of our low-priced PC offerings, providing us with
similar types of Internet revenue opportunities, including both
advertising and Internet service provider revenue sharing.

. Introduce Internet-connected peripheral products. We intend to develop
and introduce PC-related products, such as MP3 players, that download
content from the Internet. By distributing these products, we intend to
install advertising client software programs on the PCs that host these
Internet-connected devices, thereby expanding our recurring revenue
opportunities.

Leverage the retail channel. We intend to continue to strengthen our
strategic relationships with leading retailers to capture and retain prime
shelf space. We believe that by distributing our products through retailers, we
can continue to increase awareness of our brand at a relatively low cost to us,
thereby efficiently reaching millions of potential PC buyers and Internet
users. For the year ended December 31, 1999, sales of PCs and monitors to our
four largest retail customers--Office Depot, Best Buy, Circuit City and
MicroCenter--accounted for approximately 68% of our gross revenues. We will
continue to sell our products through leading retailers to benefit from their
marketing campaigns that feature our products nationwide in television, radio,
newspaper, magazine and catalog advertisements. We believe we are an attractive
partner to leading retailers because our low-priced, high-quality PCs and
integrated Internet offerings drive high sales volumes that, in turn, provide
significant profit opportunities to retailers.

Furthermore, the high desirability of our low-priced PCs as Internet access
devices combines well with retailers' recent strategic alliances with Internet
service providers such as America Online and MSN, which provide additional
incentives to the retailers to sell Internet-connected products. We believe our
relationships with these retailers enable us to quickly introduce updated
system configurations, new products and merchandising programs on a national
basis. The retail channel also enables us to effectively target first-time PC
buyers who typically do not purchase through mail order or Internet channels.

Products and Services

PC and monitor products. We currently offer our eTower line of Intel Celeron
based, value priced PCs at retail prices ranging from $399 to $699 (after
product rebates). We also currently offer our Intel Pentium III based eMonster
line of high performance PCs at retail prices ranging from $899 to $1,099
(after product rebates). Each PC comes with pre-installed software, including
Windows 98, selected software applications, our own desktop client software and
other utilities, and is Internet ready. In August 1999, we introduced the eOne
PC, an integrated single-piece PC and monitor based on the Windows-Intel
architecture for $799 (after product rebates). In December 1999, we also
introduced the eSlate400, one of the first sub-$1,000 notebook PCs

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offered through major U.S. retailers. We update our PC configurations when
appropriate to accommodate the introduction of new components and sub-systems
that we believe our PC buyers will find attractive. We also offer 15-inch
monitors for $149, 17-inch monitors for $239 and 19-inch monitors for $349.

Keyboard and desktop client software offerings. Using a combination of
proprietary and licensed technology, we have developed Internet aides that
allow consumers to reach selected Web sites through one-touch access keys on
our keyboards and desktop client software programs.

. eBoard. Our Internet-enhanced keyboard offers six more buttons than a
standard keyboard that provide one-touch access to selected Web sites.
We call the extra keys eKeys. In addition, we have developed and expect
to ship in the second quarter of 2000 an enhanced keyboard featuring 19
eKeys. eKeys direct users to Internet resources in categories such as
travel, shopping, banking, finance, auctions, chat and entertainment,
among others, providing functionality similar to that of an Internet
portal. Sponsors' color logos may also appear on the eBoard in a
removable label strip above the eKeys. With the touch of one eKey, which
is under the control of our servers, the PC will initiate a browser
window and take the user directly to a selected sponsor's site or
resource index. We can redirect the eKeys to new destination sites as we
add or change advertisers.

. eWare. eWare is a slim on-screen toolbar that encourages and facilitates
Internet navigation. Our current version includes 160 e-commerce links
in its eShop menu, 240 content/informational links in its eSurf menu, a
multi-engine search box and tray of "touch-tiles" from which users can
choose. The touch-tiles are small logos that link directly to sponsored
Web sites. The user may "drag and drop" the tiles the user chooses from
the eShop and eSurf menus into a tray that remains on-screen unless
closed. eWare also currently supports one rotating banner ad that offers
special deals available only to eWare users. In keeping with the slim
format of the application, the banner is a 468x60 pixel advertisement
scaled down 75%, making eWare one of the least intrusive advertising-
sponsored desktop applications available today.

. Two-way desktop client software. A key element of our plan is to create
an ongoing relationship with the consumer through two-way desktop client
software that is being developed by the programmers that we acquired as
a result of the FreePC acquisition. This software is being designed to
reside on a user's PC and interact with our servers on a regular basis
unless disabled by the user.

Internet access services. We offer consumers a variety of Internet access
options, including AOL Classic, CompuServe 2000 (with rebates up to $400 for
multi-year service contracts), and our e-machines.net service--all pre-
installed for easy activation.

. America Online. In June 1999, we entered into a marketing agreement with
America Online under which it will provide rebates to our PC buyers to
significantly reduce the net effective price of our PCs. To obtain an
ISP rebate, our PC buyers must enter into an agreement with America
Online to subscribe to America Online's CompuServe Internet access
service over a predetermined period of time for a stated monthly fee. In
addition to the rebate provisions, the marketing agreement also provides
that we will include America Online's software on our PCs. America
Online will pay us recurring revenue or a one-time fee depending on
which service or plan a PC buyer elects.

. e-machines.net. The vast majority of our consumers either have pre-
established Internet service provider relationships or have purchased
their PC in conjunction with an ISP rebate offer from America Online,
MSN or Prodigy. To meet the needs of the remaining consumers, we offer
our private-label Internet access service, e-machines.net. We have
entered into an Internet service provider agreement with UUNET to
provide our program on a nationwide basis.

Technology

Underlying our keyboard and desktop client software offerings are a number
of licensed and proprietary technologies developed by our Internet research and
development team. These technologies have been designed to provide an
integrated computing and Internet experience to our consumers. Technologies
supporting our current offerings include:

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. Client content caching. Advertising and other content that is delivered
to the desktop is stored in the client content cache. This allows the
user to interact with Internet content and advertising even when the
computer is no longer connected to the Internet.

. Logging/monitoring tools. With a user's permission, our logging and
monitoring technology collects and analyzes the user's Internet access
patterns. This proprietary technology uploads the data that it collects
at the desktop to our servers via the Internet. We have developed
scalable technology to parallel process this data using our servers.

. PC system maintenance and upgrades. Our system updating technology is
designed to allow us to detect the software configuration on our
products and automatically deliver new software upgrades to and perform
maintenance on the device.

. Server architecture. We use high-capacity redundant servers that are
designed to be fault-tolerant. Our servers use open source software such
as Apache, Perl, and Linux so that we can quickly integrate new
functionality into our existing server systems using standard
applications. Our servers are hosted at a third-party facility in
Sunnyvale, California, which provides redundant communications lines and
emergency power backup. We closely monitor our servers to maintain 24
hours a day, seven days a week availability.

. Advertising optimization technology. Our proprietary advertising
optimization technology is designed to maximize our advertising sales by
allowing us to match advertising content delivery with consumers'
preferences, increasing effectiveness and consumer usage.

Research and Development

We have assembled a team of technology professionals to develop new
Internet-related technologies as well as enhancements to our current Internet-
related products and services. We have focused our research and development
efforts on increasing the performance and scalability of our eBoard, eWare and
two-way desktop client software. As of January 31, 2000, our Internet
development team consisted of 17 technology professionals. These professionals
are divided into client, server, data management and quality assurance teams
that work together to develop our Internet marketing programs. The client team
consists of developers who are experienced in Windows technologies such as MFC
and C++, Internet Explorer, Netscape and ActiveX/COM. The server team
concentrates on Linux technologies such as Apache, Perl, C, CGI and HTML. The
data management team consists of personnel who specialize in database design,
development, and administration and data storage. The quality assurance team
consists of specialists who seek to ensure that our information systems
products and services meet our standards and end-user requirements. Most of our
Internet developers have technical degrees from nationally-recognized colleges
and universities. We are seeking to hire additional skilled technology
professionals for research and development. If we encounter delays in hiring,
our business operating results and financial conditions could be significantly
harmed.

The success of our future research and development efforts depends on a
number of factors, including our ability to identify emerging technological
trends in our target markets, develop and maintain competitive products,
enhance our products by adding innovative features that differentiate our
products from those of competitors, bring products to market on a timely basis
at competitive prices, properly identify target markets and respond effectively
to new technological changes of new product announcements by others.

Intellectual Property Rights

Our success and ability to compete are dependent upon our technology and
intellectual property. Although we rely on copyright, trade secret and
trademark law to protect our technology and intellectual property, we believe
that factors such as the technological and creative skills of our personnel,
new products and services and frequent service enhancements are more essential
to establishing and maintaining an intellectual property leadership position.
e-machines is our registered trademark in the United States. We have one U.S.
patent

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application pending and various U.S. trademark applications pending including
eMachines, the "e" logo, eBoard, eMonster and eTower. We have filed for
trademark protection for the mark "eMachines" and our "e" logo in the European
Communities, the United Kingdom, Japan, Taiwan, China, Canada, Brazil and
Mexico.

We generally enter into confidentiality agreements with our employees and
consultants. Our confidentiality agreements generally require our employees and
consultants to hold in confidence and not disclose any of our proprietary
information. Despite our efforts to protect our proprietary information,
unauthorized parties may attempt to obtain and use our proprietary information.
Policing unauthorized use of our proprietary information is difficult, and the
steps we have taken might not prevent misappropriation, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as do
the laws of the United States.

We collect and use data derived from users of our PCs. This data is intended
to be used for advertisement targeting and for predicting advertisement
performance. Although we believe that we have the right to use such data, trade
secret, copyright or other protection may not be available for such information
or others may claim rights to such information. Use of this data creates the
potential for claims to be made against us. Such claims could be based on
copyright or trademark infringement, invasion of privacy or other legal
theories. Although we carry general liability insurance, our insurance may not
cover potential claims of this type or may not be adequate to indemnify us for
all liability that may be imposed.

PC Sourcing, Distribution and Customer Service

Sourcing. We outsource manufacturing of all of our PCs and monitors. TriGem
Computer, a Korean company, currently manufactures all of our eTower and
eMonster PCs. TriGem Computer is the parent company of TriGem Corporation, a
California corporation. TriGem Corporation was one of our founding stockholders
and, prior to this offering, owned 23.4% of our outstanding common stock after
giving effect to the conversion of all outstanding preferred stock. Korea Data
Systems Co., a Korean company, manufactures our eOne PCs, eSlate notebook
computers, and, together with the Taiwanese manufacturer Jean Company, all of
our monitors. Korea Data Systems Co. is the parent company of Korea Data
Systems America. Korea Data Systems was one of our founding stockholders and,
prior to this offering, owned 23.1% of our outstanding common stock after
giving effect to the conversion of all outstanding preferred stock. TriGem
Computer and Korea Data Systems Co. are ISO 9001 certified and Jean Company is
ISO 9002 certified. We have no long-term obligation to order, take minimum
delivery or purchase at a pre-negotiated price from TriGem Computer, Korea Data
Systems Co. or Jean Company.

Under the terms of the supply agreement that we entered into with TriGem
Computer in January 2000, TriGem Computer has agreed to reserve a portion of
its manufacturing capacity to meet our supply requirements. In addition to its
Korean manufacturing facility, TriGem Computer recently entered into an
outsourcing manufacturing agreement for a facility in Xiamen, China, and opened
a new facility in Shenyang, China. The Xiamen facility currently has production
capacity of approximately 90,000 PC units per month. The Shenyang facility is a
final-assembly plant with production capacity of approximately 150,000 PC units
per month. TriGem Computer has supplied PCs to Epson, Hewlett-Packard, Nokia
Corp., Olivetti S.p.A., Sharp Electronics Corporation, and Sotec. Korea Data
Systems Co. has supplied monitors to OEMs, distributors and retailers including
Best Buy, Compaq, CompUSA, IBM, Ingram Micro Inc. and Tech Data Corporation.

We will pay TriGem Computer for its supply and services on a "cost plus"
basis, which price shall be adjusted monthly based upon TriGem Computer's then
current costs. Pursuant to the agreement, we will place requisitions and
purchase orders each month. TriGem Computer is obligated to meet such purchase
orders based on the projections we provide to TriGem Computer in our annual
plan. Except to the extent that we place requisitions and purchase orders with
TriGem Computer we have no obligation to purchase products from TriGem
Computer. TriGem Computer has provided several warranties to us, including that
all of its products will be free from defects in design, material and
workmanship. The term of the agreement is for two years, and automatically
renews for one year periods, unless either party provides written notice of its
intent to terminate 180 days prior to the expiration of the initial term or any
subsequent term.

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Unlike TriGem Computer, Korea Data Systems Co. and Jean Company have no
contractual obligation to supply us with PCs and monitors. We are free to
change or expand our base of original equipment manufacturer suppliers at any
time, and we are currently engaged in such discussions with other suppliers.

Distribution. We take possession of all manufactured goods at the origin
port of loading with the exception of one monitor model. We currently use one
steamship line and one freight forwarder to transport the goods from Asia to
our distribution center in Irvine. Our main distribution facility has over
85,000 square feet of warehouse space available for cross-dock shipping and
receiving. As of January 31, 2000, the distribution center was staffed with 18
full-time employees and approximately 60 temporary employees covering two
shifts, Monday through Friday. The distribution center staff is responsible for
planning and managing inbound and outbound shipments, special handling of
inventory, inventory control, verification of defective returns and
refurbishment coordination with TriGem America. Special handling services
include: product bundling, labeling, palletization, re-packaging, and parts
distribution.

Two off-site locations are also used during peak periods to maximize overall
productivity at the main distribution facility. Outbound transportation for all
locations is assigned based on the terms of sale. Transportation routing is
based on customer need, shipment weight, and cube dimensions. We are currently
using a transportation consulting firm for the majority of shipments with a
limited remainder of orders booked directly with carriers.

Customer Service. In order to maintain low costs, we outsource substantially
all technical support related to our PCs and our Internet access service to
Sykes, a leading supplier of technical support outsourcing services. We offer
technical support services free for 15 days after the first call from our PC
buyer seeking assistance. We believe that buyers of our PCs require the most
assistance during the first two weeks after they begin using their PC.
Following that period, PC buyers who require additional support can choose to
enter into an extended service contract or pay for technical support on a per-
incident basis until the problem is resolved.

Under our supply agreement with TriGem Computer, TriGem has agreed to
provide warranty and refurbishment services to eMachines. TriGem has warranted
that products that it produces shall be free from defects, and has agreed to
repair or replace and return, without cost to us or consumers, all defective
products returned within the warranty period, which lasts for fifteen months
from the date a product is delivered. If the returned products are not
defective, TriGem will charge us a service fee. Under the refurbishment
provisions of the agreement, we can return to TriGem all products that our
retailers return to us. If the returned products are defective, TriGem will
provide us with a full credit. TriGem will charge us a fee for each returned
product that is found not to be defective.

Prior to January 24, 1999, the date we entered into the supply agreement
with TriGem Computer, we sent all products returned to us to TriGem for
refurbishment. If a returned product was determined to be defective, and less
than 120 days old, TriGem refurbished and returned the product to us and gave
us a credit for a portion of the original invoice price. If a defective product
was less than 120 days old, TriGem merely refurbished and returned the product
to us. If a returned product was determined not to be defective, TriGem charged
us a service fee.

Additionally, Korea Data Systems Co. and Jean Company have agreed to warrant
monitors sold to us for 18 and 36 months, respectively. We offer a 12-month
warranty covering defects in materials or workmanship on every PC and monitor
we sell.

Sales and Marketing

Our PC sales and marketing strategy is focused on selling our products and
services through leading retailers. In recent years, retailers have attracted
fewer PC buyers as a result of the availability of custom configured systems at
substantially lower prices from direct vendors such as Dell, Gateway 2000 and
Micron Electronics. We believe that the introduction of sub-$600 PCs has
increased the number of first-time PC buyers, many of whom viewed high prices
as a barrier to PC ownership. Since first-time buyers are less likely to want
or need custom configurations and less likely to already have Internet access,
the introduction of the sub-$600

44
<PAGE>

PC has also enabled retail stores to re-emerge as significant PC vendors. Our
strategy of selling primarily through leading retailers has enabled us to
leverage their sales and marketing efforts. As a result, we have been able to
establish our brand while maintaining a relatively small sales and marketing
organization. As of January 31, 2000, our PC sales and marketing group
consisted of five employees.

Our Internet advertiser sales and marketing personnel that we acquired as a
result of the FreePC acquisition focus their attention on attracting top brand
advertisers. These advertisers may purchase keyboard buttons and other
sponsorships along with on-screen advertisements and periodic e-mail offers
that provide us with a recurring revenue stream following the initial purchase
of one of our PCs. Our Internet sales and marketing personnel operate out of
our headquarters in the Los Angeles area and three regional offices in
New York, San Francisco and Chicago. As of January 31, 2000, we had 19 sales
professionals and six members in the Internet marketing group.

Competition

The markets for PCs, Internet devices and Internet advertising are intensely
competitive, evolving and subject to rapid technological change. These markets
are characterized by an increasing number of entrants. We compete for users,
and consequently for potential electronic commerce and advertising revenue,
directly or indirectly, with the following categories of competitors:

. vendors of personal computers, such as Apple, Compaq, Dell, Gateway,
Hewlett-Packard and IBM;

. vendors of stand-alone Internet appliances, such as InfoGear, Netpliance
and WebTV;

. Internet service providers, such as America Online, EarthLink,
Mindspring, Microsoft and NetZero;

. Internet portals, such as Excite@Home, Lycos and Yahoo!; and

. providers of Internet advertising services, such as 24/7 Media,
DoubleClick and Engage Technologies.

The Internet devices industry is highly competitive, and we expect this
competition to continue. The primary competitive factors determining success in
the market for Internet devices include price, quality, brand and distribution.
We expect pricing pressures in the PC market to continue, particularly as a
result of the introduction of a variety of product rebate programs that include
Internet access with the purchase of an Internet device. Additionally,
traditional PC vendors may reduce their prices to compete with us at our price
points or offer additional services. There are relatively few barriers
preventing our competitors from capitalizing on the convergence of the PC and
Internet markets. As a result, new integrated computing and Internet services
offerings pose a threat to our business.

The Internet access services market is also highly competitive, and we
expect competition in this market to increase significantly. The primary
competitive factors determining success in the market for Internet users
include a reputation of reliable service, effective customer support, pricing,
easy-to-use software, geographic coverage and scope of services. This market is
new and subject to rapid change, including the introduction of new
technologies, price declines and well-funded promotional campaigns. In addition
to offering our own Internet access service, we actively support the customer
acquisition and retention efforts of America Online, from which we receive
registration bounties and/or ongoing revenues. Potential competitors to these
companies include established and new Internet service providers, national
telecommunications companies, regional Bell operating companies, competitive
local exchange carriers, online cable services, alternative e-commerce Internet
advertising vendors and potential new entrants to the Internet services market
such as computer hardware vendors or computer retailers. A shift in market
share away from our partners could negatively affect our revenues.

The Internet advertising market is highly competitive as well, and we expect
competition in this market to increase significantly. The primary competitive
factors determining success in the market for advertising customers include the
size and demographic profile of a user base, the ability to target users based
on specific

45
<PAGE>

demographic criteria, pricing, geographic coverage and the effectiveness of the
sales force. We believe we have a competitive advantage in all of these areas
because of our widespread distribution, our growing customer base, and our
ability to target marketing offers based on a close relationship with our
customers established from the point of sale of the PC. Companies competing for
advertising and marketing expenditures, however, may develop increasingly
sophisticated technologies and provide compelling alternatives that could pose
a threat to our revenues.

The consolidation of existing competitors, new entrants to the PC and
Internet service markets or alliances between PC vendors and Internet service
providers may result in greater competition for us. In addition to America
Online, some of our current or future strategic partners may become our
competitors. Competition is likely to remain intense as large, diversified
telecommunications and media companies acquire Internet service providers, as
Internet service providers and PC vendors merge and as Internet service
providers consolidate.

Most of our current and potential competitors have longer operating
histories, significantly greater financial, technical, marketing and other
resources, significantly greater name recognition and a substantially larger
installed base of customers than we do. In addition, many of our competitors
have nationally known brands or well-established relationships and have
extensive knowledge of our industry. Moreover, our current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products to
address consumer needs or to combine hardware product and service offerings.
The introduction of low-priced PCs combined with the brand strength, extensive
distribution channels and financial resources of the larger PC vendors may
cause us to lose market share.

Customers and Markets

Our customers include computer retailers as well as Internet advertisers.

Retailers. We currently sell our products to leading retailers, catalog and
on-line merchandisers in the United States and Canada. Our customer list
includes:

<TABLE>
<S> <C> <C>
America Online Fry's Electronics Navy Exchange
Best Buy Future Shop Nexcom
BJ's Wholesale Club Hand Technologies Office Depot
BrandsMart Ingram Micro Onsale, Inc.
Circuit City Insight Outpost.com
CompUSA J&R Computer World QVC
Costco Marine Corps. Sears
Creative Computers Merisel Canada Staples
Cyberian Outpost MicroCenter TigerDirect
Damark International MicroWarehouse Value America
Fingerhut Nationwide Electronics Walmart
</TABLE>

For the year ended December 31, 1999, approximately 68% of our gross
revenues were from sales of PCs and monitors to our four largest retail
customers. Sales to Best Buy represented 21% of our gross revenues for the year
ended December 31, 1999. Further, sales to Office Depot and Circuit City each
represented 20% of our gross revenues for the year ended December 31, 1999.
This concentration of sales allows us to maintain a low-cost infrastructure
while establishing preferred vendor status with large leading retailers. We
intend to continue to sell the majority of our PCs and monitors to a limited
number of large retailers for the foreseeable future.

Advertisers. Our development of customer relationships with advertisers is
currently in its early stages. Since our acquisition of FreePC in January 2000,
we have signed advertising agreements with USBancshares.com, eBay, Amazon.com
and GoTo.com, among others, for our hot-key enabled keyboards. In addition, we
are taking advantage of the numerous advertiser relationships cultivated by
FreePC prior to the acquisition. We are in discussions with a wide variety of
these companies and others about opportunities to reach consumers via our
direct access keyboard keys, eWare and two-way client server software.

46
<PAGE>

Facilities

Our principal executive and distribution facilities are located in Irvine,
California. We lease approximately 147,000 square feet at this facility
pursuant to a lease that expires in 2004, unless terminated earlier or extended
as described below. Under the terms of the lease, we make monthly payments of
approximately $84,000, increasing to approximately $97,000 over the term of the
lease. We have an option to extend the term of the lease for an additional 60-
month period. We sublease approximately 48,000 square feet of these facilities,
pursuant to a verbal agreement, to TriGem America for monthly payments of
approximately $27,000, increasing to approximately $32,000 over the term of the
sublease. TriGem America uses this space to refurbish our returned PCs.

Our principal Internet advertising office is located in Pasadena,
California. We lease approximately 19,000 square feet at this facility pursuant
to an agreement with Bill Gross' idealab!, one of our principal stockholders,
and we have a right of first offer to lease an additional 9,905 square feet at
this location. The initial term of the agreement is for one year commencing in
June 1999, with an option to extend for up to four additional one-year terms.
We also lease space in New York and San Francisco to support our Internet
advertising sales efforts.

Legal Proceedings

Packard Bell filed a complaint on October 6, 1999 in Federal District Court
for the Eastern District of California, alleging patent infringement on Packard
Bell patents which it asserts relates to the (i) graphics controller, (ii)
parallel port controller, and (iii) bus interface of our eTower machine. We
filed a response in January 2000 disputing infringement and asserting that the
patents at issue are invalid. We are in the early stages of discovery. As a
result, we are currently unable to estimate total expenses, possible loss or
range of loss that may be ultimately connected with these allegations. We are
indemnified against liability under the terms of our PC supply agreement. We
cannot assure you that Packard Bell will not succeed in obtaining monetary
damages or an injunction against the production of our PC products. Our defense
of the claims could result in significant expenses and diversion of
management's attention and other resources. Although we believe our direct
financial exposure is limited under our indemnification arrangement, the
results of complex litigation of this sort are inherently uncertain and
difficult to predict and we cannot assure you that the results of this
litigation would not result in our business being significantly harmed,
particularly if it affects production of our PCs.

47
<PAGE>

Packard Bell. The complaints claim that a chip in the defendants' respective PC
products contains a defect which may cause an error to occur when information
is written to a floppy disk. The complaint seeks unspecified monetary damages,
injunctive relief and declaratory relief. The lawsuit against us is in the
early stages of discovery and we have not yet filed a response. Although we
believe that we have meritorious defenses and intend to vigorously defend
ourselves in this action, these types of litigation are inherently complex and
unpredictable. We cannot assure you that the class action suit will not succeed
in obtaining unspecified monetary damages, injunctive and declaratory relief
against the production of our PC products. Our defense of the claims could
result in significant expenses and diversion of management's attention and
other resources. In addition, we cannot assure you that the results of this
litigation would not result in our business being significantly harmed.

It is common in the PC manufacturing industry for patent, trademark and
other intellectual property claims to be asserted against companies. We receive
notices from time to time that our technology allegedly infringes on
intellectual property rights held by others. As a result, we may be required to
defend legal actions relating to allegedly protected technology. Various other
lawsuits, claims and proceedings have been or may be asserted against us,
including those related to product liability, intellectual property,
environmental, safety and health and employment matters. Litigation is
expensive and time consuming regardless of the merit of the claim and could
divert management's attention from our business. Moreover, the outcome of
litigation cannot be predicted with certainty. Some lawsuits, claims or
proceedings may be disposed of unfavorably to us.

Employees

We operate with a relatively small number of employees, significantly
reducing our fixed cost base. As of January 31, 2000, we employed a total of
162 people, including 19 in Internet sales, five in channel sales and six in
marketing . None of our employees are represented by a labor union, and we have
no collective bargaining agreements. We consider our relations with our
employees to be good.

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<PAGE>

MANAGEMENT

Executive Officers and Directors

The following table sets forth information with respect to our executive
officers and directors as of January 31, 2000.

<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Stephen A. Dukker....... 47 President, Chief Executive Officer and Director

Steven H. Miller........ 44 Vice President, Chief Financial Officer and Secretary

Donald S. La Vigne...... 34 Executive Vice President, Strategy and Business Development

Audrey U. Finci......... 42 Executive Vice President, Operations

Steve Chadima........... 49 Vice President, Marketing

James Weissenborn....... 36 Vice President, Advertising Sales

Hong Soon Lee........... 39 Chairman of the Board

Michael Hong............ 38 Director

Lap Shun Hui (2)........ 44 Director

Bill Gross.............. 41 Director

Jung Koh................ 46 Director

Nathan Morton (1)(2).... 51 Director

C. Toms Newby, III
(1)(2)................. 32 Director
</TABLE>
- ---------------------
(1) Member of the audit committee.
(2) Member of the compensation committee.

Stephen A. Dukker has served as our President, Chief Executive Officer and a
member of our board of directors since founding us in September 1998. From
October 1997 through August 1998, Mr. Dukker was Senior Vice President of
Merchandising and Operations of Computer City. Prior to that, Mr. Dukker was
President of OPTi, a manufacturer of PC multimedia and core logic
semiconductors, from January 1995 through September 1997. From May 1994 through
October 1994, Mr. Dukker was President of Videologic, Inc., a United Kingdom-
based designer and manufacturer of semiconductors and videocards. Mr. Dukker
currently serves on the board of directors of OPTi and Digital Persona. Mr.
Dukker attended the University of Chicago.

Steven H. Miller has served as our Vice President, Chief Financial Officer
and Secretary since June 1999. Mr. Miller was employed by Ingram Micro, Inc., a
wholesale distributor of technology products and services, from May 1992
through May 1999, most recently as Vice President and Controller. Mr. Miller is
a CPA and received a B.A. in Economics from the University of California, Santa
Barbara.

Donald S. La Vigne has served as our Executive Vice President, Strategy and
Business Development since January 2000. Mr. La Vigne was the Chief Executive
Officer and President of FreePC, Inc. from its founding in February 1999 until
we acquired FreePC. Prior to that, from February 1997 to January 1999, Mr. La
Vigne was the founder and President of Stanton Capital, a private investment
firm. From April 1994 to January 1997, Mr. La Vigne was with Esprit de Corp., a
global apparel and retail company, as its head of the Executive Committee and
interim Chief Executive Officer of its U.S. operations. Prior to Esprit, Mr. La
Vigne was an investment banker with Hambrecht & Quist from June 1989 to April
1994. Mr. La Vigne received a B.A. in Government from Harvard College.

Audrey Finci has served as our Executive Vice President, Operations since
January 2000 and had previously held that position at FreePC since October
1999. Prior to that, Ms. Finci was employed by the

49
<PAGE>

Walt Disney Company since September 1988, most recently as the Executive Vice
President of Disney Direct Marketing and head of Operations and Technology for
Disney Consumer Products, a division of the Walt Disney Company. Ms. Finci is a
CPA and received a B.A. from UCLA and an M.B.A. from the University of Southern
California.

Steve Chadima has served as our Vice President, Marketing since January
2000. Mr. Chadima was the Vice President, Marketing for FreePC from March 1999
until we acquired Free PC. From November 1995 to January 1999, Mr. Chadima was
the Senior Vice President and General Manager of Connors Communications, Inc.,
a consumer technology public relations and online marketing firm. Prior to
that, Mr. Chadima was with Knowledge Adventure, Inc., an educational software
publisher, where he was co-founder and served as Vice President of Marketing
from 1990 to November 1995. Mr. Chadima holds a B.A. from the University of
California, Irvine, and an M.B.A. from Stanford University.

James Weissenborn has served as our Vice President, Advertising Sales since
January 2000. He held the same position with FreePC from May 1999 until we
acquired FreePC. Prior to joining FreePC, Mr. Weissenborn was Vice President of
Sales Development and Marketing at Univision, a Hispanic television network,
from May 1998 to May 1999. From January 1992 to May 1998, Mr. Weissenborn was
Vice President of Sales, Western Region at Comedy Central, a cable television
company. Mr. Weissenborn has a B.A. from the University of California,
Berkeley.

Hong Soon Lee has been Chairman of our board of directors since September
1998. Mr. Lee is currently President, Chief Executive Officer and a member of
the board of directors of TriGem Computer and has served in various positions
at TriGem Computer since June 1994. In addition, Mr. Lee has been a director of
TriGem Corporation since July 1997. Mr. Lee received a B.S. from Korea
University and a M.S. in Engineering from the Florida Institute of Technology.

Michael Hong has been a member of our board of directors since January 2000.
Mr. Hong also began serving as Executive Vice President and Chief Financial
Officer of TriGem Computer in January 2000, where he started in May 1999 as
Senior Advisor on financial matters. From January 1995 through May 1999, Mr.
Hong served as Vice President of Business Development for North Asia and
Country Manager (Korea) at General Electric Capital. Mr. Hong currently serves
on the board of directors of Gemini Capital Management LTD. He received a B.A.
from Harvard University and an M.B.A. from the Wharton School at the University
of Pennsylvania.

Lap Shun Hui has been a member of our board of directors since September
1998. Mr. Hui is currently President and a member of the board of directors of
KDS USA, a position he has held since June 1995. From January 1993 through June
1995, Mr. Hui was Chief Executive Officer of Orchestra Multisystems, a company
that was acquired by KDS USA. Mr. Hui received a B.S. in Business from the
State University of New York at Buffalo and an M.B.A. from McMaster University,
Ontario, Canada.

Bill Gross has been a member of our board of directors since January 2000.
Since March 1996, Mr. Gross has served as Chairman of the Board and President
of Bill Gross' idealab!, a company that creates and operates Internet
businesses. From June 1991 to January 1997, he served as Chairman of Knowledge
Adventure, Inc., an educational software publisher, which he founded. Mr. Gross
serves on the board of directors of Ticketmaster Online-CitySearch, Inc.
(formerly CitySearch, Inc.), GoTo.com, Inc., NetZero, Inc. and several other
private companies. Mr. Gross received his B.S. in Mechanical Engineering from
the California Institute of Technology.

Jung Koh has been a member of our board of directors since our formation in
September 1998. Mr. Koh also serves as Vice Chairman of Korea Data Systems Co.,
a position he has held since 1983. In addition, Mr. Koh has been a member of
the board of directors of Du Go since 1983. Mr. Koh received a B.A. from Rhode
Island College.

Nathan Morton has been a member of our board of directors since August 1999.
Mr. Morton is currently Chairman of both Buildnet, Inc., a provider of e-
business, technology, and project management systems for the building industry,
and Handtech.com, a retailer of computer and Internet-related products,
positions he has held since November 1998. In addition, Mr. Morton currently
serves as Chairman of Starpower and as Senior

50
<PAGE>

Partner of Channel Marketing. From July 1997 through September 1998, Mr. Morton
was Co-Chairman and Chief Executive Officer of Computer City. Prior to that,
Mr. Morton served as President and Chief Executive Officer of Open Environment
from March 1994 through February 1996. Mr. Morton has a B.A. from State
University of New York at Buffalo.

C. Toms Newby, III has been a member of our board of directors since August
1999. Mr. Newby joined Technology Crossover Ventures, a venture capital firm,
in April 1996 and has been a General Partner since July 1998. From 1994 through
April 1996, Mr. Newby was an associate at Montgomery Securities in the
Corporate Finance Technology Group. Mr. Newby currently serves on the board of
directors of several private companies. Mr. Newby received a B.S. from the
University of North Carolina and an M.B.A. from Stanford University.

Board of Directors

We currently have authorized eight directors. Our amended and restated
bylaws which will become effective upon the completion of this offering will
increase the number of authorized directors to nine.

Committees

Our board of directors has an audit committee and a compensation committee.
The audit committee consists of Messrs. Morton and Newby. The audit committee
reviews our internal accounting procedures and consults with and reviews the
services provided by our independent accountants. The compensation committee
consists of Messrs. Morton, Newby and Hui. The compensation committee reviews
the compensation and benefits of our employees and directors and makes
recommendations to our board of directors.

Compensation

Directors do not receive cash compensation from us for the services they
provide as directors, although non-employee directors are reimbursed for
expenses incurred in connection with attending board and committee meetings. In
addition, in December 1999 we granted an option to purchase 20,000 shares of
our common stock at an exercise price of $3.75 to Nathan Morton, one of our
directors.

Compensation Committee Interlocks and Insider Participation

Prior to August 1999, our board of directors did not maintain a standing
compensation committee, and the entire board participated in all decisions
regarding compensation of our executive officers. During that period, Stephen
A. Dukker, our President and Chief Executive Officer, participated as a member
of our board of directors in deliberations concerning executive officer
compensation. In August 1999, the board formed the compensation committee and
appointed Messrs. Morton and Newby as committee members. In December 1999, Mr.
Hui was also appointed as a committee member. None of the members of the
compensation committee is currently or has ever been at any time since our
formation, one of our officers or employees. No member of the compensation
committee serves as a member of the board of directors or compensation
committee of any entity that has one or more officers serving as a member of
our board of directors or compensation committee.

51
<PAGE>

Executive Officers

Compensation

The following table sets forth the compensation earned during 1999 by our
Chief Executive Officer and our other executive officer who earned more than
$100,000 during 1999.

Summary Compensation Table

<TABLE>
<CAPTION>
Long Term
Compensation
------------
Annual
Compensation Securities
----------------- Underlying
Name and Principal Positions Salary Bonus Options
- ---------------------------- -------- -------- ------------
<S> <C> <C> <C>
Stephen A. Dukker................................ $333,646 $699,647 227,897
President and Chief Executive Officer
Steven H. Miller................................. $105,404 $ 35,000 200,000
Vice President, Chief Financial Officer
</TABLE>

Option Grants in Last Fiscal Year

The following table sets forth information relating to stock options granted
during 1999 to our Chief Executive Officer and the other executive officer
named in the Summary Compensation Table above. The option granted to Stephen A.
Dukker pursuant to an employment agreement was granted below fair market value,
outside of our 1998 stock plan, and was fully-vested. The option granted to the
other executive officer in the last year was granted under the 1998 stock plan.
The fair market value of each was primarily determined by reference to the
price per share paid by the investors in the Series A preferred stock. Of the
shares subject to the option, 20% vests and becomes exercisable on the first
anniversary of the date of grant, and an additional 20% of the shares subject
to the option vests on each anniversary of the date of grant thereafter. The
percentage of the total options set forth below is based on an aggregate of
1,035,097 options granted to employees during 1999. The potential realizable
values in the table below represent hypothetical gains that could be achieved
for the options if exercised at the end of the option term. The assumed 5% and
10% rates of stock price appreciation are provided in accordance with rules of
the SEC and do not represent our estimate or projection of the future common
stock price.

<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------------
Potential Realizable Value
Number of % of Total Fair at Assumed Annual Rates of
Securities Options Market Stock Appreciation for Option
Underlying Granted to Exercise Value on Term
Options Employees Price Per the Date Expiration --------------------------------
Name Granted in 1999 Share of Grant Date 0% 5% 10%
- ---- ---------- ---------- --------- -------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Stephen A. Dukker....... 227,897 22.0% $1.61 $6.38 8/18/09 $1,087,069 $2,001,471 $3,404,343
Steven H. Miller........ 200,000 19.3 3.75 6.38 6/15/09 526,000 1,328,470 2,559,615
</TABLE>

Fiscal Year-End Option Values

Neither of the executive officers named in the summary compensation table
exercised any options during 1999. The following table sets forth information
concerning exercisable and unexercisable stock options held by the named
executive officers and the value of those options as of December 31, 1999. The
value of unexercised in-the-money options is based on an initial offering price
of $9.00 per share minus the actual exercise price of the option, multiplied by
the number of shares underlying the option.

<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at In-the-Money Options at
December 31, 1999 December 31, 1999
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Stephen A. Dukker........... 227,897 -- $1,684,159 --
Steven H. Miller............ -- 200,000 -- $1,050,000
</TABLE>

52
<PAGE>

Employment Agreement

In June 1999, we entered into an employment agreement with Stephen A.
Dukker, our President and Chief Executive Officer, which agreement was amended
and restated in August 1999. The agreement provides for an annual base salary
of $300,000 with a variable bonus. For the period from September 18, 1998
through June 30, 1999, the bonus was equal to $1 for each central processor
unit shipped during the period. For the period July 1, 1999 through November
30, 1999, Mr. Dukker's bonus is a fully vested non-forfeitable option to
purchase 227,897 shares of our common stock at an exercise price of $1.61 per
share. The agreement provides that if we terminate Mr. Dukker's employment
without cause, if Mr. Dukker voluntarily terminates his employment after he is
relocated without his consent, if his duties or benefits are materially
reduced, or if his employment terminates because of death or disability, we
must continue to pay his base salary and bonus through the term of the
agreement which ends in September 2001. Upon a change of control of eMachines,
and unless the acquiror of eMachines assumes Mr. Dukker's employment agreement,
Mr. Dukker shall be entitled to payment of his base salary and bonus through
the term of the agreement, all of Mr. Dukker's unvested options shall
immediately vest and our right to repurchase any restricted stock held by Mr.
Dukker shall terminate.

On March 19, 2000, the board of directors approved for Mr. Dukker a base
salary of $400,000 for fiscal year 2000 and a potential bonus of up to $400,000
subject to the satisfaction of performance goals that are to be agreed upon. In
addition, the board granted Mr. Dukker an option to purchase up to 2,000,000
shares of common stock at an exercise price of $9.00 per share. With respect to
the option, 25% of the shares subject to the option vest one year after the
date of grant and the remaining shares vest in equal monthly installments at
the end of the each next 36 calendar months thereafter.

Limitations on Directors' and Officers' Liability and Indemnification

Our certificate of incorporation limits the liability of our 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 associated
with any of the following:

. 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
redemption; or

. any transaction from which the director derived an improper personal
benefit.

The limitation of a director's 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 rescission.

Our certificate of incorporation and bylaws also provide that we shall
indemnify our directors and executive officers and may indemnify our other
officers and employees and other agents to the fullest extent permitted by law.
We believe that indemnification under our bylaws covers at least negligence and
gross negligence on the part of indemnified parties. Our bylaws also permit 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 our bylaws would permit indemnification. We intend to
obtain and maintain directors' and officers' liability insurance, under which
our directors and officers may be indemnified against liability they may incur
for serving in their capacities as directors and officers.

We have entered into indemnification agreements with each of our directors
and officers. The indemnification agreements contain provisions that require us
to, among other things, indemnify our officers and directors against
liabilities that may arise by reason of their status or service as directors or
officers (other than liabilities arising from willful misconduct of a culpable
nature), to advance their expenses incurred as a result of any proceeding
against them as to which they could be indemnified, and to cover our directors
and officers under any of our liability insurance policies applicable to our
directors and officers.

53
<PAGE>

We believe that these provisions and agreements are necessary to attract and
retain qualified persons as directors and officers.

Stock Plans

1998 Stock Plan

Our 1998 stock plan was approved by our board of directors in September 1998
and was amended by the board in March 2000. We have reserved a total of
5,000,000 shares of our common stock for issuance under the plan. The plan
provides for the granting to our employees of incentive stock options within
the meaning of Section 422 of the Internal Revenue Code of 1986, as amended,
and for the granting to employees, including officers and directors,
nonemployee directors and consultants of nonstatutory stock options and stock
purchase rights. Unless terminated sooner, this plan will terminate
automatically in 2010.

Our 1998 stock plan is administered by our board of directors, and, thus,
the board determines the terms of the options or stock purchase rights granted,
including the exercise price, the number of shares subject to each option or
stock purchase right, the vesting and the form of consideration payable upon
such exercise. In addition, the board has the authority to amend, suspend or
terminate the plan, provided that no such action may affect any share of common
stock previously issued and sold or any option previously granted and then
outstanding under the plan.

Options and stock purchase rights granted under our 1998 stock plan are not
generally transferable by the optionee, and each option and stock purchase
right is exercisable during the lifetime of the optionee only by the optionee.
Options granted under the plan must generally be exercised within three months
of the end of optionee's status as our employee or consultant, or within twelve
months after his or her termination by death or disability, but in no event
later than the expiration of the option's ten-year term. In the case of stock
purchase rights, unless the board determines otherwise, the agreement
evidencing the grant shall provide that we have a repurchase option exercisable
upon the voluntary or involuntary termination of his or her employment for any
reason (including death or disability). In this event, the purchase price per
share will be equal to the original price and may be paid by cancellation of
his or her outstanding indebtedness to us, if any. Our repurchase option shall
lapse at a rate determined by the board. The exercise price of any incentive
stock options granted under this plan and any nonstatutory stock options
intended to qualify as "performance-based compensation" within the meaning of
Section 162(m) of the Code, must be at least equal to the fair market value of
our common stock on the date of grant. With respect to any participant who owns
stock possessing more than 10% of the voting power of all classes of our
outstanding capital stock, the exercise price of any incentive stock option
granted must equal at least 110% of the fair market value on the grant date and
the term of such incentive stock option must not exceed five years. The term of
all other options granted under the plan may not exceed ten years.

Our 1998 stock plan provides that in the event of our merger with or into
another corporation, or a sale of substantially all of our assets, each option
or right shall be assumed or an equivalent option or right substituted by the
successor corporation. If the outstanding options or rights are not assumed or
substituted, our board shall provide for the optionee to have the right to
exercise the option or stock purchase right as to all of the optioned stock,
including shares as to which it would not otherwise be exercisable, for a
period of fifteen days from the date of such notice, and the option or stock
purchase right will terminate upon the expiration of such period.

FreePC 1999 Stock Plan and Guide.com 1998 Stock Plan

In connection with the FreePC acquisition, we assumed all outstanding
options issued under the FreePC 1999 stock plan as of January 14, 2000. These
assumed options became options to purchase an aggregate of 2,746,571 shares of
our common stock and warrants to purchase 1,177,052 shares of our common stock.
All material terms of the FreePC options are the same as the terms of our 1998
stock plan described above.

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<PAGE>

In connection with FreePC's merger with Guide.com, FreePC had assumed all
outstanding options issued under the Guide.com 1998 stock plan as of March 4,
1999. We also assumed these options when we acquired FreePC. These assumed
options became options exercisable for an aggregate of 144,704 shares of our
common stock and warrants to purchase 62,015 shares of our common stock. All
material terms of the Guide.com options are the same as the terms of our 1998
stock plan described above.

2000 Employee Stock Purchase Plan

Our 2000 employee stock purchase plan was approved by our board of directors
in March 2000. A total of 300,000 shares of common stock have been reserved for
issuance under our 2000 purchase plan, plus an annual increase equal to the
lesser of 300,000 shares, 1% of the outstanding shares on such date, or a
lesser amount determined by our board.

Our 2000 purchase plan, which is intended to qualify under Section 423 of
the Internal Revenue Code of 1986, as amended, contains consecutive,
overlapping, twenty-four month offering periods. Each offering period includes
four six-month purchase periods. The offering periods generally start on the
first trading day on or after May 1 and November 1 of each year, except for the
first such offering period which commences on the first trading day on or after
the effective date of this offering and ends on the last trading day on or
before April 30, 2002.

Employees are eligible to participate if they are customarily employed by us
or any participating subsidiary for at least 20 hours per week and more than
five months in any calendar year. However, any employee who immediately after
grant owns stock or holds outstanding options possessing 5% or more of the
total combined voting power or value of all classes of our capital stock, or
whose rights to purchase stock under all of our employee stock purchase plans
accrues at a rate which exceeds $25,000 worth of stock for each calendar year,
may be not be granted an option to purchase stock under our 2000 purchase plan.
Our 2000 purchase plan permits participants to purchase common stock through
payroll deductions of up to 10% of the participant's "compensation."
Compensation is defined as the participant's base straight time gross earnings
and commissions but is exclusive of payments for overtime, shift premium
payments, incentive compensation, incentive payments, bonuses and other
compensation. The maximum number of shares a participant may purchase during a
single purchase period is 5,000 shares.

Amounts deducted and accumulated by the participant are used to purchase
shares of common stock at the end of each purchase period. The price of stock
purchased under the 2000 purchase plan is generally 85% of the lower of the
fair market value of the common stock at the beginning of the offering period
or at the end of the purchase period. In the event the fair market value at the
end of a purchase period is less than the fair market value at the beginning of
the offering period, the participants will be withdrawn from the current
offering period following exercise and automatically re-enrolled in a new
offering period. The new offering period will use the lower fair market value
as of the first date of the new offering period to determine the purchase price
for future purchase periods. Participants may end their participation at any
time during an offering period, and they will be paid their payroll deductions
to date. Participation ends automatically upon termination of employment with
us.

Rights granted under the 2000 purchase plan are not transferable by a
participant other than by will, the laws of descent and distribution, or as
otherwise provided under the 2000 purchase plan. The 2000 purchase plan
provides that, in the event of our merger with or into another corporation or a
proposed sale of substantially all of our assets, each outstanding option may
be assumed or substituted for by the successor corporation. If the successor
corporation refuses to assume or substitute for the outstanding options, the
offering period then in progress will be shortened and a new exercise date will
be set. Our 2000 purchase plan will terminate in 2010. Our board of directors
has the authority to amend or terminate the 2000 purchase plan, except that no
such action may adversely affect any outstanding rights to purchase stock under
the 2000 purchase plan.

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<PAGE>

RELATED PARTY TRANSACTIONS

Relationship with TriGem Computer, TriGem Corporation, TriGem America, Korea
Data Systems Co., Korea Data Systems America and KDS USA

TriGem Computer, a Korean company, is the parent company of TriGem
Corporation, a California corporation. TriGem Corporation was one of our
founding stockholders and prior to this offering TriGem Corporation owned 23.4%
of our outstanding common stock after giving effect to the conversion of all
outstanding preferred stock. Hong Soon Lee, Chairman of our board of directors
and one of our stockholders, is also the President, Chief Executive Officer and
a member of the board of directors of TriGem Computer and a director of TriGem
Corporation. Michael Hong, a member of our board of directors, is also Chief
Financial Officer for TriGem Computer.

Korea Data Systems Co., a Korean company, is the parent company of Korea
Data Systems America. Korea Data Systems America was one of our founding
stockholders and prior to this offering Korea Data Systems America owned 23.1%
of our outstanding common stock after giving effect to the conversion of all
outstanding preferred stock. Jung Koh, a member of our board of directors and
one of our stockholders also serves as Vice Chairman of Korea Data Systems Co.

We have entered into a number of agreements, both written and verbal, with
TriGem Computer, TriGem Corporation, TriGem America, Korea Data Systems Co.,
Korea Data Systems America and KDS USA. These agreements are described below.

Trademark Assignment

Under an agreement entered into on June 10, 1999 and amended on August 16,
1999, Korea Data Systems America transferred to us the trademark "E-MACHINES"
for 419,538 shares of our common stock, which we issued to it on August 18,
1999. We agreed to license back to Korea Data Systems America use of the
trademark solely in the Republic of Korea.

Lease

We lease approximately 147,000 square feet of office and warehouse space
located at 14350 Myford Road, Irvine, California from the Irvine Company under
a written lease entered into on November 30, 1998. Our monthly rent is
approximately $84,000 subject to annual increases that will increase our rent
in the fifth year of the lease to approximately $97,000. The lease terminates
in 2004, subject to our right to extend the term. Our performance under the
lease is guaranteed by Korea Data Systems America. Pursuant to a verbal
agreement, we sublease approximately 48,000 square feet of this space to TriGem
America, a subsidiary of TriGem Computer, for a monthly rental of approximately
$27,000 increasing to approximately $32,000 over the term of the sublease.

Subordinated Notes

In connection with our initial capitalization, we issued a subordinated note
payable to TriGem Corporation in the amount of $270,000 and a subordinated note
payable to Korea Data Systems America in the amount of $290,000. See "--
Capitalization Agreements" for a description of our initial capitalization. The
subordinated notes bear interest at 5.79% and are due on June 7, 2004. The
subordinated notes may be prepaid without penalty at our option.

Supply of eOne PCs, eSlate Notebook Computers and Monitors

We currently source all of our eOne PCs, eSlate notebook computers and
monitors from KDS USA, a company that is wholly owned by Lap Shun Hui, a member
of our board of directors and one of our stockholders. All of the eOne PCs and
the eSlate notebook computers and a limited number of our monitors are
manufactured by Korea Data Systems Co., and all of our monitors are
manufactured by Korea Data Systems

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<PAGE>

Co. We have no obligation to order, take minimum delivery or purchase at pre-
negotiated prices from KDS USA or Korea Data Systems Co. Additionally, KDS USA
and Korea Data Systems Co. have no contractual obligation to supply us with PCs
and monitors.

Supply of eTower and eMonster PCs

On January 24, 2000, we entered into an original design manufacturer
agreement with TriGem Computer. Pursuant to the agreement, TriGem Computer has
agreed to design, procure and assemble certain computer components, and to
provide support for the assembled products. We will pay TriGem Computer for its
supply and services on a "cost plus" basis, which price shall be adjusted
monthly based upon TriGem Computer's then current costs, while maintaining a
percentage of profit for TriGem Computer, which varies from model to model.
Pursuant to the agreement, we will place requisitions and purchase orders each
month. TriGem Computer is obligated to meet such purchase orders based on the
projections we provide to TriGem Computer in our annual plan. Except to the
extent that we place requisitions and purchase orders with TriGem Computer we
have no obligation to purchase products from TriGem Computer. TriGem Computer
has provided several warranties to us, including that all of its products will
be free from defects in design, material and workmanship. The term of the
agreement is for two years, and automatically renews for one year periods,
unless either party provides written notice of its intent to terminate one
hundred and eighty (180) days prior to the expiration of the initial term or
any subsequent term.

Inventory Purchases and Extended Payment Terms

During the period from inception until December 31, 1998, we purchased an
aggregate of approximately $71 million in PCs and monitors from TriGem
Corporation and KDS USA. Pursuant to a verbal agreement with TriGem Corporation
and Korea Data Systems Co., we financed our inventory purchases by extending
payment of our accounts payable up to ninety days. Under a verbal agreement
between us, TriGem Corporation, Korea Data Systems Co. and KDS USA, we
transferred approximately $58 million of our accounts payable obligations as of
December 31, 1998 to KDS USA. Pursuant to a verbal agreement with KDS USA,
trade payables are subject to payment terms that allow us ninety days to pay
and that provide a discount on PC payables proportional to the number of days
that we pay early. The effective interest rate as of June 30, 1999 was a 10%
annual rate. During the year ended December 31, 1999, we purchased an aggregate
of $805.4 million in PCs and monitors from KDS USA. As of December 31, 1999,
approximately $131.9 million in payables were outstanding to KDS USA. In
connection with these inventory purchases, approximately $889,000 of finance
charges was incurred for the period ended December 31, 1998, and $6.5 million
of finance charges were incurred for the year ended December 31, 1999.

Warranties and PC Repair Service

Under our original design manufacturer agreement with TriGem Computer,
TriGem has agreed to provide warranty and refurbishment services to eMachines.
TriGem has warranted that products that it produces shall be free from defects,
and has agreed to repair or replace and return, without cost to us or
consumers, all defective products returned within the warranty period, which
lasts for fifteen months from the date a product is delivered. If the returned
products are not defective, TriGem will charge us a service fee for each
returned product plus shipping costs. Under the refurbishment provisions of the
agreement, we can return to TriGem all products that our retailers return to
us. If the returned products are defective, TriGem will provide us with a full
credit. TriGem will charge us a fee for each returned product if the cumulative
rate of products returned with no defect exceeds a specified percentage. In the
event that more than a specified percentage of any product that TriGem produces
pursuant to the agreement is returned, we may initiate a recall of that product
or model after consultation with TriGem. In the event of such a recall, we are
entitled to a full credit from TriGem for all recalled and returned products.

Prior to January 24, 1999, the date we entered into the original design
manufacturer agreement with TriGem Computer, we sent all products returned to
us to TriGem for refurbishment. If a returned product was

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<PAGE>

determined to be defective, and less than 120 days old, TriGem refurbished and
returned the product to us and gave us a credit for a portion of the original
invoice price. If a defective product was less than 120 days old, TriGem merely
refurbished and returned the product to us. If a returned product was
determined not to be defective, TriGem charged us a service fee.

Under verbal agreement, Korea Data Systems Co. warrants its monitors for
eighteen months. (parts and labor included).

Cooperative Advertising Costs

For the period from inception until December 31, 1998, TriGem Computer
agreed to credit us $363,000 for cooperative advertising credits from component
suppliers. In July 1999, this amount was offset against amounts due to KDS USA.

Freight Costs

For the period from inception until December 31, 1998, TriGem Computer
agreed to credit us $173,000 in freight costs for products shipped to us from
TriGem Computer. In July 1999, this amount was offset against amounts due to
KDS USA.

Capitalization Agreements

We issued an aggregate of 77,600,000 shares of our common stock at a price
per share of approximately $0.03 pursuant to agreements reached in September
1998. Among the purchasers of our common stock were the following officers,
directors and stockholders of more than 5% of our outstanding shares, and their
immediate family members:

<TABLE>
<CAPTION>
Aggregate
Number of Purchase
Stockholder Shares Price
- ----------- ---------- ---------
<S> <C> <C>
TriGem Corporation......................................... 29,200,000 $730,000

Korea Data Systems America................................. 28,400,000 710,000

Stephen A. Dukker.......................................... 8,000,000 200,000

Chul Chung................................................. 2,400,000 60,000

Jung Koh................................................... 2,400,000 60,000

Hong Soon Lee.............................................. 2,400,000 60,000

Hong Sun Lee............................................... 1,600,000 40,000

Lap Shun Hui............................................... 1,600,000 40,000

Dae Soo Koh................................................ 1,600,000 40,000
</TABLE>

Hong Sun Lee is Hong Soon Lee's brother and Dae Soo Koh is Jung Koh's
brother. Both Hong Sun Lee and Dae Soo Koh were members of our board of
directors until August 1999 when they resigned in connection with the Series A
preferred stock financing.

Messrs. Dukker, Chung, Hui, Jung Koh, Dae Soo Koh, Hong Soon Lee and Hong
Sun Lee paid for their shares with full recourse promissory notes. Each of the
notes matures in June 2004 and bears interest until maturity at 5.79% per year.
Each note is secured with the shares issued to each purchaser.

On June 10, 1999, we delivered stock certificates representing ownership of
the shares that issued pursuant to the agreements reached in September 1998.
Also on that date, we entered into a Shareholders Agreement

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<PAGE>

with the above purchasers of our common stock. This agreement superseded an
earlier agreement that had been entered into solely by two of our principal
stockholders, TriGem Corporation and Korea Data Systems America, on April 1,
1999. The Shareholders Agreement terminated upon the closing of the sale of our
Series A preferred stock in August 1999. When it was in effect, this Agreement
provided for board review of significant business decisions, a voting agreement
as to election of directors and a buy-sell agreement among TriGem Corporation
and Korea Data Systems America. When it was in effect, it also provided for
limited preferential supply arrangements with TriGem Computer and Korea Data
Systems Co.

Series A Preferred Stock Financing

On August 18, 1999, we sold an aggregate of 24,279,369 shares of our Series
A preferred stock at a price per share of $6.38.

America Online, a stockholder of more than 5% of our outstanding shares
prior to this offering, purchased 7,832,079 shares for an aggregate price of
$50 million. C. Toms Newby, III, one of our directors, is a member of
Technology Crossover Management III, L.L.C., the general partner of TCV III
(GP), TCV III, L.P., TCV III (Q), L.P. and TCV III Strategic Partners, L.P.
Entities affiliated with Technology Crossover Management III, L.L.C. purchased
3,602,757 shares for an aggregate price of approximately $23 million.

In connection with the sale of our Series A preferred stock, we also entered
into an Amended and Restated Rights and Restrictions Agreement with the
purchasers of our preferred stock and all holders of our common stock. This
agreement superseded a Rights and Restrictions Agreement entered into on June
10, 1999 with certain purchasers of our common stock. For a description of the
key terms of the Amended and Restated Rights and Restrictions Agreement, see
"Description of Capital Stock--Registration Rights".

Relationship with America Online, Inc.

In June 1999, we entered into a marketing agreement with America Online
under which America Online will provide rebates to our PC buyers to
significantly reduce the net effective price of our PCs. To obtain a rebate,
our PC buyers must enter into an agreement with America Online to subscribe to
America Online's CompuServe Internet access service. For each subscriber to AOL
Classic service or Compuserve service, America Online has agreed to pay us a
fee of $35 to $40 per subscriber. In addition, for each subscriber receiving a
rebate under this program, America Online has agreed to pay us a monthly fee,
depending upon the service selected, which payments will continue as long as
the subscriber continues service. In the event that America Online increases
its monthly pricing for certain subscribers to its Compuserve service at or
beyond $21.95 per month, we may elect to either receive an additional $1 per
month per subscriber or continue the current pricing structure, which we will
market as a special discount. Should we elect to continue the current pricing
structure as a discount to subscribers, America Online will have the right to
reasonably approve our marketing efforts connected with this discounted
service. The agreement will terminate in 2004 and may be renewed by the parties
for an additional five-year term. However, the period during which America
Online will offer rebates to PC buyers expires two years from the launch of the
rebate offer, but may be extended by America Online at its discretion. America
Online has agreed that it will ensure that our rebate offer is no less
favorable than any other rebate offer having a substantially similar structure.
America Online purchased 2,271,303 shares of our Series A preferred stock on
August 18, 1999, and purchased an additional 5,560,776 shares in September 1999
upon receipt of regulatory approval. See "Related Party Transactions--Series A
Preferred Stock Financing." Additionally, we granted America Online a warrant
to purchase shares of our common stock at an aggregate exercise price of
$3.6 million. This warrant expires five years after the date of grant. The
number of shares that may be purchased upon exercise of the warrant is equal to
the aggregate exercise price divided by the greater of 1.25 times the initial
offering price of our common stock or $7.98. If there is no successful
completion of an initial public offering, the number of shares issuable upon
exercise of the warrant is equal to the aggregate exercise price of the warrant
divided by $11.82. Upon receipt of regulatory approval, we issued America
Online an additional warrant to purchase shares of common stock at an aggregate
exercise price of $8.9 million under the same terms as the earlier warrant. The
maximum number of shares that America Online may receive, subject to anti-
dilution adjustments, upon exercise of its warrants is 1,566,219.

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<PAGE>

Employment and Indemnification Agreements

We have entered into an employment agreement with our President and Chief
Executive Officer, Stephen A. Dukker. For a description of the key terms of the
employment agreement, see "Management--Employment Agreement."

On March 19, 2000, the board of directors granted to Mr. Miller, our Vice
President and Chief Financial Officer, an option to purchase up to 75,000
shares of common stock at an exercise price of $9.00 per share. With respect to
the option, 20% of the shares subject to the option vest on the sixth-month
anniversary of the date of grant, 20% vest one year after the date of grant and
the remaining shares vest in equal monthly installments at the end of the each
next 36 calendar months thereafter.

In January 2000, we entered into an employment agreement with each of Donald
S. La Vigne, our Executive Vice President, Strategy and Business Development,
Audrey U. Finci, our Executive Vice President, Operations, Steve Chadima, our
Vice President, Marketing, and James Weissenborn, our Vice President,
Advertising Sales. These employment agreements became effective on January 14,
2000, the date that we acquired FreePC.

Under Mr. La Vigne's employment agreement, we have agreed to pay Mr. La
Vigne an annual base salary of $199,000 and to grant him an option to purchase
250,000 shares of our common stock. The option will vest as to 20% of the
shares subject to the option one year after the date of grant, and as to 20% of
the shares on each subsequent anniversary of the date of grant, subject to Mr.
La Vigne's continued employment with us on each vesting date. In addition, Mr.
La Vigne agreed to waive acceleration of vesting as to a portion of his options
to purchase Free PC common stock in exchange for our assumption of such
options. Upon a change of control of eMachines or an "involuntary termination"
of Mr. La Vigne's employment, all of the unvested options and warrants that we
issued in exchange for the Free PC options that we assumed will fully vest and
be immediately exercisable. If Mr. La Vigne's employment is otherwise
terminated he will be eligible for severance benefits in accordance with our
established severance policy as then in effect.

Under Ms. Finci's employment agreement, we have agreed to pay Ms. Finci an
annual base salary of $199,000 and to grant her an option to purchase 175,000
shares of our common stock. The option will vest as to 10% of the shares
subject to the option six months after the date of grant, as to an additional
10% of the shares one year after the date of grant and as to 20% of the shares
on each subsequent anniversary of the date of grant, subject to Ms. Finci's
continued employment with us on each vesting date. In addition, Ms. Finci
agreed to waive acceleration of vesting as to a portion of her options to
purchase Free PC common stock in exchange for our assumption of such options.
Upon a change of control of eMachines or an "involuntary termination" of Ms.
Finci's employment, all of the unvested options and warrants that we issued in
exchange for the Free PC options that we assumed will fully vest and be
immediately exercisable. If Ms. Finci's employment is otherwise terminated she
will be eligible for severance benefits in accordance with our established
severance policy as then in effect.

Under Mr. Weissenborn's employment agreement, we have agreed to pay Mr.
Weissenborn an annual base salary of $160,000, a bonus of $10,000 on the last
day of each fiscal quarter if our internet division meets its quarterly budget,
and to grant him an option to purchase 125,000 shares of our common stock. The
option will vest as to 20% of the shares subject to the option one year after
the date of grant, and as to 20% of the shares on each subsequent anniversary
of the date of grant, subject to Mr. Weissenborn's continued employment with us
on each vesting date. In addition, Mr. Weissenborn agreed to waive acceleration
of vesting as to a portion of his options to purchase Free PC common stock in
exchange for our assumption of such options. Upon a change

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<PAGE>

of control of eMachines or an "involuntary termination" of Mr. Weissenborn's
employment, all of the unvested options and warrants that we issued in exchange
for the Free PC options that we assumed will fully vest and be immediately
exercisable. If Mr. Weissenborn's employment is otherwise terminated he will be
eligible for severance benefits in accordance with our established severance
policy as then in effect.

Under Mr. Chadima's employment agreement, we have agreed to pay Mr. Chadima
an annual base salary of $175,000 and to grant him an option to purchase
125,000 shares of our common stock. The option will vest as to 20% of the
shares subject to the option one year after the date of grant, and as to 20% of
the shares on each subsequent anniversary of the date of grant, subject to Mr.
Chadima's continued employment with us on each vesting date. In addition, Mr.
Chadima agreed to waive acceleration of vesting as to a portion of his options
to purchase Free PC common stock in exchange for our assumption of such
options. Upon a change of control of eMachines or an "involuntary termination"
of Mr. Chadima's employment, all of the unvested options and warrants that we
issued in exchange for the Free PC options that we assumed will fully vest and
be immediately exercisable. If Mr. Chadima's employment is otherwise terminated
he will be eligible for severance benefits in accordance with our established
severance policy as then in effect.

We have entered into agreements with each of our directors and officers that
provide for indemnification. See "Management--Limitations on Directors' and
Officers' Liability and Indemnification."

Relationship with Bill Gross' idealab! and its affiliated entities

Bill Gross, one of our directors, is the chairman of the board of directors
and chief executive officer of Bill Gross' idealab!, a California corporation,
and is the managing member of idealab! Holdings, L.L.C., a California limited
liability company and a wholly-owned subsidiary of Bill Gross' idealab!. Bill
Gross' idealab! founded FreePC in January 1999. Prior to this offering, Bill
Gross' idealab! and other entities affiliated with Mr. Gross beneficially owned
approximately 14.3% of our outstanding common stock after giving effect to the
conversion of all outstanding preferred stock and assuming the exercise of
warrants to purchase shares of common stock held by idealab! Holdings.

Our subsidiary, FreePC, has entered into a number of agreements, both
written and verbal, with Bill Gross' idealab! and its affiliated entities.
These agreements are described below.

Lease

FreePC leases approximately 19,000 square feet of office space in Pasadena,
California, pursuant to a written agreement with Bill Gross' idealab! Under the
agreement, we have a right to rent an additional 9,905 square feet at this
location. The initial term of the agreement is for one year, and FreePC has an
option to extend the lease for four additional one-year terms.

Shared Expenses

From its inception until July 1999, FreePC shared facilities and received a
number of management services, including accounting, payroll processing, access
to shared local area computer communications network, and general business
insurance from Bill Gross' idealab!. Bill Gross' idealab! charged FreePC a
management fee for the use of its facilities and the services provided.

Advertising Agreements

FreePC has entered into various advertising agreements with companies that
are affiliated with Bill Gross' idealab!. The total revenue generated from such
entities during the year ended December 31, 1999 aggregated approximately
$218,000.

FreePC Acquisition

In connection with the acquisition of FreePC in January 2000, we entered
into a Rights and Restrictions Agreement with the stockholders of FreePC
including, among others, two of our executive officers, Donald S. La Vigne and
Steve Chadima, and certain entities affiliated with Bill Gross' idealab! For a
description of the key terms of the Rights and Restrictions Agreement, see
"Description of Capital Stock--Registration Rights."

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<PAGE>

PRINCIPAL STOCKHOLDERS

The following table sets forth information known to us with respect to the
beneficial ownership of our common stock as of January 31, 2000 and as adjusted
to reflect the sale of common stock offered hereby by the following:

. each stockholder known by us to own beneficially more than 5% of our
common stock;

. our President and Chief Executive Officer and the other executive
officer named in the Summary Compensation Table;

. each member of our board of directors; and

. all members of our board of directors and executive officers as a group.

The percentage ownership in the table below is based on 124,690,425 shares
outstanding as of January 31, 2000. The number of shares includes 41,913,255
shares of common stock issuable upon the automatic conversion of our preferred
stock upon completion of this offering. Except as otherwise indicated, we
believe that the beneficial owners of the common stock listed below, on the
information furnished by them, have sole voting power and investment power with
respect to such shares. Beneficial ownership is determined in accordance with
the rules of the Securities and Exchange Commission. In computing the number of
shares beneficially owned by a person and the percentage ownership of that
person, shares of common stock subject to options or warrants held by that
person that are currently exercisable or will become exercisable within sixty
days after January 31, 2000 are deemed outstanding, while such shares are not
deemed outstanding for purposes of computing percentage ownership of any other
person. Unless otherwise indicated below, the persons and entities named in the
table have sole voting and investment power with respect to all shares
beneficially owned, subject to community property laws where applicable. The
address for those individuals for whom an address is not otherwise indicated is
eMachines, Inc., 14350 Myford Road, Suite 100, Irvine, CA 92606.

<TABLE>
<CAPTION>
Percentage of Shares
Outstanding
-----------------------
Number of Prior to
Name or Group Beneficial Owners Shares Offering After Offering
- ------------------------------- ---------- -------- --------------
<S> <C> <C> <C>
TriGem Corporation......................... 29,200,000 23.4% 20.2%
14350 Myford Road
Irvine, CA 92606

Korea Data Systems America, Inc............ 28,819,538 23.1 19.9
12300 Edison Way
Garden Grove, CA 92841

Bill Gross (1)............................. 18,595,363 14.3 12.4
c/o idealab! Holdings, L.L.C.
130 W. Union Street
Pasadena, CA 91103

Bill Gross' idealab! and idealab! Holdings,
L.L.C. (2)................................ 17,522,165 13.5 11.7
130 W. Union Street
Pasadena, CA 91103

America Online, Inc.(3).................... 9,398,298 7.4 6.4
22000 AOL Way
Dulles, VA 20166

Stephen A. Dukker(4)....................... 8,227,897 6.6 5.7

C. Toms Newby, III (5)..................... 3,602,757 2.9 2.5
c/o Technology Crossover Ventures
575 High Street, Suite 400
Palo Alto, CA 94301
</TABLE>

62
<PAGE>

<TABLE>
<CAPTION>
Percentage of Shares
Outstanding
-----------------------
Number of Prior to
Name or Group Beneficial Owners Shares Offering After Offering
- ------------------------------- ---------- -------- --------------
<S> <C> <C> <C>
Jung Koh................................... 2,400,000 1.9 1.7
Korea World Trade Center Bldg., Room #204
159, Samsung-dong
Kangnam-gu Seoul, Korea

Hong Soon Lee.............................. 2,400,000 1.9 1.7
45-2 YOIDO
Youngdeungpo Seoul, Korea

Lap Shun Hui............................... 1,600,000 1.3 1.1
12350 Edison Way
Garden Grove, CA 92841

Nathan Morton.............................. -- * *

Michael Hong............................... -- * *

Steven H. Miller........................... -- * *

All directors and executive officers as a
group (13 persons) (6).................... 40,453,841 32.4 27.9
</TABLE>
- ---------------------
* Less than 1% of the outstanding shares of common stock.

(1) Includes (a) 12,265,514 shares held by idealab! Holdings, L.L.C. and
5,256,651 shares subject to warrants that are exercisable within sixty days
of January 31, 2000, (b) 193,933 shares held by idealab! Capital Partners
I-A, L.P. and 83,116 shares subject to warrants that are exercisable within
sixty days of January 31, 2000 and (c) 557,303 shares held by idealab!
Capital Partners I-B, L.P. and 238,846 shares subject to warrants that are
exercisable within sixty days of January 31, 2000. Mr. Gross is the
Chairman of the Board of Directors and chief executive officer of Bill
Gross' idealab!, a California corporation, and is the managing member of
idealab! Holdings, L.L.C. As such, Mr. Gross exercises voting and
investment power over shares beneficially held by those entities, and
Mr. Gross may be deemed to indirectly beneficially own such shares. Mr.
Gross is a managing member of idealab! Capital Management I, L.L.C., a
Delaware limited liability company, and shares voting and investment power
over shares beneficially held by idealab! Capital Management I, L.L.C.,
which includes shares held by idealab! Capital Partners I-A, L.P., a
Delaware limited partnership, and idealab! Capital Partners I-B, L.P., a
Delaware limited partnership, each of which are controlled by idealab!
Capital Management I, L.L.C., and Mr. Gross may be deemed to indirectly
beneficially own such shares. Bill Gross' idealab! may be deemed to
indirectly beneficially own the shares held by idealab! Holdings, L.L.C.,
which is a wholly-owned subsidiary of Bill Gross' idealab!. idealab!
Holdings, L.L.C., disclaims beneficial ownership of all shares held by
idealab! Capital Management I, L.L.C., idealab! Capital Partners I-A, L.P.,
and idealab! Capital Partners I-B, L.P.

(2) Includes 12,265,514 shares held by idealab! Holdings, L.L.C. and 5,256,651
shares subject to warrants that are exercisable within sixty days of
January 31, 2000. Bill Gross' idealab! may be deemed to indirectly
beneficially own the shares held by idealab! Holdings, L.L.C., which is a
wholly-owned subsidiary of Bill Gross' idealab!.

(3) Includes a maximum of 1,566,219 shares of common stock issuable pursuant to
the exercise of warrants at an assumed minimum exercise price of $7.98 per
share. See "Description of Capital Stock--Options and Warrants" for a
discussion of the exercise price of these warrants.

(4) Includes 227,897 shares subject to options which are exercisable within
sixty days of January 31, 2000.

(5) Includes 26,161 shares held by TCV III (GP), 124,263 shares held by TCV
III, L.P., 3,302,768 shares held by TCV III (Q), L.P. and 149,565 shares
held by TCV III Strategic Partners, L.P. (collectively, the "TCV Funds").
Mr. Newby, a director of the Company, is a Member of Technology Crossover
Management III, L.L.C. which is the General Partner of each of the TCV III
Funds. Mr. Newby disclaims beneficial ownership of such shares except to
the extent of his pecuniary interest therein. The address for each of these
persons and entities is c/o Technology Crossover Ventures, 575 High Street,
Suite 400, Palo Alto, California 94301.

(6) Represents shares held by our executive officers, directors and entities
affiliated with them. Includes:

. 227,897 shares subject to options which are exercisable within 60 days
of January 31, 2000;

. 6,425,304 shares issuable upon exercise of outstanding warrants
exercisable within 60 days of January 31, 2000;

. 241,656 shares issuable upon exercise of outstanding warrants
exercisable within 60 days of January 31, 2000 subject to our right of
repurchase, which lapses over time; and

. 563,865 shares subject to our right of repurchase, which lapses over
time.

63
<PAGE>

DESCRIPTION OF CAPITAL STOCK

Upon the completion of this offering, we will be authorized to issue
350,000,000 shares of common stock, $0.0000125 par value per share, and
35,000,000 shares of preferred stock, $0.01 par value per share. The following
description of our capital stock is only a summary. You should refer to our
certificate of incorporation and bylaws as in effect upon the closing of this
offering, which are included as exhibits to the registration statement of which
this prospectus forms a part, and to the provisions of applicable Delaware law.

Common Stock

As of January 31, 2000, there were 124,690,425 shares of common stock
outstanding, assuming the automatic conversion of all outstanding shares of
convertible preferred stock into common stock. These shares were held of record
by approximately 100 stockholders. There will be 144,690,425 shares of common
stock outstanding, assuming no exercise of the underwriters' over-allotment
option and no exercise of outstanding options or warrants after January 31,
2000, after giving effect to the sale of our common stock in this offering.

Dividend Rights. Subject to preferences that may apply to shares of our
preferred stock outstanding at the time, the holders of outstanding shares of
our common stock are entitled to receive dividends out of assets legally
available at the times and in the amounts as our board of directors may
determine.

Voting Rights. Each holder of our common stock is entitled to one vote for
each share of common stock held on all matters submitted to a vote of
stockholders. We do not provide for cumulative voting of directors in our
certificate of incorporation.

No preemptive or similar rights. Holders of our common stock are not
entitled to preemptive rights and our common stock is not subject to conversion
or redemption.

Right to receive liquidation distributions. Upon a liquidation, dissolution
or winding-up of our company, the holders of common stock are entitled to share
ratably with holders of any participating preferred stock in all assets
remaining after payment of all liabilities and the liquidation preferences of
any outstanding preferred stock. Each outstanding share of common stock is, and
all shares of common stock to be outstanding upon completion of this offering
will be, fully paid and nonassessable.

Preferred Stock

Upon the consummation of this offering, the outstanding shares of Series A,
Series B and Series C preferred stock will automatically convert into common
stock. Upon completion of this offering, our board will be authorized, without
action by the stockholders, to issue 35,000,000 shares of preferred stock in
one or more series and to fix the rights, preferences, privileges and
restrictions of each wholly unissued series and any of its qualifications,
limitations or restrictions. These rights, preferences and privileges may
include dividend rights, conversion rights, voting rights, terms of redemption,
liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of any series, all or any of which
may be greater than the rights of the common stock. The issuance of preferred
stock could adversely affect the voting power of holders of common stock and
the likelihood that the holders of common stock will receive dividend payments
and payments upon liquidation. The issuance of preferred stock, while providing
flexibility in connection with possible acquisitions and other corporate
purposes, could, among other things, have the effect of delaying, deferring or
preventing a change in control of our company and may adversely affect the
market price of our common stock and the voting and other rights of the holders
of our common stock. We have no current plan to issue any shares of preferred
stock.

Registration Rights

Pursuant to an amended and restated rights and restrictions agreement we
entered into in connection with our Series A preferred stock financing and a
rights and restrictions agreement entered into in connection with the FreePC

64
<PAGE>

acquisition, certain holders of our common stock and all holders of our
preferred stock are entitled to rights with respect to the registration of
their shares under the Securities Act as described below.

Demand Registration Rights. At any time after six months following this
offering, pursuant to the rights and restrictions agreement we entered into in
connection with our Series A preferred stock financing, and at any time after
one year following this offering, pursuant to the rights and restrictions
agreement we entered into in connection with the FreePC acquisition, the
holders of at least 50% of the shares of common stock issuable upon conversion
of our preferred stock can request that we register all or a portion of their
shares, so long as the total offering price of the shares to the public is at
least $15,000,000. We will be required to file only one registration statement
in response to their demand registration rights. We may postpone the filing of
a registration statement for up to 120 days, in the case of the rights and
restrictions agreement we entered into in connection with our Series A
preferred stock financing, and up to 180 days in the case of the rights and
restrictions agreement we entered into in connection with the FreePC
acquisition, once in a twelve-month period if we determine that the filing
would not be in the best interests of us and our stockholders.

Piggyback Registration Rights. If we register any securities for public
sale, the holders of the shares of common stock and common stock issuable upon
conversion of our preferred stock will have the right to include their shares
in the registration statement subject to the ability of the underwriters to
limit the number of shares included in the offering in view of market
conditions. However, this right does not apply to a registration statement
relating to any of our employee benefit plans or a corporate reorganization.
These registration rights expire three years after this offering is completed.

Form S-3 Registration Rights. The holders of not less than an aggregate of
25% of the shares of common stock and the common stock issuable upon conversion
of our preferred stock can request that we register their shares if we are
eligible to file a registration statement on Form S-3 and if the total price of
the shares offered to the public is at least $2,500,000. These holders may only
require us to file two registration statements on Form S-3 in any 12 month
period and only three registration statements in all. We may postpone the
filing of a registration statement for up to 120 days once in a 12 month period
if we determine that the filing would be seriously detrimental to us and our
stockholders.

We will pay all of the expenses, except underwriters' and brokers' discounts
and commissions, incurred in connection with the demand registrations and
piggyback registrations described above. The participating holders will bear
all expenses incurred in connection with the exercise of their Form S-3
registration rights.

The registration rights described above will expire with respect to a
particular stockholder if it can sell all of its shares in a three month period
following this offering under Rule 144 of the Securities Act.

Options and Warrants

Options to purchase 1,532,200 shares of common stock were outstanding as of
January 31, 2000 and subject to our 1998 stock plan and an additional 3,467,800
shares are authorized to be issued under our 1998 plan plus an automatic annual
increase to be added on the first day of our fiscal year beginning in 2001. As
of such date, 9,596,404 shares of common stock were issuable upon exercise of
warrants issued in connection with the FreePC acquisition at a warrant exercise
price of $17.13 per share, and options to purchase 2,062,394 shares of common
stock and warrants to purchase 883,843 shares of common stock were issuable
upon exercise of FreePC options that we assumed in the FreePC acquisition.
Under our 2000 employee stock purchase plan, 300,000 shares of our common stock
are authorized for issuance plus an annual increase to be added on the first
day of our fiscal year beginning in 2001. See "Management--Stock Plans." Each
FreePC option we assume will continue to have, and be subject to, the same
terms and conditions as set forth in the stock plans of FreePC and the
respective option agreements governing such options immediately prior to the
acquisition, except that such options are exercisable for units comprised of
shares of our common stock and warrants to purchase our common stock and the
number of shares subject to the option and the exercise price have been
adjusted to reflect the exchange ratio in the acquisition. As a bonus for the
period from July 1, 1999 through November 30, 1999, Mr. Dukker was granted a
fully vested option to purchase 227,897 shares of our common

65
<PAGE>

stock at an exercise price of $1.61 per share. In addition, as of January 31,
2000, options to purchase 132,400 shares of common stock outside of our 1998
stock plan were outstanding. Subsequently, Mr. Dukker was granted an option to
purchase 2,000,000 shares of common stock at an exercise price of $9.00 per
share.

We have also issued warrants to purchase shares of common stock at an
aggregate exercise price of $12.5 million in connection with a marketing
agreement with America Online. See "Related Party Transactions-- Relationship
with America Online, Inc." for a description of the marketing agreement. The
number of shares that may be purchased upon exercise of the warrant is equal to
the quotient determined by dividing the aggregate exercise price by the greater
of 1.25 times the initial offering price of our common stock or $7.98. If there
is no successful completion of an initial public offering, the number of shares
issuable upon exercise of the warrant is equal to the aggregate exercise price
of the warrant divided by $11.82. This warrant will remain outstanding after
the completion of the offering until August 18, 2004, unless sooner exercised.
The maximum number of shares that America Online may receive, subject to anti-
dilution adjustments, upon exercise of its warrants is 1,566,219.

Additionally, as of January 31, 2000, there were outstanding warrants to
purchase an aggregate of 9,596,404 shares of common stock that we issued to
FreePC stockholders pursuant to our FreePC acquisition at a per share exercise
price of $17.13.

Delaware Anti-Takeover Law and Certain Charter and Bylaw Provisions

Delaware Law

We are subject to the provisions of Section 203 of the Delaware General
Corporation Law regulating corporate takeovers. This section prevents some
Delaware corporations from engaging, under some circumstances, in a "business
combination," which includes a merger or sale of 10% or more of the
corporation's assets with any "interested stockholder," meaning a stockholder
who owns 15% or more of the corporation's outstanding voting stock, as well as
affiliates and associates of the stockholder, for three years following the
date that the stockholder became an "interested stockholder" unless:

. the transaction is approved by the board of directors prior to the date
the interested stockholder attained that status;

. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced; or

. on or subsequent to such date the business combination is approved by
the board and authorized at an annual or special meeting of stockholders
by at least two-thirds of the outstanding voting stock that is not owned
by the interested stockholder.

A Delaware corporation may opt out of this provision with an express
provision in its original certificate of incorporation or an express provision
in its certificate or incorporation or bylaws resulting from a stockholders'
amendment approved by at least a majority of the outstanding voting shares.
However, we have not opted out of this provision. The statute could prohibit or
delay mergers or other takeover or change-in-control attempts and, accordingly,
may discourage attempts to acquire us.

66
<PAGE>

Charter and Bylaw Provisions

Our certificate of incorporation and bylaws will provide, subject to
appropriate corporate action, that:

. following the completion of this offering, stockholders may not act by
written consent without a meeting; and

. following the completion of this offering, stockholders may not call
special meetings of the stockholders.

In addition, our certificate of incorporation does not provide for
cumulative voting. We also indemnify officers and directors against losses that
they may incur in investigations and legal proceedings resulting from their
services to us, which may include services in connection with the takeover
defense measures.

These provisions of our certificate of incorporation and bylaws may have the
effect of delaying, deferring or discouraging another person from acquiring
control of us, including takeover attempts that might result in a premium over
the market price for the shares of our common stock.

Transfer Agent and Registrar

The transfer agent and registrar for the common stock is Equiserve Trust
Company.

Nasdaq Stock Market National Market Listing

Our common stock has been approved for listing on The Nasdaq Stock Market's
National Market under the symbol "EEEE."

67
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, we will have 144,690,425 shares of common
stock outstanding based on shares outstanding as of January 31, 2000. Of these
shares, the 20,000,000 shares sold in this offering (23,000,000 shares if the
underwriters' over-allotment option is exercised in full) will be freely
transferable without restriction under the Securities Act, unless they are held
by "affiliates" as that term is used under the Securities Act and the
Regulations promulgated thereunder.

The remaining 124,690,425 shares outstanding upon completion of this
offering will be "restricted securities" as that term is defined under Rule
144. Restricted securities may be sold in the public market only if they are
registered or if they qualify for an exemption from registration under Rule 144
or Rule 701 under the Securities Act, which are summarized below.

All of our executive officers and directors who hold shares of our common
stock and substantially all of our stockholders, who collectively hold an
aggregate of 124,688,741 of these restricted securities, have entered into or
are subject to "lock-up" agreements in which they have agreed not to offer,
sell, contract to sell, grant any option to purchase or otherwise dispose of
any of these shares for a period of 180 days from the date of this prospectus.
We also have entered into an agreement with the underwriters that we will not
offer, sell or otherwise dispose of common stock for a period of 180 days from
the date of this prospectus. However, Credit Suisse First Boston Corporation
may in its sole discretion, at any time without notice, release all or any
portion of the shares restricted by lock-up agreements.

Taking into account the lock-up agreements and assuming Credit Suisse First
Boston Corporation does not release stockholders from these agreements, the
following shares will be eligible for sale in the public market at the
following times:

. beginning on the effective date of this prospectus, only the shares sold
in the offering will be immediately available for sale in the public
market;

. beginning 180 days after the effective date, of this prospectus,
approximately 82,693,166 shares will be eligible for sale under Rules
144 and 701 of the Securities Act; and

. approximately 41,997,259 shares will be eligible for sale under Rule 144
upon the expiration of various one-year holding periods after the
expiration of the lock-up period.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), including an affiliate, who has beneficially
owned restricted shares for at least one year is entitled to sell, within any
three-month period commencing ninety days after the date of completion of this
offering, a number of shares that does not exceed the greater of 1% of the then
outstanding shares of common stock (approximately 1,446,904 shares immediately
after this offering), or the average weekly trading volume in the common stock
during the four calendar weeks preceding such sale, subject to the filing of a
Form 144 with respect to such sale and certain other limitations and
restrictions. In addition, a person who is not deemed to have been our
affiliate at any time during the ninety days preceding a sale and who has
beneficially owned the shares proposed to be sold for at least two years, would
be entitled to sell such shares under Rule 144(k) without regard to the
requirements described above.

Any of our employees, officers, directors or consultants who purchased
shares prior to the date of completion of this offering or who hold vested
options as of that date pursuant to a written compensatory plan or contract may
be entitled to rely on the resale provisions of Rule 701, which permits
nonaffiliates to sell their Rule 701 shares without having to comply with the
public-information, holding-period, volume-limitation or notice provisions of
Rule 144 and permits affiliates to sell their Rule 701 shares without having to
comply with Rule 144's holding-period restrictions, in each case commencing
ninety days after the date of completion of this offering. However, all of our
executive officers and directors who hold shares of our common stock and
substantially all of our stockholders have agreed not to sell or otherwise
dispose of any shares of our common stock for the 180-day period after the date
of this prospectus without the prior written consent of the underwriters. See
"Underwriting."

As soon as practicable after the date of completion of this offering, we
intend to file a registration statement on Form S-8 under the Securities Act to
register shares of common stock reserved for issuance under our 1998 stock
plan, 1999 FreePC option plan, 1998 guide.com option plan and 2000 employee
stock purchase plan, and up to 360,297 shares of common stock issuable upon
exercise of options granted outside of these plans, thus permitting the resale
of such shares by nonaffiliates in the public market without restriction under
the Securities Act. Such registration statements will become effective
immediately upon filing.

Prior to this offering, there has been no public market for our common
stock, and any sale of substantial amounts in the open market may adversely
affect the market price of our common stock offered hereby.

68
<PAGE>

UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting
agreement dated March 23, 2000 we have agreed to sell to the underwriters named
below, for whom Credit Suisse First Boston Corporation, FleetBoston Robertson
Stephens Inc., Chase Securities Inc. and Salomon Smith Barney Inc. are acting
as representatives, the following respective numbers of shares of common stock:

<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ----------
<S> <C>
Credit Suisse First Boston Corporation............................ 7,920,002
Chase Securities Inc. ............................................ 3,226,666
FleetBoston Robertson Stephens Inc. .............................. 3,226,666
Salomon Smith Barney Inc. ........................................ 3,226,666
E*Offering Corp. ................................................. 300,000
Gerard Klauer Mattison & Co., Inc. ............................... 300,000
Invemed Associates LLC. .......................................... 300,000
Needham & Company, Inc. .......................................... 300,000
Samsung Securities Co., Ltd. ..................................... 300,000
SoundView Technology Group, Inc. ................................. 300,000
U.S. Bancorp Piper Jaffray Inc. .................................. 300,000
Thomas Weisel Partners LLC........................................ 300,000
----------
Total........................................................... 20,000,000
==========
</TABLE>

The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults, the
purchase commitments of nondefaulting underwriters may be increased or the
offering of common stock may be terminated.

We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 3,000,000 additional shares at the initial public offering
price less the underwriting discounts and commissions. The option may be
exercised only to cover any over-allotments of common stock.

The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of approximately $0.38 per share.
The underwriters and selling group members may allow a discount of $0.10 per
share on sales to other broker/dealers. After the initial public offering, the
public offering price and concession and discount to broker/dealers may be
changed by the representatives.

The following table summarizes the compensation and estimated expenses we
will pay.

<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting Discounts
and
Commissions paid by
us..................... $0.63 $0.63 $12,600,000 $14,490,000
Expenses payable by us.. $0.05 $0.05 $ 1,085,000 $ 1,085,000
</TABLE>

The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of the shares of common stock being offered.

We and our executive officers, directors who hold shares and certain other
of our security holders have agreed not to offer, sell, contract to sell,
announce an intention to sell, pledge or otherwise dispose of, directly or
indirectly, or file with the Securities and Exchange Commission a registration
statement under the Securities Act relating to, any shares of common stock or
securities convertible into or exchangeable or exercisable for any common stock
without the prior written consent of Credit Suisse First Boston Corporation for
a period of 180 days after the date of this prospectus, except for issuances
pursuant to the exercise of employee stock options outstanding on the date
hereof.

69
<PAGE>

The underwriters have reserved for sale, at the initial public offering
price up to 1,275,200 shares of common stock for employees, directors and
certain other persons associated with us who have expressed an interest in
purchasing common stock in this offering. The number of shares available for
sale to the general public in this offering will be reduced to the extent these
persons purchase the reserved shares. Any reserved shares not so purchased will
be offered by the underwriters to the general public on the same terms as the
other shares.

We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or contribute to payments which the underwriters may be
required to make in that respect.

The shares of common stock have been approved for listing on The Nasdaq
Stock Market's National Market under the symbol "EEEE."

A prospectus in electronic format will be made available on the Web sites
maintained by one or more of the underwriters participating in this offering.
The underwriters may agree to allocate a number of shares to underwriters for
sale to their online brokerage account holders. Internet distributions will be
allocated by the representatives of the underwriters to underwriters that may
make Internet distributions on the same basis as other allocations. E*Offering
Corp. is an online investment bank that has received an allocation of shares in
its capacity as a syndicate member.

In August 1999, we issued an aggregate of 24,279,369 shares of our Series A
preferred stock at a per share price of $6.38 in a private placement. Credit
Suisse First Boston Corporation acted as the placement agent for this private
placement, and it received a customary fee for its services. In addition,
Merchant Capital, Inc., an affiliate of Credit Suisse First Boston Corporation,
purchased 156,641 shares of Series A preferred stock.

Prior to this offering, there has been no public market for our common
stock. The initial public offering price has been determined by negotiation
between us and the underwriters. The principal factors considered in
determining the public offering price included:

. the information in this prospectus and otherwise available to the
underwriters;

. the history and the prospects for the industry in which we will compete;

. the ability of our management;

. the prospects for our future earnings;

. the present state of our development and our current financial
condition;

. the general condition of the securities markets at the time of this
offering; and

. the recent market prices of, and the demand for, publicly traded common
stock of generally comparable companies.

The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions, and penalty bids in accordance with Regulation
M under the Exchange Act.

. Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.

. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.

. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions.

. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member are purchased in a syndicate covering transaction to
cover syndicate short positions.

These stabilizing transactions, syndicate covering transactions and penalty
bids may cause the price of the common stock to be higher than it would
otherwise be in the absence of these transactions. These transactions may be
effected on The Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.

70
<PAGE>

NOTICE TO CANADIAN RESIDENTS

Resale Restrictions

The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are effected. Accordingly, any resale of the common
stock in Canada must be made in accordance with applicable securities laws
which will vary depending on the relevant jurisdiction, and which may require
resales to be made in accordance with available statutory exemptions or
pursuant to a discretionary exemption granted by the applicable Canadian
securities regulatory authority. Purchasers are advised to seek legal advice
prior to any resale of the common stock.

Representations of Purchasers

Each purchaser of common stock in Canada who receives a purchase
confirmation will be deemed to represent to us and the dealer from whom the
purchase confirmation is received that (i) the purchaser is entitled under
applicable provincial securities laws to purchase the common stock without the
benefit of a prospectus qualified under the securities laws, (ii) where
required by law, that the purchaser is purchasing as principal and not as
agent, and (iii) the purchaser has reviewed the text above under "Resale
Restrictions."

Rights of Action (Ontario Purchasers)

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.

Enforcement of Legal Rights

All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or these persons. All or a substantial portion of the assets of
the issuer and these persons may be located outside of Canada and, as a result,
it may not be possible to satisfy a judgment against the issuer or these
persons in Canada or to enforce a judgment obtained in Canadian courts against
the issuer or these persons outside of Canada.

Notice to British Columbia Residents

A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that the purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by such purchaser in this offering. This report must be
in the form attached to British Columbia Securities Commission Blanket Order
BOR #95/17, a copy of which may be obtained from us. Only one report must be
filed in respect of common stock acquired on the same date and under the same
prospectus exemption.

Taxation and Eligibility for Investment

Canadian purchasers of common stock should consult with their own legal and
tax advisors with respect to the tax consequences of an investment in the
common stock in their particular circumstances and with respect to the
eligibility of the common stock for investment by the purchaser under relevant
Canadian legislation.

71
<PAGE>

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for us
by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. Legal matters will be passed upon for the underwriters by Morrison
& Foerster, LLP, Palo Alto, California. As of the date of this prospectus,
members of Wilson Sonsini Goodrich & Rosati, Professional Corporation, and an
investment partnership composed of current and former members of Wilson Sonsini
Goodrich & Rosati, Professional Corporation, beneficially owned an aggregate of
33,000 shares of capital stock and warrants to purchase an additional 14,145
shares of common stock. In addition, certain members and employees of Wilson
Sonsini Goodrich & Rosati have expressed an interest in purchasing up to an
aggregate of 14,100 shares of our common stock in this offering through our
directed share program.

EXPERTS

The consolidated financial statements of eMachines, Inc. as of December 31,
1999 and for the period from September 18, 1998 (inception) to December 31,
1998 included in this prospectus and the related financial statement schedule
included elsewhere in the registration statement have been audited by Deloitte
& Touche LLP, independent auditors, as stated in their reports appearing herein
and elsewhere in this registration statement (which reports express an
unqualified opinion and include an explanatory paragraph referring to the
restatement of the Company's financial statements), and are included in
reliance upon the reports of such firm given upon their authority as experts in
accounting and auditing.

The consolidated financial statements of FreePC, Inc. as of December 31,
1999 and for each of the two years then ended appearing in this Prospectus and
the Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given on the authority of such firm
as experts in accounting and auditing.

ADDITIONAL INFORMATION

We have filed with the Securities and Exchange Commission, Washington, D.C.,
a registration statement on Form S-1 under the Securities Act with respect to
the shares of common stock offered hereby. This prospectus does not contain all
the information set forth in the registration statement and the exhibits and
schedules thereto. For further information with respect to us and our common
stock, reference is made to the registration statement and to the exhibits and
schedules filed therewith. Statements contained in this prospectus as to the
contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of the contract or
other document filed as an exhibit to the registration statement, each
statement being qualified in all respects by this reference. A copy of the
registration statement may be inspected by anyone without charge at the Public
Reference Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of all or any portion of the
registration statement may be obtained from the Public Reference Section of the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of
prescribed fees. The Commission maintains a Web site at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.

72
<PAGE>

INDEX TO FINANCIAL STATEMENTS

eMachines, Inc.

<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report............................................. F-2
Balance Sheets........................................................... F-3
Statements of Operations................................................. F-4
Statements of Stockholders' Equity (Deficiency).......................... F-5
Statements of Cash Flows................................................. F-6
Notes to Financial Statements............................................ F-7

Unaudited Pro Forma Condensed Combined Financial Information
<CAPTION>
Page
----
<S> <C>
Unaudited Pro Forma Condensed Combined Statement of Operations for the
year ended December 31, 1999............................................ F-21
Unaudited Pro Forma Condensed Combined Balance Sheet at December 31,
1999.................................................................... F-22
Notes to Unaudited Pro Forma Condensed Combined Financial Information.... F-23

FreePC, Inc.
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors........................................... F-25
Consolidated Balance Sheets ............................................. F-26
Consolidated Statements of Operations ................................... F-27
Consolidated Statements of Stockholders' Equity.......................... F-28
Consolidated Statements of Cash Flows ................................... F-29
Notes to Consolidated Financial Statements............................... F-30
</TABLE>

F-1
<PAGE>

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders of eMachines, Inc.

We have audited the accompanying balance sheets of eMachines, Inc. (the
"Company") as of December 31, 1998 and December 31, 1999 and the related
statements of operations, stockholders' equity (deficiency) and cash flows for
the period September 18, 1998 (inception) to December 31, 1998 and the year
ended December 31, 1999. 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 auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1998 and
1999 and the results of its operations and its cash flows for the period
September 18, 1998 (inception) to December 31, 1998 and the year ended December
31, 1999 in conformity with accounting principles generally accepted in the
United States of America.

As discussed in Note 11, the accompanying 1998 and 1999 financial statements
have been restated.

Deloitte & Touche LLP
Los Angeles, California

January 27, 2000
(Except for Note 11 as to which the date is March 10, 2000)
<PAGE>

eMachines, Inc.

BALANCE SHEETS

December 31, 1998 and December 31, 1999

(in thousands, except share information)

<TABLE>
<CAPTION>
December 31,
1998 December 31, 1999
(as restated-- ---------------------
Note 11) Actual Pro Forma
-------------- -------- -----------
(unaudited)
(Note 2)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ 3,791 $114,823
Short-term investments.................. 19,897
Accounts receivable, less allowances
($239 and $2,160 at December 31, 1998
and December 31, 1999, respectively)... 43,303 123,726
Inventories............................. 12,270 65,260
Prepaid and other current assets........ 127 3,992
-------- --------
Total current assets.................. 59,491 327,698
Property and equipment, Net (Note 4)...... 268 1,827
Other assets.............................. 252 2,188
-------- --------
$ 60,011 $331,713
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Trade payables-related party (Note 9)... $ 57,785 $131,935
Accounts payable........................ 327 12,939
Accrued rebates......................... 1,838 22,803
Accrued expenses and other current
liabilities............................ 852 19,855
-------- --------
Total current liabilities............. 60,802 187,532
Deferred revenue--noncurrent portion...... 1,343
--------
Subordinated notes payable to stockholders
(Note 5)................................. 560 560
-------- --------
Redeemable convertible preferred stock--
Series A; $.01 par value; 25,000,000
shares authorized; 24,279,369 shares
outstanding at December 31, 1999 (Note
6)....................................... 150,014 $ --
-------- --------
Commitments and contingencies (Note 8)....
Stockholders' equity (deficiency) (Notes 6
and 9):
Preferred stock, $.01 par value;
25,000,000 shares authorized; no shares
issued and outstanding................. -- -- --
Common stock, $.0000125 par value;
250,000,000 shares authorized;
57,600,000 and 78,019,538 shares
outstanding at December 31, 1998 and
December 31, 1999...................... 1 1 3
Additional paid-in capital.............. 2,027 6,582 156,596
Unearned stock compensation............. (577) (1,550) (1,550)
Notes receivable from stockholders...... (500) (500)
Accumulated deficit..................... (2,802) (12,269) (12,269)
-------- -------- --------
Total stockholders' equity
(deficiency)......................... (1,351) (7,736) $142,280
-------- -------- ========
$ 60,011 $331,713
======== ========
</TABLE>

See accompanying notes to financial statements.

F-3
<PAGE>

eMachines, Inc.

STATEMENTS OF OPERATIONS

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999

(in thousands, except share information)

<TABLE>
<CAPTION>
Period from
September 18,
1998
(inception) to Year Ended
December 31, December 31,
1998 1999
-------------- ------------
(as restated--Note 11)
<S> <C> <C>
Net revenues:
Hardware......................................... $ 58,283 $ 812,233
Internet......................................... 2,084
----------- -----------
Net revenues................................... 58,283 814,317
----------- -----------
Cost of revenues:
Hardware......................................... 58,088 780,859
Internet......................................... 86
----------- -----------
Cost of revenues............................... 58,088 780,945
----------- -----------
Gross profit..................................... 195 33,372

Operating expenses:
Sales and marketing (includes $1,153 of stock-
based compensation in 1999)..................... 840 16,451
Customer service and technical support........... 269 9,049
General and administrative (includes $11 and $179
of stock-based compensation in 1998 and 1999,
respectively)................................... 999 9,714
----------- -----------
Total operating expenses....................... 2,108 35,214
----------- -----------
Loss from operations............................... (1,913) (1,842)
Financing charges and interest expense, net (Notes
3 and 9).......................................... (889) (3,886)
----------- -----------
Net loss........................................... $ (2,802) $ (5,728)
Accretion of mandatorily redeemable preferred stock
to redemption value............................... (3,739)
----------- -----------
Net loss attributable to common stockholders....... $ (2,802) $ (9,467)
=========== ===========
Net loss per common share:
Basic and diluted................................ $ (0.05) $ (0.14)
=========== ===========
Basic and diluted--unaudited pro forma........... $ (0.07)
===========
Shares used to compute net loss per share:
Basic and diluted................................ 57,600,000 68,933,254
=========== ===========
Basic and diluted--unaudited pro forma .......... 77,913,294
===========
</TABLE>

See accompanying notes to financial statements.

F-4
<PAGE>

eMachines, Inc.

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999

(in thousands, except share information)

<TABLE>
<CAPTION>
Common Stock Additional Unearned
----------------- Paid-in Stock Notes Accumulated
Shares Amount Capital Compensation Receivable Deficit Total
---------- ------ ---------- ------------ ---------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, at September
17, 1998...............
Capital Contributions
(Note 6) (as
restated--Note 11).... 57,600,000 $ 1 $1,439 $ 1,440
Compensatory stock
options............... 588 $ (588)
Amortization of
unearned stock
compensation.......... 11 11
Net loss............... $ (2,802) (2,802)
---------- --- ------ ------- ----- -------- -------
Balance, at December 31,
1998 (as restated--Note
11).................... 57,600,000 1 2,027 (577) (2,802) (1,351)
Issuance of common
stock to founders (as
restated--Note 11).... 20,000,000 500 $(500) (500)
Issuance of common
stock in exchange for
trademark............. 419,538 50 50
Issuance of common
stock warrants........ 1,700 1,700
Compensatory stock
options............... 2,305 (2,305) --
Amortization of
unearned stock
compensation.......... 1,332 1,332
Accretion of
mandatorily redeemable
convertible preferred
stock................. (3,739) (3,739)
Net loss............... (5,728) (5,728)
---------- --- ------ ------- ----- -------- -------
Balance, at December 31,
1999................... 78,019,538 $ 1 $6,582 $(1,550) $(500) $(12,269) $(7,736)
========== === ====== ======= ===== ======== =======
</TABLE>

See accompanying notes to financial statements.

F-5
<PAGE>

eMachines, Inc.

STATEMENTS OF CASH FLOWS

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999

(in thousands)

<TABLE>
<CAPTION>
Period from
September 18,
1998
(inception) Year Ended
to December December 31,
31, 1998 1999
------------- ------------
(as restated--Note 11)
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................... $ (2,802) $ (5,728)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Provision for bad debts and sales returns ...... 239 2,394
Depreciation and amortization................... 30 420
Stock-based compensation expense................ 11 1,332
Changes in operating assets and liabilities:
Accounts receivable........................... (43,542) (82,817)
Inventories................................... (12,270) (52,990)
Prepaid and other current assets.............. (127) (3,865)
Other assets.................................. (252) (349)
Trade payables-related party.................. 57,785 74,150
Accounts payable.............................. 327 12,612
Accrued rebates............................... 1,838 20,965
Accrued expenses and other current
liabilities.................................. 852 19,003
Deferred revenue--non current portion......... 1,343
-------- --------
Net cash provided by (used in) operating
activities................................. 2,089 (13,530)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment............. (298) (1,816)
Purchases of short-term investments............... (19,897)
-------- --------
Net cash used in investing activities....... (298) (21,713)
-------- --------
Cash flows from financing activities:
Issuance of subordinated notes payable to
stockholders..................................... 560
Issuance of common stock.......................... 1,440
Issuance of preferred stock....................... 146,275
-------- --------
Net cash provided by financing activities... 2,000 146,275
-------- --------
Net increase in cash................................ 3,791 111,032
Cash and cash equivalents, beginning of period...... 3,791
-------- --------
Cash and cash equivalents, end of period............ $ 3,791 $114,823
======== ========
Supplemental disclosure of cash flow information:
Issuance of common stock in exchange for notes
receivable....................................... $ 500
========
Supplemental disclosure of noncash financing
activities:
During 1999, the Company issued warrants valued at
$1,700 to a third party (see Note 6--America
Online Agreement and Warrants)...................
</TABLE>

See accompanying notes to financial statements.

F-6
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

eMachines, Inc. (the "Company"), a Delaware corporation, distributes
personal computers, or PCs, and provides Internet advertising programs using
client-server software, in-box promotions and keyboards that provide one-touch
access to selected Web sites.

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 reported amounts of net revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Cash Equivalents--Cash equivalents consist primarily of investments in
commercial paper, repurchase agreements and money market funds. The Company
considers all highly liquid investments purchased with maturities of three
months or less to be cash equivalents.

Short-term Investments--The Company accounts for short-term investments in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Short-term
investments consist of highly liquid commercial paper and U.S. Government debt
securities with maturities of less than one year but greater than three months
when purchased. In accordance with SFAS No. 115, investments are categorized as
held to maturity and are carried at amortized cost (unless there is a decline
in the value of the individual securities that is other than temporary).
Realized gains and losses are recognized in the statement of operations in the
period that they are earned or incurred.

Concentration of Credit Risk--Financial instruments that potentially subject
the Company to credit risk are principally cash and cash equivalents, short-
term investments and accounts receivable. Cash and cash equivalents are
deposited with high credit quality financial institutions. Accounts receivable
are derived from net revenues earned from retail customers in the United States
and are denominated in U.S. dollars. The Company performs ongoing credit
evaluations of its customers and maintains an allowance for potential credit
losses. The Company's sales are concentrated in the U.S. retail channel and, as
a result, the Company maintains individually significant receivable balances
with certain retailers. While the Company frequently monitors and manages this
risk, financial difficulties on the part of one or more of the Company's retail
customers may have a material adverse effect on the Company. For the period
from September 18, 1998 (inception) to December 31, 1998, Office Depot, Best
Buy, Inc., and MicroCenter accounted for 31%, 24% and 15% of gross revenues,
respectively. These customers accounted for approximately 30%, 24% and 10% of
total accounts receivable at December 31, 1998, respectively. For the year
ended December 31, 1999, Office Depot, Circuit City, Best Buy, Inc., and
MicroCenter accounted for 20%, 20%, 21% and 7%, of gross revenue, respectively.
These customers accounted for approximately 13%, 7%, 36% and 7% of total
accounts receivable at December 31, 1999, respectively.

Financial Instruments--The Company's financial instruments include notes
receivable from stockholders and subordinated notes payable to stockholders. At
December 31, 1999, the fair values of these instruments cannot be determined
due to their related party nature.

Inventories--Inventories consist principally of personal computers and
monitors and are stated at the lower of cost, determined by the moving average
method, or market.

F-7
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

Property and Equipment--Property and equipment are stated at cost.
Depreciation and amortization is provided for over the estimated useful lives
of the assets, or the related lease terms if shorter, using the straight-line
method.

Revenue Recognition, Returns and Sales Incentives--Revenue on product sales
is recognized upon shipment. Revenue is recorded net of allowances for rebates
and other sales incentives. The allowances for sales returns, rebates and other
sales incentives are accrued concurrently with the recognition of revenue. Upon
shipment, the Company also provides for the estimated cost that may be incurred
for product warranties and post-sales support. Products are sold to customers
under a limited one-year warranty against material defects, which period is
covered by the terms provided to the Company by the product's manufacturer, a
related party (see Note 9). Deferred revenue represents payments received in
advance from consumers who purchase the Company's PCs and enter into contracts
obligating the Company to provide technical support for extended periods of
time, generally 3 years. Revenue from these extended service contracts is
recognized ratably over the term of the contracts as the services are
performed.

Stock-Based Compensation--The Company accounts for stock-based employee
compensation arrangements in accordance with provisions of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Under APB Opinion No. 25,
compensation expense is based on the difference, if any, on the date of grant,
between the fair value of the Company's stock and the exercise price. The
Company accounts for stock options issued to nonemployees in accordance with
the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."

Income Taxes--The Company accounts for income taxes in accordance with SFAS
No. 109, "Accounting for Income Taxes," which requires recognition of deferred
income tax liabilities and assets for the expected future income tax
consequences of events that have been included in the financial statements or
income tax returns. Under this method, deferred income tax liabilities and
assets are determined based on the temporary difference between the financial
statement and income tax basis of assets and liabilities using presently
enacted tax rates in effect. Valuation allowances are established when
necessary to reduce deferred income tax assets to the amounts that are more
likely than not to be realized.

Net Loss Per Share--The Company computes net income (loss) per share in
accordance with SFAS No. 128, "Earnings Per Share" which requires dual
presentation of basic earnings per share ("EPS") and diluted EPS. Basic EPS is
computed using the weighted average number of common shares outstanding during
the period. Diluted EPS is computed using the weighted average number of common
shares and potentially dilutive shares outstanding during the period. Potential
common shares consist of shares issuable upon the exercise of stock options and
warrants using the treasury stock method and convertible preferred stock.
Potentially dilutive shares are excluded from the computation in loss periods
as their effect would be antidilutive. The following table sets forth
potentially dilutive securities that were excluded in the computation of
diluted net loss per share in the periods presented, as their effect would have
been antidilutive.

F-8
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

<TABLE>
<CAPTION>
Period from
September 18,
1998 (inception) Year Ended
to December 31, December 31,
1998 1999
---------------- ------------
<S> <C> <C>
Weighted average dilutive effect of common stock
equivalents:
Series A Preferred Stock...................... 8,480,041
Common stock options.......................... 32,785 166,809
------ ---------
32,785 8,646,850
====== =========
</TABLE>

Pro Forma Stockholders' Equity and Net Loss Per Share (Unaudited)--The
unaudited pro forma stockholders' equity at December 31, 1999 reflects the
automatic conversion of Series A redeemable convertible preferred stock
outstanding as of December 31, 1999 as if it had occurred as of that date. Pro
forma net 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 Company's Series A redeemable convertible preferred stock
into shares of the Company's common stock effective upon the closing of the
Company's initial public offering as if such conversion occurred on August 18,
1999 (date of original issuance). The resulting pro forma adjustment for the
year ended December 31, 1999 includes (i) an increase in the weighted average
shares used to compute the basic net loss per share of 8,980,041 and (ii) a
decrease in the net loss attributable to common stockholders to reflect a
reduction in the accretion of mandatorily redeemable convertible preferred
stock of $3,739.

Effects of Recent Accounting Pronouncements--In June 1997, the Financial
Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive
Income," which requires an enterprise to report, by major components and as a
single total, the change in its net assets during the period from nonowner
sources, and SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information," which establishes annual and interim reporting standards
for an enterprise's business segments and related disclosures about its
products, services, geographic areas and major customers. The Company had no
comprehensive income items to report for the period from September 18, 1998
(inception) to December 31, 1998 and the year ended December 31, 1999. The
Company currently operates one reportable segment under SFAS No. 131. Adoption
of these statements at our inception did not impact the Company's financial
position, results of operations or cash flows.

In June 1998, SFAS No 133 "Accounting for Derivative Instruments and Hedging
Activities" was released. The statement requires the recognition of all
derivatives as either assets or liabilities in the balance sheet and the
measurement of those instruments at fair value. The accounting for changes in
the fair value of a derivative depends on the planned use of the derivative and
the resulting designation. The Company is required to implement the statement
in the first quarter of fiscal 2001. The Company has not used derivative
instruments and believes the impact of adoption of this statement will not have
a significant effect on the financial statements.

3. SHORT-TERM INVESTMENTS

The following is a summary of short-term investments being held to maturity
at December 31, 1999:

<TABLE>
<S> <C>
Aggregate market.................................................... $19,906
Gross unrealized gains.............................................. 9
Amortized cost basis for:
Commercial paper.................................................. 14,920
U.S. government debt securities................................... 4,977
</TABLE>

F-9
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

Gross unrealized losses on short-term investments during the year ended
December 31, 1999, were not significant. Interest and investment income of
$2,645 is included in financing charges and interest expense, net, in the
accompanying statement of operations for the year ended December 31, 1999.
Approximately $9,936 and $9,961 of the short-term investments mature in January
and February 2000, respectively.

4. PROPERTY AND EQUIPMENT

Property and equipment, net consists of:

<TABLE>
<CAPTION>
December
31,
Useful ------------
Lives 1998 1999
------- ---- ------
<S> <C> <C> <C>
Furniture and office equipment......................... 5 years $ 27 $ 417
Computers and information systems...................... 5 years 271 1,040
Machinery and equipment................................ 5 years 231
Motor vehicles......................................... 5 years 94
Leasehold improvements................................. 5 years 332
---- ------
298 2,114
Accumulated depreciation and amortization.............. (30) (287)
---- ------
Property and equipment, net............................ $268 $1,827
==== ======
</TABLE>

5. SUBORDINATED NOTES PAYABLE TO STOCKHOLDERS

On December 18, 1998, the Company issued subordinated notes payable to
TriGem and Korea Data Systems America, both stockholders of the Company (see
Note 9), in the amount of $270 and $290, respectively, bearing interest at
5.79%. Interest payments are due each May 31 and November 30. Principal and any
unpaid interest are due on June 7, 2004. The notes may be prepaid at the
Company's option without penalty.

6. STOCKHOLDERS' EQUITY

In June 1999, the Company's founding stockholders formally executed a stock
purchase agreement that defines the terms and conditions of the Company's
initial capitalization. The stock purchase agreement memorializes the
agreements under which the stockholders of the Company had been operating since
inception. The Company issued 77,600,000 shares of common stock to the founding
stockholders for an aggregate purchase price of $1,940. Of the total, $1,440
was received in cash in the fourth quarter of 1998 and $500 was received in
June 1999 in the form of promissory notes, which bear interest at an annual
rate of 5.79% and are due on June 7, 2004. The notes are collateralized by a
pledge of the Company's common stock and are full recourse notes. The
57,600,000 shares issued in June 1999 for which cash consideration was received
in the fourth quarter of 1998 have been treated as issued and outstanding since
incorporation. The remaining 20,000,000 shares issued in June 1999, which were
evidenced by promissory notes, have been reflected as outstanding since that
date.

Stock Split--In July 1999, the Board of Directors authorized an eight-for-
one stock split that became effective on August 13, 1999 and an increase in the
authorized shares of its common stock to 200,000,000 shares. In conjunction
with the stock split, the par value of the common stock was reduced from

F-10
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

$.0001 to $.0000125. All references in the accompanying consolidated financial
statements to number of shares, sales prices and per share amounts of the
Company's common stock have been retroactively restated to reflect the
increased number of common shares outstanding. In addition, stockholders'
equity has been restated to give retroactive recognition to the stock split by
reclassifying from additional paid-in capital to common stock the par value of
the additional shares arising from the split.

Preferred stock--In August 1999, the Board of Directors amended the
Company's certificate of incorporation to authorize the Company to issue two
classes of stock, to be designated, respectively, "Common Stock" and "Preferred
Stock." The total number of shares which the Company is authorized to issue is
three hundred million (300,000,000) shares. Two hundred fifty million
(250,000,000) shares ("Shares") shall be Common Stock, par value $0.0000125 per
share, and fifty million (50,000,000) shares shall be preferred stock, par
value $0.01 per share. Of the authorized shares of Preferred Stock, a total of
twenty-five million (25,000,000) shares shall be designated Series A Preferred
Stock. On August 18, 1999 the Company issued 24,279,369 shares of Series A
Preferred Stock (including 5,560,776 shares issued upon regulatory approval in
September 1999) for proceeds of $146,275 (net of approximately $8,738 in
offering costs). The amended certificate of incorporation and bylaws authorize
the Board of Directors to designate preferred stock with special rights,
including voting and dividend rights, that could make it more difficult for a
third party to acquire the Company, including takeover attempts that might
result in a premium over the market price for shares of the Company's common
stock. The Company's charter documents also eliminate the right of stockholders
to call a special meeting of stockholders, require stockholders to comply with
advance notice requirements before raising a matter at a meeting of
stockholders and eliminate the ability of stockholders to take action by
written consent. The significant terms of the Series A Preferred Stock include:

Conversion--The Series A Preferred Stock is convertible, at the option of
the holder, at the conversion rate then in effect, at any time after issuance
of such share. Each share of Preferred Stock shall automatically be converted
into shares of Common Stock at the conversion price at the time in effect for
such share of Preferred Stock immediately upon the earlier of (i) the closing
an underwritten firm commitment public offering of the Company's Common Stock
yielding gross proceeds to the Company (prior to expenses and underwriting
commissions) in excess of $30,000 and at a price per share greater than 133% of
the Series A Preferred Stock original issuance price per share (as adjusted for
any stock dividends, combinations or splits with respect to such shares), and
(ii) the election to convert all Preferred Stock into Common Stock by holders
of at least a majority of the then outstanding shares of Preferred Stock. The
initial conversion rate is one-to-one and is subject to adjustment based upon
subdivisions or combinations of Common Stock and certain dividends,
distributions and common stock equivalents.

Mandatory Redemption--The Company shall offer to redeem the unconverted
shares of Series A Preferred Stock outstanding on January 1, 2004, reduced by
the number of shares converted into Common Stock after January 1, 2004 through
the date of redemption, as follows:

<TABLE>
<CAPTION>
Cumulative
Redemption Redemption
Percentage Date
---------- -----------
<S> <C>
33.3%.................. August 2004
66.7%.................. August 2005
100.0%.................. August 2006
</TABLE>

The redemption price is payable in cash and is equal to the sum of the
original issue price plus cumulative but unpaid dividends. If any portion of
the redemption amount is not paid by the Company on the redemption

F-11
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

date, dividends will continue to accrue on the shares tendered for redemption
and late fees will accrue at an annual rate of 15% until the entire redemption
amount is paid.

Liquidation Preference--In the event of the liquidation, dissolution or
winding up of the Company, the holders of Series A Preferred Stock will be
entitled to receive, in preference to the holders of Common Stock, the amount
of $6.38 per share, which presently is equal to the aggregate amount of
$155,013, plus declared and unpaid dividends, if any. After payment has been
made to the holders of the Series A Preferred Stock, any remaining assets are
distributable ratably to the holders of Common Stock.

Voting--Each holder of shares of Series A Preferred Stock is entitled to the
number of votes equal to the number of shares of Common Stock into which each
share is then convertible. Series A Preferred Stock holders also have the
following voting rights:

Board of Directors--Three of the Company's current common stockholders are
entitled to elect a total of five of the Company's seven board members. Holders
of Series A Preferred Stock, voting together as a class, are entitled to elect
one member to the Company's Board of Directors. All remaining members of the
Board of Directors shall be elected by the holders of the then-outstanding
shares of Common Stock and Series A Preferred Stock, voting together as a
single class.

Protective Provisions--As long as 4,000,000 shares of the Series A Preferred
Stock is outstanding, the Company is required to obtain the written consent of
at least 50% of the preferred shareholders before taking certain corporate
actions.

Dividends--The holders of Series A Preferred Stock are entitled to receive
noncumulative dividends only when and if declared by the Company's Board of
Directors, equal to $0.45 per share per year. Dividends shall be paid to the
holders of Series A Preferred Stock prior to any cash dividends paid to the
holders of Common Stock. The Company has not declared any dividends to date
with respect to the Series A Preferred Stock or Common Stock.

America Online Agreement and Warrants--In June 1999, a Marketing Agreement
with America Online, Inc. ("AOL") was executed whereby the Company agreed to
pre-install and distribute America Online's AOL and CompuServe services or
other AOL products and services on the Company's PCs. The agreement also
provides for an Internet Service Provider ("ISP") rebate program. Under the
terms of this agreement, consumers who purchase the Company's PCs and enter
into a three-year Internet service contract with AOL's CompuServe service are
eligible to receive an ISP rebate directly from AOL of up to $400 (dollars not
in thousands). AOL is obligated to offer the rebates for two years, which
commenced with the program's launch in the third quarter of 1999. The Marketing
Agreement expires in June 2004 and contains an additional five-year renewal
option.

Additionally, the Marketing Agreement required the Company issue AOL
warrants, subject to AOL's participation in a Series A Preferred Stock
financing. Accordingly, AOL was granted warrants to purchase common stock at an
aggregate exercise price of $12,500. The warrants vested immediately on the
grant date and expire five years after the date of grant. The number of shares
that may be purchased upon exercise of the warrant, according to the terms of
the Marketing Agreement, is equal to the aggregate exercise price divided by
the greater of 1.25 times the initial public offering price of the Company's
common stock and $7.98. If there is no successful completion of an initial
public offering, the number of shares issuable upon exercise of the warrant is
equal to the aggregate exercise price of the warrant divided by $11.82. The
warrants vested immediately on the grant date and are not subject to forfeiture
for any reason. In accordance with Emerging

F-12
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

Issues Task Force No. 96-18, "Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services", the Company estimated the fair value of the warrants at $1,700 using
the Black-Scholes option pricing model and the following assumptions: fair
value of underlying common stock of $6.38 per share, risk-free interest rate of
5.9%, volatility of 50.0%, term to expiration of five years and dividend yield
of zero. The fair value of the Company's common stock of $6.38 per share was
based on the Series A preferred stock financing which included AOL and certain
other unrelated third parties. The estimated fair value of the warrants of
$1,700 was recorded as a deferred cost which is included in other assets on the
accompanying December 31, 1999 balance sheet, and is being amortized to expense
over the 5 year term of the marketing agreement. Approximately $113 of the
deferred cost associated with the warrant was amortized to expense during 1999.
As of December 31, 1999, none of the warrants issued to AOL had been exercised.

Stock Options--The Company has a stock option plan (the "Plan") under which
employees, consultants and directors may be granted options to purchase common
stock up to an aggregate of 3,200,000 shares. Options are generally granted at
not less than the fair market value at grant date, vest over five years, and
expire ten years after the grant date. The Company's Board of Directors is
authorized to grant options outside of the plan. When the exercise price of
employee stock options equals the fair value of the underlying stock on the
date of grant, no compensation expense is recorded. Compensation expense is
recognized for the fair value of options granted to nonemployees and to the
extent the fair value of the underlying stock exceeds the exercise price of
employee stock options. The fair value of options granted to nonemployees
during the period from September 18, 1998 (inception) to December 31, 1998 was
not significant. In December 1999, the Company granted 52,000 options to
nonemployees with a weighted average exercise price of $6.37 per share. The
options were valued at approximately $133 using the Black-Scholes option
pricing model and the following assumptions: risk-free interest rate of 5.35
percent, expected lives of five years, volatility of 44 percent, and dividend
yield of zero. During 1999 approximately $86 of stock-based compensation was
recognized in connection with these options. During the period from September
18, 1998 (inception) to December 31, 1998, and the year ended December 31,
1999, the Company issued employee common stock options with exercise prices
less than the fair value of its underlying common stock. The weighted average
fair value of the common stock, based upon securities transactions entered into
by the Company with certain unrelated third parties, was $6.38 per share and
$6.45 per share for the period from September 18, 1998 (inception) through
December 31, 1998 and the year ended December 31, 1999, respectively.
Accordingly, the Company recorded $588 and $2,305 as the intrinsic value of
such options for the period from September 18, 1998 (inception) through
December 31, 1998 and the year ended December 31, 1999, respectively. Stock-
based compensation of $11 and $1,332 was amortized to expense during the period
from September 18, 1998 (inception) to December 31, 1998 and the year ended
December 31, 1999, respectively. At December 31, 1998 and December 31, 1999 the
Company had $577 and $1,550, respectively, in deferred stock compensation
related to these options, which will be amortized to expense through 2004.

A summary of option transactions follows:

<TABLE>
<CAPTION>
Plan Non-Plan
------------------------------------------ -------------------------------------
Number Range of
Number Weighted-Average Range of of Weighted-Average Exercise
of Shares Exercise Price Exercise Prices Shares Exercise Price Prices
--------- ---------------- --------------- ------- ---------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Granted during 1998..... 270,000 $0.06 $0.03--$0.13
-------
Outstanding, December
31, 1998............... 270,000 $0.06 $0.03--$0.13
Granted................. 677,200 $4.99 $0.13--$8.00 357,897 $2.39 $1.61--$3.75
Canceled................ (88,800) $0.31 $0.03--$3.75
------- -------
Outstanding, December
31, 1999............... 858,400 $4.15 $0.03--$8.00 357,897 $2.39 $1.61--$3.75
======= =======
</TABLE>

As of December 31, 1999, there were 2,341,600 shares available for future
grant under the Plan.

F-13
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

Additional information regarding options outstanding as of December 31, 1999
is as follows:

<TABLE>
<CAPTION>
Plan
-------------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------- -------------------------------
Weighted Weighted
Weighted Average Weighted Average
Number Average Remaining Average Remaining
Exercise of Exercise Contractual Number Exercise Contractual
Prices Shares Price Life (years) of Shares Price Life (years)
-------- ------- -------- ------------ --------- -------- ------------
<S> <C> <C> <C> <C> <C> <C>
$0.03...... 136,000 $0.03 8.7 27,200 $0.03 8.7
$0.13...... 73,600 $0.13 8.6 11,360 $0.13 8.9
$1.25...... 95,600 $1.25 9.3
$1.61......
$3.75...... 215,200 $3.75 9.5
$8.00...... 338,000 $8.00 9.7 32,000 $8.00 9.5
------- ------
858,400 $4.15 9.4 70,560 $3.66 9.1
======= ======
<CAPTION>
Non-Plan
--------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------ -------------------------------
Weighted
Average Weighted
Weighted Remaining Weighted Average
Average Contractual Average Remaining
Exercise Number Exercise Life Number Exercise Contractual
Prices of Shares Price (years) of Shares Price Life (years)
-------- --------- -------- ----------- --------- -------- ------------
<S> <C> <C> <C> <C> <C> <C>
$0.03......
$0.13......
$1.25......
$1.61...... 227,897 $1.61 9.6 227,897 $1.61 9.6
$3.75...... 130,000 $3.75 9.4
$8.00......
--------- ---------
357,897 $2.39 9.5 227,897 $1.61 9.6
========= =========
</TABLE>

Accounting for Stock-Based Compensation--As permitted under SFAS No. 123,
the Company has elected to follow APB Opinion No. 25 and related
Interpretations in accounting for stock-based awards to employees. Pro forma
information regarding net income and earnings per share is required by SFAS No.
123. This information is required to be determined as if the Company had
accounted for its stock-based awards to employees under the fair value method
of that statement. The fair value of each option grant was estimated on the
date of grant using the minimum value option-pricing model with the following
weighted-average assumptions used for grants during the period from September
18, 1998 (inception) through December 31, 1998 and the year ended December 31,
1999: risk-free interest rates of 4.4 percent and 5.2 percent, expected lives
of five years for both periods, and dividend yield of zero for both periods.

The minimum value option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions. The weighted-average estimated fair value of
employee stock options granted during period from September 18, 1998
(inception) to December 31, 1998 and the year ended December 31, 1999 was $4.41
and $2.59 per share, respectively.

For purposes of pro forma disclosures, the estimated fair value of the
options is assumed to be amortized to expense over the options' vesting period.
Had the Company accounted for its stock-based awards to employees under the
fair value method prescribed by SFAS No. 123, the net loss reported during the
period from September 18, 1998 (inception) through December 31, 1998 and the
year ended December 31, 1999 would have been increased by approximately $3 and
$39, respectively, and there would have been no impact on reported earnings per
share.

F-14
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

7. INCOME TAXES

The Company's deferred income tax assets are comprised of the following:

<TABLE>
<CAPTION>
December 31,
----------------
1998 1999
------- -------
<S> <C> <C>
Reserves not recognized for income tax purposes......... $ 169 $ 947
Accrued expenses........................................ 844 1,618
Net operating loss carryforwards........................ 168
AMT credits............................................. 397
Valuation allowance..................................... (1,181) (2,962)
------- -------
Net deferred income tax assets.......................... $ -- $ --
======= =======
</TABLE>

The Company established a 100% valuation allowance at December 31, 1998 and
December 31, 1999 due to the uncertainty of realizing future income tax
benefits from its deferred income tax assets.

The provision for income taxes differs from the amount computed by applying
the federal statutory income tax rate to income before taxes as follows:

<TABLE>
<CAPTION>
Period from
September 18, 1998 Year Ended
(inception) to December 31,
December 31, 1998 1999
------------------ ------------
<S> <C> <C>
Tax benefit computed at federal
statutory rate........................ (35.0) (35.0)
Stock-based compensation............... 8.1
State taxes and other.................. 0.8 2.5
Increase in valuation allowance........ 34.2 24.4
----- -----
Total.................................. -- % -- %
===== =====
</TABLE>

8. COMMITMENTS AND CONTINGENCIES

Operating Leases--The Company leases its corporate office and warehouse
space under an operating lease expiring in 2004. The lease, which is guaranteed
by KDS America, a stockholder, is renewable at the Company's option for an
additional five-year term. Future minimum rental commitments under the lease
agreement as of December 31, 1999, excluding sublease rentals, are as follows:

Rental expenses under operating leases during the period from September 18,
1998 (inception) to December 31, 1998 and the year ended December 31, 1999
amounted to approximately $6 and $1,064 respectively.

F-15
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

The Company subleases a portion of its warehouse space to TriGem America
Corporation, a related party (see Note 9). The total minimum rentals to be
received in the future under the sublease, which expires in 2004, amounted to
$1,498 as of December 31, 1999. Sublease rental income during the year ended
December 31, 1999, amounted to approximately $347.

Legal Proceedings--In July 1999, Compaq Computer Corporation ("Compaq")
filed a complaint against the Company, TriGem Computer Inc., TriGem America
Corporation and Korea Data Systems as defendants in the U.S. District Court for
the Southern District of Texas based on the defendant's alleged infringement of
13 patents held by Compaq related to improved system processing speed, enhanced
video graphics, peripheral compatibility and overall system architecture. The
complaint seeks an accounting, treble damages, a preliminary and permanent
injunction from further alleged infringement, attorneys' fees and other
unspecified damages. The Company filed a response in September 1999, seeking
declaratory judgment of invalidity and of Compaq's patents and asserting
counterclaims against Compaq that included false and misleading advertising
under the Lanham Act, business disparagement and unfair competition under Texas
common law. The case is currently in the early stages of discovery. In October
1999, Packard Bell filed a complaint in Federal District Court for the Eastern
District of California, alleging patent infringement on Packard Bell patents
which it asserts relates to (i) graphics controller, (ii) parallel port
controller, and (iii) bus interface of the Company's eTower machine. The
Company filed a response in January 2000 disputing infringement and asserting
that the patents at issue are invalid. The Company is currently unable to
estimate the total expenses, possible loss or range of loss that may be
ultimately connected with these allegations. The Company is indemnified against
liability under the terms of its Original Design Manufacture Agreement with
TriGem Computer (see Note 8). The Company's defense of the claims could result
in significant expenses and diversion of management's attention and other
resources. Although the Company believes its direct financial exposure is
limited under its indemnification arrangement, the results of complex
litigation of this sort are inherently uncertain and difficult to predict and
the Company cannot assure that the results of this litigation would not result
in the Company's business being significantly harmed, particularly if it
affects the Company's products.

Also in October 1999, David Packard, on behalf of a putative nationwide
class, filed a complaint against the Company as a defendant in the U.S.
District Court for the Eastern District of Texas based on our alleged sale of
defective goods. Essentially identical complaints were filed contemporaneously
against Compaq, Hewlett Packard and Packard Bell. The complaints claim that a
chip in the defendants PC products contains a defect which may cause an error
to occur when information is written to a floppy disk. The complaint seeks
unspecified monetary damages, injunctive and declaratory relief. The lawsuit
against the Company is in the early stages of discovery and the Company has not
yet filed a response. Although the Company believes that they have meritorious
defenses and intend to vigorously defend themselves in this action, these types
of litigation are inherently complex and unpredictable. The Company cannot
assure you that the class action suit will not succeed in obtaining unspecified
monetary damages, injunctive and declaratory relief against the production of
its PC products. The Company's defense of the claims could result in
significant expenses and diversion of management's attention and other
resources. In addition, the Company cannot assure you that the results of this
litigation would not result in the Company's business being significantly
harmed.

Employment Agreement--In August 1999, the Company entered into an amended
and restated employment agreement with its President and Chief Executive
Officer, who is also a stockholder. Under the terms of the agreement the
Company is obligated for a three-year term, commencing September 18, 1998, to
pay the executive officer a minimum annual salary of $300 and an annual bonus.
From September 18, 1998 through June 30, 1999,

F-16
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

the bonus was equal to $1 for each CPU unit (dollars not in thousands) shipped.
In August 1999, the Company granted the executive a fully vested, non-
forfeitable option to purchase 227,897 shares of the Company's common stock at
an exercise price of $1.61 per share, which is less than the fair value of the
underlying common stock. The fair value of the common stock based upon
securities transactions entered into by the Company with certain unrelated
third parties, was $6.38 per share at the time the Company became obligated to
grant the option. Accordingly, in August 1999 the Company recorded stock based
compensation expense of $1,084 as the intrinsic value of the option which is
reflected as selling and marketing expense in the statement of operations (see
Note 6). Approximately $126 and $700 of bonus expense under the employment
agreement is reflected in selling and market expense in the accompanying
statements of operations for the period from September 18, 1998 (inception) to
December 31, 1998, and the year ended December 31, 1999, respectively.

9. RELATED PARTIES

Manufacture and Supply of PCs and Monitors--Two of the Company's major
stockholders, TriGem and KDS America, are the wholly owned subsidiaries of
Korean companies; TriGem Computer Inc. ("TriGem Computer") and Korea Data
Systems Co. Ltd. ("KDS Ltd."), respectively. All of the PCs sold by the Company
are manufactured by TriGem Computer, except for the eOne and eSlate, which are
manufactured by KDS Ltd. All of the monitors sold by the Company are either
manufactured by KDS Ltd., or supplied by KDS Ltd. through its relationship with
Jean Company Ltd. ("Jean"), an unrelated third party.

During the period from September 18, 1998 (inception) to December 31, 1998,
the Company purchased its PCs and monitors from TriGem America Corporation
("TriGem America"), another wholly owned subsidiary of TriGem Computer, and
Korea Data Systems (USA), Inc. ("KDS USA"), respectively. Under an agreement
between the Company, TriGem America, KDS Ltd., Jean, and KDS USA, $57,785 of
the Company's accounts payable obligations as of December 31, 1998 to TriGem
America, KDS Ltd., and Jean, collectively, were transferred to KDS USA. KDS USA
is wholly owned by a Board member of the Company. During the year ended
December 31, 1999, the Company purchased its PCs and monitors directly from KDS
USA.

On January 24, 2000, the Company entered into an Original Design Manufacture
Agreement ("ODM Agreement") with TriGem Computer. Pursuant to the agreement,
TriGem Computer agreed to design, procure and assemble certain computer
components, and to provide support for the assembled products. The Company will
pay TriGem Computer for its supply and services on a "cost plus" basis, which
price shall be adjusted monthly based upon TriGem Computer's then current
costs. The agreement requires the Company to issue requisitions and purchase
orders to TriGem Computer each month. TriGem Computer's obligated to meet such
purchase orders based on the projections the Company provides to TriGem
Computer in an annual plan. TriGem Computer has provided several warranties to
the Company, including that all of its products will be free from defects in
design, material and workmanship. The agreement provides the Company certain
remedies in the event that products sold to the Company by TriGem Computer are
defective. Commencing with the execution of the agreement on January 24, 2000,
these remedies include reimbursing the Company for the costs of defective
products. The agreement also provides that the Company may be reimbursed by
TriGem Computer for all reasonable costs related to defective products that
might arise with respect to products sold to the Company prior to January 24,
2000, which amounted to approximately $12.9 million in 1999. The term of the
agreement is for two years, and automatically renews for one-year periods,
unless either party provides written notice of its intent to terminate one
hundred and eighty days prior to the expiration of the initial term or any
subsequent term.

F-17
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

Inventory Purchases and Extended Payment Terms--During the period from
September 18, 1998 (inception) to December 31, 1998 and the year ended December
31, 1999, the Company purchased $70,989 and $805,372, respectively, of
inventories from TriGem Corporation and KDS USA, collectively, under extended
payment terms which resulted in an effective interest rate of 12% from
September 18, 1998 (inception) through March 31, 1999 and 10% from April 1,
1999 through August 18, 1999. Subsequent to the Series A Preferred Stock
financing (See Note 6--Preferred Stock) in August 1999, the Company ceased
financing its inventory purchases. As of December 31, 1998 and December 31,
1999, payables of approximately $57,785 and $131,935, respectively, were
outstanding to KDS USA. Approximately $889 and $6,530 of finance charges were
incurred in connection with the inventory purchases.

PC Repair Service--During the period from September 18, 1998 (inception) to
December 31, 1998 and the year ended December 31, 1999, the Company had an
arrangement with TriGem America to provide PC repair services for PCs returned
to the Company by its customers. Under the terms of the arrangement, the
Company was assessed a $15 per unit service charge (dollars not in thousands)
for the testing and repackaging of PC returns determined to be nondefective.
For the period from September 18, 1998 (inception) to December 31, 1998 and the
year ended December 31, 1999, these charges, which are included in cost of
revenues, amounted to approximately $43 and $1,855, respectively. The ODM
Agreement with TriGem Computer executed in January 2000 contains similar repair
service terms.

Trademark Assignment Agreement--Under an agreement entered into on June 10,
1999, and amended on August 16, 1999, KDS America transferred to the Company
the trademark "E-MACHINES" for 419,538 shares of the Company's common stock,
which the Company issued to KDS America on August 18, 1999. The trademark was
recorded at KDS Americas' historical cost basis of $50 and is included in other
assets in the accompanying advance sheet. In connection with the agreement the
Company agreed to license KDS America use of the trademark in the Republic of
Korea.

10. SUBSEQUENT EVENTS

FreePC Acquisition--Effective January 2000, the Company acquired FreePC,
Inc. ("FreePC"). In connection with the acquisition, the Board of Directors
amended and restated the Company's certificate of incorporation to designate
14,000,000 and 11,000,000 shares of its 50,000,000 authorized Preferred Stock
as Series B Preferred Stock and Series C Preferred Stock, respectively. The
Series B Preferred Stock and Series C Preferred Stock contain rights and
preferences similar to those of the Series A Preferred Stock described in Note
6, except they are not redeemable. To consummate the merger the Company issued
3,995,633 shares of common stock, 10,175,516 shares of Series B Preferred
Stock, 7,458,370 shares of Series C Preferred Stock, and warrants to purchase
9,269,834 shares of the Company's common stock, in exchange for all of the
outstanding shares of capital stock of FreePC. In addition, the Company
reserved 4,130,342 shares of its common stock for issuance upon the exercise of
2,891,275 FreePC and Guide.com (a predecessor of FreePC) common stock options
assumed in connection with the acquisition, including 1,239,067 warrants
issuable upon exercise of the options. The exchange ratio was approximately
1.1 shares of the Company's capital stock and warrants to purchase
approximately 0.47 shares of the Company's common stock for each share of
FreePC capital stock and options to purchase FreePC common stock. The aggregate
purchase price, based on an independent valuation, was approximately $150,500,
which includes $500 for professional fees.

F-18
<PAGE>

eMachines, Inc.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Period from September 18, 1998 (inception) to December 31, 1998,
and the year ended December 31, 1999
(in thousands, except share information)

The fair value of the securities exchanged or assumed in connection with
the acquisition was as follows:

<TABLE>
<S> <C>
Common and preferred stock....................................... $135,600
Common stock warrants............................................ 1,100
Options assumed, including warrants issuable upon exercise....... 13,300
--------
$150,000
========
</TABLE>

The transaction has been accounted for using the purchase method.

11. RESTATEMENT

Subsequent to the issuance of the Company's 1999 financial statements the
Company determined that 20,000,000 shares issued to certain founding
shareholders on June 10, 1999, pursuant to an initial capitalization agreement
(see Note 6) executed on that date, were incorrectly reported as being
outstanding since September 18, 1998 (inception) and should have been
reflected as outstanding since June 10, 1999, date of issuance.

As a result, the balance sheet as of December 31, 1998 and the related
statements of operations and stockholders' equity (deficiency) for the period
from September 18, 1998 (inception) to December 31, 1998 and for the year
ended December 31, 1999 have been restated from the amounts previously
reported to reflect the 20,000,000 shares as issued and outstanding since June
10, 1999.

The following table summarizes the effects of the restatement by major
financial statement line item.

<TABLE>
<CAPTION>
As As Reported
Restated Previously
----------- -----------
<S> <C> <C>
At December 31, 1998:
Additional paid-in capital.................... $ 2,027 $ 2,527
Notes receivable from stockholders............ -- (500)

Year ended December 31, 1998:
Net loss per common share--basic and diluted.. $ (0.05) $ (0.04)
Shares used to compute net loss per share--
basic and diluted............................ 57,600,000 77,600,000

Year ended December 31, 1999:
Net loss per common share--basic and diluted.. $(0.14) $ (0.12)
Shares used to compute net loss per share:
Basic and diluted............................ 68,933,254 77,755,172
Basic and diluted--unaudited pro forma....... 77,913,294 86,735,212
</TABLE>

F-19
<PAGE>

eMachines, Inc.

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

The following unaudited pro forma condensed combined financial information
for eMachines consists of the Unaudited Pro Forma Condensed Combined Statement
of Operations for the year ended December 31, 1999, and the Unaudited Pro Forma
Condensed Combined Balance Sheet as of December 31, 1999. In January 2000,
eMachines, Inc. completed a transaction whereby one of its wholly-owned
subsidiaries merged with and into FreePC, Inc. ("FreePC"). The Unaudited Pro
Forma Condensed Combined Statement of Operations for the year ended
December 31, 1999 gives effect to the FreePC acquisition as if it had taken
place on January 1, 1999. The Unaudited Pro Forma Condensed Combined Balance
Sheet gives effect to the FreePC acquisition as if it had taken place on
December 31, 1999.

The Unaudited Pro Forma Condensed Combined Statement of Operations combines
eMachines' historical results of operations for the year ended December 31,
1999 with FreePC's historical results for the year ended December 31, 1999. The
FreePC acquisition will be accounted for using the purchase method of
accounting. The pro forma financial information has been prepared on the basis
of assumptions described in the notes.

The pro forma financial information should be read in conjunction with the
related notes included in this document and the audited financial statements
and notes of eMachines, and the audited financial statements and notes of
FreePC included elsewhere in this prospectus. The pro forma financial
information is presented for illustrative purposes only and is not necessarily
indicative of the operating results or financial position that would have
occurred if the acquisition had been in effect during the periods presented,
nor is it necessarily indicative of future operating results or financial
position.

F-20
<PAGE>

UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 31, 1999

(Amounts in thousands, except per-share data)

<TABLE>
<CAPTION>
Pro Forma
eMachines(7) FreePC Adjustments Total
------------ -------- ----------- ----------
<S> <C> <C> <C> <C>
Statements of Operations
Data:
Net revenues.............. $ 814,317 $ 1,201 $ 815,518
Cost of revenues.......... 780,945 3,320 784,265
---------- -------- ----------
Gross profit/(loss)........ 33,372 (2,119) 31,253
Operating expenses:
Sales and marketing...... 16,451 20,755 37,206
Customer service and
technical support....... 9,049 -- 9,049
General and
administrative.......... 9,714 3,896 13,610
Research and
development............. 2,938 2,938
Amortization of
intangible assets ...... $ 49,000 (5) 49,000
Write-down of assets held
for sale................ 941 941
---------- -------- ---------- ----------
Total operating
expenses.............. 35,214 28,530 49,000 112,744
---------- -------- ---------- ----------
Loss from operations....... (1,842) (30,649) (49,000) (81,491)
Financing charges and
interest expense, net..... (3,886) 862 (3,024)
---------- -------- ---------- ----------
Net loss................... $ (5,728) $(29,787) $ (49,000) $ (84,515)
Accretion of mandatorily
redeemable preferred stock
to redemption value....... (3,739) (3,739)
---------- -------- ---------- ----------
Net loss attributable to
common stockholders....... $ (9,467) $(29,787) $ (49,000) $ (88,254)
========== ======== ========== ==========
Net loss per common share:
Basic and diluted......... $ (0.14) $ (1.21)
========== ==========
Basic and diluted--pro
forma.................... $ (0.07) $ (0.85)
========== ==========
Shares used to compute net
loss per share:
Basic and diluted......... 68,933,254 3,995,633 (6) 72,928,887
========== ========== ==========
Basic and diluted--pro
forma.................... 77,913,294 21,629,519 (6) 99,542,813
========== ========== ==========
</TABLE>

See notes to unaudited pro forma condensed combined financial information.

F-21
<PAGE>

eMachines, Inc.

UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET

as of December 31, 1999

(Amounts in thousands)

<TABLE>
<CAPTION>
Pro Forma
eMachines FreePC Adjustments Total
--------- ------- ----------- --------
<S> <C> <C> <C> <C>
ASSETS

Current assets:
Cash and cash equivalents........... $114,823 $10,939 $125,762
Short-term investments.............. 19,897 -- 19,897
Accounts receivable (net)........... 123,726 137 123,863
Inventories......................... 65,260 -- 65,260
Prepaid expenses and other current
assets............................. 3,992 2,661 6,653
-------- ------- --------
Total current assets.............. 327,698 13,737 341,435
Property and equipment................ 1,827 1,406 3,233
Other assets.......................... 2,188 1,776 3,964
Intangible assets..................... $146,955 (1) 146,955
-------- ------- -------- --------
Total assets...................... $331,713 $16,919 $146,955 $495,587
======== ======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)

Current Liabilities:
Accounts payable.................... $144,874 $ 7,391 $152,265
Accrued rebates..................... 22,803 22,803
Accrued expenses and other current
liabilities........................ 19,855 1,033 3,722 (2) 25,110
500 (3)
-------- ------- -------- --------
Total current liabilities......... 187,532 8,424 4,222 200,178
Non-current Liabilities............... 1,903 1,228 3,131
Redeemable convertible preferred
stock................................ 150,014 -- 150,014
Stockholders' equity (deficit)........ (7,736) 7,267 150,000 (4) 142,264
-- (7,267)(4) --
-------- ------- -------- --------
Total liabilities and
stockholders' equity (deficit)... $331,713 $16,919 $146,955 $495,587
======== ======= ======== ========
</TABLE>

See notes to unaudited pro forma condensed combined financial information.

F-22
<PAGE>

eMachines, Inc.

NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION

(Amounts in thousands, except per-share data)

The pro forma financial information gives effect to the following pro forma
adjustments:

(1) In connection with the acquisition of FreePC, the Company issued 3,995,633
shares of common stock, 10,175,516 shares of Series B Preferred Stock,
7,458,370 shares of Series C Preferred Stock, and warrants to purchase
9,269,834 shares of the Company's common stock, in exchange for all of the
outstanding shares of capital stock of FreePC. In addition, the Company
reserved 4,130,342 shares of its common stock for issuance upon the
exercise of 2,891,275 FreePC common stock options assumed in connection
with the acquisition, including 1,239,067 warrants issuable upon exercise
of the options. The exchange ratio was approximately 1.1 shares of the
Company's capital stock and warrants to purchase 0.47 shares of the
Company's common stock for each share of FreePC capital stock and options
to purchase FreePC common stock.

The transaction will be accounted for using the purchase method of
accounting. The purchase price, based on an independent valuation, is
estimated at $150,500, including approximately $500 for professional fees.
The fair value of the securities exchanged or assumed in connection with
the acquisition was as follows:

<TABLE>
<S> <C>
Common and preferred stock........................................ $135,600
Common stock warrants............................................. 1,100
Options assumed, including warrants issuable upon exercise........ 13,300
--------
$150,000
========
</TABLE>

With respect to the options assumed as part of the acquisition, all vested
and unvested FreePC options exchanged for Company options are included as
part of the purchase price. The total estimated purchase price for the
FreePC acquisition has been allocated as follows to assets and liabilities
based on management's best estimates of their fair value with the excess
costs over the net assets acquired of $141,655 being allocated to goodwill.

<TABLE>
<S> <C>
Workforce........................................................ $ 5,300
Goodwill......................................................... 141,655
Fair value of net assets......................................... 3,545
--------
$150,500
========
</TABLE>

(2) Represents acquisition liabilities assumed in connection with the
acquisition of FreePC. The liabilities are based on management's best
estimates of the costs to exit the FreePC Network business, including costs
to terminate two ISP contracts used to provided free internet access to
users of the FreePC Network and employee termination costs. As a result of
the purchase of FreePC, free internet access will no longer be provided to
users of the FreePC Network. FreePC's contracts with internet access
providers require minimum payments regardless of usage levels. The total of
these minimum payments has been included in the estimate. This number is
subject to change in the event that FreePC can terminate the contracts for
a fee less than the minimum required payments. The impact of such fees
could be material.

(3) Represents estimated acquisition costs incurred in connection with the
merger.

(4) The pro forma adjustment to stockholders' equity reflects the elimination
of FreePC's stockholders' equity ($7,267) and the impact of the issuance of
eMachines' common stock ($150,000) in connection with the FreePC merger.

F-23
<PAGE>

eMachines, Inc.

NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION--(Continued)

(Amounts in thousands, except per-share data)

(5) The pro forma adjustment is for amortization of intangible assets over a
three year estimated life.

(6) The pro forma adjustment to basic and diluted net loss per common share
reflects the issuance of 3,995,633 shares of the Company's common stock in
connection with the acquisition as if the transaction occurred on January
1, 1999.

The pro forma adjustment to pro forma basic and diluted net loss per share
reflects both the issuance of 3,995,633 shares of the Company's common
stock and the issuance and assumed conversion of 17,633,886 shares of the
Company's preferred stock in connection with the transaction as if the
transaction, and conversion of the related preferred stock, had occurred on
January 1, 1999. The resulting pro forma adjustment also includes a
decrease in the net loss attributable to common stockholders to reflect a
reduction in the accretion of mandatorily redeemable convertible preferred
stock of $3,739 that results from the assumed conversion of the preferred
stock.

(7) As restated, see Note 11 of Notes to Financial Statements.

F-24
<PAGE>

REPORT OF INDEPENDENT AUDITORS

The Directors and Stockholders
FreePC, Inc.

We have audited the accompanying consolidated balance sheets of FreePC, Inc.
and Subsidiary (the Company) as of December 31, 1998 and 1999, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FreePC, Inc.
and subsidiary as of December 31, 1998 and 1999, and the consolidated results
of their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States.

Ernst & Young LLP
Los Angeles, California

January 14, 2000

F-25
<PAGE>

FreePC, Inc. and Subsidiary

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
December 31
-----------------------
1998 1999
--------- ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents........................... $ 125,000 $ 10,839,000
Restricted cash..................................... -- 100,000
Receivables, net.................................... 56,000 137,000
Prepaid expenses and other current assets........... -- 301,000
Assets held for sale................................ -- 2,360,000
--------- ------------
Total current assets.............................. 181,000 13,737,000
Fixed assets, net..................................... 42,000 1,406,000
Domain names, net of accumulated amortization of
$8,000 and $91,000 at December 31, 1998 and 1999,
respectively......................................... 269,000 1,574,000
Other assets.......................................... -- 202,000
--------- ------------
Total assets...................................... $ 492,000 $ 16,919,000
========= ============
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Accounts payable.................................... $ 136,000 $ 2,143,000
Accrued expenses.................................... 11,000 970,000
Payable to related parties.......................... 21,000 5,248,000
Current portion of capital lease obligation......... -- 63,000
--------- ------------
168,000 8,424,000
Long-term capital lease obligation, less current
portion.............................................. -- 333,000
Unearned revenue...................................... 58,000 895,000

Commitments...........................................

Stockholders' equity:
Preferred stock, $0.001 par value, liquidation
preference over common stockholders:
Series A Convertible Preferred Stock; 10,000,000
shares authorized, none issued and outstanding at
December 31, 1998 and 9,250,000 issued and
outstanding at December 31, 1999................. -- 93,000
Series B Convertible Preferred Stock; 7,000,000
shares authorized, none issued and outstanding at
December 31, 1998 and 6,780,000 issued and
outstanding at December 31, 1999................. -- 33,900,000
Common stock, $0.001 par value, 50,000,000 shares
authorized, 1,260,097 issued and outstanding at
December 31, 1998 and 3,517,241 shares issued and
outstanding at December 31, 1999................... 1,000 3,000
Additional paid-in capital.......................... 881,000 11,121,000
Deferred stock compensation......................... -- (7,447,000)
Accumulated deficit................................. (616,000) (30,403,000)
--------- ------------
Total stockholders' equity........................ 266,000 7,267,000
--------- ------------
Total liabilities and stockholders' equity........ $ 492,000 $ 16,919,000
========= ============
</TABLE>

See accompanying notes.

F-26
<PAGE>

FreePC, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
Year Ended December
31
--------------------
1998 1999
-------- -----------
<S> <C> <C>
Revenues................................................... $134,000 $ 1,201,000
Cost of revenues........................................... 16,000 3,320,000
-------- -----------
118,000 (2,119,000)

Operating expenses:
Sales and marketing (includes $608,000 of stock-
based compensation in 1999)............................. 136,000 20,755,000
General and administrative (includes $415,000 of stock-
based compensation in 1999)............................. 148,000 3,896,000
Research and development (includes $879,000 of stock-
based compensation in 1999)............................. 288,000 2,938,000
Write-down of assets held for sale....................... -- 941,000
-------- -----------
Total operating expenses............................... 572,000 28,530,000
-------- -----------
Loss from operations....................................... 454,000 30,649,000

Other income (expense):
Interest income.......................................... -- 902,000
Other, net............................................... 1,000 (39,000)
-------- -----------
Loss before provision for income taxes..................... 453,000 29,786,000

Provision for income taxes................................. 2,000 1,000
-------- -----------
Net loss................................................... $455,000 $29,787,000
======== ===========
</TABLE>

See accompanying notes.

F-27
<PAGE>

FreePC, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

December 31, 1999

<TABLE>
<CAPTION>
Series A and B
Convertible Preferred
Stock Common Stock Additional Total
---------------------- ---------------- Paid-in Deferred Accumulated Stockholders'
Shares Amount Shares Amount Capital Compensation Deficit Equity
---------- ----------- --------- ------ ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1,
1998................... -- $ -- 774,155 $1,000 $ 150,000 $ -- $ (161,000) $ (10,000)
Issuance of common
stock for cash........ -- -- 179,380 -- 270,000 -- -- 270,000
Issuance of common
stock for assets or
services.............. -- -- 170,305 -- 256,000 -- -- 256,000
Issuance of common
stock for domain
names................. -- -- 136,257 -- 205,000 -- -- 205,000
Net loss............... -- -- -- -- -- -- (455,000) (455,000)
---------- ----------- --------- ------ ----------- ----------- ------------ ------------
Balance at December 31,
1998................... -- -- 1,260,097 1,000 881,000 -- (616,000) 266,000
Issuance of common
stock for assets or
services.............. -- -- 101,332 -- 500,000 -- -- 500,000
Issuance of common
stock for cash........ -- -- 2,036,250 2,000 18,000 -- -- 20,000
Exercise of stock
options............... -- -- 102,745 -- 31,000 -- -- 31,000
Deferred stock
compensation.......... -- -- -- -- 9,529,000 (9,291,000) -- 238,000
Amortization of
deferred stock
compensation.......... -- -- -- -- -- 1,844,000 -- 1,844,000
Issuance of warrant.... -- -- -- -- 137,000 -- -- 137,000
Issuance of Series A
Convertible Preferred
Stock at $0.01 per
share for cash........ 9,250,000 93,000 -- -- -- -- -- 93,000
Issuance of Series B
Convertible Preferred
Stock at $5.00 per
share for cash........ 6,780,000 33,900,000 -- -- -- -- -- 33,900,000
Exercise of warrants... -- -- 16,817 -- 25,000 -- -- 25,000
Net loss............... -- -- -- -- -- -- (29,787,000) (29,787,000)
---------- ----------- --------- ------ ----------- ----------- ------------ ------------
Balance at December 31,
1999................... 16,030,000 $33,993,000 3,517,241 $3,000 $11,121,000 $(7,447,000) $(30,403,000) $ 7,267,000
========== =========== ========= ====== =========== =========== ============ ============
</TABLE>

See accompanying notes

F-28
<PAGE>

FreePC, Inc. and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
Year ended December 31
-----------------------
1998 1999
--------- ------------
<S> <C> <C>
Operating activities:
Net loss............................................ $(455,000) $(29,787,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation expense.............................. 7,000 250,000
Amortization expense.............................. 8,000 184,000
Amortization of deferred stock compensation....... -- 1,902,000
Write-down of assets held for sale................ -- 941,000
Provision for doubtful accounts................... 14,000 35,000
Changes in operating assets and liabilities:
Receivables..................................... (71,000) (116,000)
Prepaid expenses and other current assets....... -- (301,000)
Other assets.................................... -- (22,000)
Accounts payable and accrued expenses........... 115,000 2,966,000
Payable to related party........................ 275,000 5,227,000
Unearned revenue................................ 58,000 837,000
--------- ------------
Net cash used in operating activities......... (49,000) (17,884,000)

Investing activities:
Purchase of fixed assets............................ (41,000) (4,281,000)
Purchase of domain names............................ (70,000) (1,028,000)
--------- ------------
Net cash used in investing activities......... (111,000) (5,309,000)

Financing activities:
Proceeds from the issuance of common stock.......... 270,000 76,000
Proceeds from the issuance of Series A Convertible
Preferred Stock.................................... -- 93,000
Proceeds from the issuance of Series B Convertible
Preferred Stock.................................... -- 33,900,000
Cash restricted for equipment lease................. -- (100,000)
Payments under capital lease obligations............ -- (62,000)
--------- ------------
Net cash provided by financing activities..... 270,000 33,907,000
--------- ------------
Net increase in cash and cash equivalents............. 110,000 10,714,000
Cash and cash equivalents at beginning of year........ 15,000 125,000
--------- ------------
Cash and cash equivalents at end of year.............. $ 125,000 $ 10,839,000
========= ============

Supplemental disclosures:
Income taxes paid................................... $ 2,000 $ 1,000
Interest paid....................................... -- 34,000

Non-cash transactions:
Common stock and warrants issued for assets or
services........................................... $ 205,000 $ 638,000
Common stock issued in exchange for debt
forgiveness........................................ 256,000 --
Fixed assets acquired under capital leases.......... -- 458,000
</TABLE>

See accompanying notes.

F-29
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1999

1. THE COMPANY AND BASIS OF PRESENTATION

FreePC, Inc. (FreePC) was incorporated on January 25, 1999. Beginning in
June 1999, the Company began providing consumers with free computers while
offering online advertisers a means to reach those consumers. Beginning June
1999, the Company began offering its users a free computer and free unlimited
Internet access, as well as free e-mail and navigational tools. Beginning
December 1999, the Company will no longer provide free computers, but will
continue to provide Internet access to its existing users.

In March 1999, Guide.com, Inc. (Guide.com) entered into an agreement with
FreePC, whereby Guide.com became a wholly owned subsidiary of FreePC
(collectively the Company). Under the terms of the agreement, FreePC issued
0.0996562 shares of FreePC common stock in exchange for each outstanding share
of Guide.com's common stock. The combination has been accounted for as a
reorganization of entities under common control and was completed in the second
quarter of 1999. Operations of Guide.com have been included in the consolidated
financial statements as if the reorganization occurred January 1, 1998.

Guide.com was incorporated in the state of Delaware on July 30, 1997, and
launched its service in October 1997. Guide.com provided an online guide to
restaurants and other various Internet content in cities across the Unites
States. Guide.com's customer base was located principally in the United States.
In August 1999, the Company discontinued the advertising services provided at
Guide.com's web site. The Guide.com web site remains in operation and provides
users a link to services provided at the FreePC web site.

On November 24, 1999, FreePC entered into an agreement with eMachines, Inc.
(eMachines) whereby FreePC will become a wholly owned subsidiary of eMachines.
The acquisition is intended to be accounted for as a purchase business
combination and is expected to be completed in January 2000. The terms of the
merger call for shares of FreePC common stock to be exchanged for shares of
eMachines common stock and warrants to purchase additional shares of eMachines
common stock; shares of FreePC Series A Convertible Preferred Stock to be
exchanged for shares of eMachines Series B Preferred Stock and warrants to
purchase additional shares of eMachines common stock and shares of FreePC
Series B Convertible Preferred Stock to be exchanged for shares of eMachines
Series C Preferred Stock and warrants to purchase additional shares of
eMachines common stock. The exchange ratio for FreePC common stock and Series A
and B Convertible Preferred Stock into eMachines common and preferred stock and
warrants are based on an Exchange Ratio, as defined, to be determined
immediately before the close of the merger. In addition, all options to
purchase FreePC's common stock will be converted into options to purchase
eMachines common stock.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of
FreePC and its wholly owned subsidiary Guide.com. All intercompany accounts and
transactions have been eliminated.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

Prior to June 30, 1999, the Company's revenues were derived principally from
the sale of banner advertisements and referrals of users to other web sites.
Referral revenues were recognized when referrals were made to other web sites,
provided that no significant company obligations remained and collection of the
related receivable was probable. Beginning in June 1999, the Company's revenue
was derived principally from banner advertisements and from the Company's start
page agreement. Under the start page agreement with Infospace.com, Inc.
("Infospace") the Company's internet users automatically view Infospace's start
page each

F-30
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

time they access the internet through the Company's internet service. The
Company is paid for each start page viewed and recognizes revenue as earned
(refer to Note 5). The Company's obligations typically include the guarantee of
a minimum number of impressions or the satisfaction of other performance
criteria. Advertising revenue is recognized as the impressions are displayed or
as click-through occurs, depending on the contract terms, provided that no
significant obligations remain and collection of the related receivable is
probable. To date, the duration of the Company's advertising commitments has
generally averaged from one to twelve months. To the extent minimum guaranteed
impressions or other performance criteria are not met, the Company defers
recognition of the corresponding revenues until the remaining guaranteed
impressions or other performance criteria are met.

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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Advertising Costs

The Company expenses the costs of advertising as incurred. Advertising
expense for the years ended December 31, 1998 and 1999 was $109,000 and
$355,000, respectively, and is included in the consolidated statement of
operations in sales and marketing expense.

Customer Acquisition Costs

Included in sales and marketing expense is the cost of personal computers
given away to users in exchange for a 30-month user agreement. The Company
considers the cost of the computers as the cost of procuring customers and
recognizes the expense upon delivery of the computer to the customer. For the
year ended December 31, 1999 the Company recorded approximately $18.1 million
of computer acquisition costs. No computer acquisition costs were incurred
during the year ended December 31, 1998.

Product Development Costs

Product development costs incurred by the Company to date to develop,
enhance, manage, monitor and operate the Company's interfaces, databases and
web sites and related technologies are expensed as incurred. The Company has
adopted Statement of Position No. 98-1 "Accounting For the Costs of Computer
Software Developed or Obtained For Internal Use" (SOP 98-1). SOP 98-1 requires
computer software cost associated with internal use software to be charged to
operations as incurred until certain capitalization criteria are met. No such
costs have been capitalized to date.

Cash Equivalents

The Company considers all investments with a maturity of three months or
less when purchased to be cash equivalents.

Restricted Cash

Under the terms of an equipment lease agreement, the Company maintains a
$100,000 letter of credit as collateral for the lease as a security deposit.
The letter of credit expires in June 2000.

F-31
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

Concentration of Risk

Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents, and trade
accounts receivable.

The Company maintains cash and cash equivalents with various major financial
institutions. At times, such amounts may exceed the F.D.I.C. limits. The
Company limits the amount of credit exposure with any one financial institution
and believes that no significant concentration of credit risk exists with
respect to cash investments. The Company's trade accounts receivable are
derived primarily from revenue earned from customers located in the United
States. The Company extends credit based upon an evaluation of each customer's
financial condition and generally collateral is not required. The Company
maintains an allowance for doubtful accounts based upon the expected
collectibility of trade accounts receivable.

Two customers comprised 15% and 55%, respectively, of the trade accounts
receivable balance at December 31, 1998. Two customers comprised 21.9% and
17.5%, respectively, of the trade accounts receivable balance at December 31,
1999. During the year ended December 31, 1998 three customers comprised 30.1%,
22.6% and 12.6%, respectively, of revenues. During the year ended December 31,
1999 one customer accounted for 17.5% of revenues.

Sources of Supplies

The Company relies on third-party networks, local telephone companies and
other companies to provide data communications capacity. Although management
believes that alternate telecommunications facilities could be found in a
timely manner, any disruption of these services could have an adverse effect on
the Company's financial position and results of operations.

Assets Held for Sale

At December 31, 1999, the Company held 5,000 computers for sale which were
purchased in September 1999 for distribution to FreePC users, but never placed
in service. On January 11, 2000, the Company sold 1,000 of those computers for
$520,000 resulting in an impairment charge of $105,000 which was recorded as of
December 31, 1999. In addition, management recognized an additional impairment
charge assuming an additional discount of 20% on the remaining 4,000 computers
of $836,000. The total impairment charge of $941,000 has been included in the
consolidated statement of operations as a write-down of assets held for sale.
The net book value of the remaining 5,000 computers, totaling $2,184,000, is
included in assets held for sale and is classified as a current asset.

In December 1999, management held six domain names for sale which are
carried at the lower of amortized cost or fair value less cost to sell. The
amortized net book value of the domain names at December 31, 1998 and 1999 was
$269,000 and $176,000, respectively, and is included in assets held for sale.
No impairment charge was recorded as of December 31, 1998 or 1999.

Fixed Assets

Fixed assets are stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets of six
months to five years. Maintenance and repairs are charged to expense as
incurred.

F-32
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

Long-Lived Assets

The Company evaluates the recoverability of its long-lived assets in
accordance with Statement of Financial Accounting Standards (SFAS) No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of." The Company assesses the impairment of long-lived assets
and certain identifiable intangibles whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. An impairment loss would be recognized when estimated future cash
flows expected to result from the use of the asset and its eventual disposition
is less than its carrying amount.

Domain Names

Domain names are stated at cost. Amortization is calculated using the
straight-line method over the estimated useful lives of the assets of three
years.

Other Assets

Other assets include refundable security deposits the Company is required to
maintain with its telecommunications service providers under agreements
expiring in 2000.

Income Taxes

Income taxes are accounted for under SFAS No. 109, "Accounting for Income
Taxes." Under SFAS No. 109, deferred tax assets and liabilities are determined
based on differences between financial reporting and tax basis of assets and
liabilities, and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.

Stock-Based Compensation

The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion (APB) No.
25, "Accounting for Stock Issued to Employees," and complies with the
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation." Under APB 25, compensation expense is recognized over the
vesting period based on the difference, if any, on the date of grant between
the deemed fair value of the Company's stock for accounting purposes and the
exercise price. The Company accounts for stock issued to non-employees at the
estimated fair value of the underlying option or warrant in accordance with the
provisions of SFAS No. 123.

3. RECEIVABLES

Receivables, net consists of the following:

<TABLE>
<CAPTION>
December 31
-----------------
1998 1999
------- --------
<S> <C> <C>
Trade accounts receivable............................... $71,000 $124,000
Employee receivables.................................... -- 12,000
Other receivables....................................... -- 51,000
Allowance for doubtful accounts......................... (15,000) (50,000)
------- --------
$56,000 $137,000
======= ========
</TABLE>

F-33
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

4. FIXED ASSETS

Fixed assets consists of the following:

<TABLE>
<CAPTION>
December 31
------------------
1998 1999
------- ----------
<S> <C> <C>
Computer hardware (including equipment under
capital leases)..................................... $49,000 $1,224,000
Computer software.................................... -- 252,000
Furniture and fixtures............................... -- 171,000
Other fixed assets................................... -- 16,000
------- ----------
49,000 1,663,000
Less accumulated depreciation........................ 7,000 257,000
------- ----------
$42,000 $1,406,000
======= ==========
</TABLE>

5. UNEARNED REVENUE

During 1999 the Company entered into an agreement with Infospace to provide
its internet users with Infospace's start page each time they access the
Company's internet service. The Company received cash totaling $1,000,000 upon
the close of the agreement. Included in unearned revenue at December 31, 1999
is approximately $789,000 of unearned revenue under this agreement. The Company
has recognized approximately $211,000 of revenue during the year ended December
31, 1999 for start page views delivered.

6. STOCKHOLDERS' EQUITY

Common Stock

Holders of common stock are entitled to receive, when and if declared by the
Board of Directors, dividends and other distributions in cash, stock or
property from the Company's assets or funds legally available for those
purposes subject to any dividend preferences that may be attributable to
holders of convertible Preferred Stock. Holders of common stock are entitled to
one vote for each share held of record on all matters on which stockholders may
vote. Holders of common stock are not entitled to cumulative voting for the
election of directors.

There are no preemptive, conversion, redemption or sinking fund provisions
applicable to the common stock. All outstanding shares of common stock are
fully paid and non-assessable. In the event of liquidation, dissolution or
winding up, holders of common stock are entitled to share ratably in the assets
available for distribution.

On December 13, 1999, the Company purchased the domain names freepc.com and
freepc.net. The purchase price of $1,637,000 consists of $1 million cash,
100,000 shares of common stock at $5.00 per share and a warrant to purchase
100,000 shares of common stock at an exercise price of $5.00 per share. The
common stock was recorded at fair value of $5.00 per share and the warrant was
recorded at fair value of $137,000 based on the Black-Scholes option pricing
model. As of December 31, 1999, the warrant was outstanding and expires on
March 1, 2000.

On January 25, 1999, FreePC issued 2,036,250 shares of common stock to a
consultant and two employees for cash totaling $20,000, or $0.01 per share.
These shares are subject to restricted stock agreements. Under the terms of
these agreements, the Company has the right to repurchase any unvested shares
at the original issue price in the event the employee ceases to be an employee
or service provider of the Company. Any unvested shares shall automatically
vest immediately prior to a change in control of the Company.

F-34
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

Preferred Stock

In general, holders of Series A and B Convertible Preferred Stock are
entitled to one vote for each share of common stock then issuable upon its
conversion. For so long as at least 5,000,000 shares of Series A Convertible
Preferred Stock are outstanding, the holders of Series A Convertible Preferred
Stock shall be entitled to elect one director. For so long as at least
1,000,000 shares of Series B Convertible Preferred Stock are outstanding, the
holders of Series B Convertible Preferred Stock shall be entitled to elect one
director. The holders of Series A Convertible Preferred Stock and Series B
Convertible Preferred Stock, voting as a separate class, are entitled to vote
upon the following matters: (a) changing the authorized number of shares of
Series A or Series B Convertible Preferred Stock, (b) creating or authorizing
any equity securities having preference over that series of Convertible
Preferred Stock, (c) amending the Articles in a manner that would adversely
change the rights of that series of Convertible Preferred Stock, (d)
repurchasing or redeeming common stock or that series of Convertible Preferred
Stock or (e) paying any dividends on the common stock or Convertible Preferred
Stock.

The holders of each series of Convertible Preferred Stock are entitled to
receive, out of any funds legally available therefore, noncumulative dividends
at a rate of 8% of the respective issuance price per share per annum. No such
dividends have been declared or paid to date.

In the event of any liquidation, dissolution or winding up of the Company,
the holders of Convertible Preferred Stock are entitled to receive an initial
liquidation preference equal to the price per share of such series of
Convertible Preferred Stock, plus declared and unpaid dividends. After the full
liquidation preference on all outstanding shares of Convertible Preferred Stock
has been paid, any remaining assets and funds will be distributed ratably among
the holders of common stock, Series A Convertible Preferred Stock and Series B
Convertible Preferred Stock, assuming full conversion of each such series of
Convertible Preferred Stock until the holders of Convertible Preferred Stock
have received an additional two times the initial liquidation preference price
per share of each such series. Thereafter, any remaining assets and funds will
be distributed ratably among the holders of common stock.

Each share of Convertible Preferred Stock is convertible at the holders'
option at any time into common stock, according to a ratio which is one-for-
one, subject to anti-dilution protection. Each share of Convertible Preferred
Stock automatically converts at the earlier of (a) the closing of a firm
commitment underwritten public offering of the Company's securities with at
least $15 million in gross proceeds at a per share offering price of at least
$10.00 or (b) the consent of at least 50% of the outstanding shares of each
series of Convertible Preferred Stock.

Registration Rights

The holders of Convertible Preferred Stock have certain registration rights
with respect to the shares of Convertible Preferred Stock held by them. The
Convertible Preferred Stock holders may require the Company to register their
shares upon the written demand of the holders of at least 20% of the
outstanding Convertible Preferred Stock and common stock issuable upon
conversion thereof. In addition, the holders are also entitled to include their
securities in future registration statements the Company files under the
Securities Act of 1933, referred to as piggyback registration rights. The
holders of Convertible Preferred Stock are also entitled, subject to certain
limitations, to require the Company to register their securities on a Form S-3
registration once the Company is eligible to use a Form S-3 in connection with
these rights. However, the Convertible Preferred Stock holders are restricted
from exercising these rights until one year after the Company's initial public
offering or March 31, 2004.

F-35
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

Warrants

In connection with the issuance of 179,380 shares of Guide.com common stock
in 1998 at $1.51 per share, Guide.com issued warrants to purchase 16,817 shares
of common stock at an exercise price of $1.51 per share. The warrants are
exercisable upon grant and expire upon the earlier of an initial public
offering, a change in control or five years. No amount was allocated to the
value of the warrants as such amount was insignificant. At December 31, 1998,
these warrants were outstanding. In February 1999, these warrants were
exercised.

At December 31, 1999, the Company has a warrant outstanding to purchase
100,000 shares of common stock at an exercise price of $5.00 per share. The
warrant was issued in connection with the purchase of the domain names
freepc.com and freepc.net. The warrant is exercisable upon grant and expires on
December 12, 2000. The warrant was recorded at fair value of $137,000 based on
the Black Scholes options pricing model as prescribed by SFAS No. 123 including
assumptions of a risk-free rate of 5.6%, volatility of 65%, an expected life of
1 year and a dividend yield of 0.00%. The weighted average fair value of the
warrant at the grant date was $1.37.

Deferred Stock Compensation

The excess of the deemed fair value of the Company's common stock over the
exercise price of options granted to employees and non-employees during the
year ended December 31, 1999, at the date of grant amounted to an aggregate of
$9,529,000. As a result, $9,291,000 was recorded and reflected as a reduction
of stockholders' equity for options granted to employees and $238,000 was
recorded and reflected as other assets for options granted to vendors and
consultants. The deemed fair value of the common stock was determined by the
Company based on the selling prices of contemporaneous sales of each series of
Preferred Stock considering the relative rights and privileges of each
security, the stages of development of the Company's business and the inherent
risks and perceived future potential of the Company at the time of grant or
issuance. Amortization of deferred stock compensation is charged to operations
evenly over the vesting period of the options. During the year ended December
31, 1999, deferred stock compensation amortization of $1,844,000 and $58,000
was recorded for employees and non-employees, respectively. The deferred stock
compensation amortization relates only to stock options awarded; the salaries
and related benefits of these employees and services provided by consultants or
vendors are included in the applicable cost of revenue or operating expense
line item.

7. STOCK BASED COMPENSATION

On December 10, 1998, the stockholders of Guide.com adopted the Guide.com
1998 Stock Option Plan (the Guide.com Plan) which was assumed by FreePC under
the reorganization. Under the terms of the reorganization, no further options
will be granted under the Guide.com Plan. Each grant of options under the
Guide.com Plan vests on a case-by-case basis as approved by the administrator,
generally over a range of immediately vested to vesting over four years and
expires no later than 10 years from the date of grant. Under the Guide.com
Plan, the Company has granted options to employees and non-employees to
purchase shares of the Company's common stock at a price equal to the fair
market value of the common stock on the date of grant.

On January 25, 1999, the Board of Directors of the Company adopted the
FreePC, Inc. 1999 Stock Plan (the FreePC Plan). A maximum of 4,000,000 shares
of common stock have been reserved for issuance under this plan. All employees
and consultants to the Company are eligible to participate under the FreePC
Plan. Each option granted under the plan generally vests over four years and
expires no later than 10 years from the date of grant. Under the FreePC Plan,
certain outstanding options will fully vest upon a change in control.

F-36
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

Information with respect to the Company's two stock option plans is as
follows:

<TABLE>
<CAPTION>
Exercise
Shares Price
--------- -------------
<S> <C> <C>
Outstanding at January 1, 1998................. -- $ --
Granted....................................... 203,044 1.51
Exercised..................................... -- --
Canceled...................................... -- --
--------- -------------
Outstanding at December 31, 1998............... 203,044 1.51
Granted....................................... 2,821,318 0.01 to 8.80
Exercised..................................... (102,745) 0.01 to 1.51
Canceled...................................... (284,855) 0.01 to 1.51
--------- -------------
Outstanding at December 31, 1999............... 2,636,762 $0.01 to 8.80
========= =============
</TABLE>

There were 100,928 and 435,338 options exercisable at December 31, 1998 and
1999, respectively. The weighted average fair value of options granted during
the years ended December 31, 1998 and 1999 was $0.01 and $4.08, respectively.

The weighted average exercise prices for options outstanding and exercisable
at December 31, 1999 and the weighted average remaining contractual life for
options outstanding at December 31, 1999 are as follows:

<TABLE>
<CAPTION>
Options
Options Outstanding Exercisable
------------------------------ ----------------
Weighted
Average
Remaining Weighted Weighted
Contractual Average Number Average
Number of Life Exercise of Exercise
Range of Exercise Price Shares (Years) Price Shares Price
----------------------- --------- ----------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
$0.01.................. 818,091 9.17 $0.01 56,939 $0.01
0.50.................. 1,392,077 9.53 0.50 264,077 0.50
1.51.................. 148,594 8.09 1.51 58,722 1.51
8.80.................. 278,000 9.86 8.80 55,600 8.80
--------- -------
2,636,762 435,338
========= =======
</TABLE>

SFAS No. 123 requires disclosure of pro forma net loss based upon the fair
value of the options issued. The Company calculated the fair value of each
option granted on the date of the grant using the Black-Scholes options pricing
model as prescribed by SFAS No. 123 using the following assumptions for the
year ended December 31:

<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Risk-free interest rate...................................... 5.6% 5.9%
Volatility................................................... 65% 65%
Expected life (in years)..................................... 5 4.5
Dividend yield............................................... 0.00% 0.00%
</TABLE>

The option pricing model requires the input of highly subjective assumptions
including the expected stock price volatility. Because the Company's employee
stock options have characteristics significantly different from those of traded
options and because changes in the assumptions can materially affect the fair
value estimate, in management's opinion, the existing model does not
necessarily provide a reliable single measure of the fair value of its employee
stock options.

F-37
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Using the
above assumptions, the Company's pro forma net loss for the years ended
December 31, 1998 and 1999 would be $455,000 and $29,931,000, respectively.

8. COMMITMENTS

Lease Commitments

Future minimum lease payments under noncancelable capital and operating
lease commitments at December 31, 1999 are as follows:

<TABLE>
<CAPTION>
Capital Operating
Lease Leases
-------- ---------
<S> <C> <C>
December 31, 2000....................................... $179,000 $299,000
December 31, 2001....................................... 179,000 63,000
December 31, 2002....................................... 54,000 39,000
December 31, 2003....................................... 30,000 4,000
December 31, 2004....................................... 72,000 --
-------- --------
Total minimum obligations............................... 514,000 $405,000
========
Less amounts representing interest...................... 118,000
--------
Present value of minimum lease payments................. 396,000
Less current portion.................................... 63,000
--------
Total long-term portion................................. $333,000
========
</TABLE>

Cost and accumulated depreciation of equipment under capital leases was
$416,000 and $83,000, respectively at December 31, 1999. Depreciation of
equipment under capital leases is included in depreciation expense in the
accompanying consolidated statement of operations. Prior to 1999, the Company
had no equipment under capital lease.

Total rental expense for operating leases was $23,000 and $197,000 for the
years ended December 31, 1998 and 1999, respectively.

Equipment Financing Arrangement

In May 1999, the Company entered into a 36-month line of credit arrangement
with a leasing institution that provides for sales and leaseback transactions
of capital equipment up to a maximum of $3,000,000. Under this agreement,
$3,000,000 was available for future financing transactions at December 31,
1999.

On July 21, 1999, and April 14, 1999, the Company entered into two separate
one-year agreements for the purchase of data communications capacity. Minimum
commitments under the contracts for 2000 are $3,386,000.

F-38
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

9. INCOME TAXES

As a result of the net operating losses incurred since inception, no income
tax provision has been recorded except for state minimum taxes of
approximately $2,000 and $1,000 for the years ended December 31, 1998 and
1999, respectively. The following is a reconciliation of the statutory federal
income tax rate to the Company's effective income tax rate for the year ended
December 31:

<TABLE>
<CAPTION>
1998 1999
-------- ----------
<S> <C> <C>
Statutory federal rate............................. (34)% (34)%
State income taxes, net of federal benefit......... (6) (6)
Valuation allowance................................ 40 37
Nondeductible stock compensation................... -- 2
Other.............................................. -- 1
-------- ----------
-- % -- %
======== ==========

The components of the deferred tax assets and related valuation allowance
are as follows at December 31:

<CAPTION>
1998 1999
-------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................... $200,000 $4,263,000
Depreciation....................................... -- 6,707,000
Other.............................................. -- 379,000
-------- ----------
200,000 11,349,000
Less valuation allowance........................... 200,000 11,349,000
-------- ----------
Net deferred tax assets.......................... $ -- $ --
======== ==========
</TABLE>

Due to the uncertainty surrounding the timing of realizing the benefits of
its deferred tax assets in future tax returns, the Company has recorded a
valuation allowance equal to the total deferred tax assets.

At December 31, 1998 and 1999, the Company has net operating losses
carryforwards for both federal and state income tax purposes of approximately
$399,000 and $10,600,000, respectively, which are available to offset future
taxable income, if any, through 2005 and 2019, respectively.

Utilization of the above carryforwards may be subject to limitations, which
may ultimately inhibit the Company's ability to use carryforwards in the
future. The utilization of the loss carryforwards may be further limited as a
result of the acquisition of the Company by eMachines.

10. RELATED PARTY TRANSACTIONS

During 1998, the Company shared facilities and received certain management
services, including certain accounting, payroll processing, access to shared
local area computer communications network and general business insurance from
idealab!, a significant stockholder of the Company. idealab! charged a
management fee for the use of its facilities and services provided. Management
fees incurred during the year ended December 31, 1998 totaled $56,000.

In June 1999, the Company entered into a lease agreement beginning in July
1999 with idealab! for office space in a building adjacent to the idealab!
facility. The management fee and leasing fee incurred during the year ended
December 31, 1999 was $76,000 and $112,000, respectively.

F-39
<PAGE>

FreePC, Inc. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

December 31, 1999

From inception through December 31, 1998, Guide.com's founder and
significant stockholder was the Chairman of the Company. No compensation was
paid by the Company for his services. The value of these services was not
material to the financial statements.

On May 21, 1999, the Company entered into an agreement with Compaq Computer
Corporation, a former stockholder, to purchase 10,000 computers for
approximately $8.1 million. On September 23, 1999, the Company entered into an
agreement with Shopping.com, a wholly owned subsidiary of a stockholder, to
purchase 20,025 Compaq computers for approximately $12.5 million. During 1999,
approximately 25,000 computers were distributed to subscribers. At December 31,
1999, amounts due to Shopping.com, which have not been paid totaled $5,224,000
and is included in the financial statements as a payable to related parties.

During the years ended December 31, 1998 and 1999, the Company recognized
advertising revenues from related parties totaling $49,000, or 36%, and
$268,000, or 22%, of revenues, respectively.

11. SUBSEQUENT EVENT (UNAUDITED)

On February 22, 2000 the Company sold 4,000 personal computers for cash
totaling approximately $1.7 million. These computers were classified as assets
held for sale at December 31, 1999.

F-40
<PAGE>

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