<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 1, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 000-29789
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HomeGrocer.com, Inc.
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(Exact name of registrant as specified in its charter)
Washington 91-1863408
---------- ----------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
10230 N.E. Points Drive Kirkland, WA 98033
------------------------------------------
(Address of principal executive offices)
(425) 201-7500
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X No __
---
The registrant had 128,043,971 shares of common stock, without par value,
outstanding at July 1, 2000.
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HomeGrocer.com, Inc.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION....................................... 3
ITEM 1 - FINANCIAL STATEMENTS................................... 3
Balance Sheets............................................. 3
Statements of Operations................................... 4
Statements of Cash Flows................................... 5
Notes to Unaudited Financial Statements.................... 6
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................... 8
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.................................................. 23
PART II - OTHER INFORMATION.......................................... 24
ITEM 1 - LEGAL PROCEEDINGS..................................... 24
ITEM 5 - Other Information..................................... 24
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K...................... 24
SIGNATURES ......................................................... 25
</TABLE>
2
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PART I - FINANCIAL INFORMATION:
------------------------------
Item 1 - Financial Statements -
-----------------------------
<TABLE>
<CAPTION>
HomeGrocer.com, Inc.
Balance Sheets
(in thousands, except share amounts)
July 1, January 1,
2000 2000
--------------- --------------
Assets (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 158,571 $ 39,806
Marketable securities 0 37,762
Inventories 6,890 2,555
Prepaid expenses and other current assets 16,373 3,032
--------------- --------------
Total current assets 181,834 83,155
Fixed assets, net 126,619 52,066
Deposits and other long-term assets 6,742 3,776
Restricted cash 20,304 7,932
--------------- --------------
Total assets $ 335,499 $ 146,929
=============== ==============
Liabilities & Shareholders' Equity
Current liabilities:
Accounts payable $ 4,315 $ 4,396
Accrued liabilities 12,896 4,856
Accrued compensation and related liabilities 9,190 3,249
Current portion of capital lease obligations 4,005 3,081
Current portion of long-term debt 3,934 980
--------------- --------------
Total current liabilities 34,340 16,562
Capital lease obligations, less current portion 22,013 17,041
Long-term debt, less current portion 6,259 749
Other long-term liabilities 1,259 430
--------------- --------------
Total liabilities 63,871 34,782
Commitments and contingencies
Shareholders' equity:
Convertible preferred stock, no par value:
10,000,000 and 78,357,142 shares authorized as of
July 1, 2000 and January 1, 2000:
Issued and outstanding shares -- none and
73,206,738 as of July 1, 2000 and January 1, 2000,
respectively 170,047
Common stock, no par value:
1,000,000,000 and 130,000,000 shares authorized as of
July 1, 2000 and January 1, 2000:
Issued and outstanding shares -- 128,043,971
and 29,605,536 as of July 1, 2000 and January 1, 2000,
respectively 501,800 80,207
Notes receivable from officers for common stock (3,231) ( 3,231)
Deferred stock compensation (31,744) ( 41,619)
Accumulated other comprehensive loss (88) 0
Accumulated deficit (195,109) ( 93,257)
--------------- --------------
Total shareholders' equity 271,628 112,147
--------------- --------------
Total liabilities & shareholders' equity $ 335,499 $ 146,929
=============== ==============
</TABLE>
See accompanying notes to the financial statements.
3
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HomeGrocer.com, Inc.
Statements of Operations
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
13 Weeks 13 Weeks 26 Weeks 26 Weeks
Ended Ended Ended Ended
July 1, July 3, July 1, July 3,
2000 1999 2000 1999
------------ ------------ ----------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net sales $ 29,793 $ 3,442 $ 51,008 $ 5,220
Cost of merchandise sold 22,312 2,807 39,827 4,294
Customer fulfillment center expenses 22,496 2,145 40,140 3,389
Marketing expenses 15,729 1,353 21,317 2,088
Technology operations and development expenses 8,114 2,130 14,580 3,218
Preopening expenses 5,364 256 7,379 256
General & administrative expenses 9,329 1,779 17,640 2,603
Merger expenses 1,487 0 1,487 0
Stock-based compensation expense 6,719 714 14,862 822
------------ ------------ ----------- ------------
Loss from operations (61,757) (7,742) (106,224) (11,450)
Interest expense (334) (130) (997) (151)
Interest income 3,663 352 5,351 356
Other income/(expense) 41 (125) 18 (124)
------------ ------------ ----------- ------------
Net loss ($58,387) ($7,645) ($101,852) ($11,369)
============ ============ =========== ============
Basic and diluted net loss per share ($0.50) ($0.52) ($1.26) ($0.85)
============ ============ =========== ============
Weighted average shares outstanding used to
compute basic and diluted net loss per share 116,399,865 14,571,046 80,538,749 13,375,947
============ ============ =========== ============
</TABLE>
See accompanying notes to the financial statements.
4
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HomeGrocer.com, Inc.
Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
26 Weeks 26 Weeks
Ended Ended
July 1, July 3,
2000 1999
-----------------------------------
(Unaudited) (Unaudited)
<S> <C> <C>
Operating Activities:
Net loss ($101,852) ($11,369)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 8,144 318
Amortization 120 0
Stock-based compensation expense 14,862 627
Stock options issued for services 0 195
Changes in operating assets and liabilities:
Prepaid expenses and other current assets (13,341) (567)
Inventories (4,335) (279)
Accounts payable (81) 1,248
Accrued liabilities 8,429 345
Accrued compensation and related liabilities 5,552 560
-----------------------------------------
Net cash used in operating activities (82,502) (8,922)
Investing Activities:
Purchases of fixed assets (75,195) (2,840)
Sales and maturities of marketable securities 37,762 0
Deposits and other long-term (2,257) (415)
Restricted cash (12,372) (2,250)
-----------------------------------------
Net cash used in investing activities (52,062) (5,505)
Financing Activities:
Net proceeds from sale of preferred stock -- Series C 0 52,350
Proceeds from initial public offering 243,503 0
Proceeds from exercise of stock options 2,303 942
Proceeds from exercise of warrants 877 0
Repurchase of common stock (124) 0
Proceeds from long-term debt 10,000 2,121
Repayments of long-term debt (1,536) 0
Repayments of capital lease obligations (1,694) (125)
-----------------------------------------
Net cash provided by financing activities 253,329 55,288
-----------------------------------------
Net increase in cash and equivalents 118,765 40,861
Cash and equivalents, beginning of period 39,806 1,084
-----------------------------------------
Cash and equivalents, end of period $ 158,571 $ 41,945
=========================================
Supplemental Cash Flow Information:
Cash paid during the period for interest $ 1,505 $ 158
Noncash Financing and Investing Activities:
Fixed assets acquired through capital lease arrangements $ 7,561 $ 2,054
</TABLE>
See accompanying notes to the financial statements.
5
<PAGE>
HOMEGROCER.COM
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
--------------------------------------------------------------------------------
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of HomeGrocer.com,
Inc. have been prepared in conformity with generally accepted accounting
principles for interim financial information and with the instructions for Form
10-Q and Article 10 of Regulation S-X. Accordingly, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted. In the opinion of the Company's management, the statements include all
adjustments necessary, which are of a normal and recurring nature, for the fair
presentation of the results of the interim periods presented. These financial
statements should be read in conjunction with the Company's audited financial
statements for the year ended January 1, 2000, included in the Company's
Registration Statement on Form S-1 (File No. 333-93015) dated March 9, 2000,
filed with the Securities and Exchange Commission in connection with the
Company's initial public offering. The results of operations for any interim
period are not necessarily indicative of the results of operations for any other
interim period or for a full fiscal year.
The Company reports on a 52/53-week fiscal year basis that ends on the Saturday
nearest December 31. The quarters ended July 1, 2000 and July 3, 1999 were 13-
week quarters.
2. Description of Business
HomeGrocer.com, Inc. (the "Company") is an Internet retailer of grocery and
other consumer products. The Company operates its own distribution system
providing next-day delivery of products within a customer-designated delivery
period. The Company began delivering groceries to the Seattle area from its
first customer fulfillment center ("CFC") located in Bellevue, Washington in
June 1998. As of July 1, 2000, the Company was delivering groceries from eight
CFCs serving the Seattle, Washington; Portland, Oregon; Orange County, Los
Angeles and San Diego, California; and Dallas, Texas areas.
3. Agreement to Merge with Webvan Group, Inc.
On June 25, 2000, the Company entered into a definitive merger agreement with
Webvan Group, Inc. The merger is expected to close late in the third quarter or
early in the fourth quarter of fiscal 2000 upon satisfaction of customary
closing conditions and receipt of governmental and shareholder approvals.
Under the terms of the agreement, HomeGrocer.com shareholders will receive
1.07605 shares of Webvan common stock in exchange for each share of
HomeGrocer.com common stock. Outstanding stock options and warrants to purchase
shares of HomeGrocer.com stock will be converted to options and warrants to
purchase shares of Webvan common stock at the same exchange ratio. Webvan
intends to account for the merger as a purchase transaction.
4. Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, Accounting for Certain Transactions Involving Stock Compensation (FIN
44), that clarifies guidance for certain issues related to the application of
APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). The
adoption of FIN 44 by the Company on July 1, 2000 had no impact on the Company's
operating results or financial position. The Company does not expect that FIN 44
will impact the way it accounts for its equity instruments in the future.
6
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In May 2000, the Emerging Issues Task Force reached a consensus on Issue 00-14,
Accounting for Certain Sales Incentives. The Issue addresses the accounting for
sales incentives offered by vendors without charge to customers that can be used
in a single exchange transaction. The consensus is required to be adopted
prospectively in the first fiscal quarter beginning after May 18, 2000. We
believe that our historical and existing accounting procedures for free product
and sales discounts are already in accordance with Issue 00-14.
5. Earnings Per Share
Net loss per share is computed using the weighted average number of shares of
common stock outstanding less the number of shares that the Company has the
right but not the obligation to repurchase. Shares associated with common stock
subject to repurchase, stock options and warrants are not included in the
calculation of diluted net loss per share because they are anti-dilutive.
The following table sets forth the computation of basic and diluted net loss per
share for the periods indicated:
<TABLE>
<CAPTION>
--------------------------------------------------------------
13 Weeks Ended 26 Weeks Ended
--------------------------------------------------------------
July 1, July 3, July 1, July 3,
2000 1999 2000 1999
--------------------------------------------------------------
(in thousands, except share and per share amounts)
<S> <C> <C> <C> <C>
Numerator:
Net loss ($58,387) ($7,645) ($101,582) ($11,369)
==============================================================
Denominator:
Weighted average shares outstanding 128,087,015 15,819,761 92,352,347 14,386,983
Less: Weighted average shares subject
to repurchase 11,687,150 1,248,715 11,813,598 1,011,036
--------------------------------------------------------------
Denominator for basic and diluted 116,399,895 14,571,046 80,538,749 13,375,947
==============================================================
Net loss per share:
Basic and diluted ($0.50) ($0.52) ($1.26) ($0.85)
</TABLE>
At July 1, 2000, 21,592,708 shares of common stock subject to repurchase,
stock options and warrants were excluded from the computation of actual diluted
loss per share, as their impact was anti-dilutive. If the Company had reported
net income, the calculation of earnings per share would have included the
dilutive effect of these common stock equivalents using the treasury stock
method.
6. Comprehensive Net Loss
Comprehensive net loss, as defined by accounting and reporting standards,
consists of the Company's net loss as reported and any unrealized gains or
losses on cash equivalents and investments. During the second quarter, the
Company recorded $4,000 of unrealized gains on its cash equivalents bringing the
Company's accumulated other comprehensive loss to $88,000. There were no items
of other comprehensive income or loss in the prior year.
7. Commitments and Contingencies
As of July 1, 2000, the Company had capitalized approximately $21.4 million
consisting primarily of construction costs, prepaid rent and deposits for
unopened sites. As of that date, the Company also had construction and related
commitments related to unopened sites totaling approximately $19.0 million.
As of July 1, 2000, the Company had signed agreements to acquire additional
delivery vehicles with an estimated cost of $15.9 million. In addition, the
Company has executed leases for operating facilities and office space with
future minimum lease commitments totaling $204.0 million.
7
<PAGE>
Item 2 - Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
Results of Operations -
---------------------
The following information should be read in conjunction with the historical
financial information and the notes thereto included in this quarterly report on
Form 10-Q and "Management's Discussion and Analysis" included in the Company's
Registration Statement on Form S-1 (File No. 333-93015), which was previously
filed with the Securities and Exchange Commission.
This Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, including, without limitation, statements regarding
HomeGrocer.com's expectations, beliefs, intentions or future strategies that are
signified by the words "expect", "anticipate", "intend", "believe", or similar
language. All forward-looking statements included in this document are based on
information available to HomeGrocer.com on the date hereof and HomeGrocer.com
assumes no obligation to update any such forward-looking statements. Actual
results could differ materially from those projected in the forward-looking
statements.
HomeGrocer.com's business and financial performance are subject to
substantial risks and uncertainties. In evaluating our business, you should
carefully consider various factors that might cause actual results to differ
materially from stated expectations. These risks include, among others, that
there is no certainty that the proposed merger with Webvan Group will be
consummated; that our ability to raise capital and achieve our expansion plans
may be adversely impacted by market conditions; our ability to build strong
brand identity and customer loyalty may require additional marketing
expenditures; and the risk that our customer fulfillment center ("CFC") and
delivery service model may not be readily or cost-effectively replicable in
additional geographic markets. These and other risks are described in detail in
this Form 10-Q and in our Registration Statement on Form S-1 (File No. 333-
93015).
Overview
HomeGrocer.com is a retailer of grocery and other consumer products on the
Internet. We operate our own state-of-the-art distribution system providing
next-day home delivery of a wide range of products, including high quality food
items, at prices competitive with local supermarket prices. Our goals are to
expand nationally and to be our customers' preferred regular provider of
household consumer products. We believe that our core grocery business provides
us with a strong platform to expand into other product and service areas.
We commercially launched our storefront at www.homegrocer.com and began
delivering groceries to the Seattle area from our Bellevue, Washington
customer fulfillment center in June 1998. We currently serve customers in
several additional areas: Portland, Oregon since May 1999; Orange County and
Los Angeles, California since September 1999; Dallas, Texas since May 2000; and
San Diego, California since May 2000.
The Company recently decided to conserve capital by postponing its planned
openings in Atlanta, Chicago and Washington D.C. until some or all of its
existing operations become profitable or the capital markets for the Company
improve. As of July 1, 2000, the Company had $158.6 million of unrestricted
cash and securities.
Merger with Webvan Group, Inc.
On June 25, 2000, we entered into a definitive merger agreement with Webvan
Group, Inc. The merger is expected to close late in the third quarter or early
in the fourth quarter of fiscal 2000 upon satisfaction of customary closing
conditions and receipt of governmental and
8
<PAGE>
shareholder approvals. Under the terms of the agreement, HomeGrocer.com
shareholders will receive 1.07605 shares of Webvan common stock in exchange for
each share of HomeGrocer.com common stock. Outstanding stock options and
warrants to purchase shares of HomeGrocer.com common stock will be converted to
options and warrants to purchase shares of Webvan common stock at the same
exchange ratio. Webvan intends to account for the merger as a purchase
transaction.
Results of Operations
Comparison of the 13 Weeks Ended July 1, 2000 and July 3, 1999
Net Sales. On April 26, 2000 we opened our fourth customer fulfillment
center in the Orange County/Los Angeles area. We then introduced our service in
the Dallas, Texas market on May 12, 2000 and in the San Diego, California market
on May 31, 2000. Due primarily to these openings, our sales, net of returns and
promotional discounts, increased to $29.8 million for the second quarter of
fiscal 2000 from $21.2 million in the first quarter of fiscal 2000. This
compared to only $3.4 million in the second quarter of fiscal 1999. On average,
we delivered 3,170 orders per day in the second quarter, as compared to 2,283
and 426 orders in the first quarter of fiscal 2000 and second quarter of fiscal
1999, respectively. The average order size for the Company increased to $103 in
the second quarter of fiscal 2000, as compared to $102 and $96 in the first
quarter of fiscal 2000 and second quarter of fiscal 1999, respectively. Our
repeat customers accounted for 74% of total orders in the second quarter of
fiscal 2000, as compared to 77% of total first quarter orders. A "repeat
customer" is defined as a person who has ordered with us previously. The
decrease in the repeat customer percentage reflects the impact of introducing
our service in new markets, where virtually everyone is a new customer.
Gross Profit. Our cost of sales consists of the cost of merchandise sold or
provided to customers, including inbound freight costs. Gross profit (which is
our net sales less the cost of merchandise sold) increased to $7.5 million for
the second quarter of fiscal 2000 from $3.7 million in the first quarter of
fiscal 2000 and $635,000 in the second quarter of fiscal 1999, respectively. As
a percentage of net sales, gross profit increased to 25.1% in the second quarter
of fiscal 2000 from 17.4% in the first quarter of fiscal 2000 and 18.4% in the
second quarter of fiscal 1999, respectively. The improvement in gross profit is
due largely to buying efficiencies, reduced levels of shrink and pricing
adjustments.
To promote the HomeGrocer.com brand and establish customer loyalty, we will
typically offer customers free product or a sales discount on their first or
second order. For example, we have previously given our customers a free bag of
produce with their first order, waived the delivery fee for any sized first
order, and then offered $10 off the customer's second order. The costs of the
free produce bag and similar promotions are included in the cost of merchandise
sold. Sales discounts and promotions reduce gross sales to net sales and
therefore affect the gross margin percentage. We recently began a promotion for
the summer period offering a $20 discount on a first order of $50 or more. Based
on previous consumer testing of this promotion, we expect this promotion to
attract new customers during the summer season. Since the cost of such
promotions is deducted from gross sales to achieve net sales rather than being
considered a marketing expense, the Company's gross margin as a percentage of
net sales may be negatively affected.
Customer Fulfillment Expenses. Our customer fulfillment expenses include the
wages and benefits of our delivery drivers, personal shoppers, receiving
personnel and other operations and administrative staff located at the customer
fulfillment center ("CFC"), CFC rent and related facility costs, supplies and
credit card fees. CFC expenses increased to $22.5 million for the second
quarter of fiscal 2000 from $17.6 million and $2.1 million in the first quarter
of fiscal 2000 and the second quarter of fiscal 1999, respectively. The
increase in such expenses results from the increase in the number of CFCs
delivering to customers.
9
<PAGE>
Marketing Expenses. Our marketing expenses increased to $15.7 million for
the second quarter of fiscal 2000 as compared to $5.6 million and $1.4 million
in the first quarter of fiscal 2000 and the second quarter of fiscal 1999,
respectively. Our marketing programs are designed to strengthen the
HomeGrocer.com brand name, encourage trials of our service in our target
markets, build customer loyalty, maximize repeat purchases and increase our
average order size. The increase in marketing expenses during the second
quarter from the first quarter of fiscal 2000 and the second quarter of fiscal
1999 results primarily from the increase in the number of markets we serve and
increased ongoing promotional activities in existing markets.
During the second quarter, America Online, or AOL, began delivering banner ads
or other similar promotions to AOL's customers under the interactive marketing
agreement we entered into in February 2000. We did not deliver any mailings to
Amazon.com customers under our advertising agreement with Amazon.com until
subsequent to July 1, 2000. The costs associated with both agreements are being
expensed based on the number of impressions or mailings provided in each period,
as compared to the total impressions or mailings purchased by the Company
through each agreement. In both cases, the cumulative amounts expensed are less
than the cumulative cash payments under these agreements. As of July 1, 2000, we
have paid $10.0 million to AOL and $1.3 million to Amazon.com under these
agreements and have expensed $759,000 under the AOL agreement and nothing under
the Amazon.com agreement.
Technology Operations and Development Expenses. Technology operations and
development expenses increased to $8.1 million in the second quarter of fiscal
2000 from $6.5 million and $2.1 million in the first quarter of fiscal 2000 and
the second quarter of fiscal 1999, respectively. The increase results
primarily from an increase in the number of employees developing, enhancing, and
maintaining our storefront and other internal operating systems. On April 26,
2000, we launched a new version of our web site, providing shoppers with a more
convenient shopping experience. We have also invested heavily to improve the
reliability and scalability of our systems. We expect to continue to invest
heavily in technology due to the rapidly evolving and competitive environment of
e-tailing.
Preopening Expenses. Preopening expenses represent costs incurred at our CFCs
prior to opening and consist primarily of rent and related costs and wages and
benefits. Preopening expenses increased to $5.4 million for the second quarter
of fiscal 2000 from $2.0 million for first quarter of fiscal 2000. Preopening
expenses were $256,000 in the second quarter of fiscal 1999. The increase
reflects the execution of the Company's rollout plans during the quarter.
General and Administrative Expenses. General and administrative expenses were
$9.3 million for the second quarter of fiscal 2000 as compared to $8.3 million
and $1.8 million in the first quarter of fiscal 2000 and second quarter of
fiscal 1999, respectively. Such expenses have increased significantly from the
second quarter of the prior year as we built the corporate infrastructure
necessary to support our growth plans. General and administrative expenses as a
percentage of sales decreased from 39.2% in the first quarter of fiscal 2000 to
31.3% in the second quarter of fiscal 2000. We expect that, as a percentage of
net sales, our general and administrative expenses will continue to decrease.
Merger Expenses. Merger expenses for the second quarter of fiscal 2000 were
$1.5 million. There were no comparable expenses in the first quarter of fiscal
2000 or the second quarter of fiscal 1999. The merger expenses result from our
proposed merger with Webvan and consist principally of investment banking, legal
and accounting fees. We expect that there will be additional merger expenses in
future quarters.
Stock-Based Compensation Expense. Stock-based compensation expense consists
primarily of the amortization of deferred stock compensation resulting from the
grant of stock options or sale of restricted stock at exercise or sale prices
subsequently deemed to be less than the fair value of the common stock on the
grant or sale date. We recorded total deferred stock-based compensation of $67.7
million for fiscal 1999 and an additional $1.4 million in the first
10
<PAGE>
quarter of 2000 in connection with stock options granted and restricted stock
sold during the periods. Such deferred compensation was calculated based largely
on the Company's initial public offering price and has not been adjusted for
subsequent variations in the share price, even though most of such options and
restricted stock are subject to multi-year vesting requirements. Further, on May
1, 2000, in order to retain certain existing employees and hire new employees,
we granted options to purchase an aggregate of 4,389,400 shares of common stock
at $5.00 per share, the closing price of the Company's stock on the previous
trading day. The Company's chief executive officer, president and chief
financial officer did not receive options as part of the May 1, 2000 grant. On
May 1, 2000, the closing price of our common stock was $6.125 per share.
Accordingly, because of the increase in our share price on May 1, 2000, we
recorded an additional $4.9 million of deferred stock-based compensation during
the second quarter.
Deferred stock-based compensation is being amortized to expense over the
vesting periods of the applicable agreements, resulting in amortization of
deferred stock-based compensation totaling $6.7 million in the second quarter of
fiscal 2000 and $8.2 million and $714,000 in the first quarter of fiscal 2000
and the second quarter of fiscal 1999, respectively. The remaining $31.7
million of deferred stock-based compensation for stock options and restricted
stock is expected to be amortized in the amounts of $5.9 million and $4.9
million in third and fourth quarters of fiscal 2000, $13.1 million for fiscal
year 2001, $6.0 million for fiscal year 2002, $1.5 million for fiscal year
2003, $234,000 for fiscal year 2004 and $59,000 for fiscal year 2005. Such
amortization amounts assume that all vesting periods are completed by all
employees; to the extent that unvested options are forfeited by an employee,
previously recorded amortization related to the unvested options will be
credited to stock-based compensation expense.
Interest Income. Interest income increased to $3.7 million for the second
quarter of fiscal 2000 as compared to $1.7 million and $352,000 in the first
quarter of fiscal 2000 and the second quarter of fiscal 1999, respectively, as
our cash available for investment increased significantly upon receiving the
proceeds from our initial public offering in mid-March 2000. Such proceeds are
being used to fund our operations and expansion.
Interest Expense. Interest expense decreased to $334,000 for the second
quarter of fiscal 2000 from $663,000 in the first quarter of fiscal 2000 and
increased from $130,000 in the second quarter of fiscal 1999, respectively.
Interest expense results from borrowings to finance purchases of fixed assets
and fund operations and expansion. Interest expense related to CFCs under
construction is capitalized and such capitalization accounted for the decrease
in interest expense from the first quarter of fiscal 2000 to the second quarter
of fiscal 2000.
Income Taxes. There was no provision or benefit for income taxes for any
period since inception due to our absence of taxable income to date.
Comparison of the 26 Weeks Ended July 1, 2000 and July 3, 1999
Net Sales. Net sales for the first 26 weeks of fiscal 2000 increased to
$51.0 million from $5.2 million in the comparable prior year period. As of July
1, 2000 we were delivering to consumers from eight CFCs as compared to
delivering from two CFCs as of July 3, 1999. Also, sales to consumers in the
Seattle and Portland markets increased 357% as compared to the sales in these
markets during the comparable prior year period.
Gross Profit. Gross profit increased to $11.2 million for the first 26 weeks
of fiscal 2000 from $926,000 in the comparable prior year period. As a
percentage of net sales, gross profit increased to 21.9% in the first 26 weeks
of fiscal 2000 from 17.7% in the same prior year period. The improvement in
gross profit is due largely to buying efficiencies as well as better inventory
controls and pricing and procurement systems.
11
<PAGE>
Customer Fulfillment Expenses. CFC expenses increased to $40.1 million for
the first 26 weeks of fiscal 2000 from $3.4 million in the comparable prior year
period. The increase in such expenses results from the increase in the number
of CFCs delivering to customers.
Marketing Expenses. Our marketing expenses increased to $21.3 million for
the first 26 weeks of fiscal 2000 from $2.1 million in the comparable prior year
period. The increase in marketing expenses is due to the increase in the number
of markets we serve and increased promotional activities in the Seattle and
Portland markets. Further, late in fiscal 1999, we began local television
advertising to build consumer awareness as well as extensive radio advertising
and direct mail programs to attract first-time shoppers.
Technology Operations and Development Expenses. Technology operations and
development expenses increased to $14.6 million for the first 26 weeks of fiscal
2000 from $3.2 million in the comparable prior year period. The increase results
primarily from an increase in the number of employees developing, enhancing, and
maintaining our storefront and other internal operating systems.
Preopening Expenses. Preopening expenses increased to $7.4 million for the
first 26 weeks of fiscal 2000 from $256,000 in the comparable prior year period.
The increase primarily reflects the implementation of the Company's rollout
plans.
General and administrative expenses. General and administrative expenses were
$17.6 million for the first 26 weeks of fiscal 2000 as compared to $2.6 million
in the comparable prior year period. The significant increase in such expenses
results from building the corporate infrastructure necessary to support our
increased size and expansion plans.
Merger Expenses. Merger expenses for the first 26 weeks of fiscal 2000 were
$1.5 million. There were no comparable expenses in the comparable prior year
period. The merger expenses result from our proposed merger with Webvan and
consist principally of investment banking, legal and accounting fees.
Stock-Based Compensation Expense. We recorded stock-based compensation of
$14.9 million for the first 26 weeks of fiscal 2000 as compared to $822,000 in
the comparable prior year period. The increase in such expense results from
additional options granted in the latter half of fiscal 1999 and the first half
of fiscal 2000 and increases in the share value used to calculate such expense.
Interest Income. Interest income increased to $5.4 million for the first 26
weeks of fiscal 2000 from $356,000 in the comparable prior year period, as our
cash available for investment increased significantly upon receiving the
proceeds from our initial public offering in mid-March 2000.
Interest Expense. Interest expense increased to $997,000 for the first 26
weeks of fiscal 2000 from $151,000 in the comparable prior year period, as a
result of interest paid on borrowings to finance purchases of fixed assets and
fund operations and expansion.
Income Taxes. There was no provision or benefit for income taxes for any
period since inception due to our absence of taxable income to date.
Liquidity and Capital Resources
Prior to our initial public offering, we financed our operations primarily
through sales of preferred stock with net cash proceeds of $168.4 million
through January 1, 2000. On March 10, 2000, we completed our initial public
offering of our common stock, generating net proceeds of $243.5 million.
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Net cash used in operating activities for the first 26 weeks of fiscal 2000
was $82.5 million. In addition, we invested $75.2 million primarily in new
customer fulfillment centers and the rollout of our service, including tenant
improvements and the purchase of computer and transportation equipment. We also
acquired equipment, principally trucks, through capital leases. As of July 1,
2000, we had $158.6 million of unrestricted cash and cash equivalents. As of
that date, our principal commitments consisted of minimum lease payments due
under operating leases totaling approximately $204.0 million over 15 years,
agreements to purchase additional delivery vehicles in fiscal 2000 totaling
approximately $15.9 million and approximately $50.0 million and $8.8 million due
over four and two years under our marketing agreements with America Online and
Amazon.com, respectively. Our lease commitments include amounts related to
customer fulfillment centers that we have not yet opened. Our cash needs in
future periods will be a function of our operating results, the speed and
magnitude of rollout and the terms and availability of leases for real estate
and equipment, including trucks.
We have recently decided to postpone opening additional facilities until some
or all of our existing facilities become profitable or until we are able to
raise additional capital. By postponing the rollout of our service in
additional markets during fiscal 2000, we also reduce the short-term capital
required for tenant improvements and additional start-up and marketing costs in
new markets and can focus our resources on bringing our current CFCs to
profitability.
We believe that our existing cash and cash equivalents will be sufficient to
meet our anticipated needs for working capital and capital expenditures into the
first or second quarter of 2001. In the past, the Company has been able to
lease much of its transportation equipment on relatively favorable terms.
However, changes in the equity markets since the Company's initial public
offering on March 10, 2000 may have affected other capital markets as well. The
Company may have to, for example, purchase some or all of its transportation
equipment, much of which in the past has generally been leased. At July 1, 2000,
the Company leased 349 and owned 170 delivery vehicles. In addition, the
announcement of the proposed merger with Webvan may have affected the Company's
overall ability to raise capital. Our agreement with Webvan, among other
restrictions, has limitations on what we can spend on capital improvements and
marketing activities without Webvan's approval as well as limits on our ability
to issue equity or borrow funds. If we raise additional funds through the
issuance of equity, equity-related or debt securities, such securities may have
rights, preferences or privileges senior to those of the rights of our common
stock and our stockholders may experience additional dilution. We cannot be
certain that additional financing will be available to us on acceptable terms
when required, or at all.
New Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, Accounting for Certain Transactions Involving Stock Compensation (FIN
44), that clarifies guidance for certain issues related to the application of
APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). The new
guidance under FIN 44 would not have impacted our historical accounting for
equity instruments and we do not believe that FIN 44 will have an impact on
accounting for future equity instruments.
In May 2000, the Emerging Issues Task Force reached a consensus on Issue 00-
14, Accounting for Certain Sales Incentives. The issue addresses the accounting
for sales incentives by vendors without charge to customers that can be used in
a single exchange transaction. For example, cash incentives must be recorded as
a reduction in revenue. The consensus is required to be adopted prospectively
in the first fiscal quarter beginning after May 18, 2000. We believe that our
historical and existing accounting procedures for free product and sales
discounts are already in accordance with Issue 00-14.
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Risk Factors
There are numerous risks involving any potential investment in HomeGrocer.com.
These include the risks enumerated in the Company's Registration Statements on
Form S-1 (File No. 333-93015) dated March 9, 2000 and the following:
Failure to Complete the Merger with Webvan Could Negatively Impact Our
Stock Price and Future Business Operations.
If our proposed merger with Webvan is not completed for any reason,
HomeGrocer may be subject to a number of material risks, including the
following:
. We may be required to pay Webvan a termination fee of up to
$36,000,000;
. The price of our common stock may decline to the extent that the
current market price of our common stock reflects a market assumption
that the merger will be completed;
. Costs incurred by us related to the merger, such as legal and
accounting fees as well as a portion of the financial advisor fees,
must be paid even if the merger is not completed;
. Certain benefits that we expect to realize from the merger, such as
the enhanced financial and competitive position of the combined
company, would not be realized; and
. During the period before the consummation of the merger, the diversion
of the attention of management from our day-to-day business, the
scaling back of marketing and capital spending and the unavoidable
disruption to our employees and our relationships with customers and
suppliers, may make it difficult for us to regain our Company's
momentum if the merger does not occur.
We anticipate significant increases in our operating expenses and continuing
losses for the foreseeable future.
We incurred net losses of $101.9 million, or 200% of our revenues, for the
first 26 weeks of fiscal 2000. Because all of our customer fulfillment centers
have lost money over their first several quarters of operation and none are yet
profitable, we anticipate that our net losses for the fiscal year ended December
30, 2000 will be significantly greater than in prior years. As of July 1, 2000,
we had an accumulated deficit of $195.1 million. We cannot be certain of the
size of the capital commitment we will make and the operating expenses we will
incur. If and when the Company enters new markets, we expect the expansion
will also include:
. Approximately $6 to $9 million to equip each new customer fulfillment
center in additional geographic markets;
. The lease of the site or shell of each CFC and the lease or purchase
of its transportation equipment;
. Approximately $6 to $12 million for brand development, marketing and
other promotional activities in each new geographic market;
. Continued investment in our computer network, web site, warehouse
management and order fulfillment systems and delivery and corporate
infrastructure.
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We anticipate using our current cash and equivalents, our revenues from
operations and funds from future debt and equity offerings to finance these
expenses. We expect to continue to experience substantial operating losses on a
quarterly and annual basis for the foreseeable future. At current numbers of
customers and orders, the geographic density of customers and productivity of
employees, we are not profitable and cannot predict when or if we will be
profitable.
We are an early stage company operating in the e-commerce market, which makes it
difficult for investors to evaluate our business and prospects.
Prior to June 1998, we were focused on developing our web site and
constructing and equipping our first customer fulfillment center serving the
Seattle, Washington area. We did not begin commercial operations in the Seattle
area until June 1998, the Portland, Oregon area until May 1999, and the Orange
County, California area until September 1999. Our limited operating history
makes it difficult to evaluate our financial results and future plans. You must
consider our business and prospects in light of the risks and difficulties we
encounter as an early stage company in the new and rapidly evolving market of e-
commerce. Our failure to address such risks and difficulties could hurt our
business.
If a sufficient number of grocery shoppers do not accept our online shopping
service, we may never become profitable.
We have not operated profitably to date and cannot predict when or if we will
achieve profitability overall or in any single customer fulfillment center. If
we do not achieve and maintain customer volumes and sufficient density of our
deliveries in our market areas at a reasonable cost, we will not be able to
increase our revenues or achieve profitability. The market for e-commerce is new
and rapidly evolving. It is uncertain whether e-commerce will achieve and
sustain high levels of demand and market acceptance, particularly in the home
delivery industry. Our success will depend to a substantial extent on the
willingness of consumers to increase their use of online services as a means of
buying groceries and other products and services. We may not be able to convert
a large number of consumers from traditional shopping methods to online shopping
for groceries and other consumer products. Even if we are successful in
attracting online customers, we expect that it may take several years to achieve
a sufficient base of customers in a given market. Specific factors that could
prevent widespread customer acceptance include:
. Prolonged delivery time compared to the immediate receipt of products
at a traditional store;
. Perceptions that online delivery services are premium services and
therefore may be more expensive than traditional grocery stores;
. Customers' desire to see and touch products, particularly fresh
produce, prior to purchase;
. Product selection that is less varied than customers desire;
. Perceived or actual lack of security or privacy of online
transactions; and
. Difficulties in making accurate and timely deliveries to customers.
Moreover, the growth of our business will depend on the growth of the number
of consumers who have access to personal computers or other systems that can
access the Internet. If e-commerce, especially in the grocery industry, does not
achieve high levels of demand and market acceptance, we may never become
profitable.
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Our customer fulfillment center and delivery service model may not be readily or
cost-effectively replicable in additional geographic markets; as a result, we
may fail to expand our business effectively.
A critical part of our business strategy is to expand our business by opening
customer fulfillment centers in additional geographic markets at a rapid pace.
Our expansion strategy is dependent upon our ability to replicate our customer
fulfillment center and delivery service model in a timely and cost-effective
manner. Our strategy of using proprietary technology that can be implemented in
pre-existing warehouses to quickly open customer fulfillment centers may not be
as effective as we anticipate. In addition, our existing customer fulfillment
centers have been limited to locations on the west coast and Texas, and we may
fail to recognize specific issues associated with expansion beyond these areas.
Because our customer fulfillment centers have been operational for a limited
period of time, we have not yet demonstrated whether our customer fulfillment
centers and delivery service model are in fact readily and cost-effectively
replicable for long-term use or across additional markets. If we fail to resume
the expansion of our service in new markets in a timely and cost effective
manner or if the market fails to accept our new services, we may not generate
the revenue we expect, and we could incur substantial additional operating
costs.
We will need substantial additional capital to fund our operations and potential
expansion, and we cannot be sure that additional financing will be available.
We require substantial amounts of working capital to fund our business. In
addition, the opening of new customer fulfillment centers and the continued
development of our order fulfillment and delivery systems would require
significant amounts of capital. For example, we anticipate that we will require
approximately $6 to $9 million to equip each new customer fulfillment center and
approximately $5 to $12 million for brand development, marketing and other
promotional activities in each new geographic market. In addition, we would need
substantial additional capital to fund growth beyond the initial phase of our
expansion or if we encounter unexpected costs in the initial phase of our
expansion, such as higher than anticipated real estate, technology or customer
acquisition costs. Since our inception, we have experienced negative cash flow
from operations and expect to experience significant negative cash flow from
operations for the foreseeable future. In the past, we have funded our operating
losses and capital expenditures through proceeds from equity offerings, debt
financing and equipment leases. Changes in the equity markets since the
Company's IPO on March 10, 2000 may have affected the markets for debt financing
and equipment leases. We expect to require substantial additional capital. Our
future capital needs will be highly dependent on the number and actual cost of
additional customer fulfillment centers we open, the timing of openings and the
success of our facilities once they are launched. We cannot be certain that
additional financing will be available to us on favorable terms when required,
or at all. If we are unable to obtain sufficient additional capital when needed,
we could be forced to further alter our business strategy, delay or abandon some
of our expansion plans or sell assets. Any of these events would have a material
adverse effect on our business, financial condition and our ability to reduce
losses or generate profits. The Company also recently decided to conserve
capital by postponing its planned openings in Atlanta, Chicago and Washington,
D.C. If we raise additional funds through the issuance of equity, debt or other
securities, those securities may have rights, preferences or privileges senior
or equal to those of the rights of our common stock and our shareholders may
experience dilution.
We may be unable to upgrade our existing technology in a cost-effective and
efficient manner to accommodate the increased volumes of Internet traffic and
transactions that may arise from our expansion, which could hurt our business.
The launch of the HomeGrocer.com service in additional metropolitan locations
or growth in our existing markets may require us to expand and upgrade our
technology, including our integrated set of software tools and business
processes for delivery management, web site
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production, customer service and order fulfillment. Our existing technology may
not be able to accommodate increased volumes of traffic and transactions that
may arise in the future. To the extent that customer traffic grows
substantially, we will need to expand the capacity of our web site and
transaction processing systems to accommodate a larger number of customers. If
we are unable to upgrade our technology, we may suffer from unanticipated system
disruptions, slower response times, degradation in levels of customer service,
impaired quality and speed of order fulfillment or delays in reporting accurate
financial information. We may not accurately predict the rate or timing of
increases in the use of our web site to allow us to effectively upgrade or
expand our transaction processing systems. Upgrading our current technology
could result in material expenses. If we fail to cost-effectively and
efficiently upgrade and expand our current technology, our business will suffer.
If we encounter operational difficulties, our business could suffer erosion of
customer trust and loss of income.
Our business relies on complex systems to manage the process from the receipt
of orders to the delivery of goods to our customers. The satisfactory
performance, reliability and availability of our web site and transaction
processing systems are critical to our reputation and our ability to attract and
retain customers and maintain adequate customer service levels.
Our web site has experienced numerous outages since inception. In addition to
outages, we occasionally experience periods of slow site response times. We
have, from time to time, also experienced operational "bugs" in our systems and
technologies that have resulted in order errors, such as missing items and
delays in deliveries. Operational bugs may arise from one or more factors
including mechanical equipment failures, computer server or system failures,
network outages, software bugs, power failures and human error. We may not be
able to correct every problem in a timely manner. We expect bugs to continue to
occur from time to time and our operations may experience significant
inefficiencies or failures. If we are unable to meet customer demand or service
expectations as a result of operational issues, we may be unable to develop
customer relationships that result in repeat orders, which would hurt our
business.
Our communications hardware is located at a third party hosting provider and
natural disasters and any other unanticipated problems faced by our hosting
provider may reduce our capacity or damage our systems.
Our communications hardware and other computer hardware operations are located
at a web site hosting provider in Seattle, Washington. The hardware for our
warehouse management and inventory system is maintained in our corporate data
center in Kirkland, Washington. Fires, floods, earthquakes, power losses,
telecommunications failures, break-ins and similar events could damage these
systems or cause them to fail completely. In addition, our hosting provider is
responsible for the allocation of our system capacity and any unanticipated
problems with the telecommunications network providers with whom it contracts or
with the systems by which it allocates capacity among its customers could reduce
our system capacity. Natural disasters and any other unanticipated problems
faced by our hosting provider could adversely impact the customer shopping
experience and, consequently, our business.
Our limited operating history makes it difficult for us to forecast our future
financial results.
As a result of our limited operating history, it is difficult to accurately
forecast our total revenue, revenue per customer fulfillment center, gross and
operating margins, real estate and labor costs, average order size, number of
orders per day and other financial and operating data. We have a limited amount
of meaningful historical financial data upon which to base planned operating
expenses. Sales and operating results are difficult to forecast because they
generally depend on the growth of our customer base and the volume of the orders
we receive, as well as
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the mix of products sold. As a result, we may be unable to make accurate
financial forecasts and adjust our spending in a timely manner to compensate for
any unexpected revenue shortfall. This inability to accurately forecast our
results could cause our net losses in a given quarter to be greater than
expected and could cause a decline in the trading price of our common stock.
Our quarter-to-quarter operating results are expected to fluctuate based upon
seasonal purchasing patterns, and are therefore difficult to predict.
Our quarter-to-quarter operating results are expected to fluctuate based
upon seasonal purchasing patterns of our customers and the mix of groceries and
other products sold by us. For instance, we expect a reduction in sales in the
summer months, which is a popular vacation season in most markets, and higher
sales during the weeks preceding Thanksgiving. Because of our short operating
history and limited geographical experience, we may not accurately predict the
seasonal purchasing patterns of our customers and may experience unexpected
difficulties in matching inventory to demand by customers.
If we fail to generate sufficient levels of repeat orders and market
penetration, our revenues could be significantly lower than expected.
In the online retail industry, customer attrition rates, or the rates at
which subscribers cancel a service, are generally high. Although we do not
charge a subscription fee for our service, we do depend upon customers to
continue to order from us after their initial order is placed. We compete to
retain customers once they have used our service. We currently track our repeat
customers and the data we have gathered shows during the first 26 weeks of
fiscal 2000 approximately 75% of our orders were from repeat customers. A
critical part of our business strategy depends on hiring, training and retaining
customer friendly delivery persons to interact directly with the customer on a
regular basis and promote customer loyalty. In addition, we must ensure that our
customer service agents who answer telephone and email inquiries offer prompt
attention and helpful information in response to our customers' concerns. If we
fail to provide high quality customer care and experience significant decreases
in repeat customer orders as a percentage of orders delivered, or if we are
unable to establish sufficient customer loyalty needed for market penetration,
our business could be hurt. Retention of customers is also dependent on
operational execution. If orders are incomplete or not delivered on time,
customer retention rates could decline, causing revenue and profitability to
decline as well.
We face intense competition from traditional grocery retailers and anticipate
increased competition from online grocery retailers in our existing and future
markets.
The grocery retailing market is extremely competitive. Local, regional, and
national food chains, independent food stores and markets, as well as online
grocery retailers comprise our principal competition, although we also face
substantial competition from convenience stores, liquor retailers, membership
warehouse clubs, specialty retailers, supercenters and drugstores. Many of our
existing and potential competitors, particularly traditional grocers and
retailers, have existed for a longer period of time, have greater financial
resources and have more established relationships with leading manufacturers,
suppliers and advertisers than we do.
In April 2000, Safeway, a national traditional grocery chain, announced it
would purchase 50% of Groceryworks.com, an Internet grocer currently serving
Dallas, Texas, a market we entered in mid-May. Royal Ahold, also a traditional
grocery chain, has entered into a contract to acquire a 51% ownership interest
in Peapod, an online grocer that operates in several of the markets we may
enter. In November 1999, Albertson's introduced an Internet based service in the
Seattle area and Webvan, an online grocery retailer has indicated that it will
introduce its online grocery service in Seattle sometime in 2000. We expect our
competition will intensify as more traditional and online grocery retailers
offer competitive services.
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The number and nature of competitors and the amount of competition we will
experience will vary by geographic area. We expect to compete with traditional
grocery stores in every area, including Albertson's, Safeway, Quality Food
Centers and Kroger, and other online grocers in most markets, including
companies such as Albertsons.com, Webvan, Peapod, HomeRuns, GroceryWorks.com,
ShopLink.com and Streamline.com. The principal competitive factors that affect
our business are product selection, product quality, customer service, price and
convenience. For traditional grocers, convenience is largely a function of
location and hours of operation. For online grocers, it is primarily determined
by ease of use of the web site and availability of delivery times. If we fail to
effectively compete in any of these areas, we may lose existing and potential
customers and face decreased demand for our products and services, which would
hurt our business.
If our efforts to build strong brand identity and customer loyalty are not
successful, our business will suffer.
We believe that customers may direct future grocery purchases to those
online and traditional grocers for whose brands they feel loyalty and personal
affinity. If we do not increase spending substantially to create and maintain
brand loyalty, we may not attract and retain consumers and respond to
competitive pressures. We believe the cost of our advertising campaigns could
increase substantially in the future. The costs required to successfully
establish our brand may exceed the benefits associated with creating our brand
identity and loyalty. If we fail to establish and maintain brand identity and
brand loyalty, we may not attract the customers we need in order to be
profitable.
Customer loyalty will also depend on our success in consistently providing
a high quality shopping experience for purchasing groceries and other products.
If consumers do not perceive our service offerings to be of high quality, or if
we introduce new services that are not favorably received by consumers, the
value of the HomeGrocer.com brand could be harmed. Any loss of value of our
brand could decrease the attractiveness of HomeGrocer.com to consumers, which
could harm our reputation, reduce our sales and cause us to lose customers.
We do not have long-term contracts with our suppliers and could face disruptions
in our supply of products.
We purchase products from a network of suppliers, wholesalers, brokers and
distributors. We do not have long term or exclusive contracts with these
suppliers. The loss of any of our suppliers could cause disruptions in our
supply of products and harm our business. We purchase a number of top brands and
high volume items directly from manufacturers and may increase our use of direct
suppliers as our product volumes increase with additional customer fulfillment
centers. We also utilize premium specialty suppliers and local sources for
gourmet foods, traditional and organic produce, bakery items, fish and meats and
floral products. From time to time, we may experience difficulty in obtaining
sufficient product allocations from a key vendor. In addition, our key vendors
may establish their own online retailing efforts, which may impact our ability
to obtain sufficient product allocations from these vendors. Many of our key
vendors also supply products to the retail grocery industry and our online
competitors. If we are unable to obtain sufficient quantities of products in a
timely fashion from our key vendors to meet customer demand, our business would
suffer.
We may not be able to hire and retain qualified employees necessary to support
our business, which would threaten our future growth.
Our future success depends upon attracting and retaining the continued
service of our executive officers, delivery persons, and other key software
development, merchandising, marketing and support personnel. Our relationships
with all of our employees are at will. Additionally, there are low levels of
unemployment in the Seattle, Portland, Orange County, Los Angeles, San Diego and
Dallas areas as well as in many of the regions in which we plan to operate.
These low levels of unemployment have led to upward pressure on wage rates,
which
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can make it more difficult and costly for us to attract and retain qualified
employees. The failure to attract and retain qualified employees could adversely
affect our business.
Several key members of our management team have only recently joined us and if
they are not successfully integrated into our business or fail to work together
as a management team, our business will suffer.
Several key members of our management team have joined us since September
1, 1999, including Mary Alice Taylor, our chairman and chief executive officer,
Daniel R. Lee, our senior vice president and chief financial officer, Rex L.
Carter, our senior vice president of systems development & technology, Corwin J.
Karaffa, our senior vice president of operations, David A. Pace, our senior vice
president of people capability, and Kristin H. Stred, our senior vice president,
general counsel and secretary. If we do not effectively integrate these
executives and key personnel into our business, or if they do not work together
with existing personnel as a management team to enable us to implement our
business strategy, our business will suffer.
We may not be able to obtain required licenses or permits for the sale of
alcohol in a cost-effective manner or at all, which would hurt our sales and
profitability.
For first 26 weeks of fiscal 2000, sales of alcohol accounted for
approximately 2.6% of our sales. We will be required to obtain state, and in
some cases county and municipal, licenses and permits for the sale and delivery
of alcohol in new markets. Some jurisdictions do not allow companies such as
ours to sell alcohol. We cannot assure you that we will be able to obtain any or
all required permits or licenses in a timely manner, or at all. We may be forced
to incur substantial costs and experience significant delays in obtaining these
permits or licenses. In addition, the U.S. Congress is considering enacting
legislation which would restrict the interstate sale of alcoholic beverages
over the Internet. Changes to existing laws or our inability to obtain required
permits or licenses could prevent us from selling alcohol in one or more of our
geographic markets or in a portion of those markets. In those locations where we
cannot obtain alcohol permits or licenses, we will be unable to sell these items
and will lose an opportunity to increase revenue.
We are required to verify the age of purchasers of our alcohol and tobacco
products and the failure to do so may have a negative impact on our reputation
and make us vulnerable to liability claims.
We are required to verify the age of purchasers of our alcohol and tobacco
products. If our delivery personnel fail to request the proper identification or
if false identification cards are presented by the purchaser, we could face
substantial penalties and legal liability for sales of alcohol and tobacco
products to underage persons. Any inquiry or investigation from a regulatory
authority could have a negative impact on our reputation and any liability
claims could require us to spend significant time and money in litigation.
We may incur significant costs or experience product availability delays in
complying with regulations applicable to the sale of food products, which may
hurt our business.
We are not currently regulated by the U.S. Department of Agriculture, or
USDA. Whether the handling of food items in our customer fulfillment centers,
such as meat and fish, will subject us to USDA regulation in the future will
depend on several factors, including whether we sell food products on a
wholesale basis or whether we obtain food products from non-USDA inspected
facilities. In the future the USDA may require costly changes to our food
handling operations. We are also required to comply with local health
regulations concerning the preparation and packaging of any prepared food items,
such as deli salads that we prepare on site. Applicable federal, state or local
regulations may cause us to incur substantial compliance costs or delay the
availability of items at one or more of our customer fulfillment centers. In
addition, any inquiry or investigation from a food regulatory authority could
have a negative impact on our reputation. The
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occurrence of any of these events could delay or impair our expansion plans and
could cause us to lose customers.
Intellectual property claims can be costly and could result in the loss of
significant rights.
Intellectual property rights are becoming increasingly important to us and
other e-commerce retailers. Many companies are devoting significant resources to
developing patents that could affect many aspects of our business. Other parties
may assert infringement or unfair competition claims against us that could
relate to any aspect of our technologies, business processes or other
intellectual property. We cannot predict whether third parties will assert
claims of infringement against us, the subject matter of any of these claims, or
whether these assertions or prosecutions will harm our business. If we are
forced to defend ourselves against any of these claims, whether they are with or
without merit or are determined in our favor, or defend our intellectual
property by bringing lawsuits, then we may experience diversion of technical and
management attention, an inability to use our current web site technology or
other intellectual property or product shipment delays. As a result of a
dispute, we may have to develop non-infringing technology or enter into royalty
or licensing agreements. These royalty or licensing agreements, if required, may
be unavailable on terms acceptable to us, or at all. If there is a successful
claim of infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology on a timely basis, our
business and competitive position may be hurt.
We may face product claims that create liability and adverse publicity.
Grocery and other related products can contain contaminants due to inherent
defects in the products or improper storage or handling. The delivery by us of
contaminated or spoiled products could cause adverse publicity. If any of the
products that we sell causes harm to any of our customers, we could be
vulnerable to product liability lawsuits. If we are found liable under a product
liability claim, or even if we successfully defend ourselves against this type
of claim, we could be forced to spend a substantial amount of money in
litigation expenses, our reputation could suffer and customers may substantially
reduce their orders or stop ordering from us.
If the protection of our patents, trademarks and proprietary rights is
inadequate, our business may be seriously harmed.
We regard patents, copyrights, service marks, trademarks, trade secrets and
similar intellectual property as important to our success. We rely on patent,
trademark and copyright law, trade secret protection and confidentiality or
license agreements with our employees, customers, partners and others to protect
our proprietary rights; however, the steps we take to protect our proprietary
rights may be inadequate and legal means afford only limited protection. For
example, our confidentiality and license agreements may be unenforceable in some
jurisdictions and, as a result, offer no protection of our proprietary rights.
In addition, traditional legal protections may not be applicable in the Internet
context. Because our business and technology have developed rapidly since our
incorporation, the ownership of proprietary rights in our technology may be
subject to uncertainty. Our failure to protect our proprietary rights could
materially harm our business and competitive position.
We currently have no patents. On January 10, 2000, we filed three
provisional patent applications with the U.S. Patent and Trademark Office. From
time to time, we may decide to file additional patent applications relating to
aspects of our proprietary technology. Other parties may independently develop
similar or competing technology or design around any patents that may be issued
to us. We cannot assure you that any of our pending provisional patent
applications will be approved, that any issued patents will protect our
intellectual property or that any issued patents will not be challenged by third
parties.
21
<PAGE>
We may not be able to protect our domain names against all infringers, which
could decrease the value of our brand name and proprietary rights.
We currently own the Internet domain name "homegrocer.com," as well as
various other related names. Domain names generally are regulated by Internet
regulatory bodies. The regulation of domain names in the United States and in
foreign countries is subject to change. Regulatory bodies could establish
additional top-level domains, appoint additional domain name registrars or
modify the requirements for holding domain names. The relationship between
regulations governing domain names and laws protecting trademarks and similar
proprietary rights is unclear. Therefore, we could be unable to prevent third
parties from acquiring domain names that infringe or otherwise decrease the
value of our brand name, trademarks and other proprietary rights.
Future sales of our common stock may cause our stock price to decline.
If our shareholders sell substantial amounts of our common stock in the
public market, the market price of our common stock could decline. As of July 1,
2000, we have 128,043,971 shares of outstanding common stock of which 11,035,833
million are restricted. Of these shares, 22,000,000 were sold as part of our
March 10, 2000 initial public offering ("IPO") and the majority are freely
tradable, without restriction, in the public market.
Each of our officers, directors and most of our shareholders have entered
into lock-up agreements generally providing that they will not sell or otherwise
dispose of or transfer any of our common stock or other securities for the
period of 180 days after our IPO without the consent of Morgan Stanley.
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<PAGE>
Item 3 - Quantitative and Qualitative Disclosures About Market Risk -
-------------------------------------------------------------------
We maintain a short-term investment portfolio consisting of commercial
paper with maturities of three months or less. Such securities are subject to
interest rate risk and will rise and fall in value if market interest rates
change. The extent of this risk is not quantifiable or predictable due to the
variability of future interest rates.
Our restricted cash is invested in certificates of deposit. There is
inherent risk in these instruments as they mature and are immediately renewed at
current market rates. The extent of this risk is not quantifiable or predictable
due to the variability of future interest rates.
We believe that the market risk arising from our holdings of financial
instruments is not material.
The following table provides information about our investment portfolio,
restricted cash, capital lease obligations and long-term debt as of July 1,
2000, principal cash flows and related weighted average interest rates by
expected maturity dates.
<TABLE>
<CAPTION>
Year of Maturity Total
------------------------------------------------------------------------
After Carrying
2000 2001 2002 2003 2004 2004 Value
-----------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $158,571 - - - - - $158,571
Average interest rate 6.4% - - - - - 6.0%
Restricted cash - certificates of deposit $ 9,243 $11,061 - - - - $ 20,304
Average interest rate 5.8% 6.6% - - - - 6.2%
Capital lease obligations $ 1,945 $ 4,237 $4,286 $3,666 $2,534 $9,350 $ 26,018
Average interest rate 8.5% 8.5% 8.9% 8.6% 7.6% 7.6% 8.3%
Long-term debt $ 1,924 $ 3,784 $3,841 $ 644 - - $ 10,193
Average interest rate 10.7% 10.8% 10.9% 11.0% - - 10.8%
</TABLE>
23
<PAGE>
PART II - OTHER INFORMATION:
---------------------------
Item 1 - Legal Proceedings -
--------------------------
On February 28, 2000, CNA Industrial Engineering, Inc. filed suit against
HomeGrocer.com in Superior Court of Washington for King County to collect
$473,000, which it claims it is owed for consulting, design and installation
services. We dispute the amount claimed and intend to vigorously defend the
lawsuit.
On May 11, 2000, we filed suit in United States District Court for the Western
District of Washington against Peachtree Network, Inc. alleging trademark
infringement and unfair competition for use of a logo similar to ours in online
grocery ordering and delivery.
Item 5 - Other Information -
--------------------------
Subsequent to the end of the quarter, on July 7, 2000, J. Terrence Drayton
resigned from the Board of Directors and stepped down from his role as President
of the Company. Mr. Drayton remains an employee of the Company, and his
sabbatical has been extended through the closing of the proposed merger with
Webvan Group.
Item 6 - Exhibits and Reports on Form 8-K -
-----------------------------------------
(a) Exhibits filed with this Form 10-Q are as follows:
10.8 Facility Lease dated March 1, 2000, between HomeGrocer.com, as
lessee, and Benaroya Capital Company L.L.C.
10.9 First Amendment dated March 6, 2000, to the Facility Lease between
HomeGrocer.com, as lessee, and Mercy Capital Center Joint Venture.
10.10 Facility Lease dated April 17, 2000, between HomeGrocer.com, as
lessee, and Riggs and Company.
10.11 Facility Lease dated April 18, 2000, between HomeGrocer.com, as
lessee, and Stafford Limited Partnership.
10.12 First Amendment and Modification dated June 1, 2000, to the
Facility Lease between HomeGrocer.com, as lessee, and 3 Plus
Limited Partnership.
10.13 First Amendment dated June 14, 2000, between HomeGrocer.com, as
lessee, and Duke-Weeks Realty Limited.
10.14 Master Service Agreement effective May 19, 2000 between
HomeGrocer.com and Exodus Communications, Inc.
27.1 Financial Data Schedule.
_________________________
(b) The Company filed a Current Report on Form 8-K on July 7, 2000, to
disclose that it had entered into a definitive merger agreement with Webvan
Group, Inc. on June 25, 2000. On the effective date of the merger, each
outstanding share of the Company's common stock will be exchanged for 1.07605
shares of Webvan common stock. Options and warrants to purchase HomeGrocer.com
stock will automatically be converted into options and warrants to purchase
shares of Webvan common stock using the same exchange ratio. The merger and
related documents were filed as exhibits to the Current Report on Form 8-K filed
on July 7, 2000.
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<PAGE>
SIGNATURES:
----------
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
HOMEGROCER.COM
--------------
Registrant
July 26, 2000 /s/ Mary Alice Taylor
------------- -----------------------------------------
Date Mary Alice Taylor
Chairman and Chief Executive Officer
July 26, 2000 /s/ Daniel R. Lee
------------- -----------------------------------------
Date Daniel R. Lee
Senior Vice President and
Chief Financial Officer
25
