<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended June 30, 2000
-------------
[ ] 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- 29387
PETS.COM, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4730753
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
945 Bryant St.
San Francisco, CA 94103
(Address of principal executive offices)
(415) 222-9999
(Registrant's telephone number)
435 Brannan Street, Suite 100
San Francisco, CA 94107
(Former name or former address, if changed since last report)
Check whether the registrant (1) 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 number of shares of common stock, $.00125 par value, outstanding on June 30,
2000 was 29,225,437.
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PETS.COM, INC.
CONTENTS
<TABLE>
<CAPTION>
PART I - - FINANCIAL INFORMATION PAGE NO.
<S> <C> <C>
Item 1. Condensed Financial Statements (unaudited)................................................ 3
Condensed Balance Sheets as of June 30, 2000 and December 31, 1999........................ 3
Condensed Statements of Operations for the three and six month periods ended
June 30, 2000 and 1999................................................................... 4
Condensed Statement of Cash Flows for the six month periods ended June 30, 2000
and 1999................................................................................. 5
Notes to Condensed Financial Statements................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 26
PART II - - OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 27
Item 2. Changes in Securities and Use of Proceeds................................................. 27
Item 3. Defaults upon Senior Securities........................................................... 28
Item 4. Submission of Matters to a Vote of Security Holders....................................... 28
Item 5. Other Information......................................................................... 28
Item 6. Exhibits and Reports on Form 8K........................................................... 28
SIGNATURES........................................................................................ 29
</TABLE>
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PART I -- FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
PETS.COM, INC.
CONDENSED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
--------- ------------
(unaudited) (See Note 1)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ......................... $ 37,227 $ 30,196
Inventories ....................................... 9,356 6,756
Prepaid advertising expenses ...................... 10,499 7,223
Other prepaid expenses and current assets ......... 2,645 999
--------- ---------
Total current assets ................................. 59,727 45,174
Certificate of deposit ............................... 914 845
Fixed assets, net .................................... 19,875 11,327
Intangible assets .................................... 339 399
Other assets ......................................... 6,270 2,565
--------- ---------
Total assets ......................................... $ 87,125 $ 60,310
========= =========
LIABILITIES & STOCKHOLDERS EQUITY
Current liabilities:
Accounts payable .................................. $ 4,960 $ 6,563
Accrued expenses .................................. 4,164 2,137
Payable to related parties ........................ 631 370
Capital lease obligations ......................... 176 16
--------- ---------
Total current liabilities ............................ 9,931 9,086
Capital lease obligations, long term ................. 761 104
Stockholders' equity:
Convertible preferred stock ....................... - 20
Common stock ...................................... 37 6
Additional paid-in capital ........................ 213,278 128,442
Accumulated deficit ............................... (124,925) (61,778)
Stockholder note receivable ....................... - (188)
Deferred stock-based compensation ................. (11,957) (15,382)
--------- ---------
Total stockholders' equity ....................... 76,433 51,120
--------- ---------
Total liabilities and stockholders' equity $ 87,125 $ 60,310
========= =========
</TABLE>
See accompanying notes to condensed financial statements.
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PETS.COM, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales ........................................ $ 8,764 $ 39 $ 16,415 $ 51
Cost of goods sold ............................... 10,513 76 23,028 76
-------- -------- -------- --------
Gross margin ................................ (1,749) (37) (6,613)
(25)
Operating expenses:
Marketing and sales ......................... 17,091 1,122 45,946 1,122
Product development ......................... 2,257 1,624 4,943 1,641
General and administrative .................. 2,681 838 5,012 838
Amortization of stock-based compensation .... 1,022 - 2,097 -
-------- -------- -------- --------
Total operating expenses ............... 23,051 3,584 57,998 3,601
-------- -------- -------- --------
Operating loss ................................... (24,800) (3,621) (64,611) (3,626)
Interest income, net ............................. 741 123 1,464 123
-------- -------- -------- --------
Net loss ......................................... $(24,059) $ (3,498) $(63,147) $ (3,503)
======== ======== ======== ========
Basic and diluted net loss per share ............. $ (0.89) $ (2.41) $ (2.96) $ (2.41)
======== ======== ======== ========
Weighted average shares outstanding used to
compute basic and diluted net loss per share .... 26,945 1,453 21,335 1,453
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed financial statements.
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PETS.COM, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
2000 1999
-------- --------
<S> <C> <C>
Operating Activities:
Net loss ....................................................................... $(63,147) $ (3,503)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................. 2,375 44
Amortization of deferred stock-based compensation ......................... 2,097 --
Common and preferred stock issued for intellectual property ............... -- 416
Marketing and sales ....................................................... 525 --
Changes in:
Inventories .......................................................... (2,600) (141)
Prepaid advertising expenses ......................................... 7,223 (166)
Other prepaid expenses and current assets ............................ (1,646) (220)
Certificates of deposit .............................................. (69) (135)
Accounts payable, accrued expenses and other ......................... 424 1,579
Payable to related parties ........................................... 261 --
-------- --------
Net cash used in operating activities .......................................... (54,557) (2,126)
Investing Activities
Purchase of fixed assets ....................................................... (9,835) (2,515)
Strategic debt and equity investments .......................................... (3,705) --
-------- --------
Net cash used in investing activities .......................................... (13,540) (2,515)
Financing Activities:
Proceeds from exercise of stock options ........................................ 120 --
Repurchase of stock options exercised .......................................... (123) --
Proceeds from issuances of preferred stock ..................................... -- 59,982
Proceeds from issuances of common stock ........................................ 75,342 14
Repayments on capital lease .................................................... (211) --
-------- --------
Net cash provided by financing activities ...................................... 75,128 59,996
-------- --------
Net increase in cash and cash equivalents ...................................... 7,031 55,355
Cash and equivalents at beginning of period .................................... 30,196 --
-------- --------
Cash and equivalents at end of period .......................................... $ 37,227 $ 55,355
======== ========
Supplemental Cash Flow Information:
Property and equipment acquired under capital lease obligations ............. 1,028 --
Issuance of preferred stock for media advertising ........................... 11,024 --
</TABLE>
See accompanying notes to condensed financial statements.
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PETS.COM, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying unaudited financial statements of Pets.com, Inc., (the
"Company"), 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, pursuant to the rules and regulations of the Securities and Exchange
Commission. 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 December 31, 1999, included in the
Company's Prospectus, dated February 10, 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.
2. Net Loss Per Share
Net loss per share is computed using the weighted average number of
shares of common stock outstanding less the number of shares subject to
repurchase. Shares associated with stock options and warrants are not included
in the calculation of diluted net loss per share because they are antidilutive.
The following table sets forth the computation of basic and diluted net
loss per share for the periods indicated:
(unaudited)
(in thousands, except for per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Numerator:
Net loss ............................................ $ (24,059) $ (3,498) $ (63,147) $ (3,503)
========= ======== ========= ========
Denominator:
Weighted average common shares outstanding ......... 29,199 2,625 23,598 2,400
Less weighted average common shares issued
subject to repurchase agreements ............. 2,253 1,172 2,263 947
--------- -------- --------- --------
Denominator for basis and diluted calculation .... 26,945 1,453 21,335 1,453
========= ======== ========= ========
Net loss per share:
Basic and diluted ................................... $ (0.89) $ (2.41) $ (2.96) $ (2.41)
========= ======== ========= ========
</TABLE>
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3. Stockholders' Equity
On January 7, 2000 the Company's board of directors approved an
amendment to the Company's articles of incorporation to increase the total
number of authorized preferred stock shares to 18,101,862, and to designate
1,200,000 shares of preferred stock as Series C.
On January 15, 2000, the Company entered into an agreement with Buena
Vista Internet Group and Infoseek Corporation, affiliates of The Walt Disney
Company, to perform joint marketing, content development and other promotional
activities. An affiliate of The Walt Disney Company also purchased 1,102,400
shares of Series C convertible preferred stock in exchange for media rights
valued at approximately $11 million on ABC, Inc. The approximate value of these
media rights was previously reported at $11.8 million.
On January 19, 2000 the Company's board of directors authorized,
concurrent with the Company's reincorporation in Delaware, a .8 for 1 reverse
stock split. All share and per share amounts in the accompanying financial
statements have been adjusted to reflect this split.
Initial Public Offering of Common Stock
On February 11, 2000 the Company completed its initial public offering
of 7,500,000 shares of common stock resulting in approximately $75.3 million in
net proceeds. In connection with the closing of the offering, all of the
outstanding convertible preferred stock was converted into an aggregate of
17,402,940 shares of common stock.
4. New Accounting Pronouncements
In December 1999 the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB
101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements of all public registrants. Any change in the
Company's revenue recognition policy resulting from the interpretation of SAB
101 would be reported as a change in accounting principle in the quarter ending
December 31, 2000. While the Company has not completed its assessment of the
impact of the adoption of SAB 101, it believes that the implementation will not
have a material adverse impact on its existing revenue recognition policies.
5. Subsequent Event
On July 13, 2000, the Company acquired certain strategic assets and
partnerships of PetStore.com, Inc., an online retailer of pet products and
services. As part of the all-stock transaction, the Company issued 5,815,623
shares of its common stock and 1,143,895 shares of redeemable, non-voting,
non-convertible series A preferred stock. The acquisition will be accounted for
as a purchase. Also related to the above transaction, Discovery, Inc. agreed to
acquire 1,430,700 shares of Pets.com stock for $3 million in cash.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward-Looking Statements
This discussion contains forward-looking statements. These statements
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, expect, plan, intend, anticipate, believe, estimate, predict, potential
or continue, the negative of such terms or other comparable terminology. These
statements are only predictions. Actual events or results may differ materially.
In evaluating these statements, you should consider various factors, including
the risks outlined in the Risk Factors section of our prospectus related to our
initial public offering filed with the Securities and Exchange Commission (SEC)
on February 10, 2000 pursuant to Rule 424 (b) (4) of the Securities Act of 1933
and, from time to time, in other reports we file
<PAGE> 8
with the SEC. These factors may cause our actual results to differ materially
from any forward-looking statement.
Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. Moreover, neither we nor any
other person assumes responsibility for the accuracy and completeness of the
forward looking statements after the date of this Quarterly Report on Form 10-Q
to conform such statements to actual results or to changes in our expectations.
OVERVIEW
Pets.com, Inc. is the leading online retailer of pet products,
integrating product sales with expert information on pets and their care. We are
committed to serving pets and their owners with the best care possible through a
broad product selection, expert information and superior service. We seek to
address the entire pet products market, transcending the limited product
selection of superstores, specialty stores and grocery stores. Our broad
selection of approximately 15,000 SKUs is integrated with extensive pet-related
information and resources designed to help consumers make informed purchasing
decisions. We designed our Web store to provide our customers with a convenient,
one-stop shopping experience that is organized to reflect how consumers think
about shopping for their pets. Our Web store addresses the needs of many of the
most popular pets, including dogs, cats, birds, fish, reptiles, ferrets, and
other small pets. We provide quality customer service through our in-house
distribution, fulfillment, customer service, and technology operations.
Furthermore, we encourage participation in the pet community both through our
Web store and through Pets.commitment, our charitable foundation that supports
the role that pets and people play in each others' lives.
The pet products industry in the United States is a large and growing
market characterized by a loyal and emotion-driven customer base. According to
the Pet Industry Joint Advisory Council, U.S. consumer spending on pet products
and services grew at an annual rate of approximately 9% per year between 1993
and 1997, totaling approximately $23 billion at the end of 1997. More than 60%
of U.S. households owned a pet and 40% of those households owned more than one
pet in 1998, according to a recent American Pet Products Manufacturers
Association study. The pet products market has traditionally been served by a
combination of traditional store-based retailers, including superstores,
independent specialty stores and grocery stores. This market is highly
fragmented, and generally requires consumers to expend considerable time and
effort shopping for pet products in multiple stores to meet all their needs.
We provide consumers with one-stop shopping for their pet care needs. We
seek to attract and retain consumers by emphasizing the following key
attributes:
Extensive Product Selection. Our SKU count is approximately twice the
number available at the largest pet superstores.
Expert Information and Professional Resources. We provide consumers
extensive pet and pet care information integrated throughout our Web store
through our in-house staff of pet experts and strategic relationships.
Superior Shopping Experience. We believe that we provide an intuitive,
easy-to-use Web store, categorized and organized the way people think about
shopping for their pets. We also offer our customers a highly streamlined
checkout experience and direct delivery to their doors.
Quality Customer Service. We have invested significant resources to
create our own fulfillment, distribution, and both online and in-person help
service functions to enable us to better control all aspects of the customers'
shopping experience.
<PAGE> 9
Community. Visitors to our Web store can participate online in 60
different pet discussion forums, sign up for our online newsletter and get
information on our Pets.commitment charitable foundation.
Our objective is to become one of the world's leading retailers of pet
products. Key elements of our strategy include:
- Building enduring brand equity through an advertising strategy which
includes our Pets.com sock puppet brand icon, relationships with select online
companies, and support for national events and pet-related local market
activities;
- Offering the broadest possible pet product selection available to our
customers at competitive prices;
- Establishing our private label brands for pet products marketed under the
Pets.complete and Pets.com brand names;
- Providing increasingly comprehensive and relevant content in conjunction
with a range of consumer and veterinary care partners;
- Delivering superior customer service and promoting repeat purchases
through investments in people, technology and distribution facilities;
- Continuing to maintain and expand our relationships with Amazon.com, which
is currently our largest stockholder, and GO.com; and
- Expanding internationally in order to capitalize on the global market.
Results of Operations
Because we commenced commercial operations on February 17, 1999 and have
a short operating history, we believe that period-to-period comparisons are less
meaningful than an analysis of recent quarterly operating results. Accordingly,
we are providing a discussion and analysis of our results of operations that
compares the quarter ended June 30, 2000 to the quarter ended March 31, 2000.
The following table sets forth our unaudited quarterly statement of
operations data for the three quarters ending December 31, 1999, March 31, 2000
and June 30, 2000. This unaudited quarterly information has been derived from
our unaudited financial statements and, in the opinion of management, includes
all adjustments, consisting of normal recurring adjustments necessary for a fair
presentation of such information in accordance with generally accepted
accounting principles. The operating results for any quarter are not necessarily
indicative of the operating results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
December 31, March 31, June 30,
1999 2000 2000
------------- ------------- -------------
<S> <C> <C> <C>
Net sales .................................. $ 5,168 $ 7,651 $ 8,764
Cost of goods sold ......................... 11,570 12,515 10,513
------------- ------------- -------------
Gross margin .......................... (6,402) (4,864) (1,749)
Operating expenses:
Marketing and sales ................... 30,676 28,855 17,091
Product development ................... 2,646 2,686 2,257
</TABLE>
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<TABLE>
<CAPTION>
<S> <C> <C> <C>
2,211 2,331 2,681
General and administrative
Amortization of stock-based compensation .... 979 1,075 1,022
------------- ------------- -------------
Total operating expenses ............... 36,512 34,947 23,051
------------- ------------- -------------
Operating loss ................................... (42,914) (39,811) (24,800)
Interest income, net ............................. 491 723 741
------------- ------------- -------------
Net loss ......................................... $ (42,423) $ (39,088) $ (24,059)
============= ============= =============
</TABLE>
Net Sales. Net sales consist of product sales, magazine advertising
sales and charges to customers for outbound shipping and handling and are net of
allowances for product returns, promotional discounts and coupons. We recognize
product and shipping revenues when the related product is shipped. We recognize
magazine advertising revenue when editions in which the advertising appears are
distributed. In the future, the level of our product sales will depend on a
number of factors including, but not limited to the frequency of our customers'
purchases, the quantity and mix of products, pricing of products and shipping,
sales promotions and discounts, seasonality and customer returns.
Net sales for the second quarter of 2000 were $8.8 million, a 14%
increase over net sales for the first quarter of 2000 of $7.7 million. The
increase in net sales was a result of the increase in our customer base and the
increase in our repeat orders as a percentage of total orders. Our cumulative
customer accounts increased from approximately 264,000 at the end of first
quarter 2000 to approximately 443,000 customer accounts at the end of second
quarter 2000, an increase of 68%. Orders from repeat customers also increased
during the second quarter to more than 59% of total orders, compared to 50% for
the first quarter of 2000.
Cost of Sales and Gross Margin. Cost of sales consists primarily of the
costs of products sold to customers and outbound and inbound shipping costs. We
expect cost of sales to increase in absolute dollars to the extent that our
sales volume increases. Promotional tools, which are included in cost of sales,
include rotating discounts on product segments as well as online and offline
coupons to targeted audiences. We may in the future expand or increase the
coupons and discounts we offer to our customers and may otherwise alter our
pricing structures and policies. These changes may negatively affect our gross
margin. Our gross margin will fluctuate based on a number of factors, including,
but not limited to the cost of our products, our product and shipping pricing
strategy, product mix, the number and location of distribution centers from
which we ship products, and inventory control. Our product margins currently
range from between 25% and 30% in the aggregate. The introduction of our private
label line, Pets.complete during the first quarter 2000 has had and is expected
to continue to have a positive impact on our aggregate product margin over time.
Gross Margin improved from negative 64% in the first quarter of 2000 to negative
20% during the second quarter of 2000. The negative gross margin improvement is
primarily attributable to a decrease in our shipping costs as our second
distribution center in Indianapolis reached its full load of U.S. shipping by
the end of the second quarter 2000. This new warehouse has allowed us to
eliminate priority shipping services and costs since we can now effectively
reach the majority of the country with ground service. Improved product margin
due to volume and other discounts negotiated with our product vendors also
contributed to the gross margin improvement.
Marketing and Sales Expenses. Marketing and sales expenses consist
primarily of advertising and promotional expenditures, distribution expenses,
supplies, payroll and related expenses for personnel engaged in marketing,
merchandising, business development and customer service and distribution
expenses. Marketing and sales expenses decreased from $28.9 million in the first
quarter of 2000 to $17.1 in the second quarter 2000. The decrease was due to a
decrease in expenses associated with advertising
<PAGE> 11
media and promotional costs and a decrease in distribution costs associated with
the increased shipping load from our Indianapolis distribution center. We intend
to continue to pursue our branding and marketing campaign. Marketing and sales
expenses may vary considerably as a percentage of net revenues from quarter to
quarter, depending on the timing of our advertising campaigns and our response
to competitive developments in our market.
Product Development Expenses. Product development expenses consist
primarily of payroll and related expenses for our Web store development, systems
personnel, consultants, content and other Web store costs. Product development
decreased from $2.7 million in the first quarter of 2000 to $2.3 million in the
second quarter of 2000. The decrease was due to a general decrease in
development costs as internal systems were completed and brought out of the
development stage. Over the next several months, we plan to continue to staff a
significant number of development projects that will result in increased product
development expenses. We believe that continued investment in product
development is critical to attaining our strategic objectives and maintaining
our competitive position in our market and, as a result, we expect product
development expenses to increase or remain consistent, but to fluctuate as a
percentage of net revenue from quarter to quarter.
General and Administrative Expenses. General and administrative expenses
consist of payroll and related expenses for development, design, production,
finance, human resources, executive and administrative personnel, corporate
facility expenses, professional services expenses, travel and other general
corporate expenses. General and administrative expenses increased from $2.3
million in the first quarter of 2000 to $2.7 million in the second quarter of
2000. The increase was primarily due to increased expenses associated with the
relocation of the Company's headquarters to a new larger facility as well as the
expenses associated with Company's requirements as a public company. We expect
general and administrative expenses to increase or remain consistent in the
future as we expand our staff and incur additional costs related to the
anticipated growth of our business and our status as a public company. However,
we expect such expenses to fluctuate as a percentage of net revenue from quarter
to quarter.
Amortization of Stock-Based Compensation. Amortization of stock-based
compensation decreased from $1.1 million in the first quarter of 2000 to $1.0
million in the first quarter of 2000. The decrease was due to the forfeiture of
stock options by terminated employees. The amount of stock compensation expense
to be recorded in future periods could decrease if options for which accrued but
unvested compensation has been recorded are forfeited.
Interest Income, net. Interest income represents earnings on our cash
and cash equivalents net of interest expense associated with capital lease
obligations. Interest income was at $0.7 million in the second quarter of 2000
and the first quarter of 2000.
Income Taxes. There was no provision or benefit for income taxes for any
period since inception due to our operating losses. We have not recognized any
benefit from the future use of loss carryforwards for any period since inception
because of uncertainty surrounding their realization. The amount of net
operating losses that we can utilize may be limited pursuant to tax regulations
applicable to certain circumstances, including in the event that we experience a
cumulative stock ownership change of more than 50% over a three-year period.
LIQUIDITY AND CAPITAL RESOURCES
Prior to our initial public offering, we financed our operations
primarily through private sales of convertible notes payable and preferred
stock, which, yielded net cash proceeds of $109.2 million. In February 2000, we
completed our initial public offering and issued 7,500,000 shares of common
stock at an initial public offering price of $11.00 per share. In connection
with our initial public offering, we received approximately $75.3 million in net
cash proceeds.
<PAGE> 12
We have incurred net losses of $124.9 million from inception to June 30,
2000. We believe that we will continue to incur net losses for the foreseeable
future and that the rate at which we will incur such losses could increase from
current levels.
The net cash used in operating activities of $54.6 million in the first
six months of 2000 primarily reflected the net loss for the period of $63.1
million.
Net cash used in investing activities was $13.5 million for the first
six months of 2000. Net cash used in investing activities primarily consisted of
leasehold improvements and purchases of equipment and systems, including
computer equipment, warehouse handling equipment and fixtures and furniture. The
Company also made an equity investment in Petspark, Ltd., an U.K.-based online
pet retailer, of $2.0 million.
Net cash used in financing activities was $75.1 million for the first
six months of 2000 and consisted primarily of the Company's initial public
offering in February 2000.
As of June 30, 2000 we had $37.2 million of cash and cash equivalents.
As of that date, our principal commitments consisted of obligations outstanding
under capital and operating leases aggregating approximately $2.7 million
through June 30, 2000. In April 2000 we invested $1.2 million in Petspark, Ltd.
Although we have no material commitments for capital expenditures, we anticipate
an increase in our capital expenditures and lease commitments consistent with
anticipated growth in operations, infrastructure and personnel. In the second
quarter 2000 we entered into a lease of a 40,000 square foot facility in San
Francisco that allows for continued expansion of our staff. We incurred
leasehold improvement capital expenditures of approximately $2.3 million through
the second quarter of 2000 to prepare the facility for occupancy. For 2000, we
anticipate our total capital expenditures will be at least $15 million, which
will include substantial expenditures toward technology and systems upgrades to
support our distribution centers and increases in our business volume.
We believe that our existing cash and cash equivalents, together with
our available funds, will be sufficient to meet our anticipated needs for
working capital and capital expenditures into the first quarter of 2001, and we
expect we will be required to raise additional funds at such time. In addition,
we may need to raise additional funds prior to the expiration of such period if,
for example, we pursue business or technology acquisitions or experience
operating losses that exceed our current expectations. 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. Furthermore, because of the low trading price of our
common stock, the number of shares of new equity or equity related securities
that we may be required to issue may be greater than it otherwise would be. As a
result, our stockholders may experience significant additional dilution. In
addition, the issuance of debt securities could increase the risk or perceived
risk of our company. We cannot, however, be certain that additional financing
will be available to us on acceptable terms when required, or at all. If this
additional financing is not available to us we may need to dramatically change
our business plan, sell or merge our business, or face bankruptcy.
RISK FACTORS
The following is a discussion of additional factors which currently
impact or may impact our business, operating results and/or financial condition.
Anyone making an investment decision with respect to our capital stock is
cautioned to carefully consider these factors, along with the factors discussed
in our Registration Statement on Form S-1 (File No. 333-92433) and our periodic
reports filed pursuant to the Exchange Act.
WE ONLY BEGAN SELLING OUR PRODUCTS IN FEBRUARY 1999 AND WE OPERATE IN A NEW AND
RAPIDLY EVOLVING MARKET, WHICH MAKES IT DIFFICULT FOR INVESTORS TO DETERMINE
WHETHER WE WILL ACCOMPLISH OUR OBJECTIVES.
Because we were formed in February 1999, we have a limited operating
history on which investors and securities analysts can base an evaluation of our
business and prospects. We have limited insight into trends that may emerge and
affect our business. Accordingly, you must consider the risks and difficulties
we face as an early stage company with limited
<PAGE> 13
operating history in a new and rapidly evolving market. We cannot be certain
that our business strategy will be successful.
THE SUCCESS OF OUR BUSINESS DEPENDS ON ATTRACTING AND RETAINING A LARGE NUMBER
OF POTENTIAL CUSTOMERS. IF WE ARE UNABLE TO DO SO, WE WILL NOT BE ABLE TO
ACHIEVE PROFITABILITY.
Our success depends on attracting a large number of potential customers
who shop in traditional retail stores and persuading them to shop in our Web
store. Our success is also dependent on ensuring that these customers remain
loyal long-term customers of Pets.com. In addition to our dependence on the
widespread customer acceptance of the Internet for purchasing products, we
cannot be certain that our customers will accept our online solution over those
offered by our competitors. If we do not achieve widespread customer acceptance
of our online solution, our revenues will suffer. Furthermore, we may be
required to incur significantly higher and more sustained advertising and
promotional expenditures than we currently anticipate to attract online shoppers
to our Web store and to convert those shoppers to purchasing customers. As a
result, we may not be able to achieve profitability when we expect, or at all.
WE HAVE A HISTORY OF LOSSES AND WE EXPECT SIGNIFICANT INCREASES IN OUR COSTS AND
EXPENSES TO RESULT IN CONTINUING LOSSES FOR AT LEAST THE NEXT SEVERAL YEARS.
We incurred net losses of $63.1 million for the six-month period ended
June 30, 2000 and cumulative losses of $124.9 million from our inception through
June 30, 2000. We have not achieved profitability. We only began selling
products in February 1999. We cannot be certain that we will obtain enough
customer traffic or a high enough volume of purchases to generate sufficient
revenues and achieve profitability. We believe that we will continue to incur
operating and net losses for at least the next several years. We intend to
increase our costs and expenses substantially as we:
- Open additional distribution centers and expand our existing
distribution centers;
- Provide shipping below our actual costs to attract customers;
- Increase our general and administrative functions to support our
growing operations;
- Expand our customer support organization to better serve customer
needs; and
- Develop or license from third parties enhanced technologies and
features to improve our Web store.
Because we will spend these amounts before we receive any incremental
revenues from these efforts, our losses will be greater than the losses we would
incur if we developed our business more slowly. In addition, we may find that
these efforts are more expensive than we currently anticipate or that these
efforts may not result in proportionate increases in our revenues, which would
further increase our losses. We may also engage in promotional efforts such as
coupons or discounts that would reduce our revenues.
WE MAY NOT SUCCEED IN ESTABLISHING THE PETS.COM BRAND, WHICH WOULD ADVERSELY
AFFECT CUSTOMER ACCEPTANCE AND OUR REVENUES.
Due to the early stage and competitive nature of the online market for
pet products, information and services, if we do not establish our brand
quickly, we may lose the opportunity to build a critical mass of customers.
Promoting and positioning our brand will depend largely on the success of our
marketing efforts and our ability to provide consistent, high quality customer
experiences. To promote our brand, we will incur substantial expense in our
advertising efforts on television, radio, magazines and other forms of
traditional media, along with advertising on Web sites that we believe our
customers are likely to visit. We will also incur substantial expense in our
efforts to enter into strategic alliances with, including making investments in,
online and more traditional companies that we believe will promote our brand and
drive customers to our Web store. To provide a high quality customer experience,
we will also need to spend money to attract and train customer service
personnel. We also will incur substantial expenses to develop
<PAGE> 14
content to help build our brand and attract customers to our Web store. If these
brand promotion activities do not yield increased revenues, we will incur
additional losses. Beginning in the first half of 2000, we introduced a line of
private label pet products. We may not achieve consumer acceptance of these
products. Further, we may be forced to incur higher expenses in order to produce
or market our private label product lines, which could negatively affect our
financial condition or operating results.
INCREASING OUR PRODUCT DISTRIBUTION CAPACITY IS AN IMPORTANT PART OF OUR
BUSINESS STRATEGY AND WILL REQUIRE SIGNIFICANT INVESTMENTS IN CASH AND
MANAGEMENT RESOURCES. IF WE DO NOT SUCCESSFULLY BUILD ADDITIONAL DISTRIBUTION
CENTERS, WE WILL FACE DIFFICULTIES IN INCREASING OUR REVENUES AND WE MAY LOSE
CUSTOMERS TO OUR COMPETITORS.
We currently have two distribution centers -- one in Union City,
California that has a satellite operation in Hayward, California, and a second
center in Indianapolis, Indiana. We expect to begin operating a third
distribution center within the next twenty-one months. Our success depends on
our ability to build additional distribution centers to accommodate increases in
customer demand, reduce our shipping costs, reduce shipping times to customers,
provide for a large product selection and increase our gross margins. If we do
not successfully build additional distribution centers in time to accommodate
increases in customer demand, we may not be able to increase our revenues and we
may lose customers to our competitors. Opening additional distribution centers
will require significant capital investments in facilities and equipment, will
require us to hire and train a significant number of new employees, and could
divert management attention from other issues. We have invested an additional
$1.3 million in facilities and equipment during the second quarter of 2000 in
connection with the recent opening of our Indianapolis distribution center. For
additional information relating to the risks we may face in obtaining additional
financing, see "We may need to raise additional funds and these funds may not be
available to us when we need them. If we cannot raise additional funds when we
need them, our business could fail."
SINCE WE CURRENTLY OPERATE ONLY TWO DISTRIBUTION CENTERS LOCATED IN THE SAN
FRANCISCO BAY AREA AND THE INDIANAPOLIS AREA, WE ARE SUSCEPTIBLE TO THE RISK OF
DAMAGE TO OUR DISTRIBUTION CENTERS.
Since we currently only operate two distribution centers out of which we
ship products to nearly all of our customers, we are susceptible to power and
equipment failures, disruptions in our order fulfillment and delivery systems,
and fires, floods and other disasters. Furthermore, since our original
distribution center is located in the San Francisco Bay Area, which is an
earthquake-sensitive area, we are particularly susceptible to the risk of damage
to, or total destruction of, this distribution center and the surrounding
transportation infrastructure caused by earthquakes. We cannot assure you that
we are adequately insured to cover the total amount of any losses caused by any
of the above events. In addition, we are not insured against any losses due to
interruptions in our business due to damage to or destruction of our
distribution center caused by earthquakes or to major transportation
infrastructure disruptions or other events that do not occur on our premises.
WE EXPECT OUR QUARTERLY FINANCIAL RESULTS TO FLUCTUATE SIGNIFICANTLY
FROM QUARTER TO QUARTER, WHICH CAN CAUSE THE TRADING PRICE OF OUR COMMON STOCK
TO FLUCTUATE SIGNIFICANTLY.
We expect that our revenues and operating results will vary
significantly from quarter to quarter due to a number of factors, including:
- Consumer traffic to our Web store may fluctuate depending on the
effectiveness of our sales and marketing campaign, the timing and
level of promotions we engage in with Amazon.com, GO.com and our
other strategic partners, and the effectiveness of content on our Web
store and other factors;
<PAGE> 15
- The level of repeat purchases by customers, average order size and
mix of products sold may fluctuate as a result of the experience
consumers have on our Web store, the availability of products we have
for sale, seasonal factors and other factors;
- Our revenues may decline as a result of promotional offers made by
our competitors, the introduction of products or services offered by
our competitors, or the introduction of new competitors into our
market;
- We may experience consumer dissatisfaction with our Web store as we
add or change features, or as a result of technical difficulties on
our Web store that do not permit a consumer to access our Web store
or to complete a shopping session;
- Our expenses will also fluctuate depending on the timing and nature
of expansion of our distribution center; and our ability to achieve
efficiencies and lower shipping costs as a result of this expansion;
- Changes in government regulation of the Internet, particularly the
imposition of sales tax for online transactions, may discourage
online shopping and result in decreased revenues; and
- We may incur costs related to potential acquisitions of technology or
businesses.
To the extent our revenues and operating results fall below the
expectation of investors and securities analysts, the trading price of our
common stock may fall significantly.
BECAUSE OUR OPERATING EXPENSES ARE GENERALLY FIXED IN THE SHORT TERM, IF WE FAIL
TO ACHIEVE ANTICIPATED REVENUES WE WILL INCUR SUBSTANTIAL ADDITIONAL OPERATING
LOSSES. FURTHERMORE, OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO PREDICT
REVENUES AND PLAN OUR OPERATING EXPENSES.
Because of our limited operating history and the nascent stage of the
business to consumer retailing market, we have insufficient financial data on
which to forecast our revenues and operating expenses. Our operating expenses
are largely based on anticipated revenue trends and a high percentage of our
expenses are fixed in the short term. As a result, a delay in generating or
recognizing revenue for any reason could result in substantial additional
operating losses. The volume and timing of orders of pet products on our Web
store are difficult to predict because the online market for such products is in
its infancy. Due to the limited operating history of our Web store, we do not
have a material amount of repeat business from regular customers. Because our
Web store is designed to encourage repeat business and we do not yet have
sufficient historical data on how successful this strategy will be, we cannot
currently forecast revenue from regular customers or overall anticipated revenue
trends. Furthermore, as a result of our limited operating history, it is
difficult to predict the volatility associated with the nature and timing of
special promotional offers, such as reducing the price on selected products,
providing redeemable coupons to customers, or offering shipping below our actual
costs, and our advertising efforts. For example, our revenues may decrease
significantly after a promotional offer has expired or prior to an expected
offer. In addition, our advertising expenses may be disproportionately higher
than our anticipated revenues from these advertising efforts.
WE WILL NEED TO RAISE ADDITIONAL FUNDS AND THESE FUNDS MAY NOT BE AVAILABLE TO
US WHEN WE NEED THEM. IF WE CANNOT RAISE ADDITIONAL FUNDS WHEN WE NEED THEM, OUR
BUSINESS COULD FAIL.
Based on our current projections, we will need to raise funds in the
first quarter of 2001 through the issuance of equity, equity-related or debt
securities or through obtaining credit from financial institutions. We cannot be
certain that additional funds will be available to us on favorable terms when
required, or at all. If this additional financing is not available to us we may
need to dramatically change our business plan, sell or merge our business, or
face bankruptcy. In addition, our issuance of equity or equity-related
securities will dilute the ownership interest of existing stockholders and our
issuance of debt securities could increase the risk or perceived risk of our
company. Any of these actions could cause our stock price to fall.
<PAGE> 16
A PORTION OF OUR REVENUES MAY BE SEASONAL, WHICH COULD CAUSE OUR QUARTERLY
FINANCIAL RESULTS AND OUR COMMON STOCK PRICE TO FLUCTUATE SIGNIFICANTLY.
A portion of our revenues may be seasonal in nature, associated with the
sale of gift products for pets during the holiday season, the sale of outdoor
and activity-related pet products during the Spring season and the sale of flea
and tick products for pets during the Summer season. In addition, consumer fads
and other changes in consumer trends may cause shifts in purchasing patterns,
resulting in significant fluctuations in our operating results from one quarter
to the next and may result in significant fluctuations in our common stock
price. The rapid growth in our revenues since our inception make it impossible
to assess the impact of these factors.
WE DEPEND ON OUR ADVERTISING AGREEMENT WITH AMAZON.COM TO ATTRACT CUSTOMERS TO
OUR WEB STORE AND BUILD OUR BRAND. IN THE EVENT OUR ADVERTISING AGREEMENT WITH
AMAZON.COM WAS TO TERMINATE, WE COULD FACE SIGNIFICANTLY HIGHER COSTS AND
SIGNIFICANTLY MORE DIFFICULTY IN ATTRACTING CUSTOMERS.
We have entered into an advertising agreement with Amazon.com whereby
Amazon.com provides us with online promotions mutually agreed upon, such as
emails about Pets.com, and one or more links from different locations on its Web
site to our Web store, consistent with Amazon.com's other marketing
arrangements. Although our current agreement with Amazon.com expires in October
2000, Amazon.com could terminate most of these online promotions at any time. We
cannot be certain that our relationship with Amazon.com will be available to us
in the future on acceptable commercial terms, if at all. If we are unable to
maintain our relationship with Amazon.com or agree upon the terms and conditions
of continuing the agreement beyond October 2000, our customer traffic could fall
and our brand identity could be adversely impacted resulting in decreased
revenues, and our marketing expenses could increase as we are forced to incur
higher costs to attract customers. In addition, our relationship with Amazon.com
is not exclusive. Amazon.com could partner with any of our competitors or offer
competing products, information or services directly from its Web site.
Furthermore, by virtue of the fact that we derive traffic directly from the
Amazon.com Web site, any interruption in service of Amazon.com's Web site or the
distribution of products to its customers could reduce the number of customers
to our Web store and reduce our revenues. Because we depend on the brand
awareness of Amazon.com to help build our brand, negative publicity about
Amazon.com or a reduction of the effectiveness of its brand could also have a
negative impact on our brand and reduce our revenues.
WE UTILIZE CONSULTING ADVICE AND SUPPORT FROM AMAZON.COM FOR OPERATIONAL AND
STRATEGIC EXPERTISE. AMAZON.COM HAS NO CONTRACTUAL OBLIGATION TO PROVIDE THIS
SUPPORT. IF AMAZON.COM DOES NOT CONTINUE TO PROVIDE THE ADVICE AND SUPPORT WE
NEED, WE COULD INCUR HIGHER OPERATIONAL EXPENSES IN RUNNING OUR BUSINESS AND
DIFFICULTIES IN EXECUTING ON OUR BUSINESS PLAN.
Since our inception, Amazon.com has provided us with free informal
consulting assistance relating to the operation of our business. During this
time, Amazon.com has also provided us with assistance in negotiating with
vendors who also do business with Amazon.com. This assistance has allowed us to
incur significantly lower operational expenses than we could otherwise have
achieved at our early stage of development. Amazon.com has provided these
services to us because of Amazon.com's significant equity stake in us.
Amazon.com, however, is under no contractual obligation to continue to provide
this advice and support. While Amazon.com owned approximately 25.0% of our
capital stock as of August 1, 2000, we cannot be certain that Amazon.com will
continue to provide, or provide at all, the level of consulting advice and
support that Amazon.com has provided to us in the past. If we are unable to
maintain our relationship with Amazon.com, we would lose access to important
operational and strategic expertise, which could harm our business.
WE DEPEND ON OUR ABILITY TO BUILD AND MAINTAIN RELATIONSHIPS WITH OUR SUPPLIERS
TO OBTAIN SUFFICIENT QUANTITIES OF QUALITY MERCHANDISE ON
<PAGE> 17
ACCEPTABLE COMMERCIAL TERMS. IF WE FAIL TO MAINTAIN OUR SUPPLIER RELATIONSHIPS,
OUR REVENUES WILL DECLINE.
Our business strategy depends on providing a large selection of
well-known and high-quality branded products which in turn depends on our
ability to maintain relationships with a significant number of suppliers. We
currently purchase our products from approximately 200 suppliers. Our contracts
or arrangements with suppliers do not guarantee the availability of merchandise,
establish guaranteed prices or provide for the continuation of particular
pricing practices. Our current suppliers may not continue to sell products to us
on current terms or at all, and we may not be able to establish new suppliers to
ensure delivery of products in a timely manner or on terms acceptable to us.
Furthermore, because many of the products offered on our Web store are
well-known branded products, if suppliers of these products do not supply
products to us, we may lose customers who are unwilling to substitute for other
brands we carry. We are also dependent on suppliers for assuring the quality of
products supplied to us. Because we ship products directly to our customers, if
the quality of products supplied to us fall below our customers' expectations,
we may lose customers. In addition, our supply contracts do not restrict our
suppliers from selling products to our online competitors or to retailers other
than online retailers, which could limit our ability to supply the quantity of
products requested by our customers. We are also subject to the risks our
suppliers face, including employee strikes and inclement weather. Our failure to
deliver a large selection of high-quality and well-known branded products to our
customers in a timely and accurate manner, and at acceptable prices, would harm
our reputation, the Pets.com brand and our results of operations.
WE FACE THE RISK OF SYSTEMS INTERRUPTIONS AND CAPACITY CONSTRAINTS ON OUR WEB
SITE, POSSIBLY RESULTING IN ADVERSE PUBLICITY, REVENUE LOSSES AND EROSION OF
CUSTOMER TRUST.
The satisfactory performance, reliability and availability of our Web
store, transaction processing systems and network infrastructure are critical to
our reputation and our ability to attract and retain customers and to maintain
adequate customer service levels. Any future systems interruption that results
in the unavailability of our Web store or reduced order fulfillment performance
could result in negative publicity and reduce the volume of goods sold and the
attractiveness of our Web store, which could negatively affect our revenues. We
may experience temporary system interruptions for a variety of reasons in the
future, including power failures, software bugs and an overwhelming number of
visitors trying to reach our Web store during sales or other promotions. We may
not be able to correct a problem in a timely manner. Because we are dependent in
part on outside consultants for the implementation of certain aspects of our
system and because some of the reasons for a systems interruption may be outside
of our control, we also may not be able to remedy the problem quickly or at all.
We opened our Web store for customers in February 1999 and to the extent that
customer traffic grows substantially, we will need to expand the capacity of our
systems to accommodate a larger number of visitors. Any inability to scale our
systems may cause 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 are not
certain that we will be able to project the rate or timing of increases, if any,
in the use of our Web store accurately or in a timely manner to permit us to
effectively upgrade and expand our transaction-processing systems or to
integrate smoothly any newly developed or purchased modules with our existing
systems.
WE HAVE GROWN VERY RAPIDLY. THIS GROWTH HAS PLACED, AND OUR ANTICIPATED FUTURE
OPERATIONS WILL CONTINUE TO PLACE, A SIGNIFICANT STRAIN ON OUR MANAGEMENT
SYSTEMS AND RESOURCES. WE WILL NOT BE ABLE TO IMPLEMENT OUR BUSINESS STRATEGY
UNLESS WE ARE ABLE TO EFFECTIVELY MANAGE THIS STRAIN ON OUR SYSTEMS AND
RESOURCES.
We have rapidly and significantly expanded our operations, and
anticipate that we will continue to expand. From March 31, 1999 to September 30,
1999 to December 31, 1999 to March 31, 2000 to June 30, 2000 we grew from 4 to
123 to 270 to 279 to 320 employees, respectively. We currently have two
distribution centers, and expect to begin operating a third distribution center
within the next twenty-one
<PAGE> 18
months. This growth has placed, and our anticipated future operations will
continue to place, a significant strain on our management systems and resources.
We will not be able to implement our business strategy unless we are able to
effectively manage this strain on our systems and resources. We will not be able
to increase revenues unless we continue to improve our transaction-processing,
operational, financial and managerial controls, reporting systems and
procedures, expand, train, supervise and manage our work force, and manage
multiple relationships with third parties.
WE ENTER INTO STRATEGIC RELATIONSHIPS TO HELP PROMOTE OUR WEB STORE. IF WE FAIL
TO MAINTAIN OR ENHANCE THESE RELATIONSHIPS, WE MAY NOT BE ABLE TO ATTRACT AND
RETAIN CUSTOMERS, BUILD OUR PETS.COM BRAND AND ENHANCE OUR SALES AND MARKETING
CAPABILITIES.
We believe that our ability to attract customers, facilitate broad
market acceptance of our products and the Pets.com brand, and enhance our sales
and marketing capabilities depends on our ability to develop and maintain
strategic relationships with:
- Amazon.com, with whom we have entered into an advertising agreement
pursuant to which Amazon.com provides us with online promotions
mutually agreed upon;
- GO.com, with whom we have entered into a distribution agreement which
provides that we will engage in promotions on GO.com's online
properties, and place media advertising with ABC, Inc., which, along
with GO.com, is an affiliate of The Walt Disney Company;
- American Veterinary Medical Foundation, with whom we have entered
into an exclusive marketing agreement pursuant to which our products
and services will receive coverage in the American Veterinary Medical
Foundation's bi-monthly video which is sent to 17,000 veterinarians;
- PetPlace.com, Inc., a provider of online veterinary information in
whom we have made an equity investment and with whom we have entered
into an exclusive marketing agreement which provides for cross
promotions and direct links between our respective Web sites;
- Discovery.com, with whom as of August 1, 2000, as a result of our
acquisition of key assets of Petstore.com, we have entered into an
agreement that will enable us to promote our brand through Discovery
Communications' media network, as well as through the online channel
of Discovery.com;
- Safeway,Inc., with whom as of August 1, 2000, also as a result of our
acquisition of key assets of Petstore.com, we have entered into an
agreement that will allow us to conduct marketing and promotional
activities including certain in-store programs within Safeway's
approximately 1,500 U.S. retail locations; and
- Other pets-related Web sites and portals, and other Web sites that
can drive customer traffic to our Web store.
All of these relationships are relatively new and, accordingly, we have
no historical experience on which to evaluate their impact. If these
relationships do not assist us in attracting or retaining customers, it may be
difficult for us to grow our business. In addition, we may need to expend
significant additional resources to form additional strategic relationships if
the relationships set forth above fail to produce the desired results.
COMPETITION FROM BOTH TRADITIONAL AND ONLINE RETAILERS MAY RESULT IN PRICE
REDUCTIONS AND DECREASED DEMAND FOR OUR PRODUCTS AND SERVICES.
We compete in a market that is new, rapidly evolving and highly
competitive, and we expect competition to intensify in the future. Increased
competition could result in price reductions, fewer
<PAGE> 19
customer orders, reduced gross margins and loss of market share. We currently or
potentially compete with a variety of companies, many of which have
significantly greater financial, technical, marketing and other resources. These
competitors can be divided into several groups:
- online stores that specialize in pet products such as
Petopia.com, Inc.
PetsMart.com, Inc.
- online stores that offer pet products;
- superstore retailers of pet products such as
Petco Animal Supplies, Inc.
PetsMart, Inc.;
- specialty pet stores;
- mass market retailers such as
Wal Mart Stores, Inc.
Kmart Corporation
Target Stores, Inc.;
- supermarkets;
- warehouse clubs such as Costco Companies, Inc.;
- mail order suppliers of pet products; and
- pet supply departments at major department stores.
Many of these companies, which include national, regional and local
chains, have existed for a longer period, have greater financial resources, have
established marketing relationships with leading manufacturers and advertisers,
and have longer established brand recognition among customers.
We believe we may face a significant competitive challenge from our
competitors forming alliances with each other. For instance, Petopia, Inc. is
owned in part by Petco Animal Supplies, Inc., and PetsMart.com, Inc. is owned in
part by PetsMart, Inc. The combined resources of these alliances could pose a
significant competitive challenge to Pets.com. These relationships may enable
these online stores to achieve greater brand recognition, particularly in the
case of PetsMart.com, Inc., by leveraging the better established brand awareness
of their pet retail store partner. These relationships may also enable these
online stores to negotiate better pricing and other terms from suppliers by
aggregating their demand for products and negotiating volume discounts. Our
inability to partner with a major pet store chain could be a major competitive
disadvantage to us.
We also believe we may face significant competitive challenges from
discount general merchandise stores, mass market retailers and other retailers
that commence or expand their presence on the Internet to include pet products.
Finally, we are aware of numerous other smaller entrepreneurial companies that
are focusing significant resources on developing and marketing products,
information and services that will compete directly with those offered at
Pets.com.
We believe that there may be a significant advantage in establishing a
large customer base before our competitors do so. If we fail to attract and
retain a large customer base and our competitors establish a more prominent
market position relative to ours, this could inhibit our ability to grow. We
believe the principal factors in our market include brand recognition, product
selection, quality of Web store content, reliability and speed of order
shipment, customer service, speed and accessibility of our Web store,
personalized service, convenience and price. We will have little or no control
over how successful our
<PAGE> 20
competitors are in addressing these factors. In addition, with little
difficulty, our online competitors can duplicate many of the products, services
and content offered in our Web store.
EXPANSION OF OUR INTERNATIONAL OPERATIONS WILL REQUIRE MANAGEMENT ATTENTION AND
RESOURCES AND MAY BE UNSUCCESSFUL WHICH COULD HARM OUR FUTURE BUSINESS
DEVELOPMENT AND EXISTING DOMESTIC OPERATIONS.
As of June 30, 2000, we have conducted no international operations aside
from shipping product to customers in Canada, but we have made a $2.0 million
investment in PetsPark, Ltd., an U.K.-based company that intends to sell pet
products online. We may in the future build local versions of our Web store for
foreign companies or expand our international operations through acquisitions or
alliances with third parties. Our expansion plans will require management
attention and resources and may be unsuccessful. We have no experience in
selling our products to conform to local cultures, standards and policies. We
may have to compete with local companies that understand the local market better
than we do. In addition, to achieve satisfactory performance for consumers in
international locations it will be necessary to locate physical facilities, such
as server computers and distribution centers in the foreign market. We do not
have experience establishing such facilities overseas. We may not be successful
in expanding into any international markets or in generating revenues from
foreign operations. In addition, different privacy, censorship and liability
standards and regulations and different intellectual property laws in foreign
countries may cause our business to be harmed. Furthermore, once we expand
internationally we expect to incur net losses in developing foreign markets for
the foreseeable future.
OUR SYSTEMS AND OPERATIONS, AND THOSE OF OUR SUPPLIERS AND SHIPPERS, ARE
VULNERABLE TO NATURAL DISASTERS AND OTHER UNEXPECTED PROBLEMS.
Substantially all of our computer and communications hardware is located
at our leased facility in San Francisco, California and our systems
infrastructure is hosted at an Exodus Communications, Inc. facility in Santa
Clara, California. Our systems and operations are vulnerable to damage or
interruption from fire, flood, power loss, telecommunications failure,
earthquakes and similar events. In addition, our servers are vulnerable to
computer viruses, physical or electronic break-ins and similar disruptions,
which could lead to interruptions, delays, loss of data or the inability to
accept and fulfill customer orders. We do not currently have fully redundant
systems or a formal disaster recovery plan and do not carry sufficient business
interruption insurance to compensate for losses that may occur. Our suppliers
also face these risks.
We also depend on the efficient operation of Internet connections from
customers to our systems. These connections, in turn, depend on the efficient
operation of Web browsers, Internet service providers and Internet backbone
service providers, all of which have had periodic operational problems or
experienced outages. Any system delays, failures or loss of data, whatever the
cause, could reduce customer satisfaction with our applications and services and
harm our sales.
GOVERNMENTAL REGULATION OF OUR BUSINESS COULD REQUIRE SIGNIFICANT EXPENSES, AND
FAILURE TO COMPLY WITH GOVERNMENT REGULATIONS COULD RESULT IN CIVIL AND CRIMINAL
PENALTIES.
Our business is subject to federal, state and local regulations relating
to the shipment of pet food, live animals and pet products, advice relating to
animal care, and other matters. Regulations in this area often require
subjective interpretation, and we cannot be certain that our attempts to comply
with these regulations will be deemed sufficient by the appropriate regulatory
agencies. Violations of any regulations could result in various civil and
criminal penalties, including suspension or revocation of our licenses or
registrations, seizure of our inventory, or monetary fines, which could
adversely effect our operations.
WE NEED TO HIRE AND RETAIN A NUMBER OF ADDITIONAL TECHNOLOGY, CONTENT AND
PRODUCT ORIENTED PERSONNEL WHO MIGHT BE DIFFICULT TO FIND AND WHO ARE KEY TO OUR
CONTINUED GROWTH AND ULTIMATE SUCCESS IN THE MARKET.
<PAGE> 21
We intend to continue to hire a significant number of additional
personnel, including software engineers, editorial and customer support
personnel, marketing personnel, and warehouse and operational personnel.
Competition for these individuals is intense, and we may not be able to attract,
assimilate or retain additional highly qualified personnel in the future. The
failure to attract, integrate, motivate and retain these additional employees
could seriously harm our business.
WE RELY ON THE SERVICES OF OUR KEY PERSONNEL, WHOSE KNOWLEDGE OF OUR BUSINESS
AND TECHNICAL EXPERTISE ARE IMPORTANT TO OUR CONTINUED GROWTH AND ULTIMATE
SUCCESS IN THE MARKET AND WOULD BE DIFFICULT TO REPLACE.
We rely upon the continued service and performance of a relatively small
number of key technical and senior management personnel. Our future success
depends on our retention of these key employees, such as Julie Wainwright, our
Chief Executive Officer. None of our key technical or senior management
personnel are bound by employment agreements, and as a result, any of these
employees could leave with little or no prior notice. If we lose any of our key
technical and senior management personnel, our business could be seriously
harmed. We do not have "key person" life insurance policies covering any of our
employees.
MANY MEMBERS OF OUR MANAGEMENT TEAM ARE NEW TO THE COMPANY OR TO THE PET
PRODUCTS AND SERVICES INDUSTRY OR ONLINE BUSINESSES, AND EXECUTION OF OUR
BUSINESS PLAN AND DEVELOPMENT STRATEGY COULD BE SERIOUSLY HARMED IF INTEGRATION
OF OUR MANAGEMENT TEAM INTO OUR COMPANY IS NOT SUCCESSFUL.
Many of the members of our senior management team do not have prior
experience in the pet products and services industry or in online businesses or
in publicly traded companies. Our business could be seriously harmed if
integration of our management team into our company is not successful. We expect
that it will take time for our new management team to integrate into our company
and it is too early to predict whether this integration will be successful.
WE CANNOT BE CERTAIN THAT WE WILL BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY,
AND WE MAY BE FOUND TO INFRINGE PROPRIETARY RIGHTS OF OTHERS, WHICH COULD
NEGATIVELY AFFECT OUR BUSINESS BY DIVERTING OUR MONETARY RESOURCES AND
MANAGEMENT'S ATTENTION TO THESE MATTERS INSTEAD OF ALLOWING US TO FOCUS ON THE
CONTINUING DEVELOPMENT OF OUR MARKET STRATEGY.
We rely on a combination of trademark, trade secret and copyright law
and contractual restrictions to protect our intellectual property. These afford
only limited protection. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our Web store, including the
look and feel of our Web pages, products that we sell, product organization,
product information and sales mechanics or to obtain and use information that we
regard as proprietary, such as the technology used to operate our Web store, our
content and our trademarks.
We have filed applications for the registration of Pets.com(TM), the
Pets.com logo, Because Pets Can't Drive(TM), Keep It Comin'(TM), More Products
Than a Superstore Delivers(TM), People Helping Animals, Animals Helping
People(TM), Pets.commitment(TM) and our sock puppet in the U.S. and in some
other countries, although we have not secured registration of our marks to date.
We have been granted the right to use Pets.complete(TM) from a third party in
exchange for economic consideration. We may be unable to secure these
registrations. It is also possible that our competitors or others will adopt
service names similar to ours, thereby impeding our ability to build brand
identity and possibly leading to customer confusion. In addition, there could be
potential trade name or trademark infringement claims brought by owners of other
registered trademarks or trademarks that incorporate variations of the term
Pets.com or our other trademark applications. Any claims or customer confusion
related to our trademarks, or our failure to obtain any trademark registration,
would negatively affect our business.
<PAGE> 22
Litigation or proceedings before the U.S. Patent and Trademark Office
may be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets and domain names and to determine the validity and
scope of the proprietary rights of others. Any litigation or adverse priority
proceeding could result in substantial costs and diversion of resources and
could seriously harm our business and operating results. Finally, we intend to
sell our products internationally, and the laws of many countries do not protect
our proprietary rights to as great an extent as do the laws of the United
States.
Third parties may also claim infringement by us with respect to past,
current or future technologies. We expect that participants in our markets will
be increasingly subject to infringement claims as the number of services and
competitors in our industry segment grows. Any claim, whether meritorious or
not, could be time-consuming, result in costly litigation, cause service upgrade
delays or require us to enter into royalty or licensing agreements. These
royalty or licensing agreements might not be available on terms acceptable to us
or at all.
WE MAY NOT BE ABLE TO PROTECT OUR DOMAIN NAMES IN ALL COUNTRIES OR AGAINST ALL
INFRINGERS, WHICH COULD DECREASE THE VALUE OF OUR BRAND NAME AND PROPRIETARY
RIGHTS.
We currently hold the Internet domain name "pets.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 modify the
requirements for holding domain names. As a result, we may not be able to
acquire or maintain the domain names in all of the countries in which we conduct
business that utilize the term "pets" or "pets.com." We are aware that other
entities have already registered domain names utilizing the term "pets" or
"pets.com." For example, other entities have registered in the United States the
following domain names: pets-.com, pet-s.com, p-e-t-s.net and pets.net. If we
are unable to purchase these names from these entities on commercially
reasonable terms or in the event we were to otherwise lose the ability to use a
domain name in a particular country, we would be forced to incur significant
additional expenses to market our products within that country, including the
development of a new brand and the creation of new promotional materials and
packaging.
WE ARE SUBJECT TO PRODUCT LIABILITY CLAIMS AND MAY FACE LIABILITY FOR CONTENT ON
OUR WEB STORE, ANY OF WHICH COULD HARM OUR FINANCIAL CONDITION AND LIQUIDITY IF
WE ARE NOT ABLE TO SUCCESSFULLY DEFEND AGAINST SUCH CLAIMS.
Because we sell consumer products we may be subject to product liability
claims resulting from injuries to persons and animals caused by the products we
sell. We maintain limited product liability insurance. To the extent these
claims are not covered by or are in excess of our product liability insurance, a
successful product liability claim could harm our financial condition and
liquidity. In addition, because we post product information and other content on
our Web store and permit our customers to place content on our bulletin board
systems and in other areas of our Web store, we face potential liability for
negligence, copyright, patent, trademark, defamation, indecency and other claims
based on the nature and content of the materials that we post or permit our
customers to post. Claims of this type have been brought, and sometimes
successfully pressed, against Internet content distributors. In addition, we do
not and cannot practically screen all of the content generated by our users and
placed on our Web store. Although we maintain general liability insurance of $3
million, 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. Any imposition
of liability that is not covered by insurance or is in excess of insurance
coverage could harm our financial condition and liquidity.
AMAZON.COM AND OUR CURRENT OFFICERS AND DIRECTORS HOLD VOTING CONTROL OF OUR
CAPITAL STOCK AND THEREFORE ARE ABLE TO DECIDE ALL MATTERS REQUIRING APPROVAL OF
OUR STOCKHOLDERS, WHICH COULD DISCOURAGE AN
<PAGE> 23
ACQUISITION OF US OR MAKE REMOVAL OF INCUMBENT MANAGEMENT MORE DIFFICULT.
As of August 1, 2000, Amazon.com beneficially owned approximately 25.0%
of our outstanding capital stock and Mark Britto, Amazon.com's Vice President of
Strategic Alliances is a member of our Board of Directors. Therefore, Amazon.com
is able to significantly influence all matters requiring approval by our
stockholders, including the election of directors and the approval of mergers or
other business combination transactions. Amazon.com's substantial equity stake
in us could also make us a much less attractive acquisition candidate to
potential acquirors, because Amazon.com would be able to block the acquisition
by acting in concert with only a small number of other stockholders. In
addition, Amazon.com has sufficient votes to prevent the tax-free treatment of
an acquisition. Moreover, as of August 1, 2000 our executive officers, directors
and entities affiliated with them, including Amazon.com, in the aggregate,
beneficially owned approximately 49.5% of our outstanding capital stock. These
stockholders, if acting together, would be able to decide all matters requiring
approval by our stockholders, including the election of directors and the
approval of mergers or other business combination transactions.
WE DEPEND ON CONTINUED USE OF THE INTERNET, AND IF THE USE OF THE INTERNET DOES
NOT DEVELOP AS WE ANTICIPATE, OUR SALES MAY NOT GROW.
Our future revenues and profits, if any, substantially depend upon the
widespread acceptance and use of the Internet as an effective medium of business
and communication by our target customers. Rapid growth in the use of and
interest in the Internet has occurred only recently. As a result, acceptance and
use may not continue to develop at historical rates, and a sufficiently broad
base of consumers may not adopt, and continue to use, the Internet and other
online services as a medium of commerce.
In addition, the Internet may not be accepted as a viable long-term
commercial marketplace for a number of reasons, including potentially inadequate
development of the necessary network infrastructure or delayed development of
enabling technologies and performance improvements. Our success will depend, in
large part, upon third parties maintaining the Internet infrastructure to
provide a reliable network backbone with the speed, data capacity, security and
hardware necessary for reliable Internet access and services.
OUR SUCCESS DEPENDS ON THE WILLINGNESS OF CONSUMERS TO PURCHASE PET PRODUCTS
OVER THE INTERNET INSTEAD OF THROUGH TRADITIONAL RETAILERS. IF CONSUMERS ARE NOT
WILLING TO DO THIS, THE MARKET POTENTIAL FOR OUR PRODUCTS AND SERVICES WILL BE
IMPAIRED.
The online market for pet products, information and services is in its
infancy. The market is significantly less developed than the online market for
books, auctions, music, software and numerous other consumer products. If this
market does not gain widespread acceptance, our business may fail. Demand and
market acceptance for recently introduced services and products on the Internet
are subject to a high level of uncertainty, and there are few proven services
and products. Our success will depend on our ability to engage consumers who
have historically purchased pet products through traditional retailers. In order
for us to be successful, many of these consumers must be willing to utilize new
ways of buying pet products. In addition, a substantial proportion of the
consumers who use our Web store may be using our service because it is new and
different rather than because they believe it is a desirable way to purchase pet
products. Such consumers may use our service only once or twice and then return
to more familiar means of purchasing these products.
OUR SALES COULD BE NEGATIVELY AFFECTED IF WE ARE REQUIRED TO CHARGE TAXES ON
PURCHASES.
We do not collect sales or other similar taxes in respect of goods sold
by Pets.com, except from purchasers located in California and Indiana. However,
one or more states or the federal government may seek to impose sales tax
collection obligations on out-of-state companies, such as Pets.com, which engage
in or facilitate online commerce, and a number of proposals have been made at
the state and local level that would impose additional taxes on the sale of
goods and services through the Internet. In 1998, the U.S.
<PAGE> 24
federal government enacted legislation prohibiting states or other local
authorities from imposing new taxes on Internet commerce for a three-year
period, ending on October 1, 2001. This tax moratorium does not prohibit states
or the Internal Revenue Service from collecting taxes on our income, if any, or
from collecting taxes that are due under existing tax rules. A successful
assertion by one or more states or any foreign country that we should collect
sales or other taxes on the exchange of merchandise on our Web store could harm
our business. In addition, a number of trade groups and government entities have
publicly stated their objections to this tax moratorium and have argued for its
repeal. The Federal Advisory Commission on Electronic Commerce is in the process
of evaluating these issues. It has sent to Congress a report that contains
numerous substantive suggestions for Congressional action, including but not
limited to: extending the current moratorium on taxation on electronic commerce
for five years; permanently banning taxation on internet access; and, radically
simplifying the state and local sales and use tax system. There can be no
assurance that future laws will not impose taxes or other regulations on
Internet commerce, or that the three-year moratorium will not be repealed, or
that it will be renewed when it expires, any of which events could substantially
impair the growth of electronic commerce.
We intend to open distribution centers from time to time in other states
and, regardless of the outcome of this federal tax moratorium, may be required
to collect sales or other similar taxes in respects of goods sold by Pets.com
into these states. A successful assertion by one or more states or the federal
government that we should collect further sales or other taxes on the sales of
products through Pets.com could negatively affect our revenues and business.
WE RELY ON UNITED PARCEL SERVICE FOR PRODUCT SHIPMENTS TO US AND OUR
CUSTOMERS, AND COULD LOSE CUSTOMERS IF IT DOES NOT ADEQUATELY SERVE OUR NEEDS.
We rely on United Parcel Service, which currently delivers approximately
99% of our product shipments, including shipments to and from our distribution
facility. We are therefore subject to the risks, including employee strikes and
inclement weather, associated with its ability to provide delivery services to
meet our shipping needs. In addition, we do not have a written agreement with
United Parcel Service and have no way of ensuring that it will continue to
deliver our product shipments. The U.S. Postal Service and Federal Express
currently deliver the remaining balance of our product shipments. In the event
of the unsatisfactory performance of United Parcel Service, we may need to shift
shipments to these and other carriers. While we have the ability to switch
carriers, there are only a few national ground-based carriers that we do not
already employ and any change in third-party carriers could increase our
shipping costs or result in a delay in shipment of products to our customers for
a period of time. Failure to deliver products to our customers in a timely
manner would damage our reputation and brand.
WE ARE EXPOSED TO RISKS ASSOCIATED WITH CREDIT CARD FRAUD WHICH COULD REDUCE OUR
COLLECTIONS AND HARM OUR BUSINESS BECAUSE WE ARE UNABLE TO OBTAIN SIGNATURES
FROM OUR CUSTOMERS WHEN WE PROCESS ORDERS ONLINE.
A failure to adequately control fraudulent credit card transactions
would harm our net sales and results of operations because we do not carry
insurance against this risk. Under current credit card practices, we are liable
for fraudulent credit card transactions because we do not obtain a cardholder's
signature. Although we have experienced almost no losses from credit card fraud,
we face the risk of significant losses from this fraud as our sales increase.
Our failure to adequately control fraudulent credit card transactions could
reduce our collections and harm our business.
OUR REPUTATION COULD BE HARMED IF WE FAIL TO PREVENT ONLINE COMMERCE SECURITY
BREACHES. WE MAY THEREFORE NEED TO EXPEND SIGNIFICANT RESOURCES TO PROTECT
AGAINST SECURITY BREACHES OR TO ADDRESS PROBLEMS CAUSED BY BREACHES.
A significant barrier to online commerce and communications is the
secure transmission of confidential information over public networks, and our
failure to prevent security breaches could harm our business. Currently, a
significant number of our users authorize us to bill their credit card accounts
directly for all products sold by us. We rely on encryption and authentication
technology licensed from third parties
<PAGE> 25
to provide the security and authentication technology to effect secure
transmission of confidential information, including customer credit card
numbers. Advances in computer capabilities, new discoveries in the field of
cryptography, or other developments may result in a compromise or breach of the
technology used by us to protect customer transaction data. Any compromise of
our security could harm our reputation and expose us to a risk of loss or
litigation and possible liability and, therefore, harm our business. In
addition, a party who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions in our operations.
We may need to expend significant resources to protect against security breaches
or to address problems caused by breaches. Security breaches could damage our
reputation. Our insurance policies carry low coverage limits, which may not be
adequate to reimburse us for losses caused by security breaches.
IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES TO BETTER SERVICE OUR
CUSTOMERS AND MEET THEIR EXPECTATIONS, OUR SERVICES COULD BECOME OBSOLETE AND WE
COULD LOSE CUSTOMERS.
As the Internet and online commerce industry evolve, we must license
leading technologies useful in our business, enhance our existing services,
develop new services and technology that address the increasingly sophisticated
and varied needs of our prospective customers and respond to technological
advances and emerging industry standards and practices on a cost-effective and
timely basis. We may not be able to successfully implement new technologies or
adapt our Web store, proprietary technology and transaction-processing systems
to customer requirements or emerging industry standards. If we are unable to do
so, it could adversely impact our ability to build the Pets.com brand and
attract and retain customers.
GOVERNMENTAL REGULATION OF THE INTERNET AND DATA TRANSMISSION OVER THE INTERNET
MAY NEGATIVELY AFFECT OUR CUSTOMERS AND RESULT IN A DECREASE IN DEMAND FOR OUR
PRODUCTS, WHICH WOULD CAUSE A DECLINE IN OUR SALES.
Laws and regulations directly applicable to communications or commerce
over the Internet are becoming more prevalent. The most recent session of the
U.S. Congress resulted in Internet laws regarding children's privacy,
copyrights, taxation and the transmission of sexually explicit material. The
European Union recently enacted its own privacy regulations. The law of the
Internet, however, remains largely unsettled, even in areas where there has been
some legislative action. It may take years to determine whether and how existing
laws such as those governing privacy, libel and taxation apply to Web stores
such as ours. The delays that these governmental processes entail may cause
order cancellations or postponements of product purchases by our customers,
which would seriously harm our business. The rapid growth and development of the
market for online commerce may prompt calls for more stringent consumer
protection laws, both in the United States and abroad, that may impose
additional burdens on companies conducting business online. The adoption or
modification of laws or regulations relating to the Internet business could
result in a decrease in demand for our products, which would cause a decline in
our revenues.
OUR STOCK PRICE IS SUBJECT TO FLUCTUATION, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INVESTORS.
Although our initial public offering price was determined based on
several factors, the market price for our common stock has and will continue to
vary from the initial offering price. This could result in substantial losses
for investors. The market price of our common stock may fluctuate significantly
in response to a number of factors, some of which are beyond our control. These
factors include:
- Quarterly variations in operating results;
- Changes in financial estimates by securities analysts;
- Announcements by us or our competitors, of new product and service
offerings, significant contracts, acquisitions or strategic
relationships;
<PAGE> 26
- Publicity about our company, our products and services, our
competitors, or e-commerce in general;
- Additions or departures of key personnel;
- Any future sales of our common stock or other securities; and
- Stock market price and volume fluctuations of publicly-traded
companies in general and Internet-related companies in particular,
especially Amazon.com.
The trading prices of Internet-related companies and e-commerce
companies, including Amazon.com, have been especially volatile and many have
fallen since reaching near historical highs in prior months. Investors may be
unable to resell their shares of our common stock at or above the price they
paid for them. In the past, securities class action litigation has often been
brought against a company following periods of volatility in the market price of
its securities. We may be the target of similar litigation in the future.
Securities litigation could result in substantial costs and divert management's
attention and resources, which could seriously harm our business and operating
results.
A TOTAL OF 29,004,255 SHARES, OR 79.5%, OF OUR TOTAL OUTSTANDING SHARES ARE
RESTRICTED FROM IMMEDIATE RESALE, BUT MAY BE SOLD INTO THE MARKET IN THE NEAR
FUTURE. THIS COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DROP
SIGNIFICANTLY, EVEN IF OUR BUSINESS IS DOING WELL.
Our current stockholders hold a substantial number of shares, which they
will be able to sell in the public market in the near future. Sales of a
substantial number of shares of our common stock 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. After our initial public offering,
we had outstanding 29,544,737 shares of common stock. This includes 7,500,000
shares that we sold in the offering, which were eligible for immediate resale in
the public market. The remaining 22,044,737 shares will become eligible for
resale in the public market at various times between now and January 18, 2001.
Additionally, on July 13, 2000, in connection with our acquisition of certain
strategic assets and partnerships of PetStore.com, Inc., we issued 5,815,623
shares of common stock and 1,143,895 shares of redeemable, non-voting,
non-convertible series A preferred stock. This recently issued common stock will
not be eligible for resale until July, 2001, unless earlier registered with the
Securities and Exchange Commission. The holder of 5,243,752 shares of common
stock of the foregoing has been granted registration rights with respect to such
shares at such time as we become eligible to register the shares on a
registration statement on Form S-3. That will occur in February, 2001. The
series A preferred stock cannot be converted to common stock without the
approval of a majority of our stockholders at our next annual meeting in 2001.
Once converted, such shares are also eligible for resale beginning in July,
2001. However, the holder of 286,805 shares of common stock of the foregoing and
the series A preferred stock has been granted piggyback registration rights with
respect to such shares, which rights could conceivably be invoked prior to July
2001.
STOCKHOLDERS INCUR SUBSTANTIAL DILUTION AS A RESULT OF THE EXERCISE OF PRIOR
STOCK OPTION GRANTS.
We have issued option to acquire common stock at prices significantly
below our initial public offering price. Assuming that outstanding options are
exercised in full, there would be dilution to investors who purchased out stock
either in connection with or subsequent to our initial public offering.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have assessed our vulnerability to certain market risks, including
interest rate risk associated with financial instruments included in cash and
cash equivalents. Due to the short-term nature of these investments and our
investment policies and procedures, we have determined that the risk associated
with interest rate fluctuations related to these financial instruments does not
pose a material risk to the Company.
<PAGE> 27
PART II--OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, we may be involved in litigation relating to claims
arising out of our ordinary course of business.
(a) On April 12, 2000, we filed a complaint for declaratory judgment in the
United States District Court for the Northern District of California against
Robert Smigel, the creator of Triumph, the Insult Comic Dog, to establish
that Pets.com has not infringed upon any trademark held by Mr. Smigel or
engaged in unfair competition, that Mr. Smigel defamed Pets.com by claiming
that we stole the idea for our Sock Puppet from him, and that Mr. Smigel has
engaged in trade libel by making false accusations against us.
(b) On September 21, 1999 Biolink L.L.C. dba ERI International sued us in Los
Angeles County Superior Court for breach of contract, anticipatory breach of
contract, breach of the implied covenant of good faith and fair dealing, and
fraud arising out of a contract entered into for the shipment of live fish.
ERI International has stated four causes of action, three seeking damages in
the aggregate in excess of $500,000. We answered and asserted affirmative
defenses to the complaint. By order dated June 8, 2000, the court denied
plaintiff's motion for summary adjudication.
(c) On April 24, 2000, a former employee filed a complaint against us in the
Superior Court of the State of California for the City and County of San
Francisco alleging, in connection with her employment and subsequent
resignation from Pets.com, breach of contract, breach of the covenant of
good faith and fair dealing, fraud, defamation, and misappropriation of
trade secrets. We believe we have meritorious defenses against all of the
claims and intend to vigorously defend against them.
Item 2. Changes in Securities and Use of Proceeds.
(A) On January 25, 2000, we effected a .8 for 1 reverse stock split and
reincorporated from California to Delaware. Consequently, each
outstanding share of capital stock outstanding prior to this event was
reconstituted as .8 of a share, and each shareholder of the prior
California corporation became the holder of an equivalent number of
shares of capital stock of the successor Delaware corporation.
(B) Not applicable.
(C) Recent Sales of Unregistered Securities; Uses of Proceeds From
Registered Securities.
(a) Securities Sold.
(i) Between April 1, 2000 and June 30, 2000, we granted options
to purchase an aggregate of 701,500 shares of our common stock to a total of
25 employees under our 1999 Stock Plan and options to purchase an aggregate
of 347,700 shares of our common stock to a total of 87 employees under our
2000 Non-Statutory Stock Option Plan.
(ii) Between April 1, 2000 and June 30, 2000, we issued and sold
7,700 shares of Common Stock to two (2) individuals pursuant to the exercise
of outstanding stock options all at a weighted average exercise price of
$0.45 per share.
(b) Underwriters and Other Purchasers.
There were no underwriters for the transactions set forth in (a) (i)
and (ii) above.
(c) The shares referenced in item (a) (ii) above that were sold pursuant
to the exercise of stock options were sold at an average weighted
exercise price of $0.45, for total proceeds of approximately $3,469.
(d) The sales referenced in items (a)(i) and (ii) above were exempt
from registration under Section 4(2) of the Securities Act of 1933,
as amended (the "Act"), and the securities issued in connection
therewith were subsequently registered with the Securities and
Exchange Commission on a registration statement on Form S-8 filed on
July 28, 2000 (file number 333-42410).
(e) Terms of Conversion or Exercise. Not applicable.
(f) Use of Proceeds from sale of Registered Securities
<PAGE> 28
On February 16, 2000, the Company closed its initial public offering of
its Common Stock, $0.00125 par value. The managing underwriters in the offering
were Merrill Lynch & Co., Bear Stearns & Co. Inc., Thomas Weisel Partners LLC,
and Warburg Dillon Read LLC (the "Underwriters"). The shares of Common Stock
sold in the offering were registered under the Act on a Registration Statement
on Form S-1 (the "Registration Statement") (Reg. No. 333-92433) that was
declared effective by the SEC on February 11, 2000. The offering commenced on
February 11, 2000, on which date 7,500,000 shares of Common Stock registered
under the Registration Statement were sold at a price of $11.00 per share. The
aggregate price of the offering amount registered and sold was $82,500,000. In
connection with the offering, the Company paid an aggregate of $5,775,000 in
underwriting discounts and commissions to the Underwriters and the aggregate
proceeds to the Company were approximately $75.3 million after deducting
estimated offering expenses of $1.4 million.
We currently use the net proceeds primarily for working capital and
general corporate purposes, including funding product development and expanding
the sales and marketing organization. We have not yet determined the actual
expected expenditures and thus cannot estimate the amounts to be used for each
of these purposes. The amounts and timing of these expenditures will vary
depending on a number of factors, including the amount of cash generated by our
operations, competitive and technological developments and the rate of growth,
if any, of our business. In addition, we have used a portion and may continue to
use a portion of the net proceeds for further development of our distribution
capabilities and programs to expand our customer base. None of the Company's net
proceeds of the offering were paid directly or indirectly to any director,
officer, persons owning 10% or more of any class of equity securities of
Pets.com, or an affiliate of Pets.com.
ITEM 3. Defaults Upon Senior Securities.
None.
ITEM 4. Submission of Matters to a Vote of Security Holders.
None.
ITEM 5. Other Information.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. The following exhibits are attached hereto:
EXHIBIT
NUMBER
<TABLE>
<S> <C>
10.2.3* 2000 Non-Statutory Stock Option Plan.
10.42 Change of Control Agreement with Paul G. Manca dated March 17, 2000.
10.43 Form of Key Employee Retention Agreement with the Company's Chief Executive
Officer and the Company's President.
10.44 Form of Key Employee Retention Agreement with each of the Company's Vice
Presidents.
10.45 Loan Agreement with Ralph Lewis dated May 1, 2000, together with Promissory Note.
27.1 Financial Data Schedule.
</TABLE>
------------------
* Incorporated by reference from the Company's Registration
Statement on Form S-8 filed with the Commission on July 28, 2000
(File No. 333-42410).
b. The Company filed the following reports on Form 8-K during the
quarter ended June 30, 2000: None.
<PAGE> 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PETS.COM, INC.
By: /s/ PAUL MANCA
------------------------------------------
PAUL MANCA
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING AND FINANCE OFFICER)
Date: August 11, 2000
<PAGE> 30
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
10.2.3* 2000 Non-Statutory Stock Option Plan.
10.42 Change of Control Agreement with Paul G. Manca dated March
17, 2000.
10.43 Form of Key Employee Retention Agreement with the Company's
Chief Executive Officer and the Company's President.
10.44 Form of Key Employees Retention Agreement with each of the
Company's Vice Presidents.
10.45 Loan Agreement with Ralph Lewis dated May 1, 2000, together
with Promissory Note
27.1 Financial Data Schedule
</TABLE>
* Incorporated by reference from the Company's Registration Statement on Form
S-8 filed with the Commission on July 28, 2000 (File No. 333-42410).
