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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition period from _________ to _________.
Commission file number: 0-25790
CREATIVE COMPUTERS, INC.
Delaware 95-4518700
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2555 West 190th Street, Torrance, California 90504
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (310) 354-5600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, $.001 par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [_] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment this
Form 10-K. [_]
As of March 26, 1999, the aggregate market value of the Common Stock held
by non-affiliates of the Registrant was approximately $226 million. The number
of shares outstanding of the Registrant's Common Stock as of March 26, 1999 was
10,375,893.
Documents incorporated by reference into Part III: Portions of the
definitive Proxy Statement for the Registrant's 1999 Annual Meeting of
Stockholders are incorporated by reference into Part III hereof.
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CREATIVE COMPUTERS, INC.
TABLE OF CONTENTS
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Page
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PART I
Item 1. Business.......................................................... 3
Item 2. Properties........................................................ 24
Item 3. Legal Proceedings................................................. 24
Item 4. Submission of Matters to a Vote of Security Holders............... 24
PART II
Item 5. Market for Registrant's Common Stock
and Related Stockholder Matters................................... 25
Item 6. Selected Financial Data........................................... 26
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 27
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........ 33
Item 8. Financial Statements and Supplementary Data....................... 33
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............................ 33
PART III
Item 10. Directors and Executive Officers of the Registrant................ 34
Item 11. Executive Compensation............................................ 34
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 34
Item 13. Certain Relationships and Related Transactions.................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 35
SIGNATURES..................................................................... 37
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PART I
In accordance with the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), the Securities and Exchange Commission (the "Commission")
allows us to "incorporate by reference" information into this Report, which
means that we can disclose information required in this Report by referring you
to another filing separately submitted to the Commission. The information so
incorporated by reference is deemed to be part of this Report.
Specified portions of this Report are incorporated by reference to the
Annual Report on Form 10-K of uBid, Inc., a majority-owned subsidiary of
Creative Computers, Inc., for the year ended December 31, 1998, which was filed
with the Commission on March 31, 1999 (the "uBid 1998 10-K"). Creative and uBid
are each subject to the informational requirements of the Exchange Act and file
reports, proxy statements and other information with the Commission. These
reports are available at the public reference facility maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the Commission's regional offices located at Seven World
Trade Center, New York, New York 10048 and Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such
material may also be obtained from the Public Reference Section of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates, and may also be found on the Commission's Internet site at
http://www.sec.gov.
ITEM 1. BUSINESS
General
Creative Computers, Inc. (the "Company"), founded in 1987, is a direct
marketer of personal computer hardware, software and peripheral products. The
Company offers products to individual consumers, home offices, small businesses
and large corporations through direct response catalogs, dedicated inbound and
outbound telemarketing sales executives, the Internet, a direct sales force, and
a retail showroom. The Company offers a broad selection of products through its
distinctive full-color catalogs, including MacMall, PC Mall, and ComputAbility,
other promotional materials and the Company's four worldwide websites on the
Internet, pcmall.com, macmall.com, computability.com and ccit-inc.com. The
Company's staff of knowledgeable telemarketing sales executives, customer
service and technical support personnel work together to serve customers by
assisting in product selection and offering technical assistance. The Company
believes that its high level of customer service results in customer loyalty and
repeat customer orders. During 1997, the Company acquired and assimilated two
marketers of personal computer hardware and software products, Elek-Tek, Inc.
(currently operating as CCIT) and ComputAbility, Ltd. In September 1997, the
Company formed a wholly-owned subsidiary, uBid, to sell computer-related
products and consumer electronics through an auction format on the Internet.
During 1997, the Company operated four retail showrooms in Southern
California under the name Creative Computers and three retail showrooms in
Illinois and one retail showroom in Indiana under the name of Elek-Tek. During
February 1998, the Company closed its Indiana showroom. On March 20, 1998, the
Company closed six retail showrooms to focus its efforts on its catalog,
corporate and Internet channels. Net sales from the Company's retail showroom
operations were $57.9 million, $67.8 million and $43.6 million for the years
ended December 31, 1996, 1997 and 1998, representing 13.0%, 12.4% and 6.3% of
net sales, respectively. In the first quarter of 1998, the Company recorded a
one-time pretax restructuring charge of $10.5 million relating to exit costs
associated with the closing of retail operations. Recorded in selling, general
and administrative costs were $3.1 million write-off of goodwill, $1.9 million
write-off for fixed assets, $1.5 million reserve for lease exit costs, and $0.3
million in employee-related severance costs. Recorded as cost of sales were
$3.7 million of reserves for store inventory.
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On December 9, 1998, uBid completed an initial public offering of 1,817,000
shares of its Common Stock. Upon completion of this offering, the Company
beneficially owned 80.1% of the outstanding Common Stock of uBid. The Company
has announced that it intends to distribute (the "Distribution") to its
stockholders, prior to December 31, 1999, all of its shares of Common Stock of
uBid, subject to certain conditions. See "Separation of uBid from the Company."
A description of uBid's business is contained in Part I, Item 1 of the uBid 1998
10-K under the caption "The Company" and is incorporated herein by reference.
Strategy
The Company's strategy is to be a leading high-volume, cost-effective
direct marketer of a broad range of personal computers, software and related
products. Specific elements of the Company's operating strategy include:
Expansion into Outbound Telemarketing. During 1998, the Company intensified
its outbound telemarketing efforts to focus on the under-served small and
medium-size business market. The Company believes this market represents a high
potential growth opportunity. Outbound business-to-business sales can also be
more profitable than inbound sales due to reduced advertising and higher average
order size. The Company's strategy is to rapidly expand its outbound sales
executive workforce and mine its catalog customer database as well as purchased
name lists for prospects. During the year, the Company hired experienced
outbound telemarketing executives to manage this initiative and experienced
outbound telemarketing recruiters to aggressively expand the outbound sales
executive workforce. The Company also commissioned the development of a new
comprehensive training program for outbound sales executives. The Company
expects to continue to invest in outbound telemarketing aggressively and
prospect its catalog database for sales leads. The Company expects that its
outbound telemarketing initiative will transform the Company's customer sales
mix to an even higher percentage of business customer sales.
Leverage of Internet Leadership Position. The Company considers itself a
leader in Internet e-commerce innovation and intends to continue enhancing its
leadership position on the Internet. The Company was among the first to enter
the Internet auction space with its ubid.com web site and completed a successful
initial public offering ("IPO") of uBid in December 1998. The Company was also
among the first to offer Electronic Software Distribution (ESD) that allows
customers to purchase and download software from its web site.
During 1998, the Company continued to introduce new Internet innovations
including a complete redesign of its macmall.com, pcmall.com, computability.com,
and ccit-inc.com web sites during the fourth quarter. Innovations introduced to
the web sites include: ProductPro- a context sensitive shopping tool that allows
Web users to quickly and intuitively locate products that meet their needs and
preferences; Product Comparisons- online customers can compare selected products
in a side-by-side grid format to aid in purchasing decisions and Product
Availability- availability of merchandise as the actual item count in the
Company's Memphis warehouse and selected distribution partners' warehouses. The
Company intends to take advantage of its e-commerce experience and continue to
introduce new innovations to grow its Internet retail position.
In March 1999, the Company launched eCost.com as a new wholly owned
subsidiary. eCOST.com offers a broad selection of name-brand products, most of
which are sold at or below wholesale cost. Customers are provided an itemized
description of the fees associated with processing their orders. These fees
include the costs of warehousing, administrative and shipping expenses, as well
as a small order processing fee. With the introduction of eCOST.com, the Company
is among the first full-spectrum Internet resellers in the personal computing
marketplace, offering customers many distinct and different ways to purchase
computer hardware, software, peripherals and consumer electronics.
Spin-off of uBid. During September 1997, the Company formed uBid as a
subsidiary of the Company to sell computers, computer-related products, consumer
electronics, housewares, and sports and recreation products through an auction
format on the Internet. When visiting the uBid website, shoppers review an item
or group of items and offer bids, driving the price toward a true market value.
During the auction, bidders are notified via e-mail when they are outbid by a
competing shopper. Customers can
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increase their bid by simply replying to the e-mail or by returning to the fast-
paced action at the uBid website. When the auction closes, the highest bidders
win the merchandise at the price they bid for it.
On December 9, 1998, uBid completed an initial public offering of 1,817,000
shares of its Common Stock, raising $23.8 million for uBid's advertising, brand
and infrastructure development and for general corporate purposes. As of March
25, 1999, the Company owned approximately 80.1% of the outstanding common stock
of uBid. The Company has announced that it intends to distribute to
shareholders, subject to the satisfaction of certain conditions, its ownership
in uBid by means of a tax-free stock dividend in 1999, but in no event prior to
June 7, 1999.
Focus on the Windows/Intel (WINTEL) Market. The Company launched its first
PC catalog, PC Mall, primarily for WINTEL customers, in May 1995. The Company
published seven editions of PC Mall with a total circulation of 11.1 million
copies in 1995 and thirteen editions with a circulation of 15.3 million copies
in 1996 and more than doubled its year-over-year WINTEL-based revenue. During
1997, the Company published fourteen editions of PC Mall with a circulation of
21.9 million copies and three editions of its ComputAbility catalog with a
circulation of 1.5 million copies during the third and fourth quarters,
resulting in a combined WINTEL catalog circulation increase of 53%. The
increased catalog circulation coupled with the Company's acquisitions of Elek-
Tek and ComputAbility caused its 1998 WINTEL revenue mix to exceed 50% for the
first time. WINTEL revenue for 1998 increased to $365 million, a 65% increase
over 1997. In 1998, the Company continued to expand WINTEL catalog circulation,
publishing fourteen editions of PC Mall Business Solutions with a circulation of
25.8 million copies and thirteen editions of its ComputAbility catalogs with a
circulation of 9.1 million copies. WINTEL catalog circulation increased during
1998 by 49% over 1997.
The Company is authorized or otherwise has the ability to sell IBM, Compaq,
Hewlett-Packard, Sony, Hitachi, Toshiba, Fujitsu and other name brand computers.
The Company has rapidly become one of the leading catalog resellers of WINTEL
products since the start of its WINTEL initiative in 1995.
Continued Macintosh Marketshare Expansion. Throughout 1998, the Company
continued to be a leading direct marketer of Macintosh products offering the
full line of Apple as well as related products. The Company's sales of Mac-
related products declined 14% to $279 million for 1998 from $325 million in
1997; however, the third and fourth quarters of 1998 experienced the first MAC
sales growth since January 1996. The Company plans to continue its efforts to
expand its Macintosh market share. In the third quarter of 1998, the Company
launched a Mac Software catalog as part of that effort. During 1998, the
Company published fourteen editions of its MacMall catalog with a circulation of
33.0 million copies, an 8% decrease from last year's 36.0 million circulation
and a 9% increase over the 30.3 million copies circulated in 1996.
Marketing Database Growth. The Company has compiled a proprietary mailing
list of nearly 5 million names of previous and potential customers and has added
to the database through the acquisitions of Elek-Tek and ComputAbility. The
database is continually analyzed to target customer types and increase response
and purchase rates. The Company's response rate (calculated by dividing the
number of orders generated by the number of catalogs distributed) for its
proprietary mailing list during 1998 was higher than its response rate for third
party mailing lists.
Increased Relationship-Based Selling. The Company's sales executives are
highly trained in relationship building with their customers and are
continuously coached to offer higher levels of service. The Company is committed
to relationship-based selling. The sales executive is trained and empowered to
handle all customer needs including customer service and returns-related issues.
Additionally, sales executives bring other expertise to bear as needed from
within the Company including Novell-trained
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Certified Network Engineers (CNE), Microsoft Windows NT specialists (MCSE) and
Apple-certified technicians.
The information pertaining to uBid's business strategy is contained in the
uBid 1998 10-K in Part I, Item 1 under the caption "Business Strategy" and is
incorporated herein by reference. See "Separation of uBid from the Company."
Marketing and Sales
The Company's various marketing programs are designed to attract new
customers and to stimulate additional purchases by previous customers. The
Company continuously attracts new customers by selectively mailing catalogs to
prospective customers as well as through advertising on the Internet and in
major user magazines, such as PC World, PC Magazine, Computer Shopper and
MacWorld. In addition, the Company obtains the names of prospective customers
through the use of selected mailing lists acquired from various sources,
including manufacturers, suppliers and computer magazine publishers.
The Company sells its products to individual consumers, home offices, small
businesses and large corporations. During 1998, the Company shipped
approximately 1,196,000 mail order/catalog orders with an average order size of
$502. The Company distributes its catalogs throughout the United States.
Catalogs. The Company published fourteen editions of its PC Mall catalogs
during 1998 and distributed approximately 25.8 million catalogs. PC Mall
customers receive a catalog several times a year depending on purchasing
history. In addition, the Company includes a catalog with every order shipped,
as well as special promotional flyers and manufacturers' product brochures.
The Company published fourteen editions of MacMall in 1998 and distributed
approximately 33 million catalogs. Active MacMall customers receive a catalog
several times a year depending upon purchasing history, and the Company includes
a catalog with every order shipped, as well as special promotional flyers and
manufacturers' product brochures.
The Company creates all of its catalogs in-house with its own design team
and production artists using a computer-based desktop publishing system. The in-
house preparation of the catalogs streamlines the production process, provides
greater flexibility and creativity in catalog production, and results in
significant cost savings over outside production.
The Internet. The Company offers worldwide websites on the Internet that
can be accessed via its four catalog names, pcmall.com, macmall.com,
computability.com and ccit-inc.com. During 1997, the Company expanded its
Internet retail offerings by launching uBid, an Internet site that sells
computer and other electronic products through an auction format. The Company
maintains direct links to its PC Mall website on AOL (through the AOL Shopping
Channel) and on the uBid Internet site.
The Company offers many advanced Internet features such as on-line
ordering, access to inventory availability and a large product selection with
detailed product information. Sales generated through the Internet have grown
rapidly for the Company as it offers its customers a convenient means of
shopping and ordering its products. In addition, the Company's website also
serves as another source of new customers.
Outbound and Inbound Telemarketing. The Company believes that much of its
success has come from the quality and training of its telemarketing sales
executives. These sales executives are responsible for assisting customers in
purchasing decisions, answering product pricing and availability questions and
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processing product orders. Telemarketing sales executives have the authority to
vary prices within specified parameters in order to meet prices of competitors.
In addition to product training, the sales executives are trained in systems and
networking solutions, sales techniques, phone etiquette and customer service.
Telemarketing sales executives attend frequent training sessions to stay up-to-
date on new products. The Company's toll-free order numbers are staffed by
sales executives 24 hours a day, seven days a week. Inbound and outbound
telemarketing sales executives are assisted by customer service and technical
support personnel.
The Company's phone and computer systems are used for order entry, customer
tracking and inventory management. The computer system maintains a database
listing previous customer purchases, which allows telemarketing sales executives
to make product suggestions that fit each customer's specific buying preferences
and to offer the latest upgrades for products previously purchased from the
Company.
Vendor Supported Marketing. The Company currently has a marketing team that
sells advertising space in the Company's catalogs, advertising on the Company's
Internet sites and vendor supported outbound marketing campaigns. These ad sales
generate revenues which offset a substantial portion of the expense of
publishing and distributing the catalogs. The same marketing team develops
marketing campaigns to maximize product sales.
National Off-Page Advertising. The Company continuously attracts new
catalog customers and generates orders through large multi-page color
advertisements in major publications such as PC World, PC Magazine, Computer
Shopper and MacWorld. During 1998, the Company purchased 582 pages of magazine
advertising.
Corporate Sales. The specific needs of corporate buyers are fulfilled
through a combination of inbound and outbound full-time sales personnel as well
as a direct sales force through its CCIT subsidiary. The Company's sales staff
builds long-term relationships with corporate customers through regular phone
contact and personalized service. Corporate customers may choose from several
purchase or lease options for financing product purchases, and the Company
extends credit terms to certain corporate customers.
Customer Return Policy. The Company offers a 30-day return policy on a
number of its products subject to vendor terms and conditions. Returns are
monitored to identify trends in product acceptance and defects, to enhance
customer satisfaction and to reduce overall returns.
The information pertaining to uBid's marketing and sales is contained in
the uBid 1998 10-K in Part I, Item 1 under the caption "Sales and Marketing" and
is incorporated herein by reference.
Products and Merchandising
The Company offers hardware, software, peripherals, components and
accessories for users of computer products. The Company screens new products and
selects products for inclusion in its catalogs based on features, quality, sales
trends, price, margins, cooperative/market development funds and warranties. The
Company offers its customers other value-added services, such as the ability to
purchase systems that have been specifically configured to meet the customer's
requirements. Through frequent mailings of its catalogs, the Company is able to
quickly introduce new products and replace slower selling products with new
products.
The following table sets forth the Company's (excluding uBid) net sales and
percentage of net sales by major product category for the periods presented.
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Year Ended December 31,
(in millions of dollars)
1996 % 1997 % 1998 %
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Computer systems............ $166.9 37.5% $231.1 42.3% $273.0 42.4%
Peripherals, components 227.8 51.2 247.9 45.4 291.7 45.3
and accessories..........
Software.................... 45.4 10.2 60.9 11.2 68.5 10.6
Other (1)................... 4.9 1.1 6.2 1.1 10.9 1.7
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Total.................. $445.0 100.0% $546.1 100.0% $644.1 100.0%
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(1) Other consists primarily of other electronic products, income from labor
charges and sales of extended warranties.
Computer Systems. In connection with the Company's expansion into the
WINTEL market, the Company has obtained catalog sales authorizations or
otherwise has the ability to sell WINTEL products from the major WINTEL-platform
hardware manufacturers, including IBM, Compaq, Hewlett-Packard, Sony, Hitachi,
Toshiba, Fujitsu and others. The Company is also authorized or otherwise has the
ability to sell the full line of Apple hardware.
Peripherals, Components and Accessories. The Company offers a large
selection of peripheral and component products from manufacturers such as Apple,
Hewlett-Packard, Sony, Epson, 3Com, US Robotics, IBM, Iomega and Compaq.
Peripherals and components include printers, modems, monitors, data storage
devices, add-on circuit boards, connectivity products and communications
products. The accessories offered by the Company include a broad range of
computer-related items and supplies such as diskettes, cables and connectors.
Software. The Company sells a wide variety of software packages in the
business and personal productivity, utility, language, educational and
entertainment categories, including word processing, spreadsheet and database
software. The Company offers a large number of software programs from
established vendors, such as Microsoft, Corel, Adobe, Symantec, Quark, Lotus,
Macromedia and Intuit as well as numerous specialty products from new and
emerging vendors. The Company also markets upgrades from certain vendors, such
as Symantec, Corel, Lotus and Microsoft, which the Company believes offer
incremental revenue opportunities.
The information pertaining to uBid's products and merchandising is
contained in uBid 1998 10-K in Part I, Item 1 under the caption "Products and
Merchandising" and is incorporated herein by reference.
Purchasing and Inventory
The Company believes that effective purchasing is a key element of its
business strategy to provide name brand computer products and related software
and peripherals at competitive prices. The Company believes that its high
volume of sales results in increased purchasing power with its primary
suppliers, resulting in volume discounts, favorable product return policies and
vendor promotional allowances. The Company purchases products from over 900
vendors. During 1996, 1997 and 1998, products manufactured by Apple represented
approximately 30.1%, 21.4% and 20.0% of net sales, respectively. The Company is
also linked electronically with three large distributors, which allows account
executives to view distributor product availability on line and drop-ship
product directly to their customers. The benefits of this program, known as
virtual warehouse, include reduced inventory carrying
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costs and improved inventory turns. The Company intends to expand its use of
virtual warehouse in the future.
Most key vendors have agreements to provide market development funds to the
Company, whereby such vendors finance portions of the cost of catalog
publication and distribution based upon the amount of coverage given in the
catalogs for their products. Termination or interruption of the Company's
relationships with its vendors, or modification of the terms of or
discontinuance of the Company's agreements with its vendors, could adversely
affect the Company's operating results. The Company's success is, in part,
dependent upon the ability of its vendors to develop and market products that
meet the changing requirements of the marketplace. As is customary in the
industry, the Company has no long-term supply contracts with any of its vendors.
Substantially all of the Company's contracts with its vendors are terminable
upon 30 days' notice or less.
The Company attempts to manage its inventory position to generate the
highest levels of customer satisfaction possible while limiting inventory risk.
The Company believes that it has increased its ability to provide constrained
products, which it believes is an important competitive advantage; and the
Company invested in this strategy heavily during 1998. The Company's average
annual inventory turns were 7.7 times in 1996, 9.9 times in 1997 and 13.5 times
in 1998. Inventory levels may vary from period to period, due in part to
increases or decreases in sales levels, the Company's practice of making large-
volume purchases when it deems the terms of such purchases to be attractive and
the addition of new manufacturers and products. The Company has negotiated
agreements with many of its vendors which contain price protection provisions
intended to reduce, in part, the Company's risk of loss due to manufacturer
price reductions. The Company currently has such rights with respect to products
which it purchases from Apple, IBM, Compaq, Hewlett Packard and certain other
vendors; however, such rights vary by product line, have other conditions and
limitations and can be terminated or changed at any time.
The market for personal computers, peripherals and software is
characterized by rapid technological change and a growing diversity of products.
The Company's success depends in large part on its ability to identify and
obtain the right to market products that will meet the changing requirements of
the marketplace and to obtain sufficient quantities of product to meet changing
demands. There can be no assurance that the Company will be able to identify and
offer products necessary to remain competitive or avoid losses related to excess
or obsolete inventory.
The information pertaining to uBid's purchasing and inventory is
incorporated by reference to uBid's 1998 10-K in Part I, Item 1, under the
caption "Vendor Relationships."
Distribution
The Company operates a full-service 325,000 square foot distribution center
in Memphis, Tennessee. The centralized distribution operations, strategically
located near the Federal Express hub in Memphis, allow most orders of in-stock
product accepted by 10:00 p.m. Eastern Standard Time to be shipped for delivery
by 10:30 a.m. the following day via Federal Express. Upon request, orders may
also be shipped at a lower cost by United Parcel Ground Service. In July 1998,
uBid entered into a sublease with the Company currently covering 100,000 square
feet of the Company's 325,000 square foot facility. The uBid sublease agreement
is co-terminus with the building lease.
When an order is entered into the system, a computer credit check or credit
card verification is performed and, if approved, the order is electronically
transmitted to the warehouse area, and a packing slip is printed for order
fulfillment. Orders fulfilled by certain distributors linked electronically
with the Company are transmitted directly to their warehouses. All inventory
items are bar coded and located in computer-designated areas which are easily
identified on the packing slip. All orders are checked with bar code scanners
prior to final packing to ensure that each order is packed correctly.
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The Company believes that its existing distribution facilities are
currently adequate for its needs.
The information pertaining to uBid's distribution and order fulfillment is
contained in the uBid 1998 10-K in Part I, Item 1 under the caption "Order
Fulfillment" and is incorporated herein by reference.
Management Information Systems
The Company has committed significant resources to the development of a
sophisticated computer system which is used to manage all aspects of its
business. The Company's computer system supports telemarketing, marketing,
purchasing, accounting, customer service, warehousing and distribution, and
allows the preparation of daily operating control reports which provide concise
and timely information regarding key aspects of its business. The system allows
the Company to, among other things, monitor sales trends, make informed
purchasing decisions and provide product availability and order status
information. In addition to the main computer system, the Company has a system
of networked personal computers, which facilitates data sharing. The Company
also applies its management information systems to the task of managing its
inventory. The Company currently operates its management information system
using a Hewlett Packard HP3000 Enterprise System and has a back-up system
available in the event of a system failure. The Company believes that in order
to remain competitive it will be necessary to upgrade its management information
systems on a continuing basis.
The Company's success is in part dependent on the accuracy and proper
utilization of its management information systems, including its telephone
system. In addition to the costs associated with system upgrades, the
transition to and implementation of new or upgraded hardware or software systems
can result in system delays or failures. Any interruption, corruption,
degradation or failure of the Company's management information systems or
telephone system could impact its ability to receive and process customer orders
on a timely basis.
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Retail Computer Showrooms
During 1997, the Company operated four retail computer showrooms in
Southern California and four retail computer showrooms in the Midwest, ranging
in size from approximately 3,400 to 40,000 square feet of space. However, the
Company has focused its expansion efforts and resources on the direct mail
channel. As of March 25, 1999, the Company operated one retail computer
showroom, located in Santa Monica, California.
During the first quarter of 1998, the Company closed seven retail showrooms
to focus its efforts on its catalog, corporate and Internet channels of
distribution. The Company recorded a one-time pretax restructuring charge of
$10.5 million relating to exit costs associated with the closing of retail
operations. Recorded in selling, general and administrative costs were $3.1
million of goodwill write-offs, $1.9 million of fixed asset write-offs, $1.5
million of reserves for lease exit costs, and $0.3 million of employee-related
severance costs. Recorded as cost of sales were $3.7 million of reserves for
store inventory.
Competition
The retail business for personal computers and related products is highly
competitive. The Company competes with other direct marketers, including
MicroWarehouse, CDW, Multiple Zones, Insight Direct, PC Connection and Global
Direct. The Company also competes with Internet retailers such as buy.com,
onsale@cost and beyond.com. In addition, the Company competes with computer
retail stores and resellers including superstores such as CompUSA and Best Buy,
corporate resellers such as Compucom, Entex and Inacom, certain hardware and
software vendors such as Gateway and Dell Computer which sell directly to end
users, and other direct marketers of hardware, software and computer-related
products. Barriers to entry are relatively low in the direct marketing industry
and the risk of new competitors entering the market is high. The market in which
the Company's retail showroom operates is also highly competitive.
The manner in which personal computers, software and related products are
distributed and sold is changing, and new methods of sales and distribution have
emerged, such as the Internet. Technology now allows software vendors the
ability to sell and download programs directly to consumers, if so desired. In
addition, in recent years the industry has generated a number of new, cost-
effective channels
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of distribution such as computer superstores, consumer electronic and office
supply superstores, national direct marketers and mass merchants. Computer
resellers are consolidating operations and acquiring or merging with other
resellers to achieve economies of scale and increased efficiency. In addition,
traditional retailers have entered and may increase their penetration into the
direct mail channel. The current industry reconfiguration and the trend toward
consolidation could cause the industry to become even more competitive, further
increase pricing pressures and make it more difficult for the Company to
maintain its operating margins or to increase or maintain the same level of net
sales or gross profit.
Although many of the Company's competitors have greater financial resources
than the Company, the Company believes that its ability to offer the consumer a
wide selection of products, at low prices, with prompt delivery and a high level
of customer service, and its good relationships with its vendors and suppliers,
allow it to compete effectively. There can be no assurance that the Company can
continue to compete effectively against existing or new competitors that may
enter the market. The Company believes that competition may increase in the
future, which could require the Company to reduce prices, increase advertising
expenditures or take other actions which may have an adverse effect on the
Company's operating results.
The information pertaining to uBid's competition is contained in the uBid
1998 10-K in Part I, Item 1 under the caption "Competition" and is incorporated
herein by reference.
Employees
As of December 31, 1998, the Company employed 974 full-time people,
including 159 people at the Company's distribution center. The Company
emphasizes the recruiting and training of high quality personnel and, to the
extent practical, promotes people to positions of increased responsibility from
within the Company. Each employee initially receives training appropriate for
his or her position, followed by varying levels of training in computer
technology. New account executives participate in an intensive four-week
training program, during which time they are introduced to the Company's
philosophy, available resources, products and services. Training for specific
product lines and continuing education programs for all employees are conducted
on an ongoing basis, supplemented by vendor-sponsored training programs for all
sales executives and technical support personnel.
The Company's employees are generally compensated on a basis that rewards
performance and the achievement of identified goals. For example, sales
executives receive compensation pursuant to a commission schedule which is based
primarily upon aggregate gross profit dollars generated from their sales
efforts. The Company believes that these incentives positively impact its
performance and operating results.
The Company considers its employee relations to be good. None of the
Company's employees is represented by a labor union, and the Company has
experienced no work stoppages.
Since its formation, the Company has experienced rapid growth. As a result
of this growth, the Company has added a significant number of employees and has
been required to expend considerable effort in training these new employees.
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Properties
The Company's facilities at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Description Sq. Ft. Location
- ----------- ---------- ---------------------
<S> <C> <C>
Creative Computers Corporate Headquarters.... 98,300 Torrance, CA
Distribution Center.......................... 325,000 Memphis, TN
Retail Showroom.............................. 13,050 Santa Monica, CA
CCIT/uBid Corporate Headquarters............. 28,685 Elk Grove Village, IL
Kansas Property.............................. 32,800 Lenexa, KS
CCIT Colorado Corporate Sales................ 2,315 Englewood, CO
CCIT Indiana Corporate Sales................. 6,500 Indianapolis, IN
ComputAbility Corporate Headquarters......... 15,000 Milwaukee, WI
ComputAbility Sales Office................... 15,000 Milwaukee, WI
</TABLE>
The Company leases all of its facilities, except for the following: 9,750
square feet of the Santa Monica retail showroom, the Lenexa retail showroom, and
the ComputAbility Corporate headquarters each of which is owned by the Company.
The Company's distribution center serves the Company's catalog, Elek-Tek and
ComputAbility operations as well as its retail showrooms. The Memphis facility
includes shipping, receiving, warehousing and administrative space. The Company
subleases 100,000 square feet of its distribution center to uBid. The following
leases have remaining terms greater than two years: Creative Computers corporate
headquarters, Memphis distribution center and Elek-Tek/uBid corporate
headquarters. All of the other leases have remaining terms less than two years.
During the fourth quarter of 1997, the Company consolidated its headquarters
facility and its telemarketing operations into a 160,000 square foot building in
a nearby location in Torrance, CA. The Company currently occupies 98,300 square
feet and plans to phase into the remaining space in the near future. The one-
time charge for the move was $0.8 million.
During the first quarter of 1998, the Company closed all of its retail
showrooms except for its Santa Monica showroom. The Company recorded a one-time
$1.5 million reserve for lease exit costs during the first quarter of 1998. The
Company intends to sell its Lenexa, Kansas building.
REGULATORY AND LEGAL MATTERS
The direct response business as conducted by the Company is subject to the
Merchandise Mail Order Rule and related regulations promulgated by the Federal
Trade Commission and laws or regulations directly applicable to access to or
commerce on the Internet. While the Company believes it currently is in
compliance with such laws and regulations and has implemented programs and
systems to address its ongoing compliance with such regulations, no assurances
can be given that new laws or regulations will not be enacted or adopted which
might adversely affect the Company's operations. Due to the increasing
popularity and use of the Internet, it is possible that a number of laws and
regulations may be adopted with respect to the Internet. The growth and
development of the market for Internet commerce may prompt calls for more
stringent consumer protection laws that may impose additional burdens on those
companies conducting business over the Internet. The adoption of any additional
laws or regulations may decrease the growth of the Internet, which, in turn,
could decrease the demand for and growth of the Company's Internet-based sales.
The Company, or its various subsidiaries, currently collects and remits sales
tax only on sales of products to residents of the states in which the Company or
its respective subsidiaries has a physical presence. Various states have sought
to impose on
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direct marketers with no physical presence in the taxing state the burden of
collecting state sales and use taxes on the sale of products shipped to those
states' residents, and it is possible that such a requirement could be imposed
in the future.
A number of proposals have been made at the federal, state and local level,
and by certain foreign governments, that would impose additional taxes on the
sale of goods and services over the Internet. In October 1998, Congress passed
the Internet Tax Freedom Act (the "ITFA"). The stated purpose of the ITFA is
neutral tax treatment of economic activity, electronic or otherwise. The ITFA
prohibits state and local taxes that discriminate against or single out the
Internet. As part of the ITFA, Congress created a committee to conduct an 18-
month study of whether use of or sales on the Internet should be taxed and, if
so, how taxes could be applied without subjecting the Internet and electronic
commerce to special, discriminatory or multiple taxation. Although it is not an
issue specific to the Internet, one of the agenda items for the committee set up
as part of the ITFA is a review of the sales tax "nexus" issue as it relates to
all direct marketers. There can be no assurance the committee's report to
Congress will not ultimately result in a modification by legislation of the
Supreme Court's favorable rulings regarding sales and use taxation on out of
state marketers.
Separation of uBid from the Company
Background of the Separation and Distribution. The Company has
announced that, subject to certain conditions, the Company intends to separate
uBid from the Company's other operations and businesses (the "Separation") and
to distribute to its stockholders (the "Distribution") all of the uBid common
stock owned by the Company in no event prior to 180 days after the December 9,
1998 closing date of uBid's initial public offering. The Separation will
establish uBid as a stand-alone entity with objectives separate from those of
the Company. In December 1998, uBid and the Company entered into a Separation
and Distribution Agreement (the "Separation and Distribution Agreement") and
certain other agreements providing for the Separation and the Distribution, the
provision by the Company of certain interim services to uBid, and addressing
employee benefit arrangements, and tax and other matters. These agreements (the
"Ancillary Agreements") are discussed in Part I, Item 1 of the uBid 1998 10-K
under the caption "Transactions between the Company and the Parent" and are
incorporated herein by reference. As of March 25, 1999, the Company owned
approximately 80.1% of the outstanding common stock of uBid.
The Company and uBid believe that the Separation and the Distribution
will enhance uBid's ability to implement its growth and operating strategies.
uBid believes that its future growth would be enhanced if its management were
compensated on a separate basis from the Company. The Company believes that
the Company's future growth would be enhanced if management of its remaining
business segments were more focused on such segments without also being
responsible for the online auction segment. Upon completion of the
Distribution, holders of Common Stock of the Company as of the record date for
the Distribution will be entitled to receive a dividend of uBid common stock
without the payment of further consideration, although the Company expects the
market value of shares of the Company's Common Stock to diminish upon effecting
the Distribution to reflect the value (per share of Company Common Stock) of the
shares of uBid common stock distributed by the Company. The consummation of the
Distribution will also remove current restrictions on uBid's growth as a result
of certain contractual restrictions of the Company that are applicable to the
Company and its subsidiaries. For example, certain of the Company's contractual
relationships with manufacturers prevent the Company and its subsidiaries,
including uBid, from selling such manufacturers' computers and computer-related
products at discounted prices, which has prevented uBid from obtaining such
products on a close-out or refurbished basis and selling them in uBid's
auctions. In addition, under the Company's contractual relationships with
certain of its vendors, neither the Company nor its subsidiaries, including
uBid, can sell the vendor's products outside the U.S. As a result of the
Distribution, uBid would no longer be subject to some of these restrictions.
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<PAGE>
Conditions to the Distribution. The Company has received the opinion
of PricewaterhouseCoopers LLP (the "PwC Opinion") to the effect that the
Distribution will qualify as a tax-free distribution for federal income tax
purposes under Section 355 of the Internal Revenue Code of 1986, as amended (the
"Code"), and will not result in recognition of any gain or loss for federal
income tax purposes to the Company, uBid, or the Company's or uBid's respective
stockholders. Although the Company does not presently intend to do so, the
Company also may apply for a private letter ruling ("Letter Ruling") from the
Internal Revenue Service. In accordance with the Separation and Distribution
Agreement, completion of the Distribution will be subject to the satisfaction,
or waiver by the Company's Board of Directors, of the following conditions: (i)
the PwC Opinion shall have been obtained, in form and substance satisfactory to
the Company, and be confirmed at the time of Distribution; (ii) if the Company
decides to seek a Letter Ruling, the Letter Ruling shall have been obtained and
remain effective consistent with the conclusions reached in the PwC Opinion, and
such ruling shall be in form and substance satisfactory to the Company, in its
sole discretion; (iii) any material Governmental Approvals and Consents (as such
terms are defined in the Separation and Distribution Agreement) necessary to
consummate the Distribution shall have been obtained and shall be in full force
and effect; (iv) no order, injunction or decree issued by any court or agency of
competent jurisdiction or other legal restraint or prohibition preventing the
consummation of the Distribution shall be in effect, and no other event outside
the control of the Company shall have occurred or failed to occur that prevents
the consummation of the Distribution; and (v) no other events or developments
shall have occurred that, in the judgment of the Company's Board of Directors,
would result in the Distribution having a material adverse effect on the Company
or on the stockholders of the Company. The Company's Board of Directors will
have the sole discretion to set the Distribution date for any time commencing
after June 7, 1999. The Company has agreed to consummate the Distribution,
subject to the satisfaction of the conditions set forth above. The Company may
terminate the obligation to consummate the Distribution if the Distribution has
not occurred by December 31, 1999, unless extended by the Company and uBid. In
addition, the Separation and Distribution Agreement may be amended or terminated
at any time prior to the Distribution date by the mutual consent of uBid and the
Company. See "Certain Factors Affecting Future Results--Pending Distribution."
A more detailed description of the Ancillary Agreements and the
historical relationship between the Company and uBid is contained in Part I,
Item 1 of the uBid 1998 10-K under the caption "Transactions between the Company
and the Parent" and is incorporated herein by reference.
Executive Officers
The executive officers of the Company as of March 26, 1999 and their
respective ages and positions are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Frank F. Khulusi............... 32 Chairman of the Board,
Chief Executive Officer and President
S. Keating Rhoads.............. 49 Chief Operating Officer and
Executive Vice President
Theodore R. Sanders............ 44 Chief Financial Officer
Daniel J. DeVries.............. 37 Executive Vice President - Marketing
and Sales
</TABLE>
The following is a biographical summary of the experience of the executive
officers:
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<PAGE>
Frank F. Khulusi is a co-founder of the Company and has served as Chairman of
the Board, President and Chief Executive Officer of the Company since the
Company's inception in 1987. Mr. Khulusi attended the University of Southern
California.
S. Keating Rhoads joined the Company in January 1999 as Executive Vice
President and Chief Operating Officer. Previously with the Times Mirror Company
for fourteen years, Mr. Rhoads served as Senior Vice President, Operations at
the flagship Los Angeles Times. He earned an MBA degree from Columbia
University and an A.B. degree from Stanford University.
Theodore R. Sanders has served as Chief Financial Officer since September
1998 and was Vice President - Controller of the Company from May 1997 to
September 1998. Prior to joining the Company, Mr. Sanders spent ten years with
the Pittston Company in various senior finance roles including Controller of its
Burlington Air Express Global division and Director of Internal Audit. Mr.
Sanders started his career with Deloitte & Touche and rose to the position of
manager. Mr. Sanders is a C.P.A. and received a B.S.B.A. degree from Nichols
College.
Daniel J. DeVries has served as Executive Vice President since February 1996
and was Senior Vice President from October 1994 to that time. Mr. DeVries is
responsible for all marketing, sales, purchasing and retail showrooms. Mr.
DeVries' marketing responsibilities include vendor co-op marketing,
merchandising, database marketing and Internet marketing. From April 1993 to
October 1994, he held various sales and marketing positions with the Company.
From July 1988 to April 1993, Mr. DeVries was a regional manager for Sun
Computers, a computer retailer.
Certain Factors Affecting Future Results
The Private Securities Litigation Reform Act of 1995 (the "Act") provides a
"safe harbor" for "forward-looking statements" to encourage companies to provide
prospective information, so long as such information is identified as forward
looking and is accompanied by meaningful cautionary statements identifying
important factors that could cause actual results to differ materially from
those discussed in the statement. Except for historical information, certain
statements contained in this Annual Report on Form 10-K are "forward-looking
statements" within the meaning of the Act. In order to take advantage of the
"safe harbor" provisions of the Act, the Company identifies the following
important factors which could affect the Company's actual results and cause such
results to differ materially from those projected, forecasted, estimated,
budgeted or otherwise expressed by the Company in "forward-looking statements"
made by or on behalf of the Company:
(1) The loss of a key vendor or decline in demand for products of a key
vendor, such as Apple, may reduce sales and adversely affect operating
results.
(2) Intense competition may lead to reduced prices and lower gross margins.
(3) The Company's narrow margins magnify the impact on operating results of
variations in operating performance. A number of factors may reduce the
Company's margins even further.
(4) Seasonal variations in the demand for products and services, as well as
the introduction of new products, may cause variations in the Company's
quarterly results.
(5) The availability (or lack thereof) of capital on acceptable terms may
hamper the Company in its efforts to fund its increasing working capital
needs.
(6) The failure of the Company to adequately manage its growth, including
the integration of acquired companies, may adversely impact the
Company's results of operations.
16
<PAGE>
(7) A failure of the Company's information systems may adversely impact the
Company's results of operations.
(8) The loss of a key executive officer or other key employee may adversely
impact the Company's operations.
(9) The inability of the Company to obtain products on favorable terms may
adversely impact the Company's results of operations.
(10) The Company's operations may be adversely impacted by an acquisition
that is either (i) not suited for the Company or (ii) improperly
executed.
(11) The Company's financial condition may be adversely impacted by a decline
in value of a portion of the Company's inventory.
(12) The failure of certain shipping companies to deliver product to the
Company, or from the Company to its customers, may adversely impact the
Company's results of operations.
(13) The failure of the Company to respond adequately to changes in consumer
preferences, such as the use of the Internet for purchasing, may
adversely affect the Company's business and results of operations.
(14) Rapid technological change may alter the market for the Company's
products and services, requiring the Company to anticipate such
technological changes, to the extent possible.
(15) The failure of the Company to distribute its ownership in uBid by means
of a tax-free stock dividend in the time frame contemplated or at all
could materially adversely affect the Company and the market price of
the Company's Common Stock.
It is not reasonably possible to itemize all of the many factors and specific
events that could affect the Company and/or the microcomputer industry as a
whole. However, the discussion below discusses in more detail some of the
foregoing factors, as well as additional factors which may affect the Company's
actual results and cause such results to differ materially from those projected,
forecasted, estimated, budgeted or otherwise expressed in any "forward-looking
statements."
The information pertaining to certain factors affecting future results of
uBid is contained in the uBid 1998 10-K in Part I, Item 1 under the caption
"Investment Considerations" and is incorporated herein by reference.
Dependence on Apple
The Company is dependent on sales of Apple computers and software and
peripheral products used with Apple computers. Products manufactured by Apple
represented approximately 30.1%, 21.4% and 20.0% of the Company's net sales in
1996, 1997 and 1998, respectively. A decline in sales of Apple computers or a
decrease in supply of or demand for software and peripheral products for such
computers could have a material adverse impact on the Company's business.
During parts of 1996 and 1997, certain Apple computers were in short supply. A
continuation of such shortages or future shortages could adversely affect the
Company's operating results. The Company is an authorized dealer for the full
retail line of Apple products; however, the Company's dealer agreement with
Apple is terminable upon 30 days' notice. The Company's business would be
adversely affected if all or a portion of the line of Apple products were no
longer available to the Company. The Company's success is, in part, dependent
upon the ability of Apple to develop and market products that meet the changing
requirements of the marketplace. To the extent that these products are not
available to the Company, the Company could
17
<PAGE>
encounter increased price and other competition, which would adversely affect
the Company's business, financial condition and results of operations.
Rapid Growth
Since its formation, the Company has experienced rapid growth. Net sales
have grown from $8.7 million in 1990 to $690.2 million in 1998. The Company's
catalog sales grew from $117.9 million in 1994 to $598.4 million in 1998.
Internet sales on its ubid.com, pcmall.com, macmall.com, computability.com and
ccit-inc.com web sites grew from $15.2 million in 1997 to $83.3 million in 1998.
As a result of the Company's shift from the retail showroom to the catalog
distribution channel, retail showroom sales have decreased from 28.0% of net
sales in 1994 to 6.3% in 1998. During the first quarter of 1998, the Company
closed seven retail showrooms to focus its efforts on its catalog, corporate and
Internet channels of distribution. The Company recorded a one-time pretax
restructuring charge of $10.5 million in the first quarter of 1998 relating to
exit costs, asset write-offs, other charges and related goodwill. In response
to the growth in catalog sales, the Company has rapidly added a significant
number of employees and has been required to expend considerable efforts in
training these new employees. This growth has placed strains on the Company's
management, resources and facilities. As part of its growth strategy, the
Company acquired Elek-Tek and ComputAbility in 1997 and may, in the future,
acquire other companies in the same or complementary lines of business. These
acquisitions and any such acquisition and the ensuing integration of the
operations of the acquired company with those of the Company place additional
demands on the Company's management, operating and financial resources. The
Company's success will, in part, be dependent upon the ability of the Company to
manage growth effectively. In addition, the Company's business and growth could
be affected by the spending patterns of existing or prospective customers, the
cyclical nature of capital expenditures of businesses, continued competition and
pricing pressures, changes in the rate of development of new technologies and
new products by manufacturers, acceptance by end-users and other trends in the
general economy. There can be no assurance that the Company's historical growth
rates will continue in the future.
In connection with the Company's recent expansion into the WINTEL market, the
Company has obtained catalog sales authorizations or otherwise has the ability
to sell WINTEL products from certain major hardware manufacturers, including
IBM, Compaq, Hewlett-Packard, Sony, Hitachi, Toshiba, Fujitsu and others. Many
of its current vendors of peripherals, components, accessories and software also
offer WINTEL products. While the Company has been successful to date in
becoming a major catalog reseller of WINTEL products, no assurances can be given
that the Company will be able to maintain that position.
Competition
The retail business for personal computers and related products is highly
competitive, based primarily on price, product availability, speed and accuracy
of delivery, effectiveness of sales and marketing programs, credit availability,
ability to tailor specific solutions to customer needs, quality and breadth of
product lines and services, and availability of technical or product
information. The Company competes with other direct marketers, including
MicroWarehouse, CDW, Multiple Zones, Insight Direct, PC Connection and Global
Direct. The Company also competes with Internet retailers such as buy.com,
onsale@cost and beyond.com. In addition, the Company competes with computer
retail stores and resellers, including superstores, such as CompUSA, Best Buy,
corporate resellers such as Compucom, Entex and Inacom, certain hardware and
software vendors, such as Gateway and Dell Computer, which sell directly to end
users, and other direct marketers of hardware, software and computer-related
products. In the direct marketing industry, barriers to entry are relatively low
and the risk of new competitors entering the market is high. Certain existing
competitors of the Company have substantially greater financial resources than
the Company. There can be no assurance that the Company can continue to compete
effectively against existing competitors or new competitors that may enter the
market. In addition, price is an important competitive factor in the personal
computer hardware, software and peripherals market, and there can be no
assurance that the Company will not be subject to increased price
18
<PAGE>
competition, which may have an adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will not lose market share or that it will not be forced in the
future to reduce its prices in response to the actions of its competitors and
thereby experience a further reduction in its gross margins.
Narrow Operating Margins
As a result of intense price competition in the microcomputer products
industry, the Company's margins have historically been narrow and are expected
to continue to be narrow. These narrow margins magnify the impact on operating
results of variations in operating costs and of adverse or unforeseen events.
Potential Quarterly Fluctuations
The Company experiences variability in its net sales and net income on a
quarterly basis as a result of many factors. These factors include the frequency
of catalog mailings, introduction or discontinuation of new catalogs, the
introduction of new products or services by the Company and its competitors,
changes in prices from suppliers, the loss or consolidation of a significant
supplier or customer, general competitive conditions including pricing, the
Company's ability to control costs, the timing of capital expenditures, the
condition of the personal computer industry in general, seasonal shifts in
demand for hardware and software products, industry announcements and market
acceptance of new products or upgrades, including deferral of customer orders in
anticipation of new product applications, product enhancements or operating
systems, the relative mix of products sold during the period, inability of the
Company to obtain adequate quantities of products carried in its catalogs or
delays in the release by suppliers of new products and inventory adjustments.
The Company's planned operating expenditures each quarter are based on sales
forecasts for the quarter. If sales do not meet expectations in any given
quarter, operating results for the quarter may be materially adversely affected.
The Company's narrow margins may magnify the impact of these factors on the
Company's operating results. The Company believes that period-to-period
comparisons of its operating results should not be relied upon as an indication
of future performance. In addition, the results of any quarterly period are not
necessarily indicative of results to be expected for a full fiscal year. In
certain future quarters, the Company's operating results may be below the
expectations of public market analysts or investors. In such event, the market
price of the Company's Common Stock could be materially adversely affected.
Dependence on Vendors
The Company purchases all of its products from vendors. Certain key vendors,
including IBM, Hewlett Packard, Compaq and Apple, provide the Company with trade
credit as well as substantial incentives in the form of discounts, credits and
cooperative advertising. Most key vendors have agreements to provide, or
otherwise have consistently provided, market development funds to the Company,
whereby such vendors finance portions of the cost of catalog publication and
distribution based upon the amount of coverage given in the catalogs to their
respective products. Termination or interruption of the Company's relationships
with one or more of these vendors, including Apple, or modification of the terms
or discontinuance of the agreements with these vendors, could adversely affect
the Company's operating income and cash flow. The Company's success is, in
part, dependent upon the ability of its vendors to develop and market products
that meet the changing requirements of the marketplace. Substantially all of
the Company's contracts with its vendors are terminable upon 30 days' notice or
less. In most cases, the Company has no guaranteed price or delivery
arrangements with its suppliers. As a result, the Company has experienced and
may in the future experience short-term inventory shortages on certain products.
In addition, manufacturers who currently sell their products through the Company
may decide to sell their products directly or through resellers or channels
other than the Company. Further, the personal computer industry experiences
significant product supply shortages and customer order backlogs from time to
time due to the inability of certain manufacturers to supply
19
<PAGE>
certain products as needed. There can be no assurance that suppliers will be
able to maintain an adequate supply of products to fulfill the Company's
customers' orders on a timely basis or that the Company will be able to obtain
particular products or that a product line currently offered by suppliers will
continue to be available. Similarly, there can be no assurance that the Company
will be able to obtain authorizations from new vendors which may introduce new
products that create market demand.
Business Interruption; Facilities
The Company believes that its success to date has been, and future results of
operations will be, dependent in large part upon its ability to provide prompt
and efficient service to its customers. The Company has taken several
precautionary steps to help minimize the impact of disasters that might cause
business interruptions. There can be no assurance that a disruption will not
occur; however, any disruption of the Company's day-to-day operations including
those caused by natural disasters could have a material adverse effect upon the
Company and any interruption, corruption, degradation or failure of the
Company's management information systems, distribution center or telephone
system could impair its ability to receive and process customer orders and ship
products on a timely basis. The Company does not have a redundant telephone
system and does not have a backup or redundant call center.
Changing Methods of Distribution
The manner in which personal computers and related software and products are
distributed and sold is changing, and new methods of sale and distribution, such
as the Internet, have emerged. Hardware and software vendors have sold, and may
intensify their efforts to sell, their products directly to end users. From time
to time, certain vendors have instituted programs for the direct sale of large
quantities of hardware and software to certain major corporate accounts. These
types of programs may continue to be developed and used by various vendors.
Vendors also may attempt to increase the volume of software products distributed
electronically to end users' personal computers. Any of these competitive
programs, if successful, could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Independent Shipping Companies
The Company relies almost entirely on arrangements with independent shipping
companies, especially Federal Express, for the delivery of its products. The
disruption or termination of the Company's arrangements with Federal Express or
other shipping companies, or the failure or inability of one or more shipping
companies to deliver products from the Company to its customers, or from
suppliers to the Company, could have a material adverse effect on the Company's
business, financial condition and results of operations.
Postage, Shipping and Paper Costs
Postage and shipping are significant expenses in the operation of the
Company's business. The Company ships its products to customers by overnight
delivery and ground delivery services and generally mails its catalogs through
the U.S. Postal Service. Any increases in postal or shipping rates in the
future could have a material adverse effect on the business, financial condition
and results of operations. The cost of paper is also a significant expense of
the Company in printing its catalogs. The cost of paper has fluctuated
significantly over the last several years. While the Company believes that it
may be able to recoup a portion of any increased postage and paper costs through
increases in vendor advertising rates, no assurance can be given that such
advertising rate increases can be sustained or that they will offset all of the
increased costs.
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Risk of Technological Changes and Inventory Obsolescence
The market for personal computers, peripherals and software is characterized
by rapid technological change and a growing diversity of products. The recent
growth in sales of personal computers and related software and peripherals has
been, in part, due to the introduction of new hardware and software, including
multimedia personal computer systems and upgraded Apple computers. The Company's
success depends in large part on its ability to identify and obtain the right to
market products that will meet the changing requirements of the marketplace.
There can be no assurance that the Company will be able to identify and offer
products necessary to remain competitive or avoid losses related to excess and
obsolete inventory. The Company currently has limited return rights with respect
to products which it purchases from Apple, IBM, Compaq, Hewlett Packard and
certain other vendors; however, such rights vary by product line, have other
conditions and limitations and can be terminated or changed at any time.
State Sales Tax Collection
The Company, or various subsidiaries, currently collects and remits sales tax
on sales of products to residents of the states that it has legal presence in.
Various states have sought to impose on direct marketers the burden of
collecting state sales taxes on the sale of products shipped to those states'
residents. The U.S. Supreme Court has ruled that the various states, absent
Congressional legislation, may not impose tax collection obligations on an out-
of-state mail order company whose only contacts with the taxing state are
distribution of catalogs and other advertisement materials through the mail, and
whose subsequent delivery of purchased goods is by mail or interstate common
carriers. A New York Court of Appeals case imposed tax collection obligations on
two Vermont companies, one of which was a mail order company, whose contacts
with New York consisted of visiting the state several times a year to aid
customers or visiting showrooms stocking their goods. The Company believes its
operations are different from the operations of the companies in the New York
case and thus do not give rise to tax collection obligations. However, the
Company cannot predict the level of contact with any state which would give rise
to future or past tax collection obligations within the parameters of the
Supreme Court case. It is possible that federal legislation could be enacted
that would permit states to impose sales tax collection obligations on out-of-
state mail order companies and if enacted, the imposition of a tax collection
obligation on the Company may result in additional administrative expenses to
the Company and price increases to its customers that could adversely affect the
Company's business, financial condition and results of operations.
The tax treatment of the Internet and e-commerce is currently unsettled. A
number of proposals have been made at the federal, state and local level and by
certain foreign governments that could impose taxes on the sale of goods and
services and certain other Internet activities. Recently, the Internet Tax
Freedom Act was signed into law, placing a three-year moratorium on new state
and local taxes on Internet commerce. However, there can be no assurance that
future laws imposing taxes or other regulations on commerce over the Internet
would not substantially impair the growth of e-commerce and as a result have a
material adverse effect on the Company's business, results of operations and
financial condition.
Industry Evolution and Price Reductions
The personal computer industry is undergoing significant change. In addition,
in recent years a number of new, cost-effective channels of distribution have
developed in the industry, such as the Internet, computer superstores, consumer
electronic and office supply superstores, national direct marketers and mass
merchants. Computer resellers are consolidating operations and acquiring or
merging with other resellers and/or direct marketers to achieve economies of
scale and increased efficiency. The current industry reconfiguration and the
trend towards consolidation could cause the industry to become even more
competitive, further increase pricing pressures and make it more difficult for
the Company to maintain its operating margins or to increase or maintain the
same level of net sales
21
<PAGE>
or gross profit. Declining prices, resulting in part from technological changes,
may require the Company to sell a greater number of products to achieve the same
level of net sales and gross profit. Such a trend could make it more difficult
for the Company to continue to increase its net sales and earnings growth. In
addition, the personal computer market has experienced rapid growth. If the
growth rate of the personal computer market were to decrease, the Company's
business, financial condition and operating results could be adversely affected.
Management Information Systems
The Company's success is in part dependent on the accuracy and proper
utilization of its management information systems, including its telephone
system. The Company's ability to analyze data derived from its management
information systems to increase product promotions, manage inventory and
accounts receivable collections, to purchase, sell and ship products efficiently
and on a timely basis and to maintain cost-efficient operations, are each
dependent upon the quality and utilization of the information generated by its
management information systems. During 1995, the Company significantly upgraded
its management information system hardware and software. The Company believes
that to remain competitive it will be necessary to upgrade its management
information systems on a continuing basis. In addition to the costs associated
with such upgrades, the transition to and implementation of new or upgraded
hardware or software systems (including upgrades relating to the Company's Year
2000 compliance project) can result in system delays or failures which could
impair the Company's ability to receive and process orders and ship products in
a timely manner. The Company does not currently have a redundant or back-up
telephone system, and any interruption in telephone service including those
caused by natural disasters could have a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on Senior Management
The Company's future performance will depend to a significant extent upon the
efforts and abilities of certain key management personnel, including Frank
Khulusi, Chairman of the Board, President and Chief Executive Officer. The
Company has a $3 million key man life insurance policy on Mr. Khulusi. The loss
of service of one or more of the Company's key management personnel could have
an adverse effect on the Company's business. The Company's success and plans for
future growth will also depend in part on management's continuing ability to
hire, train and retain skilled personnel in all areas of its business.
Management of Growth
The rapid growth of the Company's business has required the Company to make
significant recent additions in personnel and has significantly increased the
Company's working capital requirements. Although the Company has experienced
significant sales growth in recent years, such growth should not be considered
indicative of future sales growth. Such growth has resulted in new and
increased responsibilities for management personnel and has placed and continues
to place significant strain upon the Company's management, operating and
financial systems, and other resources. There can be no assurance that this
strain will not have a material adverse effect on the Company's business,
financial condition, and results of operations, nor can there be any assurance
that the Company will be able to attract or retain sufficient personnel to
continue the expansion of its operations. Also crucial to the Company's success
in managing its growth will be its ability to achieve additional economies of
scale. There can be no assurance that the Company will be able to achieve such
economies of scale, and the failure to do so could have a material adverse
effect upon the Company's business, financial condition and results of
operations.
22
<PAGE>
Acquisitions
As part of its growth strategy, the Company acquired two marketers of
computers and computer-related products in 1997 and may continue to pursue
acquisitions of companies that would either complement or expand its existing
business. No assurance can be given that the benefits expected from the
integration of acquired companies will be realized. In addition, acquisitions
involve a number of risks and difficulties, including expansion into new
geographic markets and business areas, the diversion of management's attention
to the assimilation of the operations and personnel of the acquired company, the
integration of the acquired company's management information systems with those
of the Company, potential short-term adverse effects on the Company's operating
results and the amortization of acquired intangible assets. Any delays or
unexpected costs incurred in connection with the integration of acquired
operations could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will be able to implement or sustain its acquisition strategy or
that its strategy will ultimately prove profitable for the Company.
Possible Volatility of Stock Price
The Company believes certain factors, such as sales of Common Stock into the
market by existing stockholders, fluctuations in quarterly operating results and
market conditions generally, including market conditions affecting stocks of
computer hardware and software manufacturers and resellers and companies in the
Internet and electronic commerce industries in particular, and other technology
or related stocks, could cause the market price of the Common Stock to fluctuate
substantially. The stock market in general, and the stocks of computer and
software resellers, and companies in the Internet and electronic commerce
industries in particular, and other technology or related stocks, have in the
past experienced extreme price and volume fluctuations which have been unrelated
to corporate operating performance. Such market volatility may adversely affect
the market price of the Common Stock. Additionally, the failure of the Company
to distribute its ownership in uBid by means of a tax-free stock dividend in the
time frame contemplated or at all could materially adversely affect the market
price of the Common Stock. In addition, the Company expects the market value of
the Company's Common Stock to diminish upon effecting the Distribution to
reflect the value of the shares of uBid common stock to be distributed by the
Company.
Pending Distribution
The Company has announced that, subject to certain conditions, the Company
intends to distribute to its stockholders prior to December 31, 1999 all of uBid
common stock owned by the Company. The Company has received an opinion letter
from PricewaterhouseCoopers LLP to the effect that the Distribution will qualify
as a tax-free distribution for federal income tax purposes under Section 355 of
the Code, and the Distribution is conditional upon obtaining such an opinion
letter in form and substance satisfactory to the Company and confirmation of
such opinion at the time of Distribution. Although it does not presently plan
to do so, the Company may also decide, in its sole discretion, to seek a private
letter ruling from the Internal Revenue Service in form and substance
satisfactory to the Company consistent with the conclusions reached in the PwC
Opinion. In that case, the Distribution would also be conditioned upon receipt
of the Letter Ruling. The Company intends to take all necessary steps to
complete such a tax-free distribution after obtaining the PwC Opinion and the
Letter Ruling, as applicable, but in no event will the Distribution occur prior
to June 7, 1999. The Distribution also is subject to the condition that no
events or developments occur that, in the sole judgment of the Board of
Directors of the Company, would or could result in the Distribution having a
material adverse effect on the Company or the Company's stockholders. In
addition, as a condition to the Distribution, the Company will be required to
obtain certain consents from third parties. There can be no assurance that any
of the foregoing conditions, or any other conditions to the Distribution, will
be satisfied, or that the Distribution will occur in the time frame contemplated
or at all. The failure of the Distribution to occur could materially adversely
affect the Company and the market price of the Company's Common Stock.
Year 2000
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed "year
2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with whom the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems, and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has established
an internal project team comprised of all functional disciplines. This project
team has begun a three-phase process of identifying internal systems (both
information technology and non-information technology systems) not year 2000
compliant, determining their significance in the effective operation of the
Company, and developing plans to resolve the issues where necessary. The Company
has been communicating with the suppliers and others to coordinate year 2000
readiness. The responses received by the Company to date have indicated that
steps are currently being undertaken to address this concern. However, if such
third parties are not able to make all systems and products year 2000 compliant,
there could be a material adverse impact on the Company.
Initial review of the Company's principal application software through
which nearly all of the Company's business is transacted, has determined it to
be year 2000 compliant and, as such, the Company does not anticipate any
material adverse operational issues to arise. The Company has completed 75% of
the year 2000 compliance assessment for critical systems and will complete its
assessment by the end of the second quarter of 1999. The Company plans to
implement corrective solutions before the end of the third quarter of 1999. To
date, the costs incurred by the Company with respect to this project are $0.1
million. Based on current estimates, management expects that the Company's total
costs in connection with its year 2000 compliance project will be approximately
$0.8 million and will be financed from general corporate funds; however, future
anticipated costs are difficult to estimate with any certainty and may differ
materially from those currently projected based on the results of the assessment
phase of the Company's year 2000 project. The anticipated costs associated with
the Company's year 2000 compliance program do not include time and costs that
may be incurred as a result of any potential failure of third parties to become
year 2000 compliant or costs to implement the Company's future contingency
plans. Management estimates that approximately one half of the expected costs
will be attributed to the redeployment of internal resources and the other half
will be comprised principally of external consulting fees and software upgrades.
No hardware expenditures for year 2000 are contemplated. The redeployment of
internal data processing resources is not expected to materially delay any
significant projects. Year 2000 spending is expected to be 10% of total budgeted
data processing expenditures. The Company has not yet developed a contingency
plan in the event that any non-compliant critical systems are not remedied by
January 1, 2000, nor has it formulated a timetable to create such contingency
plan. Upon completion of this project, if systems material to the Company's
operations have not been made year 2000 compliant, or if third parties fail to
make their systems year 2000 compliant in a timely manner, the year 2000 issue
could have a material adverse effect on the Company's business, financial
condition and results of operations.
23
<PAGE>
ITEM 2. PROPERTIES
See "Properties" in Item 1 above.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various legal proceedings or claims which arise in
the ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to those actions will not materially affect the
Company's business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of 1998.
24
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has been traded on the Nasdaq National Market
since the Company's initial public offering on April 4, 1995 (the "IPO"). Prior
to the IPO, there was no public market for the Company's Common Stock. The
following table sets forth the range of high and low closing sales prices for
the Common Stock for the periods indicated, as reported by the Nasdaq National
Market.
<TABLE>
<CAPTION>
Price Range of
Common Stock
-------------------
High Low
--------- -------
<S> <C> <C>
Year Ended December 31, 1996
----------------------------
First Quarter............... $ 18 3/4 $ 6 3/4
Second Quarter.............. 10 5/8 6
Third Quarter............... 9 7/8 4 1/2
Fourth Quarter.............. 11 3/4 7 5/16
Year Ended December 31, 1997
----------------------------
First Quarter............... 8 1/8 5
Second Quarter.............. 7 3/4 5
Third Quarter............... 13 11/16 7 1/8
Fourth Quarter.............. 16 5/16 8 1/2
Year Ended December 31, 1998
----------------------------
First Quarter............... 12 7/8 7 5/16
Second Quarter.............. 10 5 1/4
Third Quarter............... 12 1/2 6
Fourth Quarter.............. 59 11/16 5 1/4
</TABLE>
On March 26, 1999, the closing price of the Company's Common Stock as
reported on the Nasdaq National Market was $33 11/16 per share. As of March 26,
1999, there were approximately 1,500 holders of record of the Common Stock.
On August 29, 1997, the Company issued 271,739 shares of its Common Stock
valued at $2.5 million to purchase ComputAbility Ltd. The shares were issued
pursuant to the exemption from the registration requirements of the Securities
Act of 1933, as amended, provided by Rule 4(2) thereunder.
The Company has never paid and has no present plans to pay any cash dividends
on its capital stock. The Company intends to retain its earnings to finance the
growth and development of its business.
The Company announced in July 1996 that, depending on various factors
including market price, it would repurchase up to 1,000,000 shares of its stock.
The Company has repurchased 15,000 shares to date under this program. However,
there is no assurance that the Company will purchase additional shares.
The information pertaining to the market for uBid's common stock and related
stockholder matters is set forth in the uBid 1998 10-K in Part II, Item 5 and is
incorporated herein by reference.
25
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data are qualified by reference
to, and should be read in conjunction with, the Company's Consolidated Financial
Statements and the notes thereto, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained elsewhere herein. The
selected income statement data for the years ended December 31, 1996, 1997 and
1998 and the selected balance sheet data as of December 31, 1997 and 1998 are
derived from the Company's audited consolidated financial statements which are
included elsewhere herein. The selected income statement data for the years
ended December 31, 1994 and 1995 along with the balance sheet data as of
December 31, 1994, 1995 and 1996 are derived from the audited consolidated
financial statements of the Company which are not included herein. The selected
operating data are derived from the accounting records of the Company and have
not been audited.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
(in thousands, except per share data)
1994 1995 1996 1997(1) 1998(1)
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net sales..................................... $163,706 $420,877 $444,971 $546,131 $690,238
Cost of goods sold............................ 140,229 361,803 395,000 476,061 612,566
Retail store closure inventory reserve........ - - - - 3,679
-------- -------- -------- -------- --------
Gross profit.................................. 23,477 59,074 49,971 70,070 73,993
Selling, general and administrative expenses.. 19,384 49,844 60,585 63,540 85,519
Expenses related to retail store closure...... - - - - 6,773
-------- -------- -------- -------- --------
Income (loss) before uBid stock-based
compensation................................ 4,093 9,230 (10,614) 6,530 (18,299)
uBid stock-based compensation................. - - - - 5,267
-------- -------- -------- -------- --------
Income (loss) from operations................. 4,093 9,230 (10,614) 6,530 (23,566)
Interest income (expense)..................... (759) 371 593 118 (461)
-------- -------- -------- -------- --------
Income (loss) before income taxes............. 3,334 9,601 (10,021) 6,648 (24,027)
Income taxes (benefit)........................ 1,328 3,754 (3,972) 2,523 (5,034)
-------- -------- -------- -------- --------
Income (loss) before minority interest........ 2,006 5,847 (6,049) 4,125 (18,993)
Minority interest............................. - - - - 1,198
-------- -------- -------- -------- --------
Net income (loss)............................. $ 2,006 $ 5,847 $ (6,049) $ 4,125 $(17,795)
======== ======== ======== ======== ========
Basic earnings (loss) per share (2)........... $0.41 $0.71 $(0.62) $0.42 $(1.75)
======== ======== ======== ======== ========
Diluted earnings (loss) per share (2)......... $0.39 $0.66 $(0.62) $0.41 $(1.75)
======== ======== ======== ======== ========
Basic weighted average number of shares ......... ......... .........
outstanding (2)............................. 4,900 8,291 9,767 9,895 10,176
======== ======== ======== ======== ========
Diluted weighted average number of shares ......... ......... .........
outstanding (2)............................. 5,160 8,890 9,767 10,030 10,176
======== ======== ======== ======== ========
Selected Operating Data (in thousands, except
Average order size):
Mail order/catalog net sales.................. $117,863 $353,324 $387,103 $478,291 $598,427
uBid auction net sales........................ $ - $ - $ - $ 9 $ 48,232
Retail net sales.............................. $ 45,843 $ 67,553 $ 57,868 $ 67,831 $ 43,579
Number of catalogs distributed................ 7,700 38,398 48,800 62,200 69,427
Orders filled (mail order/catalog)............ 194 784 931 1,026 1,196
Average order size (mail order/catalog)....... $ 608 $ 451 $ 416 $ 466 502
Mailing list size............................. 397 1,300 2,518 4,177 4,792
</TABLE>
(1) Operating results in 1997 and 1998 reflect the effects of acquisitions of
ComputAbility, Ltd., and Elek-Tek, Inc. in August 1997 and October 1997,
respectively. See Note 9 of Notes to Consolidated Financial Statements.
(2) Earnings (loss) per share and weighted average shares outstanding have been
restated for all periods presented to reflect the adoption of SFAS 128,
"Earnings per Share." See Note 1 of Notes to Consolidated Financial
Statements.
26
<PAGE>
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data
(in thousands):
Working capital $ 161 $ 46,307 $ 42,600 $ 29,544 $ 42,805
Total assets $42,942 $112,569 $113,431 $131,154 $158,266
Short-term debt $ 4,190 $ 281 $ 283 $ 10,186 $ 122
Long-term debt, excluding current portion $ 1,878 $ 589 $ 325 $ 496 $ 161
Subordinated debt $ 2,950 $ -- $ -- $ -- $ --
Stockholders' equity $ 890 $ 56,560 $ 52,805 $ 59,770 $ 67,564
</TABLE>
The information pertaining to uBid's selected financial data is incorporated
by reference to uBid's 1998 10-K in Part II, Item 6.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere herein.
Overview
The Company began operations in May 1987 as a mail-order company and opened
its first retail computer showroom in August 1987. The showrooms and mail-order
operations primarily offered Commodore Amiga personal computers and related
products. After opening its first retail store, the Company conducted mail
order operations from one of its retail showroom locations. The Company became
an authorized Apple dealer in 1991, opened two additional retail computer
showrooms in the second quarter of 1993 and relocated and expanded an existing
showroom in the fourth quarter of 1993. Net sales from the Company's retail
computer showrooms as a percentage of net sales were 13.0%, 12.4% and 6.3% in
1996, 1997 and 1998 respectively. During 1997, the Company completed two
acquisitions. On August 29, 1997, the Company acquired the assets and assumed
the liabilities of Milwaukee-based ComputAbility Ltd., a privately owned direct
reseller of PC/WINTEL hardware, peripheral and software products, for $8.0
million. On October 15, 1997, the Company acquired substantially all the assets
of Elek-Tek, Inc., a marketer of PC/WINTEL hardware, peripheral and software
products located in the Midwest for $29.4 million plus direct costs of the
acquisition.
In the fourth quarter of 1993, the Company shifted its principal distribution
and marketing focus from retail showrooms to direct mail marketing distribution
and relocated its mail order/catalog operations to a central location. In March
1994, the Company received authorization from Apple to offer the full retail
line of Apple products via direct mail and the Company distributed the first
edition of its MacMall catalog in April 1994. During 1994, the Company mailed
five editions of its MacMall catalog with a total circulation of approximately
7.7 million to previous and potential customers. During 1995, the Company
distributed ten editions of its MacMall catalog with a total MacMall circulation
of approximately 27.3 million. In 1996, total MacMall circulation increased to
30.3 million with thirteen editions. In 1997, total MacMall circulation
increased to 36.0 million with fourteen editions. In 1998, total MacMall
circulation decreased to 33.0 million with fourteen editions.
In May 1995, the Company distributed its first PC Mall catalog focusing on
the WINTEL personal computer market. During 1995, the Company distributed seven
PC Mall catalogs to approximately 11.1 million previous and prospective
customers. In 1996, the Company distributed thirteen PC Mall catalogs with a
total circulation of 15.3 million. In 1997, total PC Mall circulation was 21.9
million with fourteen editions. In 1998, total PC Mall circulation was 25.8
million with fourteen editions. In September 1997, the Company distributed its
first ComputAbility
27
<PAGE>
catalog. During 1997, the Company distributed three ComputAbility catalogs to
approximately 1.5 million previous and prospective customers. In 1998, total
ComputAbility circulation was 9.1 million with thirteen editions.
All catalogs feature new products and contain detailed information about
product capabilities, specifications, key features and system requirements.
Net sales from mail order/catalog operations, as a percentage of net sales,
were 87.0%, 87.6% and 86.7% in 1996, 1997 and 1998, respectively, with average
order size being $416, $466 and $502 for those respective years.
Net sales of the Company are derived primarily from the sale of personal
computer hardware, software, peripherals and accessories to individual
consumers, home offices, small businesses and large corporations through direct
response catalogs, dedicated inbound and outbound telemarketing sales
executives, a direct sales force, retail showrooms and advertising on the
Internet. Gross profit consists of net sales less product and shipping costs.
The Company receives marketing development funds ("MDF") from manufacturers of
products included in the Company's catalogs, as well as co-operative advertising
funds ("Co-Op") on products purchased from manufacturers and vendors.
A substantial portion of the Company's business is dependent on sales of
Apple computers and software and peripheral products used with Apple computers.
Products manufactured by Apple represented approximately 30.1%, 21.4% and 20.0%
of the Company's net sales in 1996, 1997 and 1998, respectively.
Results of Operations
The following table sets forth for the years indicated information derived
from the Company's consolidated statement of operations expressed as a
percentage of net sales. There can be no assurance that trends in sales growth
or operating results will continue in the future.
<TABLE>
<CAPTION>
Percentage of Net Sales
--------------------------
Year Ended December 31,
--------------------------
1996 1997 1998
------- ------- ------
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 88.8 87.2 89.3
----- ----- -----
Gross profit 11.2 12.8 10.7
Selling, general and administrative expenses 13.6 11.6 12.4
Expenses related to retail store closure --- --- 1.0
----- ----- -----
Income (loss) before uBid stock-based compensation (2.4) 1.2 (2.7)
uBid stock-based compensation --- --- 0.7
Interest (income) expense, net (0.1) --- 0.1
----- ----- -----
Income (loss) before income taxes (2.3) 1.2 (3.5)
Income taxes (benefit) (0.9) 0.4 (0.7)
----- ----- -----
Income (loss) before minority interest (1.4) 0.8 (2.8)
Minority interest --- --- 0.2
----- ----- -----
Net income (loss) (1.4)% 0.8% (2.6)%
===== ===== =====
</TABLE>
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
Net sales for the year ended December 31, 1998 were $690.2 million, an
increase of $144.1 million or 26% over net sales for the year ended December 31,
1997 of $546.1 million. Mail order/catalog sales for 1998 were $598.4 million,
an increase of $120.1 million or 25% over 1997 mail order/catalog sales of
$478.3 million. The increase in mail/order catalog sales was primarily due to
an increase in WINTEL sales partially offset by a decrease in MAC sales.
28
<PAGE>
Catalog circulation in 1998 increased 11.6% to 69.4 million catalogs, of which
MacMall comprised 33.1 million, PC Mall 25.8 million, ComputAbility 9.1 million
and DataCom Mall 1.4 million. Retail net sales in 1998 were $43.6 million, a
decrease of $24.2 million or 36% due to the closure of seven of the Company's
stores in the first quarter of 1998. WINTEL net sales increased 65% to $364.6
million in 1998, versus $221.3 million in 1997. uBid's first auction took place
in December 1997 and had revenue of $9 thousand in 1997. uBid sales in 1998 were
$48.2 million on a registered user base of 229,000.
Gross profit for the year ended December 31, 1998 was $74.0 million, an
increase of $3.9 million or 6% from gross profit of $70.1 million for the year
ended December 31, 1997. The increase in gross profit was primarily due to the
increase in sales in 1998 over 1997, offset by the large first quarter write-off
related to the retail store closures and slow-moving and excess inventory. Gross
profit as a percentage of sales was 10.7% in 1998, versus 12.8% in 1997. The
decrease in gross profit percentage was primarily due to the first quarter
write-offs as well as the ramp-up of lower margin sales by uBid.
Selling, general and administrative expenses (SG&A) were $85.5 million for
the year ended December 31, 1998, an increase of $22.0 million or 35% over SG&A
expenses of $63.5 million for the year ended December 31, 1997. As a percentage
of net sales, SG&A expenses were 12.4% in 1998, versus 11.6% in 1997. The
increase is primarily due to the ramp-up of uBid, first quarter write-offs
related to a more rapid decline in Mac sales and the effect of rapid price
erosion and other charges related to the store closures in the first quarter.
Interest expense (income) was $0.5 million for the year ended December 31,
1998 compared with $(0.1) million for the year ended December 31, 1997. The
increase is primarily attributed to borrowings in conjunction with the
acquisition of Elek-Tek.
Income tax benefit for the year ended December 31, 1998 was $5.0 million
versus a provision of $2.5 million for the year ended December 31, 1997. The
effective tax rate for 1998 decreased to (21.0%) from 38.0% in 1997. The
decrease in effective tax rate is primarily due to the loss recorded in 1998,
net of a valuation allowance against uBid's deferred tax assets.
During 1997, the Company operated four retail showrooms in Southern
California under the name Creative Computers and three retail showrooms in
Illinois and one retail showroom in Indiana under the name of Elek-Tek. During
February 1998, the Company closed its Indiana showroom. On March 20, 1998, the
Company closed six of its other retail showrooms to focus its efforts on its
catalog, corporate and Internet channels. Net sales from the Company's retail
showroom operations were $57.9 million, $67.8 million and $43.6 million for the
years ended December 31, 1996, 1997 and 1998, representing 13.0%, 12.4% and 6.3%
of net sales, respectively. In the first quarter of 1998, the Company recorded
a one-time pretax restructuring charge of $10.5 million relating to exit costs
associated with the closing of retail operations. Recorded in selling, general
and administrative costs were a $3.1 million write-off of goodwill, a $1.9
million write-off for fixed assets, a $1.5 million reserve for lease exit cost,
and $0.3 million employee-related severance costs. Recorded as cost of sales
were $3.7 million of reserves for store inventory. The reserves have been fully
utilized as of December 31, 1998. In addition, during the first quarter of
1998, $7.0 million of pretax write-offs were taken primarily relating to a more
rapid decline in Mac sales during the quarter and the effects of rapid price
erosion and other changes in the industry on inventory and receivables during
the quarter.
Beginning in October 1997, uBid granted stock options to attract and retain
key employees. These options were exercisable only in the event of a successful
initial public offering or sale of uBid. Accordingly, the Company recorded a
$5.3 million non-cash charge to compensation upon the consummation of uBid's
initial public offering in December 1998. uBid expects to record additional
non-cash compensation charges of approximately $8.0 million over the remaining
vesting period of such options.
29
<PAGE>
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Net sales for the year ended December 31, 1997 were $546.1 million, an
increase of $101.1 million or 23% over net sales for the year ended December 31,
1996 of $445.0 million. Mail order/catalog sales for 1997 were $478.3 million,
an increase of $91.2 million or 24% over 1996 mail order/catalog sales of $387.1
million. The increase in net sales was primarily due to an increase in the
number of catalogs distributed during the year, the growth from the PC Mall
catalog, an increase in telemarketing sales executives and $37 million in sales
from the two acquisitions in the third and fourth quarters of 1997. The Company
distributed approximately 62.2 million catalogs during 1997, of which MacMall
comprised 36.0 million, PC Mall 21.9 million, DataCom Mall 2.9 million and
ComputAbility 1.4 million. This compared to 48.8 million catalogs distributed
in 1996. Retail net sales in 1997 were $67.8 million, an increase of $9.9
million or 17% from retail net sales of $57.9 million in 1996. WINTEL net sales
increased 116% to $221.3 million in 1997, versus $102.4 million in 1996. WINTEL
net sales for 1997 comprised 40.5% of total net sales as compared to 23.0% in
1996. By December 1997, WINTEL net sales comprised 51.8% of total Company net
sales.
Gross profit for the year ended December 31, 1997 was $70.1 million, an
increase of $20.1 million or 40% from gross profit of $50.0 million for the year
ended December 31, 1996. Gross profit as a percentage of net sales was 12.8% in
1997, versus 11.2% in 1996. The increase in gross profit was primarily due to
the increase in sales in 1997 over 1996 and the large write-downs in 1996 for
slow-moving and excessive inventory, products returned to vendors for which the
Company did not receive payment, and for theft and shrinkage of inventory.
Selling, general and administrative (SG&A) expenses were $63.5 million for
the year ended December 31, 1997, an increase of $2.9 million or 5% over SG&A
expenses of $60.6 million for the year ended December 31, 1996. As a percentage
of net sales, SG&A expenses were 11.6% in 1997, versus 13.6% in 1996. This
decrease is primarily due to write-offs in 1996 associated with the allowance
for doubtful accounts, credit card fraud and significantly lower net advertising
costs in 1997.
In the fourth quarter of 1997, the Company incurred approximately $0.8
million in expenses associated with the relocation and consolidation of its
headquarters and telemarketing operations into a 160,000 square foot building in
a nearby location in Torrance, CA. The Company is phasing into the facility
over two years and initially occupied 60,000 square feet. The Company currently
occupies approximately 98,000 square feet at the Torrance facility.
The Company expensed $1.5 million of non-recurring charges associated with
the Elek-Tek acquisition in the fourth quarter of 1997. These acquisition
related expenses were primarily associated with integrating Elek-Tek's sales
force and customer base into Creative Computers.
Interest income (net of interest expense) was $0.1 million in 1997 compared
to $0.6 million in 1996. The reduction in interest income resulted from cash
outlays and increased borrowings for the acquisitions of ComputAbility and
Elek-Tek.
Liquidity and Capital Resources
The Company's primary capital need has been funding the working capital
requirements created by its rapid growth in sales. Historically, the Company's
primary sources of financing have come from public offerings and borrowings from
its stockholders, private investors and financial institutions. In April and
August 1995, the Company completed an initial public offering and a follow-on
offering of its Common Stock which resulted in aggregate net proceeds to the
Company of approximately $46.6 million. On December 9, 1998, uBid completed an
initial public offering which resulted in net proceeds of $23.8 million. Cash
flows from operations were $(7.8) million, $18.8 million and $13.5 million for
1996, 1997
30
<PAGE>
and 1998, respectively. Cash flows from operations in 1998 were favorable due to
improved management of inventory and payables. Cash flows from operations in
1997 were favorable due to improved management of inventory as well as a return
to profitability. Cash flows from operations in 1996 were negative primarily due
to investments in inventory and accounts receivable necessitated by the rapid
sales growth of the Company, including those associated with the introduction of
the Company's MacMall, PC Mall and DataCom Mall catalogs.
Inventory increased $5.3 million in 1998 as more inventory was required to
support the increase in sales. Inventory turns continued to improve from 1997
and 1996. Accounts receivable decreased $2.7 million during 1998, primarily due
to improved collection efforts.
During the year ended December 31, 1998, the Company's capital expenditures
were $3.6 million as compared to $3.3 million in 1997. The Company's primary
capital needs will continue to be funding its working capital requirements for
anticipated sales growth and possible acquisitions.
On August 29, 1997, the Company acquired the assets and liabilities of
ComputAbility Ltd. for $5.5 million cash and 271,739 shares of the Company's
Common Stock.
As of December 31, 1998, the Company had advances outstanding of $38.0
million under a $60 million line of credit with a finance company. The line of
credit allows working capital advances up to $27.5 million and floorplan
inventory financing up to $45.0 million, however, total advances and floorplan
financing cannot exceed $60.0 million. The advances outstanding at December 31,
1998 relate to floorplan inventory financing to purchase inventory which is
included in accounts payable. There were no outstanding working capital advances
at December 31,1998. Working capital advances are also limited to eligible
accounts receivable and inventory collateral. The line of credit is secured by
substantially all of the Company's assets and is cancelable upon 90 days'
advance notice. Interest for amounts owed for working capital advances are
calculated at the finance company's prime rate (7.75% and 8.25% per annum at
December 31, 1998 and 1997, respectively). Floorplan financing does not bear
interest if paid within an average of 30 days of the inventory purchase date.
Interest on floorplan financing not paid within an average of 45 days is charged
at the finance company's prime rate plus 2% (9.75% and 10.25% per annum at
December 31, 1998 and 1997, respectively). The line of credit requires that the
Company maintain a minimum tangible net worth, a minimum pretax earnings to
interest expense ratio and limits debt as a ratio to tangible net worth. At
December 31, 1998, the Company was in compliance with these covenants. At
December 31, 1998, the Company had $22.0 million available for working capital
advances and floorplan inventory financing.
On October 15, 1997, the Company borrowed $20.7 million from the credit line
and paid $8.7 million from its cash reserves to purchase the assets of Elek-Tek
for $29.4 million. As of December 31, 1998, the Company has repaid all funds
borrowed to purchase Elek-Tek.
At December 31, 1998, the Company had cash and short-term investments of
$32.5 million and working capital of $42.8 million. The Company believes that
current working capital, together with cash flows from operations and available
lines of credit, will be adequate to support the Company's current operating
plans through 1999. However, if the Company needs extra funds, such as for
acquisitions or expansion or to fund a significant downturn in sales that causes
losses, there are no assurances that adequate financing will be available at
acceptable terms, if at all.
In July 1996, the Company announced its plan to repurchase up to 1,000,000
shares of its Common Stock. The shares will be repurchased from time to time at
prevailing market prices, through open market or negotiated transactions,
depending upon market conditions. No limit was placed on the duration of the
repurchase program. There is no guarantee as to the exact number of shares that
the Company will repurchase. Subject to applicable securities laws, repurchases
may be made at such times and in such amounts as the Company's management deems
appropriate. The program can also be discontinued at any time management feels
additional purchases are not warranted. The Company will
31
<PAGE>
finance the repurchase plan with existing working capital. As of December 31,
1998, the Company has repurchased 15,000 shares.
As part of its growth strategy, the Company may, in the future, acquire other
companies in the same or complementary lines of business. Any such acquisition
and the ensuing integration of the operations of the acquired company with those
of the Company would place additional demands on the Company's management,
operating and financial resources. The Company currently has no definitive
agreements with respect to any acquisitions.
Year 2000
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed "year
2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with whom the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems, and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has established
an internal project team comprised of all functional disciplines. This project
team has begun a three-phase process of identifying internal systems (both
information technology and non-information technology systems) not year 2000
compliant, determining their significance in the effective operation of the
Company, and developing plans to resolve the issues where necessary. The Company
has been communicating with the suppliers and others to coordinate year 2000
readiness. The responses received by the Company to date have indicated that
steps are currently being undertaken to address this concern. However, if such
third parties are not able to make all systems and products year 2000 compliant,
there could be a material adverse impact on the Company.
Initial review of the Company's principal application software through which
nearly all of the Company's business is transacted, has determined it to be year
2000 compliant and, as such, the Company does not anticipate any material
adverse operational issues to arise. The Company has completed 75% of the year
2000 compliance assessment for critical systems and will complete its assessment
by the end of the second quarter of 1999. The Company plans to implement
corrective solutions before the end of the third quarter of 1999. To date, the
costs incurred by the Company with respect to this project are $0.1 million.
Based on current estimates, management expects that the Company's total costs in
connection with its year 2000 compliance project will be approximately $0.8
million and will be financed from general corporate funds; however, future
anticipated costs are difficult to estimate with any certainty and may differ
materially from those currently projected based on the results of the assessment
phase of the Company's year 2000 project. The anticipated costs associated with
the Company's year 2000 compliance program do not include time and costs that
may be incurred as a result of any potential failure of third parties to become
year 2000 compliant or costs to implement the Company's future contingency
plans. Management estimates that approximately one half of the expected costs
will be attributed to the redeployment of internal resources and the other half
will be comprised principally of external consulting fees and software upgrades.
No hardware expenditures for year 2000 are contemplated. The redeployment of
internal data processing resources is not expected to materially delay any
significant projects. Year 2000 spending is expected to be 10% of total budgeted
data processing expenditures. The Company has not yet developed a contingency
plan in the event that any non-compliant critical systems are not remedied by
January 1, 2000, nor has it formulated a timetable to create such contingency
plan. Upon completion of this project, if systems material to the Company's
operations have not been made
32
<PAGE>
year 2000 compliant, or if third parties fail to make their systems year 2000
compliant in a timely manner, the year 2000 issue could have a material adverse
effect on the Company's business, financial condition and results of operations.
Inflation
Inflation has not had a material impact upon operating results, and the
Company does not expect it to have such an impact in the near future. There can
be no assurances, however, that the Company's business will not be so affected
by inflation.
The Management's Discussion and Analysis Of Financial Condition and Results
of Operations of uBid is contained in the uBid 1998 10-K in Part II, Item 7 and
is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and long-term debt. At
March 26, 1999, the carrying values of the Company's financial instruments
approximated their fair values based on current market prices and rates.
It is the Company's policy not to enter into derivative financial
instruments. The Company does not have any significant foreign currency
exposure since it does not transact business in foreign currencies. Therefore,
the Company does not have significant overall currency exposure at March 26,
1999.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements listed in Item 14(a) under the caption "Consolidated Financial
Statements" and commencing on page F-1 of this Report.
uBid's financial statements and supplementary data are contained in Part II,
Item 8 of the uBid 1998 10-K and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
33
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of the Company is set forth under the caption
"Election of Directors," in the Company's definitive Proxy Statement to be filed
in connection with its 1999 Annual Meeting of Stockholders and such information
is incorporated herein by reference. A list of executive officers of Registrant
is included in Part I of this report. Effective March 1998, the Company accepted
Al S. Joseph's resignation as a director of the Company. Effective December
1999, the Company accepted Ahmed Alfi's resignation as a director of the
Company.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the caption
"Executive Compensation and Other Information" and "Election of Directors
Compensation of Directors" in the Company's definitive Proxy Statement to be
filed in connection with its 1999 Annual Meeting of Stockholders and such
information is incorporated herein by reference.
The information pertaining to the compensation of uBid's executives is
incorporated by reference to uBid's definitive proxy statement for uBid's 1999
annual meeting of stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's definitive Proxy Statement to be filed in connection with its 1999
Annual Meeting of Stockholders and such information is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the captions
"Executive Compensation and Other Information -- Certain Relationship and
Related Transactions and Compensation Committee Interlocks and Insider
Participation" in the Company's definitive Proxy Statement to be filed in
connection with its 1999 Annual Meeting of Stockholders and such information is
incorporated herein by reference.
34
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following consolidated financial statements of Registrant are filed as part
of this report:
(a) (1) Consolidated Financial Statements. See Index to Consolidated
Financial Statements.
(2) Financial Statement Schedules. See Index to Consolidated Financial
Statements.
(3) Exhibits.
The following exhibits are filed or incorporated by reference as
part of this report:
Exhibit Number Description
-------------- -----------
3.1 Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
10.1* 1994 Stock Incentive Plan and form of stock option agreement (1)
10.2* Employment Agreement dated January 1, 1995, between Creative
Computers, Inc. and Frank F. Khulusi (1)
10.4* Employment Agreement dated January 1, 1994, between Creative
Computers, Inc. and Dan DeVries (1)
10.5 Standard Industrial/Commercial Single-Tenant Lease-Net dated
February 10, 1993 between Herman Platt and Marjorie Platt, as
Co-Trustees of the Herman Platt and Marjorie Platt Trust dated
October 11, 1985 and Creative Computers, Inc. for the premises
located at 2645 Maricopa Street, Torrance, California (2)
10.6 ITT Commercial Financial Corporation ("ITT") financing
arrangements:
a. Agreement for Wholesale Financing (Security Agreement-
Arbitration) dated April 4, 1991, as amended, between ITT
and Creative Computers, Inc. (1)
10.13 Warrant to Purchase Common Stock of Creative Computers, Inc.
dated September 29, 1994 in favor of Creative Partners, L.P. (1)
10.14 Security Agreement dated as of September 26, 1994 by Creative
Computers, Inc. in favor of Creative Partners, L.P. (1)
10.18* Form of Directors' Non-Qualified Stock Option Plan (1)
10.22 Agreement dated August 1, 1995 between Creative Computers, Inc.
and Deutsche Financial Services (formerly known as ITT
Commercial Finance Corp.) (2)
10.25 Industrial Lease Agreement between Corporate Estates, Inc. and
Creative Computers, Inc. dated September 15, 1995 for the
premises located at 4515 E. Shelby Drive, Memphis, Tennessee,
filed in connection with the Company's 10-Q for the quarter
ended September 30, 1995 (4)
10.28 Authorized Apple Dealer U.S. Sales Agreement dated August 29,
1996; Authorized Apple Catalog Reseller Sales Agreement dated
August 29, 1996; Dealer Apple Authorized Service Provider
Agreement dated August 29, 1996; Apple Corporate Alliance
Program Addendum to the Authorized Apple Dealer Sales Agreement
dated August 29, 1996 (4)
10.29 Amendment to Agreement for Wholesale Financing dated February
25, 1997 (4)
10.30 Asset Purchase Agreement dated September 27, 1997 between
Creative Computers, Inc. and Elek-Tek (3)
35
<PAGE>
10.31 Business Credit and Security Agreement dated October 14, 1997
between Deutsche Financial Service Corporation and Elek-Tek
Acquisition Corp. (3)
10.32 Business Credit and Security Agreement dated October 14, 1997
between Deutsche Financial Service Corporation and Creative
Computers, Inc. (3)
10.33 Asset Purchase Agreement dated August 29, 1997 between Creative
Computers, Inc. and ComputAbility, Ltd. (5)
10.34 Registration Rights Agreement by and between Creative Computers,
Inc. and uBid, Inc., dated as of December 7, 1998 (6)
10.35 Separation and Distribution Agreement by and between Creative
Computers, Inc. and uBid, Inc., dated as of December 7, 1998.
(6)
10.36 Services Agreement by and between Creative Computers, Inc. and
uBid, Inc., dated as of December 7, 1998 (6)
10.37 Tax Indemnification and Allocation Agreement by and between
Creative Computers, Inc. and uBid, Inc., dated as of December 7,
1998, as amended (7)
10.38 Sublease Agreement between Creative Computers, Inc. and uBid,
Inc., dated as of July 1, 1998 (6)
10.39 Agreement Restricting Transfer of Assets and Letter Agreement
dated as of September 23, 1998 by and between Deutsche
Financial Services Corporation and Creative Computers, Inc. and
uBid, Inc. (6)
10.40 Assignment and License Agreement by and between Creative
Computers, Inc. and uBid, Inc., dated as of November 30,
1998 (6)
10.41* Employment Agreement dated January 21, 1999, between
Creative Computers, Inc. and S. Keating Rhoads
21.1 Subsidiaries (2)
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Ernst & Young LLP
27.1 Financial Data Schedule (filed with EDGAR version only)
99.1 uBid, Inc. Form 10-K for the year ended December 31, 1998
(1) Incorporated by reference to the Company's Registration
Statement on Form S-1 (33-89572) declared effective on April 4,
1995.
(2) Incorporated by reference to the Company's Registration
Statement on Form S-1 (33-95416) declared effective on
August 23, 1995.
(3) Incorporated by reference to the Company's Form 8-K dated
October 11, 1997, filed with the Commission on October 30, 1997
(4) Incorporated by reference to the Company's 1996 Form 10-K,
filed with the Commission on March 31, 1997.
(5) Incorporated by reference to the Company's 1997 Form 10-K,
filed with the Commission on March 31, 1998.
(6) Incorporated by reference to the Registration Statement on Form
S-1 of uBid, Inc. (File No. 333-58477), on file with the
Commission.
(7) Incorporated by reference to the uBid, Inc. Form 10-K for the
year ended December 31, 1998, filed with the Commission on
March 31, 1999.
* The referenced exhibit is a compensatory contract, plan or arrangement.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the period
covered by this Report.
The information pertaining to uBid's exhibits, financial statement schedules,
and reports on Form 8-K is incorporated by reference to Part IV, Item 14 of
uBid's 1998 10-K.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Torrance,
State of California, on March 31, 1999.
CREATIVE COMPUTERS, INC.
By: /s/ FRANK F. KHULUSI
-------------------------------------
Frank F. Khulusi
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Frank F. Khulusi and Theodore R. Sanders,
and each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this Report
on Form 10-K, and to file the same, with exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in connection therewith, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ FRANK F. KHULUSI Chairman of the Board of March 31, 1999
- -------------------------- Directors, President and
Frank F. Khulusi Chief Executive Officer
(Principal Executive Officer)
/s/ THEODORE R. SANDERS Chief Financial Officer March 31, 1999
- -------------------------- (Principal Financial and
Theodore R. Sanders Accounting Officer)
/s/ SAM U. KHULUSI Director March 31, 1999
- --------------------------
Sam U. Khulusi
/s/ THOMAS MALOOF Director March 31, 1999
- --------------------------
Thomas Maloof
37
<PAGE>
CREATIVE COMPUTERS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements and Supplementary Data
- -------------------------------------------
Report of Independent Accountants F-2
Consolidated Balance Sheet at December 31, 1998 and 1997 F-3
Consolidated Statement of Operations for the Years Ended
December 31, 1998, 1997 and 1996 F-4
Consolidated Statement of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statement of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
Quarterly Financial Information (unaudited) F-20
Financial Statement Schedules
- -----------------------------
Schedule II -- Valuation and Qualifying Accounts F-21
All other schedules are omitted since the required information is not
present or is not present in amounts sufficient to require submission of
the schedule, or because the information required is included in the
consolidated financial statements and notes thereto.
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Creative Computers, Inc.
In our opinion, based upon our audits and the report of other auditors, the
consolidated financial statements listed in the accompanying index on page F-1
present fairly, in all material respects, the financial position of Creative
Computers, Inc. and its subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of uBid, Inc., a majority-owned subsidiary, for the year ended
December 31, 1998, which statements reflect total assets of $34,625,000 at
December 31, 1998 and total revenues of $48,232,000 for the year then ended.
Those statements were audited by other auditors whose report thereon has been
furnished to us, and our opinion expressed herein, insofar as it relates to the
amounts included for uBid, Inc., is based solely on the report of the other
auditors. We conducted our audits of the consolidated financial statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
February 3, 1999
F-2
<PAGE>
CREATIVE COMPUTERS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
<TABLE>
<CAPTION>
December 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 32,495 $ 8,018
Accounts receivable, net of allowance for
doubtful accounts of $3,697 and $2,859, respectively 39,775 42,455
Inventories 47,971 42,643
Prepaid expenses and other current assets 3,991 2,894
Income tax refund receivable 190 469
Deferred income taxes 5,216 2,484
-------- --------
Total current assets 129,638 98,963
-------- --------
Property, plant and equipment, net 14,910 16,868
Goodwill, net 12,318 15,141
Deferred income taxes 1,262 -
Other assets 138 182
-------- --------
$158,266 $131,154
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 71,142 $ 45,958
Accrued expenses and other current liabilities 15,569 13,275
Line of credit - 9,956
Capital leases--current portion 116 207
Notes payable--current portion 6 23
-------- --------
Total current liabilities 86,833 69,419
-------- --------
Capital leases 6 148
Notes payable 155 348
Deferred income taxes - 1,469
-------- --------
Total liabilities 86,994 71,384
Minority Interest 3,708 -
Stockholders' equity:
Common stock, $.001 par value; authorized 15,000,000
shares; 10,264,539 and 10,105,258 shares issued
and outstanding 10 10
Preferred stock, $.001 par value; authorized 5,000,000 shares;
none issued and outstanding
Additional paid-in capital 82,361 56,772
Treasury stock, at cost: 15,000 shares (91) (91)
Retained earnings (accumulated deficit) (14,716) 3,079
-------- --------
Total stockholders' equity 67,564 59,770
-------- --------
$158,266 $131,154
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net sales $690,238 $546,131 $444,971
Cost of goods sold 612,566 476,061 395,000
Retail store closure inventory reserve 3,679 - -
-------- -------- --------
Gross profit 73,993 70,070 49,971
Selling, general and administrative
expenses 85,519 63,540 60,585
Expenses related to retail store closures 6,773 - -
-------- -------- --------
Income (loss) before uBid stock-based
compensation (18,299) 6,530 (10,614)
uBid stock-based compensation 5,267 - -
-------- -------- --------
Income (loss) from operations (23,566) 6,530 (10,614)
Interest income (expense), net (461) 118 593
-------- -------- --------
Income (loss) before income taxes (24,027) 6,648 (10,021)
Income tax provision (benefit) (5,034) 2,523 (3,972)
-------- -------- --------
Income (loss) before minority interest (18,993) 4,125 (6,049)
Minority interest 1,198 - -
-------- -------- --------
Net income (loss) $(17,795) $ 4,125 $ (6,049)
======== ======== ========
Basic earnings (loss) per share $(1.75) $0.42 $(0.62)
======== ======== ========
Diluted earnings (loss) per share $(1.75) $0.41 $(0.62)
======== ======== ========
Basic weighted average number of
shares outstanding 10,176 9,895 9,767
======== ======== ========
Diluted weighted average number of
shares outstanding 10,176 10,030 9,767
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Stock Additional Retained
-------------- Paid-In Earnings Treasury
Shares Amount Capital (Deficit) Stock Total
------ ------ ---------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 9,750 $10 $51,547 5,003 $ $ 56,560
Purchase of treasury stock (91) (91)
Stock option exercises 42 239 239
Contribution from director 2,146 2,146
Net loss (6,049) (6,049)
------ --- ------- -------- ---- --------
Balance at December 31, 1996 9,792 10 53,932 (1,046) (91) 52,805
Issuance of stock in connection
with acquisition 272 2,500 2,500
Stock option exercises, including
related income tax benefit 41 340 340
Net income 4,125 4,125
------ --- ------- -------- ---- --------
Balance at December 31, 1997 10,105 10 56,772 3,079 (91) 59,770
Capital contributed by minority
stockholders of subsidiary 18,943 18,943
uBid stock-based compensation 5,267 5,267
Stock option exercises, including
related income tax benefit 160 1,379 1,379
Net loss (17,795) (17,795)
------ --- ------- -------- ---- --------
Balance at December 31, 1998 10,265 $10 $82,361 $(14,716) $(91) $ 67,564
====== === ======= ======== ==== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(17,795) $ 4,125 $ (6,049)
-------- -------- --------
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,033 2,337 1,955
Provision (benefit) for deferred income taxes (5,017) 2,350 (3,010)
Loss on disposal of property, plant and equipment 1,950 783 -
Loss on impairment of goodwill 3,095 - -
uBid non-cash stock-based compensation charge 5,267 - -
Minority interest (1,198) - -
Changes in assets and liabilities, net of acquisitions:
Accounts receivable 2,680 (5,112) (1,643)
Inventories (5,328) 17,414 (3,066)
Prepaid expenses and other current assets (1,158) 906 27
Other assets (742) 3 242
Accounts payable 25,184 (6,827) 4,164
Accrued expenses and other current liabilities 2,294 1,064 550
Income tax refund receivable 279 1,723 (959)
-------- -------- --------
Total adjustments 31,339 14,641 (1,740)
-------- -------- --------
Net cash provided by (used in) operating activities 13,544 18,766 (7,789)
-------- -------- --------
Cash flows from investing activities:
Redemptions of securities available for sale - 1,536 31,805
Purchase of securities available for sale - (1,015) (19,751)
Acquisition of Elek-Tek - (9,083) -
Acquisition of ComputAbility - (5,482) -
Acquisition of property, plant and equipment (3,552) (3,276) (2,050)
Proceeds from sale of equipment - 13 -
-------- -------- --------
Net cash (used in) provided by investing activities (3,552) (17,307) 10,004
-------- -------- --------
Cash flows from financing activities:
Net line of credit payments (9,956) (10,775) -
Payments under notes payable (210) (81) (13)
Proceeds from profits realized by Director on sale of stock - - 2,146
Principal payments of obligations under capital leases (233) (254) (249)
Purchase of treasury stock - - (91)
Net proceeds of uBid initial public offering 23,847 - -
Proceeds from stock issued under stock option plans 1,037 340 239
-------- -------- --------
Net cash provided by (used in) financing activities 14,485 (10,770) 2,032
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 24,477 (9,311) 4,247
Cash and cash equivalents:
Beginning of year 8,018 17,329 13,082
-------- -------- --------
End of year $ 32,495 $ 8,018 $ 17,329
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
1. Summary of Significant Accounting Policies
Description of Company
Creative Computers, Inc. (the "Company"), founded in 1987, is a direct
marketer of personal computer hardware, software and peripheral products. The
Company offers products to individual consumers, home offices, small businesses
and large corporations through direct response catalogs, dedicated inbound and
outbound telemarketing sales executives, a direct sales force, a retail showroom
and advertising on the Internet. The Company offers a broad selection of
products through its distinctive, full-color catalogs, MacMall, PC Mall, PC
Mall.Com, MacMall Buyers Software Guide and ComputAbility, the Company's
worldwide websites on the Internet, and other promotional materials.
During 1997, the Company acquired and assimilated two marketers of personal
computer hardware and software products, Elek-Tek, Inc. and ComputAbility, Ltd.
In September 1997, the Company formed a wholly owned subsidiary, uBid, Inc.
("uBid") to sell computer-related products and consumer electronics through an
auction format on the Internet. In December 1998, uBid completed an initial
public offering of 1,817,000 shares of its common stock. At December 31, 1998,
the Company owned approximately 80.1% of the outstanding shares of common stock
of uBid. The Company intends to distribute to shareholders, subject to the
satisfaction of certain conditions, its ownership in uBid by means of a tax-free
stock dividend in 1999, but in no event prior to June 7, 1999.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
respective reporting periods. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and transactions
have been eliminated.
Revenue Recognition
Revenue on product sales is recognized at the time of shipment. The
Company's return policy varies from product to product, and in some cases
provides a money-back guarantee. An allowance for potential product returns is
established based upon historical trends.
Cash Equivalents
All highly liquid investments with initial maturities of three months or
less are considered cash equivalents.
F-7
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Inventories
Inventories consist of computer hardware, software and peripheral products,
and are stated at cost (determined under the first-in, first-out cost method) or
market, whichever is lower. At December 31, 1998 and 1997, the Company had
reserves of $5,036 and $5,364, respectively, for demonstration inventory, lower
of cost or market pricing and potential excess and obsolete inventory.
Deferred Advertising Costs and Revenue
The Company produces and circulates catalogs at various dates throughout
the year. The Company receives market development funds and cooperative (co-op)
advertising funds from vendors included in each catalog. These funds are
recognized based on sales generated over the life of the catalog, which
approximates eight weeks. The costs of developing and circulating each catalog
are deferred and charged to advertising expense in the same time period as the
co-op funds based on sales over the life of the catalog. Advertising expense,
net of advertising revenue earned, included in selling, general and
administrative expenses, was $6,816, $1,397 and $8,155 in 1998, 1997, and 1996,
respectively. Deferred advertising costs were $3,106 and $2,105 at December 31,
1998 and 1997, respectively, and are included in prepaid expenses and other
current assets in the consolidated balance sheet.
Property, Plant and Equipment
Property, plant and equipment (including equipment acquired under capital
leases) are stated at cost and are depreciated using straight-line methods over
the estimated useful lives of the assets, as follows:
Furniture and fixtures 5 - 7 years
Leasehold improvements Life of lease--not to exceed 15 years
Computer, machinery and equipment 3 - 7 years
Building 31.5 years
Disclosures About Fair Value of Financial Instruments
The carrying amount of cash, cash equivalents, accounts receivable,
accounts payable and accrued expenses and other current liabilities approximates
fair value because of the short maturity of these instruments. The carrying
amount of the Company's notes payable approximate fair value based upon the
current rates offered to the Company for obligations of similar terms and
remaining maturities.
Goodwill
Goodwill, resulting from acquisitions, is amortized using the straight-line
method over periods not exceeding twenty-five years and is subject to periodic
review for impairment. Accumulated amortization at December 31, 1998 and 1997
was $604 and $90, respectively. Amortization expense totaled $514 and $90 in
1998 and 1997.
F-8
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Accounting for the Impairment of Long-Lived Assets
The Company reviews long-lived assets and certain intangible assets for
impairment when events or changes in circumstances indicate the carrying amount
of an asset may not be recoverable. In the event the sum of the expected
undiscounted future cash flows resulting from the use of the asset is less than
the carrying amount of the asset, an impairment loss equal to the excess of the
asset's carrying value over its fair value is recorded. During 1998, in
conjunction with the store closures, the Company determined that goodwill
related to acquired retail stores was impaired and, accordingly, the Company
recorded a write-off of $3,095.
Income Taxes
The Company accounts for income taxes under the liability method. Under
this method, deferred income taxes are recognized by applying enacted statutory
tax rates applicable to future years to differences between the tax bases and
financial reporting amounts of existing assets and liabilities. A valuation
allowance is provided when it is more likely than not that all or some portion
of deferred tax assets will not be realized.
Earnings (Loss) per Share
Effective in the fourth quarter of 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). SFAS
128 requires dual presentation of Basic Earnings (Loss) per Share (Basic EPS)
and Diluted Earnings (Loss) per Share (Diluted EPS). Basic EPS excludes
dilution and is computed by dividing net income (loss) by the weighted average
number of common shares outstanding during the reported periods. Diluted EPS
reflects the potential dilution that could occur if stock options and other
commitments to issue common stock were exercised using the treasury stock
method. Earnings (loss) per share has been restated for all periods to reflect
the adoption of SFAS 128.
The composition of Basic and Diluted EPS is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------
1998 1997 1996
------------ ----------- ----------
<S> <C> <C> <C>
Net income (loss) $ (17,795) $ 4,125 $ (6,049)
=========== =========== ==========
Weighted average shares - Basic 10,175,864 9,895,179 9,766,863
Effect of dilutive stock options
and warrants - 135,328 -
----------- ----------- ----------
Weighted average shares - Diluted 10,175,864 10,030,417 9,766,863
=========== =========== ==========
Net income (loss) per share - Basic $ (1.75) $ 0.42 $ (0.62)
=========== =========== ==========
Net income (loss) per share - Diluted $ (1.75) $ 0.41 $ (0.62)
=========== =========== ==========
</TABLE>
F-9
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Accounting for Stock-Based Compensation
The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25 and related interpretations. The
disclosures required by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123), have been included in
Note 7.
New Accounting Standards
During 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosure about Segments of an Enterprise and Related
Information" (SFAS 131). The adoption of this statement did not have a material
effect on the Company's consolidated financial statements, and the appropriate
disclosures required by this statement have been incorporated herein.
Reclassifications
Certain reclassifications have been made to the 1996 and 1997 financial
statement balances to conform to the 1998 presentation.
2. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following as of December 31:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Furniture and fixtures $ 2,370 $ 2,907
Leasehold improvements 2,703 3,483
Computer, machinery and equipment 15,152 12,337
Building 2,827 2,827
Land 1,446 1,446
------- -------
24,498 23,000
Less: Accumulated depreciation and amortization (9,588) (6,132)
------- -------
$14,910 $16,868
======= =======
</TABLE>
The Company leases certain equipment under capital leases. The following
is a summary of such equipment as of December 31:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Computer, machinery and equipment $ 454 $ 1,705
Furniture and fixtures 119 372
----- -------
573 2,077
Less: Accumulated amortization (472) (1,660)
----- -------
$ 101 $ 417
===== =======
</TABLE>
F-10
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
3. Line of credit
As of December 31, 1998, the Company had advances outstanding of $37,971
under a $60,000 line of credit with a finance company. The line of credit
allows working capital advances up to $27,500 and floorplan inventory financing
up to $45,000, however, total advances and floorplan financing cannot exceed
$60,000. The advances outstanding at December 31, 1998 relate to floorplan
inventory financing to purchase inventory which is included in accounts payable.
There were no outstanding working capital advances at December 31,1998. Working
capital advances are also limited to eligible accounts receivable and inventory
collateral. The line of credit is secured by substantially all of the Company's
assets and is cancelable upon 90 days' advance notice. Interest for amounts
owed for working capital advances are calculated at the finance company's prime
rate (7.75% and 8.25% per annum at December 31, 1998 and 1997, respectively).
Floorplan financing does not bear interest if paid within an average of 30 days
of the inventory purchase date. Interest on floorplan financing not paid within
an average of 45 days is charged at the finance company's prime rate plus 2%
(9.75% and 10.25% per annum at December 31, 1998 and 1997, respectively). The
line of credit requires that the Company maintain a minimum tangible net worth,
a minimum pretax earnings to interest expense ratio and limits debt as a ratio
to tangible net worth. At December 31, 1998, the Company was in compliance with
these covenants. At December 31, 1998, the Company had $22,029 available for
working capital advances and floorplan inventory financing.
As of December 31, 1997, the Company had advances of $16,340 comprised of
$9,956 of working capital loans borrowed in connection with the acquisition of
Elek-Tek, and $6,384 of floorplan inventory financing to purchase inventory,
which is included in accounts payable.
4. Income Taxes
The provision (benefit) for income taxes consists of the following for the
years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------ --------
<S> <C> <C> <C>
Current
Federal $ (100) $ 103 $(1,011)
State 83 70 49
------- ------ -------
(17) 173 (962)
------- ------ -------
Deferred
Federal (4,584) 2,101 (2,514)
State (433) 249 (496)
------- ------ -------
(5,017) 2,350 (3,010)
------- ------ -------
$(5,034) $2,523 $(3,972)
======= ====== =======
</TABLE>
The provision (benefit) for income taxes differed from the amount computed
by applying the U.S. federal statutory rate to income (loss) before income taxes
due to the effects of the following:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ -------
<S> <C> <C> <C>
Expected taxes at federal
statutory tax rate (34.0)% 34.0 % (34.0)%
State income taxes, net of federal
income tax benefit (2.7)% 5.0 % (4.6)
Change in valuation allowance 14.5 % -- --
Other 1.2 % (1.0)% (1.0)
----- ----- ------
(21.0)% 38.0 % (39.6)%
====== ===== ======
</TABLE>
F-11
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The significant components of deferred tax assets and liabilities are as
follows at December 31:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Accounts receivable $ 1,445 $ 530
Inventories 849 1,326
Property, plant and equipment (1,190) (1,222)
Amortization (396) (340)
Accrued expenses and reserves 642 529
Stock options 1,559 --
Tax credits and loss carryforwards 6,885 143
Other 3 49
Less: Valuation allowance (3,319) --
------- -------
Net deferred tax assets $ 6,478 $ 1,015
======= =======
</TABLE>
At December 31, 1998, the Company had federal net operating loss
carryforwards of $18,185, which begin to expire in 2018. At December 31, 1998,
the Company had various state net operating loss carryforwards ranging in
amounts from $1,296 to $3,463, which begin to expire in 2002. At December 31,
1998, the Company had federal and state capital loss carryforwards of $71, which
begin to expire in 2001. The Company also had state tax credit carryforwards of
$101, which begin to expire in 2011.
5. Commitments and Contingencies
Leases
The Company occupies office and warehouse space under various operating
leases with independent parties which provide for minimum annual rentals and
escalations based on increases in real estate taxes and other operating
expenses.
Minimum annual rentals at December 31, 1998 were as follows:
<TABLE>
<CAPTION>
<S> <C>
1999 $2,148
2000 2,368
2001 2,333
2002 1,689
------
Total $8,538
======
</TABLE>
In 1998, 1997 and 1996 rent expense was $2,486, $1,978 and $1,408,
respectively. Some of the leases contain renewal options, escalation clauses
and require the Company to pay taxes, insurance and maintenance costs.
Legal Proceedings
Various claims and actions, considered normal to the Company's business,
have been asserted and are pending against the Company. The Company believes
that such claims and actions will not have any material adverse effect upon the
Company's consolidated financial position or results of operations.
F-12
F-12
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
6. Stockholders' Equity
Initial Public Offering of uBid, Inc.
On December 9, 1998, uBid, Inc., a subsidiary of the Company, completed an
initial public offering (the Offering) of 1,817,000 shares of common stock at an
offering price of $15.00 per share. Net proceeds to uBid were $23,847, and will
be used for advertising and brand development of uBid's infrastructure to
support growth, and for uBid's general corporate purposes. The shares sold to
the public in the offering represent approximately 19.9% of uBid's outstanding
common stock. The Company will continue to own the remaining 80.1% of uBid but
intends to distribute, subject to the satisfaction of certain conditions, its
ownership in uBid by means of a tax-free stock dividend to the Company's
stockholders in 1999, but in no event prior to June 7, 1999. As a result of the
Offering, the Company's share of the amount of the Offering Proceeds in excess
of the corresponding carrying value of uBid equity in the amount of $18,943 was
credited to additional paid-in capital.
Treasury Stock
In July 1996, the Company announced its plan to repurchase up to 1,000,000
shares of its Common Stock. The shares will be repurchased from time to time at
prevailing market prices, through open market or negotiated transactions,
depending upon market conditions. No limit was placed on the duration of the
repurchase program. There is no guarantee as to the exact number of shares that
the Company will repurchase. Subject to applicable securities laws, repurchases
may be made at such times and in such amounts as the Company's management deems
appropriate. The program can also be discontinued at any time management feels
additional purchases are not warranted. The Company will finance the repurchase
plan with existing working capital. As of December 31, 1998, the Company has
repurchased 15,000 shares.
Proceeds from Profits Realized by Director in the Sale of Stock
In June 1996, the Company recorded additional paid-in capital in the amount
of $2,146, net of expenses, which represents cash contributed to the Company
associated with profits realized in the sale of stock by one of the Company's
directors pursuant to Section 16(b) of the Securities Exchange Act of 1934.
7. Employee Benefits
401(k) Savings Plan
Effective January 1, 1994, the Company adopted a 401(k) Savings Plan which
covers substantially all full-time employees who meet the plan's eligibility
requirements. Participants may make tax-deferred contributions of up to 15% of
annual compensation (subject to other limitations specified by the Internal
Revenue Code). In December 1995, the Company amended the Plan to make a 25%
matching contribution for amounts which do not exceed 4% of the participants
annual compensation. During 1998, 1997 and 1996, the Company incurred $87, $84
and $66, respectively, of expenses related to the 401(k) matching component of
this plan.
F-13
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
1994 Employee Stock Option Plan
In November 1994, the Board of Directors and stockholders of the Company
approved the 1994 Stock Option Plan (the "1994 Plan"), which provides for the
grant of stock options to employees and consultants of the Company. Under the
1994 Plan, the Company may grant options ("Incentive Stock Options") within the
meaning of Section 422A of the Internal Revenue Code of 1986, or options not
intended to qualify as Incentive Stock Options ("Nonstatutory Stock Options").
A total of 1,950,000 shares of common stock have been reserved for issuance upon
the exercise of options granted under the 1994 Plan. As of December 31, 1998,
802,847 shares of authorized but unissued common stock are available for future
grants under the 1994 Plan. All options granted through December 31, 1998 have
been Nonstatutory Stock Options.
The 1994 Plan is administered by the Compensation and Stock Option
Committee of the Board of Directors. Subject to the provisions of the 1994 Plan,
the Committee has the authority to select the employees and consultants to whom
options are granted and determine the terms of each option, including (i) the
number of shares of common stock covered by the option, (ii) when the option
becomes exercisable, (iii) the option exercise price, which must be at least
100%, with respect to Incentive Stock Options, and at least 85%, with respect to
Nonstatutory Stock Options, of the fair market value of the common stock as of
the date of grant, and (iv) the duration of the option (which may not exceed ten
years). All options generally vest annually over five years, and are
nontransferable other than by will or by the laws of descent and distribution.
1995 Director Stock Option Plan
The Company adopted the Directors' Non-Qualified Stock Option Plan (the
"Director Plan") in 1995. A total of 50,000 shares of Common Stock are reserved
for issuance under the Director Plan of which options to purchase 31,000 shares
are outstanding as of December 31, 1998.
Under the Director Plan each non-employee director of the Company ("Non-
Employee Director") receives a non-qualified option to purchase 5,000 shares of
Common Stock (an "Initial Grant") upon his or her first election or appointment
to the Board of Directors. In addition, the Director Plan provides that each
Non-Employee Director who is a director immediately prior to an annual meeting
of the Company's stockholders and who continues to be a director after such
meeting will be granted an option to purchase 5,000 shares of Common Stock (a
"Subsequent Grant"); provided that no Subsequent Grant will be made to any Non-
Employee Director who has not served as a director of the Company, as of the
time of such annual meeting, for at least one year. The exercise price per
share of each option granted under the Director Plan will be the fair market
value of the Company's Common Stock on the date the option is granted. Options
granted under the Director Plan vest on the first anniversary of the date of
grant, subject to earlier vesting upon a change of control or corporate
transaction.
F-14
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The following table summarizes stock option activity:
<TABLE>
<CAPTION>
Weighted
Average
Number Exercise Price
------ --------------
<S> <C> <C>
Outstanding at December 31, 1995 480,560 $17.60
Granted 576,200 8.51
Canceled (294,221) 9.00
Exercised (41,825) 5.66
--------
Outstanding at December 31, 1996 720,714 6.36
Granted 351,750 7.61
Canceled (176,593) 7.00
Exercised (41,694) 5.42
--------
Outstanding at December 31, 1997 854,177 6.80
Granted 500,100 8.43
Canceled (290,893) 8.04
Exercised (159,031) 6.26
--------
Outstanding at December 31, 1998 904,353 7.34
========
</TABLE>
On February 12, 1996, the Compensation Committee of the Board of Directors
repriced all stock options granted from April 15, 1995 through February 12, 1996
to the closing price for the day of $9.50. On Saturday July 27, 1996, the
Compensation Committee of the Board of Directors repriced all stock options
(with exercise prices in excess of $6.00 per share) to $6.00 per share. The
closing price per share on July 26, 1996 was $5.25.
Of the options outstanding at December 31, 1998, 1997 and 1996, options to
purchase 306,483, 274,914 and 144,531 shares were exercisable at weighted
average prices of $6.41, $6.21 and $5.85 per share, respectively. The following
table summarizes information concerning currently outstanding and exercisable
stock options:
<TABLE>
<CAPTION>
Options exercisable at
Options Outstanding at December 31, 1998 December 31, 1998
----------------------------------------------- ---------------------------
Weighted- Weighted- Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
- -------------------------- ----------------------------------------------- ---------------------------
<S> <C> <C> <C> <C> <C>
$5.00 - $6.00 305,151 6.92 $ 5.82 212,286 $5.84
$6.06 - $7.38 346,601 9.09 $ 6.87 64,368 $7.08
$7.50 - $12.94 252,601 9.33 $10.03 29,829 $9.02
------- -------
904,353 306,483
======= =======
</TABLE>
F-15
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The fair value of each stock option grant has been estimated pursuant to SFAS
123 on the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Risk free interest rates 4.89% 6.34% 6.23%
Expected dividend yield none none none
Expected lives 7 yrs. 6 yrs. 5 yrs.
Expected volatility 100.0% 80.0% 60.0%
</TABLE>
The weighted average grant date fair values of options granted under the
Plans during 1998, 1997 and 1996 were $8.43, $5.55 and $2.75, respectively.
uBid Employee Stock Option Plans
uBid has granted non-qualified options to certain employees and directors of
uBid to purchase Common Stock. Each option agreement provides that options may
not be exercised prior to the earlier of (i) the day following the distribution
of all uBid stock held by the Parent to its shareholders or (ii) 18 months from
the closing date of uBid's IPO. Accordingly, no options were exercisable at
December 31, 1998.
The terms of the options provide for vesting, generally over a 5-year period,
except for options to purchase 183,247 shares of common stock at December 31,
1998 which vested as to the first 20% of the shares covered by such options upon
completion of the IPO. The options expire 10 years from the date of grant.
The following table summarizes stock option activity:
<TABLE>
<CAPTION>
Weighted
Average
Number Exercise Price
------ --------------
<S> <C> <C>
Granted 458,118 $ 0.27
Canceled -
Exercised -
---------
Outstanding at December 31, 1997 458,118 0.27
Granted 651,725 4.62
Canceled (2,565) 0.27
Exercised -
---------
Outstanding at December 31, 1998 1,107,278 2.79
=========
</TABLE>
The options outstanding at December 31, 1997 all have an exercise price of
$0.27. Of the options granted during the year ended December 31, 1998, options
to purchase 370,526, 18,325, 109,948, 1,832, 79,529 and 69,000 common shares are
outstanding, and have exercise prices of $0.27, $6.82, $8.87, $10.20, $11.79 and
$15.00, respectively. Options at December 31, 1998 have a weighted average
estimated remaining life of 5.95 years.
F-16
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
uBid commenced its IPO on December 4, 1998 causing a measurement date to occur
and requiring the computation of compensation expense based upon the difference
between the exercise price of the options and the IPO price. Based upon the
difference between the IPO price of $15.00 per share and the exercise prices of
the 1,038,278 options outstanding at December 4, 1998, the total compensation
charge will be approximately $13,300, which will be recognized over the vesting
period, approximately $5,300 of which was recognized in December 1998.
The fair value of each stock option grant has been estimated pursuant to SFAS
No. 123 on the date of grant using the minimum value method for those options
granted prior to the IPO, and the Black-Scholes option pricing method for those
options issued concurrent with the IPO, with the following weighted average
assumptions:
<TABLE>
<CAPTION>
Minimum Value Black-Scholes
Assumptions Assumptions
------------- -------------
<S> <C>
Risk free interest rate 6.3% 4.89%
Expected dividend yield none none
Expected lives 6 years 6 years
Expected volatility 100% 142%
</TABLE>
The weighted average grant date fair values of options granted during the
twelve months ended December 31, 1998 and the period from Inception to
December 31, 1997 were $4.03 and $0.08, respectively.
uBid 1998 Stock Incentive Plan
In August 1998, uBid's Board of Directors adopted the 1998 Stock Incentive
Plan (the "1998 Plan") and reserved 1,832,470 shares of uBid Common Stock for
issuance thereunder. The plan authorized the award of options, stock
appreciation rights, restricted stock awards and performance based stock awards
(each an "Award"). The maximum number of shares with respect to options and
stock appreciation rights granted to any employee in any fiscal year is 476,442
shares. Options granted under the Plan may be either incentive stock options
("ISOs") or non-qualified stock options ("NSOs"). ISOs may be granted only to
employee (including officers and directors who are also employees). Awards
other than ISOs may be granted to employees, directors and consultants, as
defined.
Options under the Plan may be granted for periods up to ten years and at
prices no less than 85% of the fair value of the shares on the date of grant
provided, however, that the exercise price of an ISO may not be less than 100%
of the fair market value of the shares on the date of grant and the exercise
price of an ISO granted to a 10% shareholder may not be less than 110% of the
fair market value of the shares on the date of grant.
There have been no options granted under the 1998 Plan through December 31,
1998.
FAS 123 PRO FORMA INFORMATION
The Company accounts for its 1994 Plan, Director Plan and uBid Employee Stock
Option Plans (the "Plans") under APB Opinion No. 25. Had compensation expense
for these Plans been determined consistent with SFAS 123, the Company's net
income (loss) and net income (loss) per share would have been adjusted to the
pro forma amounts in the following table.
F-17
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) As Reported $(17,795) $4,125 $(6,049)
Pro Forma $(14,094) $3,549 $(7,478)
Diluted net income (loss)
per share As Reported $ (1.75) $ 0.41 $ (0.62)
Pro Forma $ (1.39) $ 0.37 $ (0.77)
</TABLE>
8. Supplemental Disclosures of Cash Flow Information
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash paid during the year ending December 31:
Interest $ 851 $ 488 $ 119
Income taxes $ 281 $ 538 $ 74
Non-cash investing and financing activities:
Borrowing incurred in connection with the
acquisition of Elek-Tek, Inc. -- $20,731 --
Equipment acquired under capital lease
Obligations -- $ 73 --
Notes payable assumed in connection with
acquisition of ComputAbility -- $ 380 --
</TABLE>
9. Acquisitions
On August 29, 1997, the Company acquired the assets and assumed the
liabilities of Milwaukee-based ComputAbility, Ltd., ("ComputAbility") a
privately held direct market reseller of PC/WINTEL hardware, peripheral and
software products, for $8,000 consisting of $5,500 paid in cash and the
remainder through the issuance of 271,739 shares of common stock valued at
$2,500. The acquisition of ComputAbility has been accounted for using the
purchase method and the operating results of ComputAbility have been combined
with those of the Company since the date of acquisition. The total cost of the
acquisition exceeded the fair value of the net assets acquired and liabilities
assumed by $6,763 and, accordingly, the excess has been recorded as goodwill and
is being amortized using the straight-line basis over 25 years.
On October 15, 1997, the Company acquired substantially all of the assets
of Elek-Tek, Inc. ("Elek-Tek"), a Delaware corporation, for a purchase price of
$29,400 plus direct costs of the acquisition pursuant to an Asset Purchase
Agreement dated September 17, 1997, as amended. Such assets consisted primarily
of accounts receivable, inventory, property, plant and equipment, certain
intangibles and customer lists and the businesses associated with mail order,
direct sales and retail activities. The acquisition was completed as a result of
bankruptcy court approval of the agreement signed by the Company and Elek-Tek in
connection with the September 17, 1997 filing by Elek-Tek for protection under
Chapter 11 of the U.S. Bankruptcy Code. Elek-Tek currently operates as a wholly
owned subsidiary of the Company under the name CCIT.
F-18
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The Elek-Tek acquisition was accounted for as a purchase. Accordingly, the
operating results of Elek-Tek have been combined with those of the Company since
the date of acquisition. The Company borrowed $20.7 million of the purchase
price from Deutsche Financial Services Corporation, and the remaining $8.7
million was paid in cash. The purchase price was allocated to the net assets
acquired based upon their estimated fair values at the date of acquisition. The
excess of the purchase price over the net assets acquired of $8,468 is being
amortized using the straight line basis over 25 years. In connection with the
acquisition of Elek-Tek, the Company incurred expenses of $1,470 in the fourth
quarter of 1997. These expenses related primarily to integrating Elek-Tek's
sales force and customer base into the Company.
The following table reflects unaudited pro forma combined results of
operations of the Company, ComputAbility and Elek-Tek as if these acquisitions
had occurred at the beginning of the years presented. However, these pro forma
results are not necessarily indicative of the actual results of operations that
would have occurred.
<TABLE>
<CAPTION>
Year ended December 31,
------------------------
1997 1996
----------- ----------
<S> <C> <C>
Net sales $791,345 $835,024
Net income (loss) $ 1,046 $(13,391)
Diluted earnings (loss) per share $ 0.10 $ (1.33)
</TABLE>
10. Headquarters Move
In November 1997, the Company consolidated its headquarters and
telemarketing facilities into a 160,000 square foot building in Torrance, CA.
The charge associated with the move was $815, and was expensed in the fourth
quarter of 1997. The Company plans to phase in the occupancy of the entire
facility over a two-year period, initially leasing approximately one third of
the building. As of December 31, 1998, the Company leases approximately 60% of
the building.
11. Retail Store Closures
During February 1998, the Company closed its Indiana retail showroom. On
March 20, 1998, the Company closed six retail showrooms to focus its efforts on
its catalog, corporate and Internet channels of distribution. The Company
recorded a one-time pretax restructuring charge of $10.5 million in 1998
relating to exit costs associated with the closing of retail operations.
Recorded in selling, general and administrative costs were $3.1 million in
write-offs of goodwill, $1.9 million in write-offs of fixed assets, a $1.5
million reserve for lease exit costs, and $0.3 million in employee-related
severance costs. Recorded in cost of sales were $3.7 million of reserves for
store inventory. No reserves remain at December 31, 1998 related to the retail
store closures.
12. Segment Information
The Company operates in two business segments in the computer retail
industry: mail order/catalog and Internet auction. The mail order/catalog
segment sells personal computer hardware, software, and peripheral products
through means of catalog distribution, Internet websites, and outbound
telemarketing. Prices are set based on available inventory and market
conditions.
F-19
<PAGE>
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The Internet auction segment offers consumers and small- to medium-sized
businesses excess, refurbished, closeout and limited edition merchandise through
live-action bidding. The segment's Internet auctions feature a rotating
selection of brand name computer, consumer electronics, home/leisure and
sports/fitness products. Prices are determined by the highest bidders.
Summarized segment information for the year ended December 31, 1998 is as
follows:
<TABLE>
<CAPTION>
Mail Order/Catalog Internet Auction Consolidated
------------------- --------------------- ----------------------
<S> <C> <C> <C>
Net sales $642,006 $48,232 $690,238
Gross profit(1) 70,018 3,975 73,993
Operating loss(1) (13,567) (9,999) (23,566)
Total assets $123,641 $34,625 $158,266
</TABLE>
(1) Gross profit and operating loss include special charges.
Segment information is not provided for the years ended December 31, 1997
and December 31, 1996 as the Company did not operate in the Internet auction
segment until the formation of uBid in November 1997. Results for the year ended
December 31, 1997 for the Internet auction segment were immaterial.
F-20
<PAGE>
CREATIVE COMPUTERS, INC.
Quarterly Financial Information (Unaudited)
(in thousands except per-share data)
<TABLE>
<CAPTION>
1998
----------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---------------- --------------- --------------- ----------------
<S> <C> <C> <C> <C>
Net Sales $164,134 $149,934 $185,741 $190,429
Gross Profit 12,577 18,498 21,294 21,624
Net income (loss) (12,809) 212 435 (5,633)
Net earnings (loss) per share
Basic (1.27) 0.02 0.04 (0.55)
Diluted (1.27) 0.02 0.04 (0.55)
<CAPTION>
1997
----------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net Sales $120,140 $116,018 $132,236 $177,737
Gross Profit 15,448 14,836 16,902 22,884
Net income 770 760 1,594 1,001
Net earnings per share
Basic 0.08 0.08 0.16 0.10
Diluted 0.08 0.08 0.16 0.10
</TABLE>
A discussion of special charges for the year ended December 31, 1998 is
included in Note 7 and Note 11 of the consolidated financial statements.
F-21
<PAGE>
SCHEDULE II
CREATIVE COMPUTERS, INC.
Valuation and Qualifying Accounts
For the years ended December 31, 1996, 1997 and 1998
(in thousands)
<TABLE>
<CAPTION>
Balance at Additions Deduction Balance
Beginning Charged to from at End
of Year Operations Reserves of Year
---------- ---------- --------- -------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts for the year ended:
December 31, 1996 $1,365 $ 2,041 $ (1,272) $2,134
December 31, 1997 2,134 5,680 (4,955) 2,859
December 31, 1998 2,859 3,948 (3,110) 3,697
Reserve for inventory for the year ended:
December 31, 1996 1,419 6,432 (1,547) 6,304
December 31, 1997 6,304 6,548 (7,488) 5,364
December 31, 1998 5,364 6,468 (6,796) 5,036
Restructuring reserve for the year ended:
December 31, 1998 - 10,452 (10,452) -
Deferred tax asset valuation allowance for the year ended:
December 31, 1998 - 3,319 - 3,319
</TABLE>
F-22
<PAGE>
EXHIBIT 10.41
[LETTERHEAD OF CREATIVE COMPUTERS]
January 21, 1999
Mr. S. Keating Rhoads
Dear Keating:
On behalf of Creative Computers, Inc. ("Creative," or the "Company"), it is
my pleasure to confirm our offer to you of the position of Executive Vice
President and Chief Operating Officer of Creative under the terms and conditions
outlined below. As we discussed, you will report directly to Creative's CEO.
Your responsibilities will be to act as Executive Vice President and Chief
Operating Officer of the Company. Your duties may change from time to time as
necessary. As we discussed, your position may involve and require travel and
time away from your residence.
You will start your new position as soon as possible and it will be
effective from the date of the signing of this letter. Your employment
relationship with Creative will remain "at will," and your employment may be
terminated by the Company without cause and without notice in the sole
discretion of the Company. If the Company terminates your employment (other than
for "cause" as defined below) you will be entitled to severance in the amount
equal to three months salary (as specified below), subject to your execution of
a separation agreement, satisfactory to the Company's Board of Directors,
containing customary mutual releases. For the purpose of this paragraph, "cause"
shall mean: (i) a material breach by you of your employment obligations with the
Company, which breach is not cured within fifteen (15) days after written notice
thereof from the Company; (ii) your commission of an act of personal dishonesty
or breach of fiduciary duty involving personal profit in connection with your
employment by the Company; (iii) your commission of an act involving willful
misconduct or gross negligence on your part in the conduct of your duties as an
officer of the Company; (iv) a material and willful violation of a federal or
state law or regulation by you applicable to the business of the Company; (v)
your conviction of, or pleading of nolo contendere to, a felony or a crime
involving moral turpitude; or (vi) a diagnosis of your addiction to illegal
drugs. No act, or failure to act, by you shall be considered
<PAGE>
[LETTERHEAD OF CREATIVE COMPUTERS APPEARS HERE]
S. Keating Rhoads
January 21, 1999
Page Two
willful unless committed without good faith and without a reasonable belief that
the act or omission was in the Company's best interest.
You will be employed in the Company's Torrance, California facility and
accordingly need to commute to that facility.
As compensation for your services you will earn a base salary of $233,400
per annum ($4,488 per week) payable in accordance with Creative's standard
payroll practices. You will also be eligible to receive a bonus of up to $75,000
per annum in the sole discretion of Creative's Board of Directors or
Compensation Committee, based upon its evaluation of your performance each year.
Bonus performance goals will be set within the first ninety days of employment
and annually thereafter and may be changed by mutual agreement of the parties.
Your yearly salary may be increased or decreased, by mutual agreement.
In addition to the compensation set forth above, provided you are employed
by the company on the intended grant date described below, you will be granted
an option to purchase 150,000 shares of the Common Stock of Creative. The option
will be granted to you within ten days following the tax-free spin-off by
Creative to its stockholders of its remaining shares held in uBid, Inc. (the
"Distribution"), with a per share exercise price equal to the closing price of
Creative's stock on the Nasdaq National Market on the date of grant. Vesting of
your option will be at a rate of not less than 25% per year commencing on your
date of hire, and vesting of your option will be subject to the condition that
you are still employed by the Company. The option shall expire 90 days after you
are no longer with the Company. If the Distribution does not occur by 12/31/99,
Creative and you will negotiate in good faith on an alternative to the options
described in this paragraph, that does not create an accounting charge for
Creative.
You will be eligible for all benefits (excluding car allowance) generally
accorded a similarly situated executive officer of Creative associated with
employment as an executive at Creative Computers.
It is Company policy that all new employees pass a drug screen and
background check before employment. By signing this offer letter, you consent
for us to run the background check and agree to take the drug screen and have
the results released to the Company. Please call our Human Resources Department
at (310) 225-4072 to arrange for the drug test. We retain the right to terminate
this offer and agreement (or to terminate your employment if you begin before we
receive the results of the drug screen or background check) if either of these
screens is not acceptable.
<PAGE>
[LETTERHEAD OF CREATIVE COMPUTERS]
S. Keating Rhoads
January 21, 1999
Page Three
In addition, you agree not to in any way jeopardize or expose Creative to
liability by using for Creative's benefit trade secrets of any former employer
or client. You further agree and represent that you have not entered into any
agreements with any former employer or client that would affect your ability to
give your full efforts to Creative, would expose Creative to any liability, or
would negatively impact Creative's ability to run its business and compete
effectively for personnel or for business on a go-forward basis. You further
agree to sign an employee proprietary information agreement. A copy of this
agreement is attached for your review and signature.
We look forward to you joining our organization. In order to confirm your
agreement with an acceptance of these terms, please sign a copy of this letter
and return it to us. This offer of employment is valid for three days from the
date of this letter. If there is any matter in this letter that you want to
discuss further, please do not hesitate to contact me.
Sincerely,
/s/ Frank F. Khulusi
Frank F. Khulusi
Chairman, President and Chief Executive Officer
Accepted and Agreed:
/s/ S. Keating Rhoads
- ---------------------------
S. Keating Rhoads
January 21, 1999
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-848) of Creative Computers, Inc. of our report
dated February 3, 1999 appearing on page F-2 of this Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
March 31, 1999
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference of our report dated January
22, 1999, with respect to the financial statements and schedule of uBid, Inc.
in this Annual Report (Form 10-K) of Creative Computers, Inc. for the year ended
December 31, 1998.
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-848) pertaining to Creative Computers, Inc. of our report
dated January 22, 1999, with respect to the financial statements and schedule of
uBid, Inc. incorporated by reference in the Annual Report (Form 10-K) of
Creative Computers, Inc. for the year ended December 31, 1998.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
March 29, 1999
<PAGE>
EXHIBIT 99.1
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
<TABLE>
<S> <C>
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER:
</TABLE>
----------------
UBID, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 33-0775328
(State or other jurisdiction of (I.R.S. Employer
Identification No.) incorporation or organization)
</TABLE>
2525 BUSSE ROAD, ELK GROVE VILLAGE, ILLINOIS 60007
(Address of principal executive offices, including zip code)
(847) 860-5000
(Registrant's telephone number, including area code)
----------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<S> <C>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
NONE N/A
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $0.001 par value per share
----------------
Indicate whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment the
Form 10-K. [X]
As of March 23, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $129,415,000, computed with reference to
the closing price quoted on the Nasdaq National Market on such date. Although
directors, executive officers and 10% stockholders were assumed to be
"affiliates" of the Registrant for purposes of this calculation, the
classification is not to be interpreted as an admission of such status.
As of March 23, 1999, there were 9,146,883 shares of Common Stock ($0.001 par
value) outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the registrant's definitive Proxy Statement for the
1999 Annual Meeting of Stockholders are incorporated by reference into Part
III of this Report.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
UBID, INC. FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PART I
Item 1 Business...................................................... 1
Item 2 Properties.................................................... 36
Item 3 Legal Proceedings............................................. 36
Item 4 Submission of Matters to a Vote of Security Holders........... 36
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 38
Item 6 Selected Financial Data....................................... 39
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 40
Item 7A Quantitative and Qualitative Disclosures About Market Risk.... 45
Item 8 Financial Statements and Supplementary Data................... 45
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 45
PART III
Item 10 Directors and Executive Officers of the Registrant............ 45
Item 11 Executive Compensation........................................ 45
Item 12 Security Ownership of Certain Beneficial Owners and
Management.................................................... 45
Item 13 Certain Relationships and Related Transactions................ 45
PART IV
Item 14 Exhibits, Financial Statements Schedules and Reports on Form
8-K........................................................... 46
Signatures............................................................. 47
Index to Exhibits...................................................... 48
</TABLE>
ii
<PAGE>
FORWARD-LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Annual Report on
Form 10-K that are not historical fact are "forward-looking statements" which
can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should" or "anticipates," or the
negative thereof or other variations thereon or comparable terminology, or by
discussions of strategy that involve risks and uncertainties. Management
cautions the reader that these forward-looking statements, including the
discussions of the Company's growth and operating strategies and expectations
concerning market position, future operations, margins, revenue,
profitability, liquidity and capital resources and other matters contained in
this Annual Report regarding matters that are not historical facts, are not
guarantees of future performance. No assurance can be given that the future
results indicated, whether expressed or implied, will be achieved. While
sometimes presented with numerical specificity, these forward-looking
statements are based upon a variety of assumptions relating to the business of
the Company, which, although considered reasonable by the Company, may not be
realized. Because of the number and range of the assumptions underlying the
Company's projections and forward-looking statements, many of which are
subject to significant uncertainties and contingencies that are beyond the
reasonable control of the Company, some of the assumptions inevitably will not
materialize and unanticipated events and circumstances may occur subsequent to
the date of this Report. The forward-looking statements contained herein are
based on current expectations, and the Company assumes no obligation to update
this information. Therefore, the actual experience of the Company and results
achieved during the period covered by any particular projections or forward-
looking statements may differ substantially from those projected. There can be
no assurance that any of these expectations will be realized or that any of
the forward-looking statements contained herein will prove to be accurate.
Factors that could cause actual results to differ materially from those
discussed in such forward-looking statements include, without limitation,
those discussed under "Investment Considerations" in this Report.
PART I
ITEM 1. BUSINESS
THE COMPANY
uBid operates an online auction for excess merchandise, offering close-out
and refurbished products to consumers and small to medium-sized businesses.
The Company believes that its online auction represents an exciting sales
format for users that leverages the interactive nature of the Internet. The
Company's Internet auctions feature a rotating selection of brand name
computer, consumer electronics and housewares, and sports and recreation
products which typically sell at significant discounts to prices found at
traditional retailers. uBid currently runs auctions seven days a week,
offering on the average over 1,000 total items in each of its auctions. From
its first auction in December 1997 through December 31, 1998 the Company
auctioned over 278,000 merchandise units, registered over 229,000 users and
recorded more than 17.8 million visits to its Website.
The Company operates in the rapidly growing Internet commerce industry.
Jupiter Communications has estimated that U.S. retail consumer purchases of
goods and services over the Internet will increase from $5 billion in 1998 to
$29.4 billion in 2002. The single largest online retail category in the U.S.
is projected to be computers and consumer electronics (including software),
which is forecasted to grow from $2.4 billion in 1998 to $9.6 billion by the
year 2002. The personal computer and consumer electronics markets are
characterized by significant quantities of excess merchandise due to extremely
short product life cycles and the prevalence of returned items through the
consumer retail channel. Because of the highly fragmented and relatively
undeveloped liquidator channel, prices received by vendors for excess goods
tend to be highly variable. The Company estimates that the value of such
products exceeded $4 billion in 1998 in the U.S. alone.
uBid's online auctions provide an ideal distribution channel for
unpredictable, odd-lot quantities of close-out and refurbished goods. The
frequency of the Company's auctions and its ability to continuously add new
items
1
<PAGE>
allow vendors to dispose of inventory quickly to minimize the risk of price
erosion. Online sales also allow vendors to liquidate excess merchandise
directly to a nationwide audience, without cannibalizing their primary
distribution channels. Furthermore, uBid offers customers a unique retail
experience--the opportunity to set their own prices on popular, brand name
products with the convenience of shopping 24 hours a day, seven days a week.
The element of gamesmanship, combined with an ever-changing merchandise mix,
entices customers to participate in the auction in hopes of "hitting the
jackpot" and winning a bargain.
The Company employs sophisticated merchandising techniques to manage the
auction process, which allows the Company to maximize revenues on products put
into auction. uBid's sophisticated auction management methodology capitalizes
on the Company's direct marketing and merchandising expertise to help predict
the level of customer traffic to the Website, the appropriate product mix of
each auction and the ultimate price realized on each product.
The Company has designed its online auctions to offer a superior customer
experience and to encourage repeat visits by customers and potential
customers. The Company believes it offers a consistently superior experience
to its customers through an entertaining and fast auction process, tight
control of the order process and a high level of customer support.
Approximately 90% of the products shipped from the Company's warehouse are
shipped the next business day after an auction closes. In addition, uBid has
established multiple channels for communicating with customers before and
after the sale, including telephone, e-mail and online support. The Company
has also incorporated other features to encourage repeat visits, including a
personalized page with a user's bidding history. Repeat customers accounted
for approximately 69% of customer orders for the three months ended December
31, 1998.
In the electronic commerce industry, a strong brand is critical to creating
a high level of vendor awareness and attracting customer traffic. Accordingly,
the Company's strategy is to aggressively increase its visibility and brand
recognition through a variety of marketing and promotional efforts.
Specifically, the Company intends to increase points of access by establishing
relationships with other on line companies similar to its existing
relationships with AOL, CNET, Wired Digital, MSN/LinkExchange, PCWorld Online
and LookSmart.
The Company obtains merchandise directly from computer, consumer electronics
and home and leisure products manufacturers and indirectly through other
vendors, such as retailers, distributors and Fortune 1000 companies.
Currently, this merchandise is sourced from over 150 vendors. uBid's
merchandise has included brands such as AST, AT&T, Aiwa, Apple, Canon, Casio,
Compaq, Dell, Gateway, Hewlett-Packard, IBM, JVC, Lexmark, Micron, NEC,
Panasonic, Seagate, Sony, Toshiba and Uniden. In March 1999, the Company
announced the introduction of the uBid Auction Community(TM), which will
provide approved vendors access to the uBid Website to place products on the
site for direct auction to customers.
uBid's business was established by Creative Computers, Inc. (the "Parent")
in April 1997 and the Company was incorporated in Delaware on September 19,
1997 as a wholly-owned subsidiary of the Parent. In December 1998, the Company
completed an initial public offering of 1,817,000 shares of its Common Stock
(the "Offering" or "IPO"). As of March 23, 1999, the Parent owned
approximately 80.1% of the outstanding shares of Common Stock of the Company.
The Company's executive offices are located at 2525 Busse Road, Elk Grove
Village, Illinois 60007, and its telephone number at such location is (847)
860-5000.
INDUSTRY BACKGROUND
Growth of the Internet and the Web
The Internet and the Web are experiencing dramatic growth in terms of the
number of Web users. International Data Corporation ("IDC") has estimated that
at the end of 1998 there were over 51 million Web users in the United States
and that by the end of 2002 the number of Web users in the United States will
increase to over 135 million. The growth in the number of Web users and the
amount of time users spend on the Web is being driven by the increasing
importance of the Internet as a communications medium and an information
resource and a sales and distribution channel.
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Growth of Online Commerce
The Internet is dramatically affecting the methods by which consumers and
businesses are buying and selling goods and services. The Web provides online
merchants with the ability to reach a global audience and to operate with
minimal infrastructure, reduced overhead and greater economies of scale, while
providing consumers and businesses with a broad selection, increased pricing
power and unparalleled convenience. As a result, a growing number of parties
are transacting business on the Web, including trading securities, buying
consumer goods, paying bills and purchasing airline tickets. In addition, IDC
has estimated that the percentage of U.S. Internet users buying goods and
services on the Internet is projected to grow from approximately 28% in
December 1998 to 40% in December 2002. Additionally, Jupiter Communications
has estimated that U.S. retail consumer purchases of goods and services over
the Internet will increase from $5 billion in 1998 to $29.4 billion in 2002.
The single largest online retail category is projected to be computers and
consumer electronics (including software), which is forecasted to grow from
$2.4 billion in 1998 to $9.6 billion by the year 2002 in the U.S. alone.
Market for Excess Computer Products and Consumer Electronics
Each year, vendors of computer products and consumer electronics, including
manufacturers, distributors, resellers and retailers, dispose of significant
volumes of excess merchandise, including close-out and refurbished
merchandise. Close-out merchandise includes overstocked or slow-moving new
products that have or will shortly become previous generation, typically due
to a change in selling seasons or the introduction of next generation software
or hardware. Refurbished products include products returned by the consumer to
the retailer or manufacturer. Refurbished products typically require a nominal
amount of service, such as minor repairs, cleaning and repackaging, and
installation of current versions of leading software prior to being sold as
refurbished goods.
The disposal of excess goods represents a substantial burden on many
vendors. Excess goods are currently sold through auction houses, catalogs,
company stores or "outlets," resellers and specialized retailers, as well as
large superstores and mass merchants that are not committed to the resale of
these goods and generally sell them as a supplementary product line or "loss
leader." Prices received by vendors for excess goods tend to be highly
variable and subject to negotiation based on quantity, age and condition of
the merchandise. In addition, since vendors lack control over product
placement these sales channels may compete with the vendor's more profitable,
primary sales channels.
The personal computer and consumer electronics markets are characterized by
significant quantities of close-out and refurbished merchandise due to
extremely short product life cycles and the prevalence of returned items
through the consumer retail channel. The U.S. end market for computer hardware
and peripherals is estimated by IDC to grow from approximately $86.3 billion
in 1997 to approximately $112.7 billion in 2001. According to IDC, in the
United States, the total market for personal computers alone was estimated to
be greater than $70 billion in 1997. The Company estimates that the portion of
this market that became close-out and refurbished goods exceeded $4 billion in
1997 in the U.S. alone. Jupiter Communications has estimated that the number
of on-line auction purchasers in the U.S. will grow from 1.2 million in 1998
to 6.5 million in 2002 and that business to consumer auctions will sell $3.2
billion in merchandise and services in 2002.
The Company believes that vendors will look favorably upon a distribution
channel that enables them to dispose of significant quantities of merchandise
quickly and at the best prices possible, without affecting their traditional
sales channels.
THE UBID SOLUTION
The Company believes that its online marketplace represents an exciting
sales format for users that leverages the interactive nature of the Internet.
The Company's Internet auctions provide vendors with an efficient and
economical channel for disposing of excess merchandise and provide consumers
and small and medium-sized businesses with a convenient method for obtaining
such products at substantial savings.
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VENDOR BENEFITS. The Company's online auctions provide manufacturers with an
ideal distribution channel for unpredictable, odd-lot quantities of close-out
and refurbished goods. The frequency of the Company's auctions and its ability
to continuously add new items allow vendors to dispose of inventory quickly to
minimize the risk of price erosion. In addition, online sales allow vendors to
liquidate excess merchandise directly to a nationwide audience, without
cannibalizing their primary distribution channels.
CUSTOMER BENEFITS. uBid offers customers a unique retail experience--the
opportunity to set their own prices on popular, brand name products with the
convenience of shopping 24 hours a day, seven days a week. With an average of
over 1,000 total items available in each auction, the Company's broad
selection of goods also sells at significant discounts to prices found at
traditional retailers. The element of gamesmanship, combined with an ever-
changing merchandise mix, entices customers to participate in the auction in
hopes of "hitting the jackpot" and winning a bargain.
BUSINESS STRATEGY
The Company's objective is to become the Internet auction site of choice for
vendors and consumers. The Company intends to achieve this objective by
pursuing the following key strategies:
. INCREASE BRAND AWARENESS. The Company operates in a market in which a
strong brand is critical to differentiating itself and attracting a high
level of vendor awareness and customer traffic. Accordingly, the
Company's strategy is to aggressively increase its visibility and brand
recognition through a variety of marketing and promotional techniques.
Specifically, the Company intends to increase points of access by forming
relationships with, and advertising on, leading Websites, such as the
Company's existing arrangements with AOL, CNET, Wired Digital,
MSN/LinkExchange, PCWorld Online and LookSmart. Premier positioning on
these sites not only drives traffic, but also gives uBid credibility to
users and vendors who are unfamiliar with the Company. The Company also
reinforces the uBid brand in users' minds by employing consistent
branding from the design of its Website to the use of distinctive uBid
packaging.
. PROMOTE REPEAT VISITS. The Company has designed its Website to encourage
repeat visits by customers and potential customers, since each return
visit represents another selling opportunity for uBid. The Company
believes that its auction format and Website encourage bidders to return
on a frequent basis to determine the status of their bids relative to
others and ultimately to find out if they've won their bids for
merchandise. The regular rotation of merchandise also encourages
customers to revisit the site frequently. In addition, the Company
believes that its "My Page" feature, which allows a customer to track his
or her complete bidding history and quickly update customer information,
increases user loyalty. Repeat customers accounted for approximately 69%
of customer orders for the three months ended December 31, 1998.
. OFFER A SUPERIOR CUSTOMER EXPERIENCE. The Company believes it offers a
consistently superior experience to its customers through an entertaining
and fast auction process, tight control of the order process and a high
level of customer support. Every order is tracked at each step in the
process, from order placement to shipment. As a result of uBid's strict
inventory and shipping standards, approximately 90% of products shipped
from the Company's warehouse are shipped the next business day after an
auction closes, compared to competitors who take up to three weeks to
ship products from a variety of third-party sites across the country.
Because the Company believes that customer support is an essential
component of the shopping experience and leads to increased customer
loyalty, uBid has established multiple channels for communicating with
its customers before and after the sale, including telephone, e-mail and
online support. In addition, the Company's automated systems continually
monitor and measure its customer service response times to ensure user
satisfaction.
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. Continue to Employ Sophisticated Merchandising Techniques. The Company's
sophisticated auction management methodology capitalizes on the Company's
direct marketing and merchandising expertise to help predict the level of
customer traffic to the Website, the appropriate product mix of each
auction and the ultimate price realized on each product. The auction
management model allows the Company to forecast the number of visitors
that will be derived from the Company's marketing and advertising efforts
and to maximize the flow of these visitors to the site. Additionally, the
model allows the Company to capture detailed information concerning
where, when, how and to whom product is sold and shipped, helping the
Company to predict customer preferences going forward. The auction
merchandising model allows the Company to maximize revenues on products
put into auction, by using a sophisticated statistical software package
to project the price at which each product will ultimately be sold to
consumers based on current traffic and demand, and by determining what
price to purchase products from over 150 vendors, the product mix, the
number of products the Company should auction on a given day to enable it
to maximize its margins, and the appropriate "add-on" and straight-sale
merchandising opportunities.
. Develop New Revenue Opportunities. The Company believes that significant
opportunities exist to develop new revenue opportunities by expanding its
lines of merchandise. Specifically, the Company expects to expand its
product mix by partnering with market leaders in various categories that
are well suited for the Company's online auction format. Although the
Company has focused primarily on the sale of computer products in an
effort to target and attract the "early adopters," as the Internet grows
and develops, the Company believes a broad array of categories of
merchandise can be sold effectively through its online auction format,
including any overstock products, limited source products and commodity-
type products for which pricing is highly competitive. In particular, the
Company has recently begun selling sporting goods and memorabilia, and
housewares, including kitchen appliances, vacuum cleaners, personal care
devices, furniture, gifts, photography, jewelry and sunglasses, and plans
to begin offering several categories of fine jewelry in the second
quarter of 1999.
. Increase Revenue Sharing Arrangements with Vendors. In order to reduce
the level of principal risk when the Company purchases products from
vendors for resale, the Company has entered into a number of revenue
sharing arrangements with vendors to split the sales proceeds on an
agreed-upon percentage basis. The Company believes these revenue sharing
arrangements provide margin upside for the vendors while also
guaranteeing gross margin percentage for the Company. As of December 31,
1998, the Company had entered into over 40 of these revenue sharing
agreements with vendors and expects to increase the number over time.
The uBid Auction
The Company has designed its attractive, fast, and easy-to-use Website to
provide a compelling shopping experience for the user through an interactive
auction format. Customers enter the auction at the uBid home page, which
displays a list of product categories and sub-categories and showcases the
auction's "best deals." Within a specific sub-category, uBid auctions a number
of identical items at the same time. The minimum opening bid for each item is
generally $7. The product page for each item features a concise product
description, full-color image, and detailed technical specifications. In
addition, a table lists the quantity available, the bid range, the minimum
incremental bid, the current winning bidders and the amount of their bids and
the time of auction close.
To participate in the auction, a first-time bidder must complete the simple
electronic registration form found on the Website. The bidder is then given an
identification number and chooses a password. Once registered, the customer
can bid and buy at will in the same or future auctions. After a customer bids
on a product, the corresponding bidder list is instantly updated to reflect
the bid and the customer's new position in the list of bidders. At the
customer's option, he or she may elect to receive an e-mail when outbid or to
use agent bidding to automatically increase the bid to a predetermined maximum
dollar amount. These functions increase the likelihood that the user will
place an additional bid.
When the auction closes, the highest bidders win the available inventory at
their actual bid prices. Each winning bidder may pay a price that is different
from the prices paid by other winning bidders. When bidders'
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prices are equal, bids for larger quantities and with earlier initial bid
times prevail. Using its proprietary software, uBid automatically determines
the winning bidders and sends an e-mail message to confirm their purchases the
same day. After being screened by the Company's anti-fraud software, the
customer's credit card is charged and the merchandise is shipped.
uBid Auction Community. In March 1999, the Company introduced the uBid
Auction Community(TM), which allows vendors to place products directly on the
uBid Website for auction. The Auction Community provides approved suppliers
access to the site directly, allowing them to benefit from the uBid
infrastructure, including the Company's marketing resources, call center
operations, credit card processing and auction software. Upon sale, the
Company processes the credit card transaction and receives a commission from
the sale, and the supplier ships the products directly to the customer. The
Company believes that the Auction Community will increase the number of
products offered on its Website and expand the number of vendors offering
products for auction.
Products and Merchandising
The Company offers on the average over 1,000 total items in each of its
auctions. Currently, the merchandise consists primarily of computers, consumer
electronics and housewares and has included brands such as AST, AT&T, Aiwa,
Apple, Canon, Casio, Compaq, Dell, Gateway, Hewlett-Packard, IBM, JVC,
Lexmark, Micron, NEC, Panasonic, Seagate, Sony, Toshiba and Uniden. For the
quarter ended December 31, 1998, the product mix based on revenues consisted
of approximately 40% new merchandise and 60% refurbished products. This mix
can fluctuate from quarter to quarter depending on the type of products most
available for purchase at acceptable prices. Regardless of the source of the
merchandise, most merchandise sold by the Company is warranted by the
manufacturer or refurbisher. The customer may purchase an extended warranty
provided by a third party, Independent Dealer Services, Inc., in those states
where such third-party warranties are permitted by law. The Company believes
that this extended warranty combined with the Company's emphasis on customer
service provide it with an advantage over its competitors, which generally
rely solely on the warranties provided by the vendor.
The Company currently offers merchandise in the following categories:
Computer Products: Desktops, portable computers, computer accessories, disk
drives, modems, monitors/video equipment, components, printers, scanners,
digital cameras, software and home office products.
Consumer Electronics: Home theater equipment, home audio equipment,
speakers, televisions, camcorders, VCRs, DVD players, portable audio players
and automobile audio equipment.
Housewares: Kitchen appliances, vacuum cleaners, personal care devices,
furniture, gifts, photography, jewelry and sunglasses.
Sports and Recreation: Sports memorabilia, golf and tennis, health and
fitness, outdoor sports, bicycles, water sports, and team sports equipment.
In March 1999, the Company announced the addition of a fine jewelry
category, along with an alliance with D.G. Jewelry Canada Ltd. This new
category will cover a broad range of jewelry, including rings, earrings,
watches, bracelets and loose stones.
Vendor Relationships
The Company obtains merchandise directly from computer and electronics
manufacturers and indirectly through other vendors, such as retailers,
distributors and Fortune 1000 companies. Currently, this merchandise is
sourced from over 150 vendors. The Company believes that it has substantial
access to additional sources of excess merchandise and is in a position to
leverage its existing relationships and add new vendors to increase the
breadth and number of products offered. Since merchandise availability can be
unpredictable, a strong base of vendor relationships is important to the
Company's success. See "Investment Considerations--Reliance on Merchandise
Vendors." As a result, the Company's buying staff maintains ongoing contact
with its vendors to learn when new merchandise becomes available. The
percentage of the Company's revenues attributable to sales of products sourced
from the Parent has declined from over 90% in the first two months of
operations to less than 10% in 1998.
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The Company directly purchases most of its products and holds them for
resale. By purchasing merchandise, the Company assumes the full inventory and
price risk involved in selling such merchandise. The Company believes its
ability to sell its inventory quickly through its auctions justifies the cost
of and risk involved in carrying inventory. The Company attempts to minimize
its exposure to inventory and price risk through its auction management model
that employs a sophisticated statistical software package to project the price
at which each product will ultimately be sold to consumers based on current
traffic and demand, and by determining at which price to purchase products
from vendors. In the event the Company is left with excess inventory, the
Company seeks to immediately dispose of such inventory through its auction
site. To date, the Company's exposure to excess inventory has not been
material. See "Investment Consideration--Risks of a Purchased Inventory
Model."
REVENUE SHARING. The Company also has entered into revenue sharing
arrangements with several vendors to split the sales proceeds on an agreed-
upon percentage basis. The Company believes these revenue sharing arrangements
are attractive to vendors because it allows the vendor to potentially realize
more revenue than in the case where the Company purchases the merchandise for
a fixed price. The Company's avoidance of any inventory risk, unlimited margin
upside for the vendors and guaranteed gross margin percentage for the Company
make revenue sharing agreements an attractive arrangement to both the Company
and vendors. As of December 31, 1998, the Company had entered into over 40 of
these revenue sharing agreements with vendors. Such agreements represented
slightly under 4% of the Company's revenue for the quarter ended December 31,
1998. The Company believes that the percentage of its revenues represented by
revenue sharing arrangements will continue to increase over the next 12
months.
SALES AND MARKETING
The Company sells to consumers and small and medium-sized businesses. To
achieve its objective of becoming the Internet auction site of choice for
vendors and consumers, the Company has developed a marketing strategy in order
to strengthen its brand name and increase customer traffic to its Website.
This marketing strategy consists of establishing relationships with leading
online companies, as well as employing a mix of media and promotional
activities to achieve these goals.
RELATIONSHIPS WITH LEADING ONLINE COMPANIES. uBid has established
relationships with a number of Internet service and content providers to
increase its access to online customers and to build brand recognition. The
Company intends to complement its existing relationships and establish a
leading brand name by pursuing additional agreements. See "Investment
Consolidations--Reliance on Relationships with Online Companies."
Representative relationships include:
. AOL. This relationship provides access to AOL's members through a premier
button (a fixed icon displaying the uBid logo, visible on the computer
screen without using the scroll button, which provides a direct link to
the Company's Website) in the Auction and Outlets and Computer Hardware
departments of AOL's Shopping Channel. Additionally, uBid's promotional
banners (rectangular graphic advertisements) rotate throughout the AOL
Shopping Channel.
. CNET. uBid has a rotating position on the home page of Computers.com,
CNET's computer channel designed to provide consumers with pertinent news
and advice in purchasing computer hardware and software.
. WIRED DIGITAL. uBid is a featured sponsor on the Computer Hardware
Channel of Wired's HotBot Shopping Directory. The Company receives
premier positioning within the Computer Hardware Channel along with a
link to its Website on the Directory home page under the Computer
Hardware listing. uBid also has promotional links within each of the
Auctions, Computer Software and Small Business Needs Channels, along with
banner ads circulating throughout the entire HotBot Shopping Directory.
. MSN/LINKEXCHANGE. uBid is the premier auction sponsor on the
MSN/LinkExchange network. The Company receives a text link on the
homepage of the MSN/LinkExchange member site as well as banner ads
circulating throughout the entire MSN/LinkExchange network.
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. PCWORLD ONLINE. uBid is the premier auction sponsor in the PCWorld Online
website. The Company receives a non-rotating banner within the "Where To
Shop" block, access to the "TipWorld" e-mail list and banner ads
circulating throughout the entire PCWorld Online website.
. LOOKSMART. uBid is the exclusive co-branded auction partner for
LookSmart. The Company receives keyword banner ads, category banner ads,
and a homepage link, as well as banner ads circulating throughout the
entire LookSmart website.
INTERNET ADVERTISING. The Company has taken a disciplined and selective
approach in its advertising strategy that primarily considers the costs of
customer acquisition. The Company attempts to maximize the return from
promotional expenditures by choosing advertising media based on the cost
relative to the likely audience and ability to generate increased traffic for
the Company's Website. The Company places advertisements on various high-
profile and high-traffic conduit Websites, including AOL, CNET, Excite, Yahoo!
and others, as well as Websites that are targeted at a more focused audience.
These advertisements usually take the form of banner ads that encourage
readers to click through directly to the Company's Website. In addition, the
Company and the Parent have reciprocal links on their Websites.
CUSTOMER ELECTRONIC MAIL BROADCASTS. The Company actively markets to its own
base of customers through e-mail broadcasts. All bidders in the Company's
auctions are automatically added to the Company's electronic mailing list,
which numbered over 229,000 registrants through December 31, 1998. The Company
currently sends more than 2 million e-mail messages each month announcing new
items available at each auction, special products available, site changes and
new features. The Company has a strict policy of sending only solicited e-
mail, and a customer can remove his or her name from the Company's mailing
list at any time.
ORDER FULFILLMENT
The Company obtains products from its vendor network shortly before the
products are put into auction. Although most products are held in inventory at
the Company's distribution facility, in the case of refurbished products, the
products may be held at the refurbisher's facility and shipped directly to the
customer. In addition, certain vendors drop-ship products directly to
customers. However, the refurbisher is required to use uBid labeling and
packaging standards and transmit shipment information to the Company to
provide a uniform customer experience.
The product fulfillment process, from receipt of products through shipment,
is largely automated, enabling the Company to capture real-time data on
inventory receiving, shipping and stock levels. Approximately 90% of the
products shipped from the Company's warehouse are shipped the next business
day after an auction closes, and the Company's tight shipping controls have
historically kept shipping errors at negligible levels. The Company believes
that the speed and accuracy of its order fulfillment process reinforces and
enhances its customers' total purchase experience.
Pursuant to the Company's exclusive agreement with the Parent, the Company
has contracted its distribution functions to the Parent utilizing the Parent's
fully developed distribution infrastructure which, in 1997, was responsible
for the distribution of over one million orders of computer-related products.
In July 1998, the Company entered into a sublease currently covering 100,000
square feet of the Parent's 325,000 square foot distribution center in
Memphis, Tennessee. The sublease also provides for the Company's continued use
of the Parent's sophisticated inventory control and shipping systems during
the term of the sublease. This distribution arrangement enables uBid to
provide distribution services, which the Company believes far exceed that of
the competition, who generally rely upon contract warehouses for the bulk of
their fulfillment and logistics requirements.
CUSTOMER SUPPORT AND SERVICE
The Company believes that its ability to establish and maintain long-term
relationships with its customers and encourage repeat visits and purchases is
dependent, in part, on the strength of its customer support and
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service operations and staff. In contrast to most of the Company's
competitors, uBid has established multiple channels for communicating with its
customers before and after the sale, including phone, e-mail and online
support. The Company currently employs a staff of customer support and service
personnel who are responsible for handling customer inquiries, tracking
shipments and investigating problems with merchandise. While merchandise sold
by the Company is sold on an "as is" basis, products may be covered by
manufacturers' warranties or third party warranties purchased by the customer.
The Company, though not obligated to do so, may in specific instances accept
merchandise returns if a product is defective or does not conform to the
specifications of the item sold at auction, and attempts to work with its
customers to resolve complaints about merchandise. In addition, the Company
has automated certain of its customer service functions, including providing
users of the Website with online access to information such as product
shipping status. The Company is committed to continue enhancing its customer
support and service operations, through a variety of measures including
improved customer reporting systems. See "Investment Considerations--Reliance
on Merchandise Vendors" and "--Management of Potential Growth; New Management
Team."
TECHNOLOGY
The Company has implemented a broad array of customer support, transaction-
processing and fulfillment systems using a combination of both proprietary and
commercially available, licensed technologies. These systems are designed to
make both the customer experience and the transaction reporting and tracking
process as seamless and simple as possible, with an emphasis on speed. The
Company's hardware and software systems are designed to integrate seamlessly
and manage real-time transactions with limited human intervention. The
Company's current strategy is to license commercially available technology
wherever possible rather than seek internally-developed solutions and to focus
its internal software development efforts on creating and enhancing the
specialized, proprietary software that is unique to its business. The
Company's auction processing and auction management applications discussed
below are jointly owned, in perpetuity, by the Parent and the third-party
developers of the software pursuant to agreements between the Parent and such
third-party developers. The agreements provide that the Parent and the third-
party developers of the software jointly own all patent, copyright and other
proprietary rights with respect to the Company's auction processing and
auction management applications and certain general purpose libraries (used
for general website and Java software development) which have been developed
by the third-party developers and are used with the auction processing and
auction management applications. The agreements provide that the Parent and
the third-party developers of the software jointly own all patent, copyright
and other proprietary rights with respect to the initial auction processing
and auction management applications software platform developed for the Parent
by the third-party developers (the "Original Auction Software") and certain
general purpose libraries (used for general website and Java software
development) (the "Libraries") used with the Original Auction Software. The
three agreements material to the Company's ownership rights in externally
developed software are the agreements with each of the two co-developers of
the Original Auction Software (one of which is David L. Matthews, the
Company's Director of Applications Development) and an Assignment and License
Agreement between the Parent and the Company. Under the first two agreements
with the co-developers of the Original Auction Software, such individuals have
granted the Parent (i) joint ownership rights in the Original Auction
Software, related work product and the Libraries developed by them prior to
December 1997 and (ii) in the case of Mr. Matthews, sole ownership rights to
the software and related work product developed for the Parent beginning in
December 1997. Under the Assignment and License Agreement with the Parent, the
Parent has assigned to the Company all of its right, title and interest in the
copyrights in (i) the Original Auction Software and Libraries covered by the
third-party developer agreements described above and (ii) the on-line auction
software developed by the Parent's employees for the Company, which consist
primarily of interfaces with existing distribution, credit processing and
other administrative systems. Under the Assignment and License Agreement, the
Company has granted to the Parent a perpetual, non-exclusive, transferable,
royalty-free license to those portions of the assigned software that are not
specific to the operation of the Company's current on-line auction system.
As co-owners of the Original Auction Software and the Libraries, the two co-
developers and the Company have the right to grant licenses covering such
software and libraries without the consent or notification of the
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other co-owners. In addition, the two co-developers have previously granted a
license covering such software and libraries to the Parent (which is included
in the rights being assigned to the Company under an Assignment and License
Agreement with the Parent) and another third party. Such licensees have the
right to use, distribute, re-license and otherwise modify the licensed source
codes without royalties or further payment to any of the other co-developers
or licensees.
Substantial modifications and enhancements to the Company's Original Auction
Software and Libraries have been made by employees of the Parent and the
Company on a work-for-hire basis and are the property of the Company.
AUCTION PROCESSING AND AUCTION MANAGEMENT APPLICATIONS. The Company uses a
set of automated software applications for receiving and validating bids,
registering bidders, placing customers on the Company's mailing list, listing
currently active and recent winning and losing bids and reviewing and
submitting customer service requests. The Company's internally developed
proprietary auction management software continually tracks every bid posted on
all auctions and utilizes regression analysis to assist the Company in
determining the number of products to auction at any given time. The Company
believes that this system enables it to maximize margins in each product
category.
ORDER PROCESSING APPLICATIONS. The Company uses a set of applications for
processing successful bids as they are converted into customer orders. These
applications charge customer credit cards, print order information, transmit
order information electronically to the Company's contract warehouse and
vendors, and deposit transaction information into the Company's accounting
system. All credit card numbers and financial and credit information are
secured using the Internet security protocol Secure Socket Layer, Version 3,
an encryption standard, and credit card numbers are maintained behind
appropriate fire walls.
MARKETING APPLICATIONS. The Company has developed a set of applications for
sending automated broadcast e-mails to customers on a frequent basis. This
software extracts e-mail addresses from the Company's mailing list, sends e-
mails to the designated recipients and automatically services requests from
customers to remove them from the mailing list.
SYSTEMS OPERATIONS
The continued uninterrupted operation of the Company's Website is critical
to its business, and the Company strives to maximize uptime of the Website.
The Company uses the services of Pacific Bell and other Internet service
providers to provide connectivity to the Internet over a dedicated DS-3 line.
IDT Corporation provides Internet traffic and data routing services to the
Company as well as e-mail services. MCI provides frame relay services for the
Company's back office operations. The Company believes that these
telecommunication and Internet service facilities are essential to the
Company's operation. The Pacific Bell, IDT Corporation and MCI Internet
access, traffic, data routing and e-mail services and frame relay services are
provided by such parties through agreements with the Parent and are made
available to the Company under the Internet/Telecommunications Agreement with
the Parent. See "Investment Considerations--Management of Potential Growth;
New Management Team," "--Risk of System Failure; Single Site" and
"Transactions between the Company and the Parent--Internet/Telecommunications
Agreement."
The Company's hardware and software systems run in parallel on multiple
servers, which allows the system to balance the workload among the servers.
The system also includes redundant hardware on mission critical components,
which the Company believes would enable it to survive a potential failure of
any server with minimal downtime. In addition, capacity can be quickly and
easily expanded by adding additional servers, without incurring significant
development costs. In particular, the Company strives to maintain access to
its Website and speed of use during the most heavily trafficked times of day--
the evening hours around the time scheduled for auction close. In order to do
this, the Company anticipates expanding its system as usage increases to avoid
any decrease in system response time. The Company pays the Parent for use of
hardware systems that are located in Torrance, California. In December 1998,
the Company and the Parent entered into an agreement
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pursuant to which the Parent will continue to provide the Company with certain
Internet and telecommunications services, including the related hardware
systems. In March 1999, the Company entered into an agreement with a leading
hosting provider to co-locate the Company's servers and to develop a mirrored
site location. Although the Company anticipates continuing to use the Parent's
hardware systems for the near term, the Company intends to purchase its own
hardware and software systems, by the end of 1999, at an estimated cost of
approximately $500,000. The Company expects to fund its purchase of such
capital equipment with working capital (including the proceeds from the
Offering). See "Transactions between the Company and the Parent--
Internet/Telecommunications Agreement."
Insurance Coverage
Through the date of the Distribution (as defined under "Separation from the
Parent" below), the Company will be covered by the insurance policies
maintained by the Parent. As of December 31, 1998, the Parent maintained,
among other types of coverage, a commercial liability policy with an aggregate
limit of $27 million, including a $25 million umbrella policy, and a transit
cargo policy with a limit of $1.5 million, a workers compensation policy with
a limit of $1 million and blanket crime coverage with a limit of $2 million.
Following the Distribution, the Company will be required to obtain its own
insurance.
Competition
The electronic commerce market is new, rapidly evolving and intensely
competitive, and the Company expects competition to intensify in the future.
The Company currently or potentially competes with a variety of other
companies depending on the type of merchandise and sales format offered to
customers. These competitors include: (i) various Internet auction houses such
as ONSALE, eBay, Yahoo! Auctions, First Auction (the auction site for Internet
Shopping Network, a wholly-owned subsidiary of Home Shopping Network Inc.),
Surplus Auction (a wholly-owned subsidiary of Egghead, Inc.), WebAuction (the
auction site for MicroWarehouse, Inc.), Insight Auction (the auction site for
Insight Enterprises, Inc.) and Amazon.com Auctions; (ii) a number of indirect
competitors that specialize in electronic commerce or derive a substantial
portion of their revenue from electronic commerce, including Internet Shopping
Network, AOL and Cendant Corp.; (iii) a variety of other companies that offer
merchandise similar to that of the Company but through physical auctions and
with which the Company competes for sources of supply; (iv) personal computer
manufacturers that have their own direct distribution channels for their
excess inventory or refurbished products; and (v) companies with substantial
customer bases in the computer and peripherals catalog business, including CDW
Computer Centers, Inc., PC Connection, Inc. and the Parent, some of which
already sell online or may devote more resources to Internet commerce in the
future. In particular, ONSALE, Inc. began conducting auctions on the Internet
in May 1995 and has established significant market share and brand name
recognition for online auctions for computer-related equipment. In addition,
AOL has taken a minority equity interest in Bid.com (formerly Internet
Liquidators International, Inc.), a competitor of the Company, and announced
that the two companies have formed a strategic partnership under which revenue
from Bid.com's auction platforms is shared with AOL and AOL provides a direct
link for Bid.com's members to reach Bid.com's electronic commerce site on the
Web.
The Company believes that the principal competitive factors affecting its
market are the ability to attract customers at favorable customer acquisition
costs, operate the Website in an uninterrupted manner and with acceptable
speed, provide effective customer service and obtain merchandise at
satisfactory prices. Although the Company believes that it currently competes
favorably with respect to such factors, there can be no assurance that the
Company can maintain its competitive position against current and potential
competitors, especially those with greater financial, marketing, customer
support, technical and other resources than the Company.
Current and potential competitors have established or may establish
cooperative relationships among themselves or directly with vendors to obtain
exclusive or semi-exclusive sources of merchandise. Accordingly, it is
possible that new competitors or alliances among competitors and vendors may
emerge and rapidly acquire market share. In addition, manufacturers may elect
to liquidate their products directly. Increased competition is likely to
result in reduced operating margins, loss of market share and a diminished
brand franchise, any one of
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which could materially adversely affect the Company's business, results of
operations and financial condition. Many of the Company's current and
potential competitors have significantly greater financial, marketing,
customer support, technical and other resources than the Company. As a result,
such competitors may be able to secure merchandise from vendors on more
favorable terms than the Company, and they may be able to respond more quickly
to changes in customer preferences or to devote greater resources to the
development, promotion and sale of their merchandise than can the Company. See
"Investment Considerations--Competition."
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
The Company's performance and ability to compete are dependent to a
significant degree on its proprietary technology. The Company relies on a
combination of trademark, copyright and trade secret laws, as well as
confidentiality agreements and non-compete agreements executed by each manager
and technical measures to establish and protect its proprietary rights. The
uBidSM service mark is registered in the United States. There can be no
assurance that the Company will be able to secure significant protection for
its service marks or trademarks. It is possible that competitors of the
Company or others will adopt product or service names similar to "uBid" or
other service marks or trademarks of the Company, thereby impeding the
Company's ability to build brand identity and possibly leading to customer
confusion. The inability of the Company to protect the name "uBid" adequately
could have a material adverse effect on the Company's business, results of
operations and financial condition. The Company's proprietary software is
protected by copyright laws. The source code for the Company's proprietary
software also is protected under applicable trade secret laws. All patent,
copyright and other proprietary rights with respect to the Company's auction
processing and auction management applications and certain general purpose
libraries are co-owned by the Company and the third-party developers of such
applications and libraries pursuant to various agreements among such third-
party developers and the Parent which the Parent has assigned to the Company.
As part of its confidentiality procedures, the Company generally enters into
agreements with its employees and consultants and limits access to and
distribution of its software, documentation and other proprietary information.
There can be no assurance that the steps taken by the Company will prevent
misappropriation of its technology or that agreements entered into for that
purpose will be enforceable. Notwithstanding the precautions taken by the
Company, it might be possible for a third party to copy or otherwise obtain
and use the Company's software or other proprietary information without
authorization or to develop similar software independently. Policing
unauthorized use of the Company's technology is difficult, particularly
because the global nature of the Internet makes it difficult to control the
ultimate destination or security of software or other data transmitted. The
laws of other countries may afford the Company little or no effective
protection of its intellectual property.
The Company may in the future receive notices from third parties claiming
infringement by the Company's software or other aspects of the Company's
business. While the Company is not currently subject to any such claim that
would have a material effect on the Company's business or financial condition,
any future claim, with or without merit, could result in significant
litigation costs and diversion of resources including the attention of
management, and require the Company to enter into royalty and licensing
agreements, which could have a material adverse effect on the Company's
business, results of operations and financial condition. Such royalty and
licensing agreements, if required, may not be available on terms acceptable to
the Company or at all. In the future, the Company may also need to file
lawsuits to enforce the Company's intellectual property rights, to protect the
Company's trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation, whether successful or
unsuccessful, could result in substantial costs and diversion of resources,
which could have a material adverse effect on the Company's business, results
of operations and financial condition.
The Company also relies on a variety of technologies that it licenses from
third parties, including its database and Internet server software, which is
used in the Company's Website to perform key functions. There can be no
assurance that these third-party technology licenses will continue to be
available to the Company on commercially reasonable terms. The loss or
inability of the Company to maintain or obtain upgrades to any of these
technology licenses could result in delays in completing its proprietary
software enhancements and new
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developments until equivalent technology could be identified, licensed or
developed and integrated. Any such delays would materially adversely affect
the Company's business, results of operations and financial condition. See
"Investment Considerations--Protection of Intellectual Property."
EMPLOYEES
As of December 31, 1998, the Company had 74 employees and 35 full-time
equivalent contract personnel. None of the Company's employees is represented
by a labor union, and the Company considers its employee relations to be good.
Competition for qualified personnel in the Company's industry is intense,
particularly for software development and other technical staff. The Company
believes that its future success will depend in part on its continued ability
to attract, hire and retain qualified personnel. See "Investment
Considerations--Management of Potential Growth; New Management Team" and "--
Dependence on Key Personnel; Need for Additional Personnel."
SEPARATION FROM THE PARENT
Background of the Separation and Distribution. The Parent has announced
that, subject to certain conditions, the Parent intends to separate the
Company from the Parent's other operations and businesses (the "Separation")
and to distribute to its stockholders all of the uBid Common Stock owned by
the Parent (the "Distribution") in no event prior to 180 days after the
December 9, 1998 closing date of the Company's initial public offering, (the
"Offering Closing Date"). The Separation will establish the Company as a
stand-alone entity with objectives separate from those of the Parent. The
Company intends to focus its resources and management emphasis on the
operations and markets it views as critical to its long-term success as a
stand-alone entity. In December 1998, the Company and the Parent entered into
a Separation and Distribution Agreement (the "Separation and Distribution
Agreement") and certain other agreements providing for the Separation and the
Distribution, the provision by the Parent of certain interim services to the
Company, and addressing employee benefit arrangements, and tax and other
matters. These agreements (the "Ancillary Agreements") are discussed in
"Transactions between the Company and the Parent" below. The Parent currently
owns approximately 80.1% of the outstanding Common Stock of the Company.
The Company and the Parent believe that the Separation and the Distribution
will enhance the Company's ability to implement its growth and operating
strategies. The Company believes that its future growth would be enhanced if
its management were compensated on a separate basis from the Parent.
Similarly, the Parent believes that its future growth would be enhanced if
management of its remaining business segments were more focused on such
segments without also being responsible for the online auction segment.
Finally, upon completion of the Distribution, holders of Parent Common Stock
as of the record date for the Distribution will be entitled to receive a
dividend of uBid Common Stock without the payment of further consideration,
although the Parent expects the market value of shares of Parent Common Stock
to diminish upon effecting the Distribution to reflect the value (per share of
Parent Common Stock) of the shares of uBid Common Stock distributed by the
Parent. The consummation of the Distribution will also remove current
restrictions on the Company's growth as a result of certain contractual
restrictions of the Parent that are applicable to the Parent and its
subsidiaries. For example, certain of the Parent's contractual relationships
with manufacturers prevent the Parent and its subsidiaries, including the
Company, from selling such manufacturers' computers and computer-related
products at discounted prices, which has prevented the Company from obtaining
such products on a close-out or refurbished basis and selling them in the
Company's auctions. In addition, under the Parent's contractual relationships
with certain of its vendors, neither the Parent nor its subsidiaries,
including the Company, can sell the vendor's products outside the U.S. As a
result of the Distribution, the Company would no longer be subject to these
restrictions.
Conditions to the Distribution. In connection with the Company's IPO, the
Parent received the opinion of PricewaterhouseCoopers LLP (the "PwC Opinion")
to the effect that the Distribution will qualify as a tax-free distribution
for federal income tax purposes under Section 355 of the Internal Revenue Code
of 1986, as amended ("the Code"), and will not result in recognition of any
gain or loss for federal income tax purposes to the Parent, the Company, or
the Parent's or the Company's respective stockholders. The Parent may, but
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presently does not intend to, apply for a private letter ruling ("Letter
Ruling") from the Internal Revenue Service. In accordance with the Separation
and Distribution Agreement, completion of the Distribution will be subject to
the satisfaction, or waiver by the Board of Directors of the Parent (the
"Parent Board"), of the following conditions: (i) the PwC Opinion shall have
been obtained, in form and substance satisfactory to the Parent, and be
confirmed at the time of Distribution; (ii) if the Parent decides to seek a
Letter Ruling, the Letter Ruling shall have been obtained and remain effective
consistent with the conclusions reached in the PwC Opinion, and such ruling
shall be in form and substance satisfactory to the Parent, in its sole
discretion; (iii) any material Governmental Approvals and Consents (as such
terms are defined in the Separation and Distribution Agreement) necessary to
consummate the Distribution shall have been obtained and shall be in full
force and effect; (iv) no order, injunction or decree issued by any court or
agency of competent jurisdiction or other legal restraint or prohibition
preventing the consummation of the Distribution shall be in effect, and no
other event outside the control of the Parent shall have occurred or failed to
occur that prevents the consummation of the Distribution; and (v) no other
events or developments shall have occurred subsequent to the closing of the
Offering that, in the judgment of the Parent Board, would result in the
Distribution having a material adverse effect on the Parent or on the
stockholders of the Parent. The Parent Board will have the sole discretion to
set the Distribution for any time commencing after June 7, 1999. The Parent
has agreed to consummate the Distribution, subject to the satisfaction of the
conditions set forth above. The Parent may terminate the obligation to
consummate the Distribution if the Distribution has not occurred by December
31, 1999, unless extended by the Parent and the Company. In addition, the
Separation and Distribution Agreement may be amended or terminated at any time
prior to the Distribution Date by the mutual consent of the Company and the
Parent. See "Investment Considerations--Risk of Noncompletion of a Tax-Free
Distribution" and "Transactions between the Company and the Parent."
TRANSACTIONS BETWEEN THE COMPANY AND THE PARENT
HISTORICAL INTERCOMPANY RELATIONSHIPS
Prior to the Offering, the Company was a wholly-owned, indirect subsidiary
of the Parent. As a wholly-owned subsidiary, the Company received various
services provided by the Parent, including administration (accounting, human
resources, legal), warehousing and distribution (through June 1998),
Internet/telecom and joint marketing. The Parent has also provided the Company
with the services of a number of its executives and employees. In
consideration for these services, the Parent historically allocated a portion
of its overhead costs related to such services to the Company. Management of
the Company believes that the amounts allocated to the Company have been no
less favorable to the Company than the expenses the Company would have
incurred to obtain such services on its own or from unaffiliated third
parties. None of these services were provided to the Company pursuant to any
written agreement between the Company and the Parent.
SEPARATION AND DISTRIBUTION AGREEMENT
The Separation and Distribution Agreement entered into between the Company
and the Parent sets forth certain agreements among the Company and the Parent,
with respect to the principal corporate transactions required to effect the
Separation, the Offering and the Distribution, and certain other agreements
governing the relationship among the parties thereafter.
The Distribution. The Separation and Distribution Agreement provides that,
subject to the terms and conditions thereof, the Parent and the Company will
take all reasonable steps necessary and appropriate to cause all conditions to
the Distribution to be satisfied and to effect the Distribution. The Parent
Board will have the sole discretion to set the date of the distribution (the
"Distribution Date") for any date after June 7, 1999 and ending on or prior to
December 31, 1999. The Parent has agreed to consummate the Distribution
promptly but in no event prior to June 7, 1999, subject to the satisfaction or
waiver by the Parent Board of the conditions described under "Separation from
the Parent--Conditions to the Distribution" above.
The Company and the Parent have agreed that none of the parties will take,
or permit any of its affiliates to take, any action which reasonably could be
expected to prevent the Distribution from qualifying as a tax-free
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distribution to the Parent and the Parent's stockholders pursuant to Section
355 of the Code. The parties have also agreed to take any reasonable actions
necessary in order for the Distribution to qualify as a tax-free distribution
to the Parent and the Parent's stockholders pursuant to Section 355 of the
Code. Without limiting the foregoing, prior to the Distribution Date, the
Company will not issue or grant, directly or indirectly, any shares of its
capital stock or any rights, warrants, options or other securities to purchase
or acquire (whether upon conversion, exchange or otherwise) any shares of its
capital stock (whether or not then exercisable, convertible or exchangeable)
that would affect the tax-free nature of the Distribution.
Registration Rights. The Separation and Distribution Agreement provides that
the Parent, and Messrs. Frank and Sam Khulusi, holders of approximately 18%
and 19%, respectively of Parent Common Stock, will have the right in certain
circumstances, but in no event prior to June 7, 1999 (in the case of the
Parent) and 180 days after the Distribution (in the case of Messrs. Frank and
Sam Khulusi), to require the Company to use its best efforts to register for
resale shares of Common Stock held by them under the Securities Act of 1933,
as amended ("1933 Act"), subject to certain conditions, limitations and
exceptions ("Demand Registration"). The Company also has agreed with the
Parent and Messrs. Frank and Sam Khulusi that if the Company files a
registration statement for the sale of securities under the 1933 Act, then
such persons may, subject to certain conditions, limitations and exceptions,
include in such registration statement shares of Common Stock held by them
("Piggyback Registration"). In addition, for an additional 90 days after the
applicable 180-day period, the Company will be entitled to include its shares
in any requested Demand Registration and to reduce the number of shares to be
sold by the Parent or Messrs. Frank and Sam Khulusi thereunder to a minimum of
20%, collectively, of the total offering plus the amount of any underwriters'
over-allotment option. In the case of Messrs. Frank and Sam Khulusi, the
Company will bear up to $100,000 of the cost of the first, and up to $50,000
of the second, requested registrations and will bear the cost of all piggyback
registrations. In addition, the Parent's registration rights will terminate
upon consummation of the Distribution.
Releases and Indemnification. The Separation and Distribution Agreement
provides for a full and complete release and discharge as of the Offering
Closing Date of all liabilities, known or unknown, existing or arising from
all acts and events occurring or failing to occur or alleged to have occurred
or to have failed to occur and all conditions existing or alleged to have
existed on or before the Offering Closing Date, between the Company and the
Parent (including any contractual agreements or arrangements existing or
alleged to exist between them on or before the Offering Closing Date), except
as expressly set forth in the Separation and Distribution Agreement.
Except as provided in the Separation and Distribution Agreement, the Company
has agreed to indemnify, defend and hold harmless the Parent and each of the
Parent's directors, officers and employees from and against all liabilities
relating to, arising out of or resulting from: (i) the failure of the Company
or any other person to pay, perform or otherwise promptly discharge any
liabilities of the Company in accordance with their respective terms; (ii) any
breach by the Company of the Separation and Distribution Agreement or any of
the Ancillary Agreements; and (iii) any untrue statement or alleged untrue
statement of a material fact or omission or alleged omission to state a
material fact required to be stated therein or necessary to make the
statements therein not misleading, with respect to all information contained
in the Prospectus or the Registration Statement used in connection with the
Offering.
Except as provided in the Separation and Distribution Agreement, the Parent
has agreed to indemnify, defend and hold harmless the Company and each of the
Company's directors, officers and employees from and against all liabilities
relating to, arising out of or resulting from: (i) the failure of the Parent
or any other person to pay, perform or otherwise promptly discharge any
liabilities of the Parent other than the liabilities of the Company; and (ii)
any breach by the Parent of the Separation and Distribution Agreement or any
of the Ancillary Agreements. Neither the Company nor the Parent is obligated
under the Separation and Distribution Agreement to indemnify the other for:
(i) any liability, contingent or otherwise, assumed, transferred, assigned or
allocated to the other under the Separation and Distribution Agreement or any
Ancillary Agreement; (ii) any liability for the sale, lease, construction or
receipt of goods, property or services purchased, obtained or used in the
ordinary course of business between the parties prior to December 9, 1998;
(iii) any liability for unpaid amounts for
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products or services or refunds owing on products or services due on a value-
received basis for work done by one party at the request or on behalf of the
other; (iv) any liability that the Company or the Parent may have with respect
to indemnification or contribution pursuant to the Separation and Distribution
Agreement for claims brought against other party by third persons; or (v)
generally, any liability the release of which would result in the release of
any person other than a person released pursuant to the Separation and
Distribution Agreement.
The Separation and Distribution Agreement contains provisions that govern,
except as otherwise provided in any Ancillary Agreement, the resolution of
disputes, controversies or claims that may arise between or among the parties.
These provisions contemplate that efforts will be made to resolve disputes,
controversies and claims by escalation of the matter to senior management (or
other mutually agreed) representatives of the parties. If such efforts are not
successful, any party may submit the dispute, controversy or claim to
mandatory, binding arbitration, subject to the provisions of the Separation
and Distribution Agreement. The Separation and Distribution Agreement contains
procedures for the selection of a sole arbitrator of the dispute, controversy
or claim and for the conduct of the arbitration hearing, including certain
limitations on discovery rights of the parties. These procedures are intended
to produce an expeditious resolution of any such dispute, controversy or
claim.
In the event that any dispute, controversy or claim is, or is reasonably
likely to be, in excess of $5 million, or in the event that an arbitration
award in excess of $5 million is issued in any arbitration proceeding
commenced under the Separation and Distribution Agreement, subject to certain
conditions, any party may submit such dispute, controversy or claim to a court
of competent jurisdiction and the arbitration provisions contained in the
Separation and Distribution Agreement will not apply. In the event that the
parties do not agree that the amount in controversy is in excess of $5
million, the Separation and Distribution Agreement provides for arbitration of
such disagreement.
Noncompetition; Certain Business Transactions. The Separation and
Distribution Agreement provides that, for a period of nine months after the
Distribution Date, the Parent will not directly or indirectly, including by
way of acquisition of other companies, engage in the Internet online auction
business in substantially the same manner and format as conducted by the
Company on the date of the Separation and Distribution Agreement (the "Company
Business"). The Separation and Distribution Agreement also provides for the
allocation of certain corporate opportunities during the period prior to the
Distribution Date. During this period, neither the Company nor the Parent will
have any duty to communicate or offer such opportunities to the other and may
pursue or acquire any such opportunity for itself or direct such opportunity
to any other Person. Except as otherwise contemplated under the intercompany
agreements, it is anticipated that all contracts between the Company and the
Parent after consummation of the Offering will be at arms length. See
"Investment Considerations--No Duty to Communicate Corporate Opportunities."
Expenses. Except as expressly set forth in the Separation and Distribution
Agreement or in any Ancillary Agreement, whether or not the Distribution is
consummated, each party will bear its own respective third-party fees, costs
and expenses paid or incurred in connection with the Distribution.
Parent Stock Options. Options to purchase common stock of the Parent that
are outstanding as of the Distribution Date will, as of the Distribution Date,
become options to purchase shares of both Parent Common Stock and Common Stock
("Adjusted Options"). The number of shares of Common Stock that will be
subject to such Adjusted Options will be based upon the ratio of the number of
shares of uBid Common Stock distributed to the Parent's stockholders in the
Distribution divided by the total number of shares of Parent Common Stock
outstanding on the record date for the Distribution. In addition, the exercise
price for each Adjusted Option will be allocated between the option to
purchase Parent Common Stock and the option to purchase Common Stock based on
the respective pre- and post-Distribution prices of Parent Common Stock and
Common Stock on the Nasdaq National Market. The options to purchase uBid
Common Stock covered by the Adjusted Options will be issued under the
Company's 1998 Stock Incentive Plan. As of March 26, 1999 there were
outstanding options to purchase 777,051 shares of Parent Common Stock. Based
on the number of shares of Parent Common Stock and
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options to purchase Parent Common Stock outstanding on March 26, 1999 and the
number of shares of Common Stock outstanding on such date, options to purchase
approximately 548,935 shares of uBid Common Stock would be granted in
connection with Adjusted Options.
Termination. The Separation and Distribution Agreement may be terminated at
any time prior to the Distribution Date by the mutual consent of the Parent
and the Company. In the event of any termination of the Separation and
Distribution Agreement, only the provisions of the Separation and Distribution
Agreement that obligate the parties to pursue the Distribution, or take, or
refrain from taking, actions which would or might prevent the Distribution
from qualifying for tax-free treatment under Section 355 of the Code, will
terminate, and the other provisions of the Separation and Distribution
Agreement and each Ancillary Agreement will remain in full force and effect.
Services Agreement
In December 1998, the Company and the Parent entered into a services
agreement (the "Services Agreement") pursuant to which the Parent provides to
the Company various administrative services, including general accounting
services, credit services and payroll and benefits administration. The
following services will be provided by the Parent until the Distribution is
consummated.
General Accounting Services. Pursuant to the Services Agreement, the Parent
provides uBid with accounts payable services and general ledger services. The
services are provided on a cost-plus 10% basis.
Credit Services. The Services Agreement also provides for the provision by
the Parent to uBid of credit services, including full credit checking and
analysis at a cost to uBid of $1.50 per transaction. The Parent will undertake
to use its best efforts to process each credit check within 24 hours of
receipt of the Company's request.
Payroll and Benefits Administration. Under the Services Agreement, the
Parent administers uBid's payroll and uBid's employees are covered under the
Parent's health insurance plan and participate in the Parent's 401(k) plan.
The Company reimburses the Parent for all payroll and benefits costs, and the
Parent receives a monthly servicing fee on a cost-plus 10% basis per covered
or participating employee.
Payments pursuant to the Service Agreement are made monthly in arrears
within 30 days after the Company's receipt of an invoice detailing the
services rendered. The Company believes that the fees for services to be
provided under the Services Agreement are no less favorable to the Company
than could have been obtained by the Company from unaffiliated third parties.
Any services rendered to the Company by the Parent beyond the services to be
provided under the terms of the Services Agreement that the Parent determines
are not covered by the fees provided for under the terms of the Services
Agreement will be billed to the Company as described in the Services
Agreement, or on such other basis as the Company and the Parent may agree,
provided that the price payable by the Company for non-covered services will
be established on a negotiated basis which is no less favorable to the Company
than the charges for comparable services from unaffiliated third parties.
Termination of the Services Agreement at Distribution. The Company and the
Parent expect that, as of the Distribution Date, the Services Agreement will
be terminated and the Parent will no longer perform the transactional and
administrative services described above and certain other services
historically performed by the Parent. The Company anticipates that, after the
Distribution, it will have to engage third parties to perform such services or
perform such services internally by Company personnel. The Company believes
that it will be able to make the transition to internal and third party
administration and transaction processing without significant additional
expense or disruption of the Company's business; however, because the Company
has historically relied heavily on the Parent for such services, no assurance
can be given that the transition will not cause the Company to experience
interruptions or temporary delays in the Company's operations and its ability
to process customer transactions and ship products on a timely basis.
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TAX INDEMNIFICATION AND ALLOCATION AGREEMENT
The Company and the Parent have entered into a Tax Indemnification and
Allocation Agreement, which provides that if any one of certain events occurs,
and such event causes the Distribution not to be a tax-free transaction to the
Parent under Section 355 of the Code, then the Company will indemnify the
Parent for income taxes the Parent may incur by reason of the Distribution not
so qualifying under the Code (the "Distribution Taxes"). Such events include
any breach of representations relating to the Company's activities and
ownership of its capital stock made to the Parent or in connection with the
PwC Opinion or any solicitation of a Letter Ruling. In connection with the
Distribution, confirmation of the PwC Opinion at the time of the Distribution
and any Letter Ruling, the Company will likely make certain representations
regarding its intentions at the time of the Distribution with respect to its
business.
The Tax Indemnification and Allocation Agreement also provides that the
Parent will indemnify the Company for Distribution Taxes for which the Company
has no liability to the Parent under the circumstances described above.
In addition to the foregoing indemnities, the Tax Indemnification and
Allocation Agreement provides for: (i) the allocation and payment of taxes for
periods during which the Company and the Parent are included in the same
consolidated group for federal income tax purposes or the same consolidated,
combined or unitary returns for state tax purposes; (ii) the allocation of
responsibility for the filing of tax returns; (iii) the conduct of tax audits
and the handling of tax controversies; and (iv) various related matters.
For periods during which the Company is included in the Parent's
consolidated federal income tax returns or state consolidated, combined, or
unitary tax returns (which will include the periods on or before the
Distribution Date), the Company will be required to pay an amount of income
tax equal to the amount it would have paid had it filed its tax return as a
separate entity, except in cases where the consolidated or combined group as a
whole realizes a detriment from consolidation or combination. The Company will
be responsible for its own separate tax liabilities that are not determined on
a consolidated or combined basis. The Company will also be responsible in the
future for any increases to the consolidated tax liability of the Company and
the Parent that is attributable to the Company, and will be entitled to
refunds for reductions of tax liabilities attributable to the Company for
prior periods.
The Company will be included in the Parent's consolidated group for federal
income tax purposes so long as the Parent beneficially owns at least 80% of
the total voting power and value of the outstanding Common Stock. Each
corporation that is a member of a consolidated group during any portion of the
group's tax year is jointly and severally liable for the federal income tax
liability of the group for that year. While the Tax Indemnification and
Allocation Agreement allocates tax liabilities between Company and the Parent
during the period on or prior to the Distribution Date in which the Company is
included in the Parent's consolidated group, the Company could be liable in
the event federal tax liability allocated to the Parent is incurred, but not
paid, by the Parent or any other member of the Parent's consolidated group for
the Parent's tax years that include such periods. In such event, the Company
would be entitled to seek indemnification from the Parent pursuant to the Tax
Indemnification and Allocation Agreement. See "Investment Considerations--
Control of Company; Relationship with the Parent."
As a condition to the Parent effecting the Distribution, the Company will be
required to indemnify the Parent for any tax liability suffered by the Parent
arising out of actions by the Company after the Distribution that would cause
the Distribution to lose its qualification as a tax-free distribution or to be
taxable to the Parent for federal income tax purposes under Section 355 of the
Code. For example, Section 355 generally provides that a company that
distributes shares of a subsidiary in a spin-off that is otherwise tax-free
will incur U.S. federal income tax liability if 50% or more, by vote or value,
of the capital stock of either the company making the distribution or the
subsidiary is acquired by one or more persons acting pursuant to a plan or
series of related transactions that include the spin-off. To ensure that
issuances of equity securities by the Company will not cause the Distribution
to be taxable to the Parent, the Tax Indemnification and Allocation Agreement
contains certain restrictions on issuances of equity securities of the Company
and its repurchase of equity securities until three years following
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the Distribution Date (the "Restriction Period"). Until the second anniversary
of the Distribution Date, the Company cannot issue Common Stock and other
equity securities (including the shares sold in the Offering) that would cause
the number of shares of Common Stock distributed by the Parent in the
Distribution to constitute less than 60% of the outstanding shares of Common
Stock unless the Company first obtains either the consent of the Parent or a
favorable IRS letter ruling that the issuance will not affect the tax-free
status of the Distribution. After this period until the end of the third year
from the Distribution Date, the Company cannot issue Common Stock and other
equity securities that, when combined with equity securities sold in and after
the Offering would cause the number of shares of Common Stock distributed by
the Parent in the Distribution to constitute less than 55% of the outstanding
shares of Common Stock unless the Company first obtains the consent of the
Parent or a favorable IRS letter or opinion of tax counsel that the issuance
would not affect the tax-free status of the Distribution. These restrictions
on the issuance of equity securities may impede the ability of the Company to
raise necessary capital or to complete acquisitions, if any, using equity
securities. The foregoing prohibitions do not apply to issuances of debt
securities of the Company that are not convertible into Common Stock or other
equity securities. The same requirements for an IRS ruling, consent of the
Parent or an opinion of counsel are applicable to any proposed repurchases of
Common Stock during the Restriction Period. In the event that the Company is
required to indemnify and reimburse the Parent for any tax liability incurred
by the Parent arising out of the Distribution, such indemnification and
reimbursement would have a material adverse effect on the business, results of
operations and financial condition of the Company. See "Investment
Considerations--Tax Indemnification Obligation, Limitation on Issuances of
Equity Securities Following the Distribution" and "--Limited Ability to Issue
Common Stock Prior to Distribution."
JOINT MARKETING AGREEMENT
The Company and the Parent have entered into a joint marketing agreement
(the "Marketing Agreement"), pursuant to which the Parent and the Company
agreed to continue certain joint marketing efforts presently in place. The
Marketing Agreement provides that the Company will continue to be presented on
the home page of the Parent's "PC Mall" Website on at least one quarter of the
page as well as receive a banner advertisement on the home page of the
Parent's "PC Mall" Website. The Marketing Agreement provides that uBid will
provide to the Parent a button that "clicks through" from the home page of the
Company's Website to the Parent's "PC Mall" Website. As consideration for
these marketing services, the Company will either make a payment of $10,000
per month to the Parent or the Parent, in its sole discretion, may elect to
receive a banner advertisement on each page of the Company's Website in lieu
of the monthly payment. The Marketing Agreement has a term of one year and is
terminable by either party upon 60 days prior written notice.
INTERNET/TELECOMMUNICATIONS AGREEMENT
The Company and the Parent have also entered into an
Internet/telecommunications agreement (the "Internet/Telecommunications
Agreement") pursuant to which the Parent will continue to provide the Company
with certain Internet and telecommunications services, including hosting the
Company's Website. The Company agreed to reimburse the Parent for all
telecommunications charges (other than personnel charges), as well as pay
additional monthly personnel charges on a cost-plus 10% basis and capital
equipment charges based on standard lease rates. The
Internet/Telecommunications Agreement has an initial term of one year and is
cancelable, at the option of either party, upon 90 days prior written notice,
provided that, upon such cancellation, the Company will be required to
purchase all capital equipment from the Parent at its depreciated book value.
SUBLEASE AGREEMENT
In July 1998, the Company and the Parent entered into a sublease currently
covering 100,000 square feet of the Parent's 325,000 square foot distribution
center in Memphis, Tennessee. The sublease provides for the Company's
continued use of the Parent's sophisticated inventory control and shipping
systems during the term of the sublease. The sublease is at a monthly rate
equal to the Parent's obligations to the landlord, plus taxes and utilities,
and will expire in 2002.
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OTHER RELATIONSHIPS WITH THE PARENT
As of March 23, 1999 the Parent owned 7,329,883 shares of Common Stock,
which represents approximately 80.1% of the voting power of all outstanding
shares of Common Stock. Frank F. Khulusi, a director of the Company, also is
the Chairman, President and Chief Executive Officer of the Parent.
Parent Credit Agreement. The Parent is party to a credit agreement pursuant
to which it has a credit facility of up to $60 million. Under the credit
agreement, each of the Parent's subsidiaries, including the Company, is
required to guarantee the Parent's obligations and to grant the lender a
security interest in its assets to secure the obligations under the guaranty.
The lender has signed a letter consenting to the Distribution and releasing
the Company's guaranty obligations and the lender's security interest in the
Company's assets. In connection with obtaining the lender's consent thereto,
the Company and the Parent have entered into an agreement with the lender that
provides that, through the Distribution Date, neither the Company nor the
Parent will make certain transfers to each other of their respective assets
which might impair the effectiveness or enforceability of the lender's
security interest in assets of the Parent.
Payable to Parent. Since April 1, 1997 ("Inception") the Parent has provided
the funds to finance the Company's operations in the form of advances that
bear interest at the prime rate. The Company had amounts due to the Parent for
working capital and fixed asset purchases (the "Payable") totaling
approximately $4.6 million as of December 31, 1998, of which $3.3 million is
represented by a note due in June 2000 with interest payable monthly, and the
remaining $1.3 million of which was repaid during the first quarter of 1999.
Advances made by the Parent after the first quarter of 1999, if any, will be
repaid within the respective quarter.
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INVESTMENT CONSIDERATIONS
In addition to the other information in this Annual Report on Form 10-K, the
following factors should be considered carefully in evaluating the Company and
its business because such factors currently have a significant impact or may
have a significant impact on the Company's business, prospects, financial
condition and results of operations. See "Forward-Looking Statements."
EXTREMELY LIMITED OPERATING HISTORY
The Company was incorporated in September 1997 and began conducting auctions
on the Internet in December 1997. Prior to the incorporation of the Company,
the Parent, beginning on April 1, 1997, funded certain startup and development
activities. Accordingly, there is an extremely limited operating history upon
which to base an evaluation of the Company and its business and prospects. The
Company's business and prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in new and rapidly evolving
markets such as electronic commerce. Such risks for the Company include: an
evolving and unpredictable business model; management of growth; the Company's
ability to anticipate and adapt to a developing market; acceptance by
customers of the Company's Internet auctions and excess merchandise sold at
such auctions; dependence upon the level of auction activity; development of
equal or superior Internet auctions by competitors; dependence on vendors for
merchandise; dependence on the Parent for certain services; and the ability to
identify, attract, retain and motivate qualified personnel. To address these
risks, the Company must, among other things, continue to expand its vendor
channels and buyer resources, increase traffic to its Website, maintain its
customer base and attract significant numbers of new customers, respond to
competitive developments, implement and execute successfully its business
strategy and continue to develop and upgrade its technologies and customer
services. There can be no assurance that the Company will be successful in
addressing these risks. In addition, the Company's limited operating history
prevents the use of period-to-period comparisons of its financial results. The
financial information included herein may not necessarily provide any
indication as to expected or possible results of operations, financial
condition and cash flows of the Company in the future or what the results of
operations, financial condition and cash flows would have been had the Company
been a separate, independent entity during the periods presented. See "--
Dependence of the Company on the Parent for Certain Services" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
FUTURE CAPITAL REQUIREMENTS; NEED FOR ADDITIONAL CAPITAL; ABSENCE OF PARENT
FUNDING
The Company's working capital requirements and cash flow provided by
operating activities can vary from quarter to quarter, depending on revenues,
operating expenses, capital expenditures and other factors. The Company
requires substantial working capital to fund its business. Since Inception,
the Company has experienced negative cash flow from operations and expects to
continue to experience significant negative cash flow from operations for the
foreseeable future. The Company currently anticipates that its existing
capital resources (including proceeds from the Company's initial public
offering), will be sufficient to meet the Company's capital requirements
through the next 12 months, although there can be no assurance that the
Company will not have additional capital needs prior to the end of such
period. Thereafter, the Company expects that it will be required to raise
additional funds. Prior to its initial public offering, the Company's needs
for working capital and general corporate purposes were satisfied pursuant to
the Parent's corporate-wide cash management policies. However, since the
Company's initial public offering, the Parent has not been required to provide
funds to finance the Company's operations, nor does the Parent currently
anticipate providing such funds in the future. If the Company is unable to
obtain financing in the amounts desired and on acceptable terms, or at all,
the Company may be required to reduce significantly the scope of its presently
anticipated advertising and other expenditures, which could have a material
adverse effect on the Company's growth prospects and the market price of the
Common Stock. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
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HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICITS; ANTICIPATED LOSSES AND
NEGATIVE CASH FLOW
Since its formation, the Company has expended significant resources on its
technology, Website development, advertising, hiring of personnel and startup
costs. As a result, the Company has incurred losses since Inception and
expects to continue to incur losses for the foreseeable future. The Company
had an accumulated deficit of approximately $10.5 million at December 31,
1998. The Company intends to expend significant financial and management
resources on brand development, marketing and advertising, Website
development, strategic relationships, and technology and operating
infrastructure. Primarily as a result of the significant increase in marketing
and promotional expenses, the Company expects to incur additional losses, and
such losses are expected to increase significantly from current levels.
Because the Company has relatively low gross margins, achieving profitability
given planned investment levels depends upon the Company's ability to generate
and sustain substantially increased levels of net revenue. In addition, the
Company historically has had relatively low operating margins and plans to
continue to increase its operating expenses significantly in order to increase
its customer base, increase the size of its staff, expand its marketing
efforts to enhance its brand image, increase its visibility on other
companies' high-traffic Websites, purchase larger volumes of merchandise to be
sold at auction, increase its software development efforts, and support its
growing infrastructure. Moreover, to the extent that increases in such
operating expenses precede or are not subsequently followed by increased
revenues, the Company's business, results of operations and financial
condition will be materially adversely affected. There can be no assurance
that the Company's revenues will increase or even continue at their current
level or that the Company will achieve or maintain profitability or generate
positive cash flow from operations in future periods. The Company has made and
expects in the future to continue to make significant investments in
infrastructure and personnel in advance of levels of revenue necessary to
offset such expenditures. As a result, these expenditures are based on the
Company's operating plans and estimates of future revenues. Sales and
operating results generally depend, among other things, on the volume and
timing of orders received, which are difficult to forecast. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Beginning in October 1997, the Company granted stock options to attract and
retain key employees. These options were exercisable only in the event of a
successful initial public offering or sale of the Company. Accordingly, the
Company recorded a non-cash charge to compensation expense in the quarter
ended December 31, 1998, calculated based upon the initial public offering
price for the Common Stock. The Company expects to record a non-cash
compensation charge of approximately $13.3 million over the five-year vesting
period of the options. The Company recorded approximately $5.3 million of this
charge in the fourth quarter of 1998. See Note 5 to the financial statements.
UNPREDICTABILITY OF, AND FLUCTUATIONS IN, OPERATING RESULTS
The Company's operating results are unpredictable and are expected to
fluctuate in the future, due to a number of factors, many of which are outside
the Company's control. These factors include: (i) the Company's ability to
significantly increase its customer base, manage its inventory mix and the mix
of products offered at auction, meet certain pricing targets, liquidate its
inventory in a timely manner, maintain gross margins and maintain customer
satisfaction; (ii) the availability and pricing of merchandise from vendors;
(iii) product obsolescence and price erosion; (iv) consumer confidence in
encrypted transactions in the Internet environment; (v) the timing, cost and
availability of advertising on other entities' Websites; (vi) the amount and
timing of costs relating to expansion of the Company's operations; (vii) the
announcement or introduction of new types of merchandise, service offerings or
customer services by the Company or its competitors; (viii) technical
difficulties with respect to consumer use of the auction format on the
Company's Website; (ix) delays in shipments as a result of computer systems
failures, strikes or other problems with the Company's delivery service or
credit card processing providers; (x) the level of merchandise returns
experienced by the Company; and (xi) general economic conditions and economic
conditions specific to the Internet and electronic commerce. As a strategic
response to changes in the competitive environment, the Company may from time
to time make certain service, marketing or supply decisions or acquisitions
that could have a material adverse effect on the Company's
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quarterly results of operations and financial condition. The Company also
expects that, in the future, it, like other retailers, may experience
seasonality in its business. Due to all of the foregoing factors, in some
future quarter the Company's operating results may fall below the expectations
of securities analysts and investors. In such event, the trading price of the
Company's Common Stock would likely be materially adversely affected. See "--
Extremely Limited Operating History" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Uncertain Acceptance of the uBid Brand; Evolving and Unpredictable Business
Model
The Company believes that the importance of brand recognition will increase
as more companies engage in commerce over the Internet. Development and
awareness of the uBid brand will depend largely on the Company's success in
increasing its customer base. If vendors do not perceive the Company as an
effective marketing and sales channel for their merchandise, or consumers do
not perceive the Company as offering an entertaining and desirable way to
purchase merchandise, the Company will be unsuccessful in promoting and
maintaining its brand. Furthermore, in order to attract and retain customers
and to promote and maintain the uBid brand in response to competitive
pressures, the Company is finding it necessary to increase its marketing and
advertising budgets and otherwise to increase substantially its financial
commitment to creating and maintaining brand loyalty among vendors and
consumers. If the Company is unable to or incurs significant expenses in an
attempt to achieve or maintain a leading position in Internet commerce or to
promote and maintain its brand, the Company's business, results of operations
and financial condition will be materially adversely affected. See "Business--
Business Strategy," and "--Sales and Marketing."
The Company expects to expand the focus of its operations beyond the auction
and sale of closeout and refurbished computer, consumer electronics and home
and leisure products to the auction and sale of other excess merchandise. The
Company also has begun to develop its business model and to explore other
opportunities such as the use of the Company's Website as an advertising
medium for services and products of other companies, promoting new or
complementary products or sales formats and expanding the breadth and depth of
products and services offered on its Website. In addition, the Company has
begun offering credit to certain of its business customers that have been pre-
qualified as having appropriate credit ratings. As its business model evolves,
the Company risks diluting its brand, confusing customers and decreasing
interest from vendors. In addition, the Company could be exposed to additional
or new risks associated with these new opportunities. If the Company is unable
to address these risks, the Company's business, results of operations and
financial condition will be materially adversely affected.
Competition
The electronic commerce market is new, rapidly evolving and intensely
competitive, and the Company expects competition to intensify in the future.
The Company currently or potentially competes with a variety of other
companies depending on the type of merchandise and sales format offered to
customers. These competitors include: (i) various Internet auction houses such
as ONSALE, eBay, Yahoo! Auctions, First Auction (the auction site for Internet
Shopping Network, a wholly-owned subsidiary of Home Shopping Network Inc.),
Surplus Auction (a wholly-owned subsidiary of Egghead, Inc.), WebAuction (the
auction site for MicroWarehouse, Inc.), Insight Auction (the auction site for
Insight Enterprises, Inc.) and Amazon.com Auction; (ii) a number of indirect
competitors that specialize in electronic commerce or derive a substantial
portion of their revenue from electronic commerce, including Internet Shopping
Network, AOL and Cendant Corp.; (iii) a variety of other companies that offer
merchandise similar to that of the Company but through physical auctions and
with which the Company competes for sources of supply; (iv) personal computer
manufacturers that have their own direct distribution channels for their
excess inventory or refurbished products; and (v) companies with substantial
customer bases in the computer and peripherals catalog business, including CDW
Computer Centers, Inc., PC Connection, Inc. and the Parent, some of which
already sell online or may devote more resources to Internet commerce in the
future. In particular, ONSALE, Inc. began conducting auctions on the Internet
in May 1995 and has established significant market share and brand name
recognition for online auctions for computer-related equipment. In
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addition, AOL has taken a minority equity interest in Bid.com (formerly,
Internet Liquidators International, Inc.), a competitor of the Company, and
announced that the two companies have formed a strategic partnership under
which revenue from Bid.com's auction platforms is shared with AOL and AOL
provides a direct link for Bid.com's members to reach Bid.com's electronic
commerce site on the Web. The Company has its own relationship with AOL
pursuant to which the Company advertises on AOL and which provides AOL's
members with a direct link to the Company's Website.
The Company believes that the principal competitive factors affecting its
market are the ability to attract customers at favorable customer acquisition
costs, operate the Website in an uninterrupted manner and with acceptable
speed, provide effective customer service and obtain merchandise at
satisfactory prices. There can be no assurance that the Company can maintain
its competitive position against current and potential competitors, especially
those with greater financial, marketing, customer support, technical and other
resources than the Company.
Current and potential competitors have established or may establish
cooperative relationships among themselves or directly with vendors to obtain
exclusive or semi-exclusive sources of merchandise. Accordingly, it is
possible that new competitors or alliances among competitors and vendors may
emerge and rapidly acquire market share. In addition, manufacturers may elect
to liquidate their products directly. Increased competition is likely to
result in reduced operating margins, loss of market share and a diminished
brand franchise, any one of which could materially adversely affect the
Company's business, results of operations and financial condition. Many of the
Company's current and potential competitors have significantly greater
financial, marketing, customer support, technical and other resources than the
Company. As a result, such competitors may be able to secure merchandise from
vendors on more favorable terms than the Company, and they may be able to
respond more quickly to changes in customer preferences or to devote greater
resources to the development, promotion and sale of their merchandise than can
the Company. See "Business--Competition."
Reliance on Relationships with Online Companies
The Company depends to some extent and is increasing its dependence on
relationships with other online companies. These relationships include, but
are not limited to, agreements for anchor tenancy, promotional placements,
sponsorships and banner advertisements. Generally, these agreements have terms
for up to a year, are not exclusive and do not provide for guaranteed renewal.
The risks included in this dependence include: (i) the possibility that a
competitor will purchase exclusive rights to attractive space on one or more
key sites; (ii) the uncertainty that significant spending on these
relationships will increase the Company's revenues substantially or at all;
(iii) the possibility that potential revenue increases resulting from such
spending will not occur within the time periods that the Company is expecting;
(iv) the possibility that space on other Websites or the same sites may
increase in price or cease to be available on reasonable terms or at all; (v)
the possibility that, if these relationships are successful, the Company may
not be able to obtain adequate amounts of merchandise to meet the increased
demand that is generated; (vi) the possibility that such online companies will
be unable to deliver a sufficient number of customer visits or impressions;
and (vii) the possibility that such online companies will compete with the
Company for limited online auction revenues. Any termination of the Company's
arrangements with other online companies could have a material adverse effect
on the Company's business, results of operations and financial condition. See
"Business--Sales and Marketing."
Risks of a Purchased Inventory Model
The Company purchases a majority of its merchandise from vendors and thereby
assumes the inventory and price risks of these products to be sold at auction.
These risks are especially significant because much of the merchandise
currently auctioned by the Company (e.g., computers, consumer electronics and
home and leisure products) is characterized by rapid technological change,
obsolescence and price erosion. Since the Company relies heavily on purchased
inventory, its success will depend on its ability to liquidate its inventory
rapidly through its auctions, the ability of its buying staff to purchase
inventory at attractive prices relative to its resale value at auction, and
its ability to manage customer returns and the shrinkage resulting from theft,
loss and
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misrecording of inventory. Due to the inherently unpredictable nature of
auctions, it is impossible to determine with certainty whether an item will
sell for more than the price paid by the Company. Further, because minimum
opening bid prices for the merchandise listed on the Company's Website
generally are lower than the Company's acquisition costs for such merchandise,
there can be no assurance that the Company will achieve positive gross margins
on any given sale. If the Company is unable to liquidate its purchased
inventory rapidly, if the Company's buying staff fails to purchase inventory
at attractive prices relative to its resale value at auction, or if the
Company fails to predict with accuracy the resale prices for its purchased
merchandise, the Company may be forced to sell its inventory at a discount or
at a loss and the Company's business, results of operations and financial
condition would be materially adversely affected. See "Business--Products and
Merchandising" and "--Vendor Relationships."
RELIANCE ON MERCHANDISE VENDORS
The Company depends upon vendors to supply it with excess merchandise for
sale through the Company's Internet auctions, and the availability of such
merchandise can be unpredictable. Since Inception, the Company has sourced
merchandise from over 150 vendors. Merchandise acquired from 10 of these
vendors has represented approximately 52% of the Company's gross merchandise
sales since Inception. In addition, merchandise acquired from one vendor, the
Parent, represented over 90% of the merchandise sold by the Company in the
first two months of operations, but represented less than 10% in 1998. None of
these vendors is subject to a long-term supply contract with the Company.
There can be no assurance that the Company's current vendors will continue to
sell merchandise to the Company or otherwise provide merchandise for sale in
the Company's auctions or that the Company will be able to establish new
vendor relationships that ensure merchandise will be available for auction on
the Company's Website. A limited number of these vendors process and ship
merchandise directly to the Company's customers. The Company has limited
control over the shipping procedures of such vendors, and shipments could be
subject to delays outside the control of the Company. Most merchandise sold by
the Company carries a warranty supplied either by the manufacturer or the
vendor. In addition, although the Company is not obligated to accept
merchandise returns, the Company could be compelled to accept returns from
customers for which the Company did not receive reimbursements from its
vendors or manufacturers if such warranties are not honored. If the Company is
unable to develop and maintain satisfactory relationships with vendors on
acceptable commercial terms, if the Company is unable to obtain sufficient
quantities of merchandise, if the quality of service provided by such vendors
falls below a satisfactory standard or if the Company's level of returns
exceeds its expectations, the Company's business, results of operations and
financial condition will be materially adversely affected. See "Business--
Products and Merchandising," "--Vendor Relationships" and "--Customer Support
and Service."
RELIANCE ON OTHER THIRD PARTIES
In addition to its merchandise vendors, the Company's operations depend on a
number of third parties for Internet/telecom access, delivery services, credit
card processing and software services. The Company has limited control over
these third parties and no long-term relationships with any of them. For
example, the Company does not own a gateway onto the Internet, but instead,
through the Parent, relies on an Internet service provider, Pacific Bell, to
connect the Company's Website to the Internet. From time to time, the Company
has experienced temporary interruptions in its Website connection and also its
telecommunications access. Continuous or prolonged interruptions in the
Company's Website connection or in its telecommunications access, or slow
Internet transmissions, would have a material adverse effect on the Company's
business, results of operations and financial condition. The Company uses UPS
and Federal Express as its delivery services for substantially all of its
products. Should either or both be unable to deliver the Company's products
for a sustained time period as a result of a strike or other reason, the
Company's business, results of operations and financial condition would be
adversely affected. If, due to computer systems failures or other problems
related to these third-party service providers, the Company experiences any
delays in shipment, its business, results of operations and financial
condition would be adversely affected. The Company's internally developed
auction software
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depends on operating system, database and server software that was developed
and produced by and licensed from third parties. The Company has from time to
time discovered errors and defects in the software from these third parties
and, in part, relies, on these third parties to correct these errors and
defects in a timely manner. If the Company is unable to develop and maintain
satisfactory relationships with such third parties on acceptable commercial
terms, or the quality of products and services provided by such third parties
falls below a satisfactory standard, the Company's business, results of
operations and financial condition will be materially adversely affected. See
"Business--Order Fulfillment," "--Technology" and "--Systems Operations."
RISK OF CAPACITY CONSTRAINTS; RELIANCE ON INTERNALLY-DEVELOPED SYSTEMS; SYSTEM
DEVELOPMENT RISKS
A key element of the Company's strategy is to generate a high volume of
traffic to, and use of, its Website. The Company's revenues depend entirely on
the number of customers who use its Website to purchase merchandise.
Accordingly, the satisfactory performance, reliability and availability of the
Company's Website, transaction-processing systems, network infrastructure and
delivery and shipping systems are critical to the Company's operating results,
as well as to its reputation and its ability to attract and retain customers
and maintain adequate customer service levels.
The Company periodically has experienced minor systems interruptions,
including Internet disruptions, which it believes may continue to occur from
time to time. Any systems interruptions, including Internet disruptions, that
result in the unavailability of the Company's Website or reduced order
fulfillment performance would reduce the volume of goods sold, which could
have a material adverse effect on the Company's business, results of
operations and financial condition. The Company is continually enhancing and
expanding its transaction-processing systems, network infrastructure, delivery
and shipping systems and other technologies to accommodate a substantial
increase in the volume of traffic on the Company's Website. There can be no
assurance that the Company will be successful in these efforts or that the
Company will be able to accurately project the rate or timing of increases, if
any, in the use of its Website or timely expand and upgrade its systems and
infrastructure to accommodate such increases. There can be no assurance that
the Company's or its suppliers' network will be able to timely achieve or
maintain a sufficiently high capacity of data transmission, especially if the
customer usage of the Company's Website increases. The Company's failure to
achieve or maintain high capacity data transmission could significantly reduce
consumer demand for its services and have a material adverse effect on its
business, results of operations and financial condition. See "Business--
Technology" and "--Systems Operations."
MANAGEMENT OF POTENTIAL GROWTH; NEW MANAGEMENT TEAM
The Company has rapidly and significantly expanded its operations and
anticipates that significant expansion of its operations will continue to be
required in order to address potential market opportunities. This rapid growth
has placed, and is expected to continue to place, a significant strain on the
Company's management, operational and financial resources. The Company
expanded from two employees at Inception to 74 employees and 35 full-time
equivalent contract personnel at December 31, 1998, and its sales increased
from approximately $9,000 from Inception to December 31, 1997 to over $24
million in the fourth quarter of 1998. The Company expects to add additional
key personnel in the near future. Increases in the number of employees and the
volume of merchandise sales have placed significant demands on the Company's
management, which as of December 31, 1998 included only five executive
officers. In order to manage the expected growth of its operations, the
Company will be required to expand existing operations, particularly with
respect to customer service and merchandising, to improve existing and
implement new operational, financial and inventory systems, procedures and
controls. The Company also will be required to expand its accounting staff.
Further, the Company's management will be required to maintain relationships
with various merchandise vendors, freight companies, warehouse operators,
other Websites and services, Internet service providers and other third
parties and to maintain control over the strategic direction of the Company in
a rapidly changing environment. Historically, the Company has been dependent
upon the Parent for various services, including administration (accounting,
human resources, legal), Internet/telecom and joint marketing. See "--
Dependence of the Company on the Parent for Certain Services." There can be no
assurance that the Company's current personnel, systems, procedures and
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controls will be adequate to support the Company's future operations, that
management will be able to identify, hire, train, retain, motivate and manage
required personnel or that management will be able to manage and exploit
existing and potential market opportunities successfully. If the Company is
unable to manage growth effectively, the Company's business, results of
operations and financial condition will be materially adversely affected. See
"Business--Employees and Management."
RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE; DEPENDENCE ON THE INTERNET
The Internet and electronic commerce industries are characterized by rapid
technological change, changes in user and customer requirements, frequent new
service or product introductions embodying new technologies and the emergence
of new industry standards and practices that could render the Company's
existing Website and proprietary technology obsolete. The Company's
performance will depend, in part, on its ability to license or acquire leading
technologies, enhance its existing services, and respond to technological
advances and emerging industry standards and practices on a timely and cost-
effective basis. The development of Website and other proprietary technology
entails significant technical and business risks. There can be no assurance
that the Company will be successful in using new technologies effectively or
adapting its Website and proprietary technology to emerging industry
standards. If the Company is unable, for technical, legal, financial or other
reasons, to adapt in a timely manner to changing market conditions or customer
requirements, or if the Company's Website does not achieve market acceptance,
the Company's business, results of operations and financial condition would be
materially adversely affected. The success of the Company's services will
depend in large part upon the development of an infrastructure for providing
Internet access and services. The Internet could lose its viability due to
delays in the development or adoption of new standards and protocols intended
to handle increased levels of Internet activity or due to increased
governmental regulation. There can be no assurance that the infrastructure or
complementary services necessary to make the Internet a viable commercial
marketplace will be developed or that, if they are developed, the Internet
will become a viable marketing and sales channel for excess merchandise such
as that offered by the Company. The recent growth in the use of the Internet
has caused frequent periods of performance degradation, requiring the upgrade
of routers and switches, telecommunications links and other components forming
the infrastructure of the Internet service providers and other organizations
with links to the Internet. Any perceived degradation in the performance of
the Internet as a whole could undermine the benefits of the Company's
services. The Company's ability to increase the speed with which it provides
services to customers and to increase the scope of such services ultimately is
limited by and reliant upon the speed and reliability of the networks operated
by third parties. Consequently, the emergence and growth of the market for the
Company's services is dependent on improvements being made to the entire
Internet infrastructure to alleviate overloading and congestion. If the
infrastructure or complementary services necessary to make the Internet a
viable commercial marketplace are not developed or if the Internet does not
become a viable commercial marketplace, the Company's business, results of
operations and financial condition will be materially adversely affected. See
"Business--Industry Background," "--Technology," and "--Systems Operations."
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
The Company is not currently subject to direct regulation by any government
agency, other than regulations applicable to businesses generally, laws
applicable to auction companies and auctioneers, and laws or regulations
directly applicable to access to or commerce on the Internet. However, due to
the increasing popularity and use of the Internet, it is possible that a
number of laws and regulations may be adopted with respect to the Internet,
covering issues such as user privacy, pricing, and characteristics and quality
of products and services. Furthermore, the growth and development of the
market for Internet commerce may prompt calls for more stringent consumer
protection laws that may impose additional burdens on those companies
conducting business over the Internet. The adoption of any additional laws or
regulations may decrease the growth of the Internet, which, in turn, could
decrease the demand for the Company's Internet auctions and increase the
Company's cost of doing business or otherwise have an adverse effect on the
Company's business, results of operations and financial condition. Moreover,
the applicability to the Internet of existing laws in various jurisdictions
governing
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issues such as property ownership, auction regulation, sales tax, libel and
personal privacy is uncertain and may take years to resolve. In addition, as
the Company's service is available over the Internet in multiple states, and
as the Company sells to numerous consumers resident in such states, such
jurisdictions may claim that the Company is required to qualify to do business
as a foreign corporation in each such state. The Company is qualified to do
business in only three states, and failure by the Company to qualify as a
foreign corporation in a jurisdiction where it is required to do so could
subject the Company to taxes and penalties for the failure to qualify. Any
such new legislation or regulation, or the application of laws or regulations
from jurisdictions whose laws do not currently apply to the Company's
business, could have a material adverse effect on the Company's business,
results of operations and financial condition.
The tax treatment of the Internet and e-commerce is currently unsettled. A
number of proposals have been made at the federal, state and local level and
by certain foreign governments that could impose taxes on the sale of goods
and services and certain other Internet activities. Recently, the Internet Tax
Freedom Act was signed into law, placing a three-year moratorium on new state
and local taxes on Internet commerce. However, there can be no assurance that
future laws imposing taxes or other regulations on commerce over the Internet
would not substantially impair the growth of e-commerce and as a result have a
material adverse effect on the Company's business, results of operations and
financial condition.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's future performance depends to a significant degree upon the
continued contributions of members of Company's senior management and other
key personnel, particularly its CEO and President, Gregory K. Jones; Vice
President--Information Systems, George Lu; Vice President--Merchandising,
Timothy Takesue; and Vice President and Chief Financial Officer, Thomas E.
Werner. The loss of any of these individuals could have a material adverse
effect on the Company's business, results of operations and financial
condition. In addition, as a result of the Separation, the Company will need
to employ additional personnel for certain functions that were previously
performed by employees of the Parent. The Company has a long-term employment
agreement with only one of its key personnel, Gregory K. Jones, and maintains
no key person life insurance. In order to meet expected growth and to operate
independently of the Parent, the Company believes that its future success will
depend upon its ability to identify, attract, hire, train, motivate and retain
other highly-skilled managerial, merchandising, engineering, marketing and
customer service personnel. Competition for such personnel is intense. There
can be no assurance that the Company will be successful in attracting,
assimilating or retaining the necessary personnel, and the failure to do so
could have a material adverse effect on the Company's business, results of
operations and financial condition.
RISK OF SYSTEM FAILURE; SINGLE SITE
The Company's success is largely dependent upon its communications hardware
and computer hardware, substantially all of which are located at a leased
facility in Torrance, California. The Company's systems are vulnerable to
damage from earthquake, fire, flood, power loss, telecommunication failure,
break-in and similar events. The Company currently has redundant systems but
not duplicate geographic locations. The Company plans to add a fully redundant
site outside of California in 1999 and recently entered into an agreement with
a leading hosting provider to co-locate the Company's servers and develop a
mirrored site. There can be no assurance that the second site will be
established or that it can be established without interruption in the
Company's systems. A substantial interruption in these systems would have a
material adverse effect on the Company's business, results of operations and
financial condition. To date, the Company has experienced variable
interruptions to its service as a result of loss of power and
telecommunications connections. The property and business interruption
insurance covering the Company may not be adequate to compensate the Company
for all losses that may occur. Despite the implementation of network security
measures and firewall security by the Company, its servers are also vulnerable
to computer viruses, physical or electronic break-ins, attempts by third
parties deliberately to exceed the capacity of the Company's systems and
similar disruptive problems. Computer viruses, break-ins or other problems
caused by third parties could lead to interruptions, delays, and loss of data
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or cessation in service to users of the Company's services and products. The
occurrence of any of these risks could have a material adverse effect on the
Company's business, results of operations and financial condition. See
"Business--Technology," "--Systems Operations," "--Insurance Coverage," "--
Facilities" and "Item 2. Properties."
INTERNET COMMERCE SECURITY RISKS; RISK OF CREDIT CARD FRAUD
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. The
Company relies on encryption and authentication technology licensed by the
Parent from third parties to provide the security and authentication necessary
to effect secure transmission of confidential information. This technology is
currently available to the Company under the Internet/Telecommunications
Agreement with the Parent. There can be no assurance that advances in computer
capabilities, new discoveries in the field of cryptography or other events or
developments will not result in a compromise or breach of the algorithms used
by the Company to protect customer transaction data. If any such compromise of
the Company's security were to occur, it could have a material adverse effect
on the Company's business, results of operations and financial condition. A
party who is able to circumvent the Company's security measures could
misappropriate proprietary information or cause interruptions in the Company's
operations. The Company may be required to expend significant capital and
other resources to protect against the threat of such security breaches or to
alleviate problems caused by such breaches. Concerns over the security of
Internet transactions and the privacy of users may also inhibit the growth of
the Internet generally, and the Web in particular, especially as a means of
conducting commercial transactions. To the extent that activities of the
Company or third party contractors involve the storage and transmission of
proprietary information, such as credit card numbers, security breaches could
expose the Company to a risk of loss or litigation and possible liability.
There can be no assurance that the Company's security measures will prevent
security breaches or that failure to prevent such security breaches will not
have a material adverse effect on the Company's business, results of
operations and financial condition. See "Business--Technology" and "--Systems
Operations."
PROTECTION OF INTELLECTUAL PROPERTY
The Company's performance and ability to compete are dependent to a
significant degree on its proprietary technology. The Company relies on a
combination of trademark, copyright and trade secret laws, as well as
confidentiality agreements and non-compete agreements executed by each manager
and technical measures to establish and protect its proprietary rights. The
uBidSM service mark is registered in the United States. There can be no
assurance that the Company will be able to secure significant protection for
its service marks or trademarks. It is possible that competitors of the
Company or others will adopt product or service names similar to "uBid" or
other service marks or trademarks of the Company, thereby impeding the
Company's ability to build brand identity and possibly leading to customer
confusion. The inability of the Company to protect the name "uBid" adequately
could have a material adverse effect on the Company's business, results of
operations and financial condition. The Company's proprietary software is
protected by copyright laws. The source code for the Company's proprietary
software also is protected under applicable trade secret laws.
All patent, copyright and other proprietary rights with respect to the
Company's auction processing and auction management applications and certain
general purpose libraries are co-owned by the Company and the third-party
developers of such applications and libraries pursuant to various agreements
among such third-party developers and the Parent which the Parent has assigned
to the Company. As co-owners of such software and libraries, the two co-
developers and the Company have the right to grant licenses covering such
software and libraries without the consent or notification of the other co-
owners. In addition, the two co-developers have previously granted a license
covering such software and libraries to the Parent (which is included in the
rights assigned to the Company under an Assignment and License Agreement with
the Parent) and another third party. Such licensees have the right to use,
distribute, re-license and otherwise modify the licensed source codes without
royalties or further payment to any of the other co-developers or licensees.
As part of its confidentiality procedures, the Company generally enters into
agreements with its employees and consultants and limits access to and
distribution of its software, documentation and other proprietary
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information. There can be no assurance that the steps taken by the Company
will prevent misappropriation of its technology or that agreements entered
into for that purpose will be enforceable. Notwithstanding the precautions
taken by the Company, it might be possible for a third party to copy or
otherwise obtain and use the Company's software or other proprietary
information without authorization or to develop similar software
independently. Policing unauthorized use of the Company's technology is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. The laws of other countries may afford the Company little or
no effective protection of its intellectual property.
The Company may in the future receive notices from third parties claiming
infringement by the Company's software or other aspects of the Company's
business. While the Company is not currently subject to any such claim that
would have a material effect on the Company's business or financial condition,
any future claim, with or without merit, could result in significant
litigation costs and diversion of resources, including the attention of
management, and require the Company to enter into royalty and licensing
agreements, which could have a material adverse effect on the Company's
business, results of operations and financial condition. Such royalty and
licensing agreements, if required, may not be available on terms acceptable to
the Company or at all. In the future, the Company may also need to file
lawsuits to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, or to determine the validity and scope of the
proprietary rights of others. Such litigation, whether successful or
unsuccessful, could result in substantial costs and diversion of resources,
which could have a material adverse effect on the Company's business, results
of operations and financial condition.
The Company also relies on a variety of technology that it licenses from
third parties. There can be no assurance that these third-party technology
licenses will continue to be available to the Company on commercially
reasonable terms. The loss of or inability of the Company to maintain or
obtain upgrades to any of these technology licenses could result in delays in
completing its proprietary software enhancements and new developments until
equivalent technology could be identified, licensed or developed and
integrated. Any such delays would materially adversely affect the Company's
business, results of operations and financial condition. See "Business--
Intellectual Property and Other Proprietary Rights."
RISKS ASSOCIATED WITH GLOBAL EXPANSION
Although the Company currently may not sell merchandise to customers outside
the United States due to contractual restrictions involving the Parent, it
intends to do so after the Distribution. The Company does not currently have
any overseas fulfillment or distribution facility or arrangement or any
Website content localized for foreign markets, and there can be no assurance
that the Company will be able to establish a global presence. In addition,
there are certain risks inherent in doing business on a global level, such as
regulatory requirements, export restrictions, tariffs and other trade
barriers, difficulties in staffing and managing foreign operations,
difficulties in protecting intellectual property rights, longer payment
cycles, problems in collecting accounts receivable, political instability,
fluctuations in currency exchange rates and potentially adverse tax
consequences, which could adversely impact the success of the Company's global
operations. In addition, the export of certain software from the United States
is subject to export restrictions as a result of the encryption technology in
such software and may give rise to liability to the extent the Company
violates such restrictions. There can be no assurance that the Company will be
able to successfully market, sell and distribute its products in foreign
markets or that one or more of such factors will not have a material adverse
effect on the Company's future global operations, and consequently, on the
Company's business, results of operations and financial condition.
RISKS ASSOCIATED WITH ACQUISITIONS
The Company may choose to expand its market presence through acquisitions of
complementary businesses. Although no such acquisitions are currently being
negotiated, any future acquisitions would expose the Company to increased
risks, including risks associated with the assimilation of new operations,
sites and personnel, the diversion of resources from the Company's existing
businesses, sites and technologies, the inability to generate revenues from
new sites or content sufficient to offset associated acquisition costs, the
maintenance of uniform
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standards, controls, procedures and policies and the impairment of
relationships with employees and customers as a result of any integration of
new management personnel. Acquisitions may also result in additional expenses
associated with amortization of acquired intangible assets or potential
businesses. There can be no assurance that the Company would be successful in
overcoming these risks or any other problems encountered in connection with
such acquisitions, and its inability to overcome such risks could have a
material adverse effect on the Company's business, results of operations and
financial condition.
RISK OF NONCOMPLETION OF A TAX-FREE DISTRIBUTION
The Parent has announced that, subject to certain conditions, following the
Offering, the Parent intends to distribute to its stockholders in 1999 all of
the Common Stock of the Company owned by the Parent. See "Separation from the
Parent" and "Transactions between the Company and the Parent--Separation and
Distribution Agreement." In connection with the Company's IPO, the Parent
received an opinion letter from PricewaterhouseCoopers LLP to the effect that
the Distribution will qualify as a tax-free distribution for federal income
tax purposes under Section 355 of the Code, and the Distribution is
conditional upon obtaining such an opinion letter in form and substance
satisfactory to the Parent and confirmation of such opinion at the time of
Distribution. Although it does not presently intend to do so, the Parent may
also decide, in its sole discretion, to seek a private letter ruling from the
Internal Revenue Service ("IRS") in form and substance satisfactory to the
Parent consistent with the conclusions reached in the PwC Opinion. In that
case, the Distribution would also be conditioned upon receipt of the Letter
Ruling. The Parent intends to take all necessary steps to complete such a tax-
free distribution after obtaining the PwC Opinion and the Letter Ruling, as
applicable, but in no event will the Distribution occur prior to June 7, 1999.
If the Parent decides to apply for the Letter Ruling, the Parent does not plan
to distribute its shares of Common Stock to the Parent's stockholders without
such a favorable Letter Ruling. Due to recent changes in the tax law and other
factors, there is no assurance that the Parent will receive the Letter Ruling,
or that it will receive it within the time frame contemplated, and,
consequently, there is no assurance that the Distribution will occur or will
occur within the time frame contemplated. The Distribution also is subject to
the condition that no events or developments occur that, in the sole judgment
of the Parent Board, would or could result in the Distribution having a
material adverse effect on the Parent or the Parent's stockholders. In
addition, as a condition to the Distribution, the Parent will be required to
obtain certain consents from third parties. There can be no assurance that any
of the foregoing conditions, or any other conditions to the Distribution, will
be satisfied, or that the Distribution will occur in the time frame
contemplated or at all. The failure of the Distribution to occur could
materially adversely affect the Company and the market price of the Common
Stock. See "Separation from the Parent" and "Transactions between the Company
and the Parent--Tax Indemnification and Allocation Agreement."
CONTROL OF THE COMPANY; RELATIONSHIP WITH THE PARENT
Prior to its December 1998 initial public offering, the Company was a
wholly-owned, indirect subsidiary of the Parent. The Parent currently owns
approximately 80.1% of the outstanding shares of Common Stock. As a result,
until the Distribution, the Parent generally will be able to control all
matters requiring approval of the stockholders of the Company, including the
election of all of the Company's directors. The Company's Board of Directors
(the "Board") currently consists of five members, one of whom serves
concurrently as a member of the Parent's Board. The Parent intends to maintain
ownership of at least 80% of the voting power of the Common Stock until the
Distribution can be completed. There can be no assurance that the Parent will
complete the Distribution of the Common Stock held by it to the Parent's
stockholders. If the Distribution is not effected, the Parent could maintain a
controlling interest in the Company indefinitely, which may materially
adversely affect the Company and the market price of the Common Stock. In
addition, for so long as the Parent maintains a significant interest in the
Company, the market price of the Common Stock may be adversely affected by
events relating to the Parent which are unrelated to the Company. It is the
intention of the Parent to complete the Distribution promptly but in no event
prior to June 7, 1999. See "Separation from the Parent."
Each member of a consolidated group for federal income tax purposes is
jointly and severally liable for the federal income tax liability of each
other member of the consolidated group. For benefit plan purposes, the
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Company will be part of the Parent's consolidated group, which includes the
Parent and its other subsidiaries. Under the Employee Retirement Income
Security Act of 1974, as amended, and federal income tax law, each member of
the consolidated group is jointly and severally liable for funding and
termination liabilities of tax qualified defined benefit retirement plans as
well as certain plan taxes. Accordingly, during the period in which the
Company is included in the Parent's consolidated group, the Company could be
liable under such provisions in the event such liability or tax is incurred,
and not discharged, by any other member of the Parent's consolidated group.
See "Transactions between the Company and the Parent--Tax Indemnification and
Allocation Agreement."
DEPENDENCE OF THE COMPANY ON THE PARENT FOR CERTAIN SERVICES
The Company historically has been dependent upon the Parent for various
services, including administration (accounting, human resources, legal),
Internet/telecom and joint marketing. In December 1998, the Company and the
Parent entered into an agreement under which the Parent will continue to
provide these services to the Company in exchange for fees payable by the
Company to the Parent. The Company and the Parent expect that, as of the
Distribution Date, the Services Agreement will be terminated and the Parent
will no longer perform transactional, administrative and certain other
services for the Company. The Company anticipates that, after the
Distribution, it will have to engage third parties to perform such services or
perform such services internally by Company personnel. The Company believes
that it will be able to make the transition to internal and third party
administration and transaction processing without significant additional
expense or disruption of the Company's business; however, because the Company
has historically relied heavily on the Parent for such services, no assurance
can be given that the transition will not cause the Company to experience
interruptions or temporary delays in the Company's operations and its ability
to process customer transactions and ship products on a timely basis. Any
significant unanticipated expenses or delays in connection with such
transition or any disruption in the Company's business or operations could
have a material adverse effect on the Company's business and financial
results. See "Transactions between the Company and the Parent--Services
Agreement."
INTERCOMPANY AGREEMENTS NOT SUBJECT TO ARM'S-LENGTH NEGOTIATIONS; POSSIBLE
COMPETITION FROM THE PARENT; INDEMNIFICATION OBLIGATIONS
The Parent and the Company have entered into certain intercompany
agreements, including agreements pursuant to which the Parent will provide
various services, such as administration (accounting, human resources, legal),
Internet/telecom and joint marketing, that are material to the conduct of the
Company's business. Because the Company is a majority-owned, indirect
subsidiary of the Parent, none of these agreements resulted from arm's-length
negotiations and, therefore, there is no assurance that the terms and
conditions of such agreements will be no less favorable to the Company as
could be obtained by the Company from unaffiliated third parties. See
"Transactions between the Company and the Parent." The Company's intercompany
agreements provide that the Parent, for a period of nine months after the date
of the Distribution, will not compete in the online Internet auction business
in substantially the same manner or format as currently conducted by the
Company. After that period, the Parent will not be prohibited from competing
directly or indirectly with the Company, including by way of acquiring other
companies or businesses, which could have a material adverse effect on the
Company's business, results of operations and financial condition. In
addition, the Company has agreed to indemnify, defend and hold harmless the
Parent and each of the Parent's directors, officers and employees from and
against all liabilities relating to, arising out of or resulting from: (i) the
failure of the Company or any other person to pay, perform or otherwise
promptly discharge any liabilities of the Company in accordance with their
respective terms; (ii) any breach by the Company of any of the intercompany
agreements entered into by the parties in connection with the Separation and
Distribution; and (iii) any untrue statement or alleged untrue statement of a
material fact or omission or alleged omission to state a material fact
required to be stated therein or necessary to make the statements therein not
misleading, with respect to all information contained in the Prospectus or the
Registration Statement used in connection with the Offering. See "--No Duty to
Communicate Corporate Opportunities" and "Transactions between the Company and
the Parent--Releases and Indemnification."
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TAX INDEMNIFICATION OBLIGATION; LIMITATIONS ON ISSUANCES OF EQUITY SECURITIES
FOLLOWING THE DISTRIBUTION
As a condition to the Parent effecting the Distribution, the Company will be
required to indemnify the Parent for any tax liability suffered by the Parent
arising out of actions by the Company after the Distribution that would cause
the Distribution to lose its qualification as a tax-free distribution or to be
taxable to the Parent for federal income tax purposes under Section 355 of the
Code. For example, Section 355 generally provides that a company that
distributes shares of a subsidiary in a spin-off that is otherwise tax-free
will incur U.S. federal income tax liability if 50% or more, by vote or value,
of the capital stock of either the company making the distribution or the
subsidiary is acquired by one or more persons acting pursuant to a plan or
series of related transactions that include the spin-off. To ensure that
issuances of equity securities by the Company will not cause the Distribution
to be taxable to the Parent, the Tax Indemnification and Allocation Agreement
between the Parent and the Company contains certain restrictions on issuances
of equity securities of the Company and its repurchase of equity securities
until three years following the Distribution Date. Until the second
anniversary of the Distribution Date, the Company cannot issue Common Stock
and other equity securities (including the shares sold in the Offering) that
would cause the number of shares of Common Stock to be distributed by the
Parent in the Distribution to constitute less than 60% of the outstanding
shares of Common Stock unless the Company first obtains either the consent of
the Parent or a favorable IRS letter ruling that the issuance will not affect
the tax-free status of the Distribution. After this period until the end of
the third year from the Distribution Date, the Company cannot issue additional
shares of Common Stock and other equity securities that, when combined with
equity securities sold in and after the Offering, would cause the number of
shares of Common Stock to be distributed by the Parent in the Distribution to
constitute less than 55% of the outstanding shares of Common Stock unless the
Company first obtains the consent of the Parent or a favorable IRS letter or
opinion of tax counsel that the issuance would not affect the tax-free status
of the Distribution. These restrictions on the issuance of equity securities
may impede the ability of the Company to raise necessary capital or to
complete acquisitions, if any, using equity securities. The foregoing
prohibitions do not apply to issuances of debt securities of the Company that
are not convertible into Common Stock or other equity securities. The same
requirements for an IRS ruling, consent of the Parent or an opinion of counsel
are applicable to any proposed repurchases of Common Stock during the
Restriction Period. In the event that the Company is required to indemnify and
reimburse the Parent for any tax liability incurred by the Parent arising out
of the Distribution, such indemnification and reimbursement would have a
material adverse effect on the business, results of operations and financial
condition of the Company. See "--Limited Ability to Issue Common Stock Prior
to Distribution," and "Transactions between the Company and the Parent--Tax
Indemnification and Allocation Agreement."
CONFLICTS OF INTEREST WITH THE PARENT
None of the executive officers of the Parent are executive officers of the
Company. However, one member of the Board of Directors of the Company is also
a member of the Parent's Board. In addition, certain executive officers,
directors and employees of the Company hold shares of Parent Common Stock and
options to acquire shares of Parent Common Stock. In particular, Mr. Frank F.
Khulusi, a director of the Company, is the Chairman of the Board of the Parent
and beneficially owned approximately 1.8 million shares of Parent Common Stock
constituting approximately 17.7% of the issued and outstanding Parent Common
Stock as of March 23, 1999. Accordingly, such individuals may have conflicts
of interest with respect to certain decisions relative to business
opportunities and similar matters that may arise in the ordinary course of the
business of the Parent or the Company, including with respect to relationships
between the Parent and the Company under intercompany agreements and whether
to complete the Distribution. See "Transactions between the Company and the
Parent." The Company and the Parent intend to resolve such conflicts on a
case-by-case basis. In that regard, certain of the conflicts, if any, could be
resolved in a manner adverse to the Company and its stockholders, which would
have a material adverse effect on the business, results of operations and
financial condition of the Company.
NO DUTY TO COMMUNICATE CORPORATE OPPORTUNITIES
Neither the Company nor the Parent has any duty to communicate or offer any
corporate opportunities to the other and may pursue or acquire any such
opportunities for itself or direct such opportunities to any other
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person. There can be no assurance that the Parent's failure to communicate any
corporate opportunity to the Company, the Parent's pursuit of such opportunity
for itself or the Parent's communication of such corporate opportunity to a
third party will not have a material adverse affect on the Company's business,
results of operations or financial condition.
LIMITED ABILITY TO ISSUE COMMON STOCK PRIOR TO DISTRIBUTION
In order for the Distribution to be tax-free to the Parent and the Parent's
stockholders, among various other requirements, the Parent must distribute to
the Parent's stockholders on the Distribution Date (a) stock of the Company
possessing at least 80% of the total combined voting power of all classes of
voting stock of the Company and (b) 80% of the total number of shares of each
class of non-voting stock of the Company (the "Required Distribution
Percentage"). If the Parent were not able to distribute to its stockholders
shares of stock of the Company constituting the Required Distribution
Percentage, the Distribution would not be tax-free and would not occur.
Accordingly, the Company agreed in the Separation and Distribution Agreement
not to issue additional shares of Common Stock, or any other class of stock
including preferred stock, without the consent of the Parent if such issuance
would, or could, dilute or otherwise reduce the Parent's ownership of Common
Stock, or any other such class of stock, below the Required Distribution
Percentage or otherwise prevent the Distribution from receiving tax-free
status. The Separation and Distribution Agreement will terminate if the
Distribution does not occur on or prior to December 31, 1999, unless extended
by the Parent and the Company. Prior to the Distribution Date, these
restrictions may impede the ability of the Company to issue equity securities,
including Common Stock, to raise necessary equity capital or to complete
acquisitions using equity securities, including Common Stock, as acquisition
currency, or to attract qualified persons to become employees, officers and
directors of the Company. See "Transactions between the Company and the
Parent--Separation and Distribution Agreement."
YEAR 2000 RISK
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed
"year 2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with which the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has
established an internal project team comprised of all functional disciplines.
This project team has begun a three-phase process of identifying internal
systems (both information technology and non-information technology systems)
that are not year 2000 compliant, determining their significance in the
effective operation of the Company, and developing plans to resolve the issues
where necessary. The Company has been communicating with the suppliers and
others with whom it does business to coordinate year 2000 readiness. The
responses received by the Company to date have indicated that steps are
currently being undertaken to address this concern. However, if such third
parties are not able to make all systems year 2000 compliant, there could be a
material adverse impact on the Company.
Initial review of the Company's principal transaction processing software
through which nearly all of the Company's business is transacted has
determined it to be year 2000 compliant and, as such, the Company does not
anticipate any material adverse operational issues to arise. The Company has
completed 75% of its year 2000 assessment for critical systems and plans to
complete its assessment by the end of the second quarter of 1999. The Company
plans to implement corrective solutions before the end of the third quarter of
1999. To date, the costs incurred by the Company with respect to this project
are approximately $10,000. Based on current estimates, management expects that
the Company's total costs in connection with its year 2000 compliance
34
<PAGE>
project will be approximately $500,000 and will be financed from general
corporate funds; however, future anticipated costs are difficult to estimate
with any certainty and may differ materially from those currently projected
based on the results of the assessment phase of the Company's year 2000
project. The anticipated costs associated with the Company's year 2000
compliance program do not include time and costs that may be incurred as a
result of any potential failure of third parties to become year 2000 compliant
or costs to implement the Company's future contingency plans. Management
estimates that approximately one half of the expected costs will be attributed
to the redeployment of internal resources and the other half will be comprised
of external consulting fees and software upgrades. The redeployment of
internal data processing resources is not expected to materially delay any
significant projects.
The Company believes its auction software to be year 2000 compliant;
however, full compliance of the auction software will be verified by an
external consultant no later than the end of the third quarter of 1999. The
Company currently runs various third party applications that require year 2000
updates. These are available and are expected to be implemented no later than
the end of the third quarter of 1999. The Company has not yet developed a
contingency plan in the event that any non-compliant critical systems are not
remedied by January 1, 2000, nor has it formulated a timetable to create such
contingency plan. Upon completion of this project, if systems material to the
Company's operation have not been made year 2000 compliant, or if third
parties fail to make their systems year 2000 compliant in a timely manner, the
year 2000 issue could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Possible Volatility of Stock Price
The trading price of the Common Stock has been and is likely to be highly
volatile and could be subject to wide fluctuations in response to factors such
as actual or anticipated variations in the Company's quarterly operating
results, announcements of technological innovations, new services by the
Company or its competitors, changes in financial estimates by securities
analysts, conditions or trends in the Internet and online commerce industries,
changes in the market valuations of other Internet or online service
companies, announcements by the Company or its competitors of significant
acquisitions, strategic partnerships, joint ventures or capital commitments,
additions or departures of key personnel, sales of Common Stock or other
securities of the Company in the open market and other events or factors, many
of which are beyond the Company's control. In the past, following periods of
volatility in the market price of a company's securities, securities class-
action litigation has often been instituted against such company. Such
litigation, if instituted, could result in substantial costs and a diversion
of management's attention and resources, which would have a material adverse
effect on the Company's business, results of operations and financial
condition.
Possibility of Substantial Sales of Common Stock
Subject to applicable law and to the contractual restriction with the
underwriters of the Company's initial public offering as described below, the
Parent may sell any and all of the shares of Common Stock it owns after
completion of the Offering. The Separation and Distribution Agreement provides
that the Parent, and certain holders of more than 5% of Parent Common Stock,
will have the right in certain circumstances to require the Company to use its
best efforts to register for resale shares of Common Stock held by them. See
"Transactions between the Company and the Parent--Separation and Distribution
Agreement." The planned Distribution would involve the distribution of an
aggregate of approximately 7.3 million shares of Common Stock to the
stockholders of the Parent prior to December 31, 1999 (assuming that no shares
of Common Stock are disposed of or acquired by the Parent prior to the
Distribution Date). In addition, pursuant to the Separation and Distribution
Agreement, options to purchase Parent Common Stock outstanding as of the
Distribution Date will be converted into options to purchase both Parent
Common Stock and uBid Common Stock. Based on the number of outstanding options
to purchase Parent Common Stock and the total shares of Parent Common Stock
outstanding as of March 26, 1999, the Company anticipates that it will grant
options to purchase approximately 548,935 shares of the Company's Common Stock
in connection with the Distribution. Of these options,
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<PAGE>
approximately 188,379 will have vested on or prior to June 7, 1999 (the
earliest date on which the Distribution could occur). See "Transactions
between the Company and the Parent--Separation and Distribution Agreement."
Except for shares held by affiliates of the Company, all of the shares of
Common Stock to be distributed to the Parent's stockholders in the
Distribution (including shares of Common Stock issuable upon exercise of stock
options) will be eligible for immediate resale in the public market. The
Company is unable to predict whether substantial amounts of Common Stock will
be sold in the open market in anticipation of, or following, the Distribution.
Any sales of substantial amounts of Common Stock in the public market, or the
perception that such sales might occur, whether as a result of the
Distribution or otherwise, could materially and adversely affect the market
price of the Common Stock. In connection with the Offering, the Company
agreed, for a period of 180 days after the date of the Offering, and Messrs.
Frank and Sam Khulusi agreed, until 180 days after the Distribution, not to
offer or sell any shares of Common Stock, subject to certain exceptions
(including the Distribution), without the prior written consent of Merrill
Lynch, Pierce, Fenner & Smith Incorporated.
Item 2. Properties
The Company's principal administrative, engineering, merchandising and
marketing facilities total approximately 9,000 square feet, and are located in
Elk Grove Village, Illinois under leases that are shared with the Parent and
expire in 2002. Until July 1998, the Company was dependent upon the Parent for
warehousing and distribution services. In July 1998, the Company became
responsible for its own warehousing and distribution and entered into a
sublease for 100,000 square feet of the Parent's 325,000 square foot
distribution center in Memphis, Tennessee. The sublease provides for the
Company's continued use of the Parent's sophisticated inventory control and
shipping systems during the term of the sublease. The sublease is at a monthly
rate equal to the Parent's obligation to the landlord, plus taxes and
utilities, and will expire in 2002. The Company believes that it has adequate
space for its current needs. As the Company expands, it expects that suitable
additional space will be available on commercially reasonable terms, although
no assurance can be made in this regard. The Company does not own any real
estate.
Item 3. Legal Proceedings
The Company is not currently a party to any legal proceedings which may or
could have a material adverse impact on the Company or its operations.
Item 4. Submission of Matters to a Vote of Security Holders
On November 30 1998, the Parent executed a written consent as sole
stockholder of the Company in lieu of an annual meeting, pursuant to which the
Parent (1) approved Amended and Restated Articles of Incorporation effecting a
.7329883-for-one reverse stock split, (2) approved the Company's Amended and
Restated Bylaws, and (3) elected the following four directors to serve until
the next annual meeting of the year set forth beside their respective names:
Gregory K. Jones (2001); Howard A. Tullman (2000); Norman H. Wesley (2000);
and Frank F. Khulusi (1999).
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<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and key employees and directors of the Company are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Gregory K. Jones................. 38 Chairman, President and Chief
Executive Officer
Thomas E. Werner................. 41 Vice President and Chief Financial
Officer
George Lu........................ 34 Vice President - Information Systems
Timothy E. Takesue............... 30 Vice President - Merchandising
David L. Hirschman............... 36 Senior Vice President - Operations
</TABLE>
GREGORY K. JONES. Mr. Jones has been President and Chief Executive Officer of
the Company since November 1997, and Chairman of the Board since July 1998.
Prior thereto, from October 1995 to November 1997, Mr. Jones was Senior Vice
President of Strategic Markets at APAC TeleServices, Inc., a provider of
outsourced telephone-based marketing, sales and customer management solutions.
Prior thereto, from October 1990 to October 1995, Mr. Jones served as the
President and Chief Operating Officer of The Reliable Corporation/Office 1, a
Chicago-based direct mail/retailer of office products. Before that, from
January 1988 to October 1990, Mr. Jones was a Senior Manager, consulting on
systems and technology strategic planning for the accounting/consulting firm of
Ernst & Young LLP. He sits on the Board of Directors of Ohio-based D.I.Y. Home
Warehouse, an operator of 16 warehouse-format home improvement centers, and of
E-Sport, an Internet sports content company. Mr. Jones received his B.A. degree
from Miami University (Ohio) and his M.M. in marketing and finance from the
J.L. Kellogg Graduate School of Management of Northwestern University.
THOMAS E. WERNER. Mr. Werner has been Vice President and Chief Financial
Officer of the Company since October 1998. From December 1995 to October 1998,
Mr. Werner was Corporate Controller for Gateway, Inc., a manufacturer and
marketer of personal computers and related products. From March 1995 until
December 1995, Mr. Werner was Vice President and Assistant Corporate Controller
for Dade International, a manufacturer of medical diagnostic equipment and
products. From 1989 until 1995, Mr. Werner held various financial management
positions with Baxter International, a manufacturer and distributor of health
care products. Mr. Werner received his B.S. degree in Business from Indiana
University and is a Certified Public Accountant.
GEORGE LU. Mr. Lu has been Vice President--Information Systems of the Company
since February 1998. Prior thereto, from March 1994 to January 1998, Mr. Lu was
employed by Rand McNally & Company, most recently in the position of technical
development manager for Rand McNally New Media and TDM. Prior thereto, from
March 1993 to March 1994, Mr. Lu was with AECOM Corp. as a senior systems
analyst. Mr. Lu received his B.S. degree from Huazhong University, currently
known as Central China Normal University, and his M.S. degree from the
University of Memphis.
TIMOTHY E. TAKESUE. Mr. Takesue joined uBid as Vice President--Merchandising
in December 1997. Prior to December 1997, Mr. Takesue was Director of
Merchandising/Purchasing for Elek-Tek Inc., a catalog, retail and corporate
reseller. Mr. Takesue was a buyer of computer and computer-related products and
accessories at Montgomery Ward from March 1996 to August 1996 and from February
1988 to March 1996, Mr. Takesue held several positions with Fretter, Inc., a
specialty retailer in appliances, consumer electronics and computers. During
his eight years with that company, Mr. Takesue held the positions of General
Store Manager, District Sales Manager of Indiana, Marketing Manager of the Ohio
region with responsibility for all marketing functions, Regional Marketing
Manager for the New England region, Merchandise Manager with responsibility for
all buying and marketing of computer peripheral, software and accessory
products, and Senior Merchandise Manager with responsibility for all buying and
marketing of computer and related products. Mr. Takesue attended Wayne State
University.
DAVID L. HIRSCHMAN. Mr. Hirschman has been the Company's Senior Vice
President--Operations since April 1997. Prior thereto, Mr. Hirschman served as
Vice President of Marketing Operations at the Parent from August 1996 to March
1997, as Vice President of the Macintosh Marketing Division of the Parent from
May 1996 to July 1996, and from June 1993 to April 1996 as the Vice President
of Product Management at the Parent with responsibility for purchasing,
inventory maintenance and vendor relations. From 1990 to 1993, Mr. Hirschman
was the Purchasing Manager for Sun Computers, a large regional computer
reseller. Mr. Hirschman holds a B.S. degree in business from Washington
University in St. Louis.
37
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE OF COMMON STOCK
uBid's Common Stock is traded on the Nasdaq National Market under the symbol
"UBID." The table below presents high and low closing price information for
the Common Stock by quarter as reported on Nasdaq since December 4, 1998, the
date the Company's Common Stock commenced trading. Prior to such time, there
was no public market for the Company's Common Stock.
<TABLE>
<CAPTION>
1998 HIGH LOW
---- ------- ------
<S> <C> <C>
Fourth Quarter (commencing December 4, 1998).................. $188.00 $33.00
</TABLE>
On March 23, 1999, the last sale price of the Company's Common Stock as
quoted on Nasdaq was $71.50. As of March 23, 1999, the number of stockholders
of record of the Company's Common Stock was 41. The Company has not paid any
cash dividends to date and currently intends to retain any earnings for use in
business and does not anticipate paying any cash dividends in the foreseeable
future.
RECENT SALES OF UNREGISTERED SECURITIES
Prior to the Company's initial public offering, options to purchase an
aggregate of 1,097,278 shares of the Company's Common Stock had been granted
in reliance upon the exemption provided in Rule 701 under the Securities Act
of 1933, as amended.
USE OF PROCEEDS FROM SALES OF REGISTERED SECURITIES
The Company commenced its initial public offering on December 4, 1998
pursuant to a Registration Statement on Form S-1 (File No. 333-58447), which
was declared effective by the Commission on December 3, 1998. In the IPO the
Company sold an aggregate of 1,817,000 shares of its Common Stock (including
237,000 shares sold pursuant to the exercise of the underwriters' over-
allotment option) at an initial public offering price of $15.00 per share. The
IPO was closed on December 9, 1998. Merrill Lynch & Co. and William Blair &
Company served as managing underwriters for the IPO.
Aggregate proceeds from the IPO were $27,255,000, which included $2,055,000
in aggregate proceeds due to the exercise of the underwriters' option to
purchase shares to cover over-allotments. The Company paid underwriters'
discounts and commissions of $1,907,850 and other expenses of approximately
$1,500,000 in connection with the IPO. The total expenses paid by the Company
in the IPO were $3,407,850 and the net proceeds to the Company were
$23,847,000, all of which has been allocated for general corporate purposes,
including working capital requirements of the Company resulting from its
growth. From the closing date of the Offering to March 1, 1999, the Company
paid an aggregate of $447,000 to the Parent (which owns approximately 80.1% of
the Company's Common Stock), consisting of payments for certain administrative
services provided by the Parent under the Services Agreement and excluding
repayments of advances from the Parent. With the exception of the foregoing,
none of the proceeds of the IPO were paid directly or indirectly to any
officer or director of the Company or their respective associates, persons
owning 10 percent or more of any class of equity securities of the Company, or
any affiliate of the Company.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is certain selected financial and operating data of the
Company for the periods indicated, which have been derived from the Company's
audited financial statements. The selected financial data set forth below
should be read in conjunction with the Company's financial statements and
notes thereto included elsewhere in this Form 10-K and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
INCEPTION YEAR
(APRIL 1, 1997) ENDED
TO DECEMBER 31, DECEMBER 31,
1997 1998
--------------- ------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues..................................... $ 9 $ 48,232
Gross profit..................................... 1 3,975
Loss from operations before stock-based
compensation.................................... (287) (4,732)
Loss from operations............................. (287) (9,999)
Net Loss......................................... (313) (10,169)
Basic and diluted net loss per share (1)......... $ (0.04) $ (1.36)
Shares used to compute basic and diluted net loss
per share (1)................................... 7,329,833 7,461,061
<CAPTION>
DECEMBER 31,
----------------------------
1997 1998
--------------- ------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................ $ -- $ 26,053
Working capital.................................. 31 21,444
Total assets..................................... 358 34,625
Advances and notes from the Parent............... 670 4,608
Total stockholders' equity (deficit)............. (312) 18,632
</TABLE>
- --------
(1) See Notes 1 and 7 of the notes to the financial statements for an
explanation of the number of shares used in computing the amount of basic
and diluted net loss per common share and Note 5 for an explanation of the
non-cash charge recorded in the fourth quarter of 1998 in connection with
certain employee and director stock options granted prior to the Company's
initial public offering.
39
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The Management's Discussion and Analysis of Financial Condition and Results
of Operations which follows contains forward-looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including but not limited to those set forth under
"Investment Considerations" in Item 1 and elsewhere in this Annual Report on
Form 10-K. The following discussion should be read in conjunction with the
financial statements and notes thereto included in this Report. The historical
information included in this Report does not necessarily reflect what the
Company's financial condition and results of operations would have been had
the Company been operated as an independent entity during the periods
presented and may not be indicative of future performance. Dollar amounts are
in thousands, except per share data.
OVERVIEW
uBid is engaged in the retail sale of excess merchandise, including close-
out and refurbished products, utilizing an interactive online auction. The
Company currently specializes in selling brand name computer, consumer
electronics and home and leisure products over the World Wide Web to consumers
and small and medium-sized businesses. The Company was incorporated in
September 1997. Prior to the incorporation of the Company, the Parent,
beginning on April 1, 1997, funded certain startup and development activities.
During 1997, the Company's operating activities related primarily to
recruiting personnel, developing the computer infrastructure necessary to
conduct live auctions on the Internet, building an operating infrastructure
and establishing vendor relationships. From its first auction in December 1997
through December 31, 1998, the Company auctioned over 278,000 merchandise
units, registered over 229,000 users and recorded more than 17.8 million
visits to its Website. The Company's net loss of $10,169 for 1998 was due in
part to a $5,267 non-cash charge for amortization of stock compensation
expense related to pre-IPO stock options, and investments in infrastructure as
the Company commenced sales operations. The Company expects to continue to
experience losses for the foreseeable future as it continues to make
significant investments in building its customer base and operating
infrastructure.
Prior to its initial public offering, the Company was a wholly-owned
subsidiary of the Parent. The Company was set up as a subsidiary with the
intention to function independently from the Parent. To date, the Company has
received services provided by the Parent, including administrative
(accounting, human resources, legal), warehousing and distribution,
Internet/telecom and joint marketing. In consideration for these services, the
Parent generally charges the Company its costs plus 10%. Management believes
that the amounts charged to the Company have been no less favorable to the
Company than costs the Company would have incurred to obtain such services on
its own or from unaffiliated third parties. It is estimated that the Company
will need to spend approximately $1,750 in capital expenditures to establish
itself as an independent company. These expenditures will include warehouse
and distribution equipment, hardware and software for computer systems and
furniture and fixtures. The Company expects to fund its purchase of such
capital equipment with working capital (including the proceeds from the
Offering). In addition, the Company and the Parent expect that the Services
Agreement will be terminated upon completion of the Distribution. Thereafter,
the Company will have to engage third parties to perform certain
administrative and transactional services previously provided b the Parent or
have such services performed by Company personnel.
Due to its dependence on the Parent for funding and certain services, the
Company's ability to grow prior to its initial public offering was constrained
by the allocation of resources made by the Parent. The Company's growth has
also been constrained by its inability to sell and ship products
internationally due to contractual restraints on the Parent and because it has
been precluded from selling certain lines of merchandise as a result of
agreements to which the Parent is subject. For example, certain of the
Parent's contractual relationships with manufacturers prevent the Parent and
its subsidiaries, including the Company, from selling such manufacturers'
40
<PAGE>
computers and computer-related products at discounted prices, which has
prevented the Company from obtaining such products on a close-out or
refurbished basis and selling them in the Company's auctions. In addition,
under the Parent's contractual relationships with certain of its vendors,
neither the Parent nor its subsidiaries, including the Company, can sell the
vendor's products outside the U.S. As a result of the Distribution, the
Company would no longer be subject to these restrictions.
The Company either purchases the merchandise outright ("purchased
inventory") or acquires the rights to sell the merchandise under consignment-
type relationships with vendors on a revenue sharing basis ("revenue
sharing"). In the case where the Company purchases the merchandise outright,
the Company bears both inventory and credit risk. When merchandise is acquired
on a revenue sharing basis, title to the inventory passes to the Company only
after the sale, the Company invoices the customer and bears the credit and
return risks. Under both types of transactions (purchased inventory or revenue
sharing), the Company recognizes the full sales amount as revenue upon
verification of the credit card transaction authorization and shipment of the
merchandise. In instances where the credit card authorization has been
received but the merchandise has not been shipped, the Company defers revenue
recognition until the merchandise is shipped The Company has begun offering
credit to certain of its business customers that have been pre-qualified as
having appropriate credit ratings, and accordingly, the Company will be
required to manage the associated risks of accounts receivable expansion and
collection.
The Company has an extremely limited operating history upon which to base an
evaluation of the Company and its business and prospects. The Company's
business and prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets such
as electronic commerce. Although the Company has experienced significant
growth in revenue since its commencement of operations, there can be no
assurance that the Company's revenue will continue at its current level or
rate of growth. The Company's revenue depends substantially upon the level of
auction activity on its Website. In addition, the Company has relatively low
gross margins and plans to increase its operating expenses significantly by
increasing the size of its staff, expanding its marketing efforts, purchasing
larger volumes of merchandise to be sold at auction and building a larger
infrastructure to support planned growth. To the extent that increases in
operating expenses precede or are not subsequently followed by increased
revenue, the Company's business, results of operations and financial condition
will be materially adversely affected. See "Investment Considerations--
Extremely Limited Operating History."
Beginning in October 1997, the Company granted stock options to attract and
retain key employees. These options were exercisable only in the event of a
successful initial public offering or sale of the Company. The Company will
record a non-cash compensation expense charge of approximately $13,292 in
connection with stock options granted prior to the IPO at prices less than the
initial public offering price of the Company's Common Stock. The compensation
charge will be recognized over the five-year vesting period of such options.
Accordingly, the Company recorded a compensation expense of approximately
$5,267 in the fourth quarter of 1998. See Note 5 to the financial statements
and "Investment Considerations--History of Operating Losses; Accumulated
Deficits; Anticipated Losses and Negative Cash Flow."
RESULTS OF OPERATIONS
Net Revenues. Net revenues are comprised of gross merchandise sales plus
shipping income net of returns. The Company held its first auction the last
week of December 1997. For the year ended December 31, 1998, net revenues were
$48,232. Growth in net revenues was due to significant growth in the Company's
customer base, an expanded selection of merchandise offered and an increase in
the number of auctions per week. The Company intends to increase traffic to
its Website, further allowing it to broaden its customer base, increase the
number of auctions per week and expand the selection and number of items
offered.
Gross Profits. Gross profits are comprised of net revenues minus the cost of
merchandise, shipping and shipping-related expenses, net of returns. Gross
profits for the year ended December 31, 1998 were $3,975. As a
41
<PAGE>
percent of net revenues, the Company's gross margin was 8.2% for the year
ended December 31, 1998. Gross margin is affected by the Company's ability to
cost-effectively source merchandise and attract sufficient traffic to the
Company's Website to achieve a favorable balance between the number of bidders
and the amount of merchandise auctioned. Merchandise acquired from the Parent
represented over 90% of the merchandise sold in the first two months of
operations, decreased to approximately 30% in March and April 1998, and
represented less than 10% for 1998.
Operating Expenses. The Company's operating expenses have increased
significantly since the Company's Inception. This trend is expected to
continue as the Company continues to expand its operations to increase its
customer base, enhance its brand name and increase its market share, all of
which will require significant increases in marketing and advertising,
additional personnel, enhancements to its Website and further development of
its infrastructure. To date, the Parent has provided administrative
(accounting, human resources, legal), warehousing and distribution,
Internet/telecom and joint marketing services to the Company. The cost of
these services represented 72% and 21% of the Company's total operating
expenses from Inception to December 31, 1997 and for the year ended December
31, 1998, respectively. It is expected that these costs will continue to
decline as a percent of total operating expenses and in absolute dollars in
the future. After the Distribution, the Company will have to engage third
parties to perform certain administrative and transactional services
previously provided by the Parent or have such services performed by Company
personnel. The Company does not expect that the costs associated with the
transition to internal and third party administration and transaction
processing will be material.
Sales and Marketing. Sales and marketing expenses consist primarily of
advertising and promotional expenditures, as well as payroll and related
expenses for sales and marketing personnel. Sales and marketing expenses were
$10 and $2,829 from Inception to December 31, 1997 and for the year ended
December 31, 1998, respectively. Sales and marketing expenses as a percent of
net revenues were 5.9% for the year ended December 31, 1998. These expenses
have increased significantly each month of operations due to increasing
advertising expenditures and personnel additions. The Company expects sales
and marketing expenses to increase significantly in absolute dollars as it
endeavors to increase its customer base. The Company has established
relationships with a number of online companies, such as AOL, CNET, Wired
Digital, MSN/LinkExchange, PCWorld Online and LookSmart to increase its access
to online customers and build brand recognition.
Technology and Development. Technology and development expenses consist
primarily of payroll and related expenses for systems personnel who develop
the Company's Website and related systems as well as charges from the Parent
relating to hosting of the Company's Website and Internet/telecom operations.
Technology and development expenses were $66 and $1,022 from Inception to
December 31, 1997 and for the year ended December 31, 1998, respectively.
Technology and development costs as a percent of net revenues were 2.1% for
the year ended December 31, 1998. In addition to the expenses in 1997, the
Company capitalized $267 relating to the development of the core software for
the Website. These costs are being amortized over three years. The increase in
technology and development expenses during 1998 was primarily attributable to
increased staffing and associated costs relating to enhancing the features and
functionality of the Company's Website and related systems. The Parent has
been responsible for hosting the Company's Website and for Internet/telecom
operations. The Parent has charged the Company rates that management believes
are no less favorable than that which could be obtained from a third party.
General and Administrative. General and administrative expenses consist
primarily of credit card processing, payroll and related expenses, warehousing
and distribution, merchandising, customer service, accounting and
administration, executive and other general corporate expenses. General and
administrative expenses were $212 and $4,856 for the period from Inception to
December 31, 1997 and for the year ended December 31, 1998, respectively.
General and administrative expenses as a percent of net revenues were 10.1%
for the year ended December 31, 1998. The Parent supplied general and
administrative services for warehousing and distribution, credit card
processing, accounting and benefits administration. Although the Parent will
continue to supply certain general and administrative services to the Company
until the Distribution, the current warehousing and distribution services
conducted by the Parent were assumed by the Company in July 1998
42
<PAGE>
pursuant to a sublease agreement between the Company and the Parent. The
Parent charged the Company rates that were no less favorable than what a third
party would have charged. General and administrative expenses have increased
during 1998 primarily due to hiring additional personnel and related costs to
support increased sales such as credit card processing and distribution costs.
The Company expects general and administrative expenses to increase in
absolute dollars in the future as the Company expands its operations.
Stock Option Compensation Expense. Prior to the Offering, the Company had
granted 1,038,278 options to purchase Common Stock at prices less than the
$15.00 per share Offering price. The completion of the Offering on December 4,
1998 caused a new measurement date to occur, requiring the Company to compute
compensation expense based upon the difference between the exercise price of
the options and the IPO price. Based upon the difference between the IPO price
of $15.00 per share and the exercise prices of the 1,038,278 options
outstanding at December 4, 1998, the total compensation charge will be
approximately $13,292, which will be amortized over the vesting periods of the
outstanding options. Approximately $5,267 of this charge to compensation was
recognized in December 1998.
Income Taxes. The Company records its income tax provision on a separate
return basis. The Company had a net loss since Inception in 1997 and expects
to incur losses for the foreseeable future. No benefit for income taxes was
provided in 1997 or 1998 due to the uncertainty of realization of these
benefits in future years.
Net Loss. Based on the foregoing information, the Company had a net loss of
$313 and $10,169 for the period from Inception to December 31, 1997 and for
the year ended December 31, 1998, respectively. In the year ended December 31,
1998 the loss from operations before the non-cash stock option compensation
expense was $4,732, and the stock option compensation expense totaled $5,267.
LIQUIDITY AND CAPITAL RESOURCES
From Inception until its December 1998 initial public offering, the Company
financed its operations with advances from the Parent and cash flow from
operations. Net cash (used in) operating activities were ($340) and ($108) for
the period from Inception to December 31, 1997 and for the year ended December
31, 1998, respectively. For 1997, the net cash used in operating activities
was primarily attributable to the net loss of $313. For the year ended
December 31, 1998, the net cash used in operating activities was primarily due
to the net loss of $4,732, (before the non-cash stock option compensation
expense), an increase in accounts receivable of $614, a net increase in
inventory of $7,233 offset by an increase in accounts payable of $9,014,
short-term advances from the Parent of $1,277 and various accrued expenses of
$2,371.
Cash flows provided by (used in) investing and financing activities were
($340) and $26,161 for 1997 and the year ended December 31, 1998,
respectively. In 1997, investing activities were for the capitalization of
software development. In 1998, financing activities included the proceeds of
the initial public offering of $23,847 and advances from the Parent of $2,661,
offset by purchases of equipment of $347.
The Company anticipates that it will have negative cash flows for the
foreseeable future. The Parent advanced the Company cash for its operations
until the consummation of its December 1998 initial public offering. Upon
consummation of the Offering, these advances were converted into a note
repayable to the Parent. The outstanding balance on the note bears interest at
the prime rate and will be repaid in June 2000. Interest expense was $26 and
$244 for 1997 and the twelve months ended December 31, 1998, respectively. Net
proceeds from the IPO are being used for working capital needs to include
advertising and brand development for growth, as well as development of the
Company's infrastructure. It is estimated that the Company will need to spend
approximately $1,750 in capital expenditures to establish itself as an
independent company. These expenditures will include warehouse and
distribution equipment, hardware and software for computer systems and
furniture and fixtures. The Company expects to fund its purchase of such
capital equipment with working capital.
The Company intends to retain all earnings for the foreseeable future for
use in the operation and expansion of its business. Consequently, the Company
does not anticipate paying any cash dividends on its Common Stock to its
stockholders for the foreseeable future. In addition, it is probable that any
debt financing agreements to be entered into by the Company will contain
restrictions on the Company's ability to declare dividends.
43
<PAGE>
The Company believes that the net proceeds from its initial public offering
will satisfy the Company's working capital and capital expenditure
requirements for at least the next 12 months, although the Company may seek to
raise additional capital during that period. There can be no assurance the
Company will not require additional funds prior to the expiration of such 12
month period. Even if such additional funds are not required, the Company may
seek additional equity or debt financing. There can be no assurance that such
financing will be available on acceptable terms, if at all, or that such
financing will not be dilutive to the Company's stockholders.
Year 2000 Systems Costs
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed
"year 2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with whom the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has
established an internal project team comprised of all functional disciplines.
This project team has begun a three-phase process of identifying internal
systems (both information technology and non-information technology systems)
that are not year 2000 compliant, determining their significance in the
effective operation of the Company, and developing plans to resolve the issues
where necessary. The Company has been communicating with the suppliers and
others with whom it does business to coordinate year 2000 readiness. The
responses received by the Company to date have indicated that steps are
currently being undertaken to address this concern. However, if such third
parties are not able to make all systems year 2000 compliant, there could be a
material adverse impact on the Company.
Initial review of the Company's principal transaction processing software
through which nearly all of the Company's business is transacted has
determined it to be year 2000 compliant and, as such, the Company does not
anticipate any material adverse operational issues to arise. The Company has
completed 75% of its year 2000 assessment for critical systems and plans to
complete its assessment by the end of the second quarter of 1999. The Company
plans to implement corrective solutions before the end of the third quarter of
1999. To date, the costs incurred by the Company with respect to this project
are approximately $10. Based on current estimates, management expects that the
Company's total costs in connection with its year 2000 compliance project will
be approximately $500 and will be financed from general corporate funds;
however, future anticipated costs are difficult to estimate with any certainty
and may differ materially from those currently projected based on the results
of the assessment phase of the Company's year 2000 project. The anticipated
costs associated with the Company's year 2000 compliance program do not
include time and costs that may be incurred as a result of any potential
failure of third parties to become year 2000 compliant or costs to implement
the Company's future contingency plans. Management estimates that
approximately one half of the expected costs will be attributed to the
redeployment of internal resources and the other half will be comprised of
external consulting fees and software upgrades. The redeployment of internal
data processing resources is not expected to materially delay any significant
projects.
The Company believes its auction software to be year 2000 compliant;
however, full compliance of the auction software will be verified by an
external consultant no later than the end of the third quarter of 1999. The
Company currently runs various third party applications that require year 2000
updates. These are available and are expected to be implemented no later than
the end of the third quarter of 1999. The Company has not yet developed a
contingency plan in the event that any non-compliant critical systems are not
remedied by January 1, 2000, nor has it formulated a timetable to create such
contingency plan. Upon completion of this project, if systems material to the
Company's operations have not been made year 2000 compliant, or if third
parties fail to make their systems year 2000 compliant in a timely manner, the
year 2000 issue could have a material adverse effect on the Company's
business, financial condition and results of operations.
44
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and government repurchase
agreements at fixed rates. At March 23, 1999, the carrying values of the
Company's financial instruments approximated their fair values based on
current market prices and rates. The Company has not entered into any
derivative financial instruments. The Company does not have any foreign
currency exposure because it does not transact business in foreign currencies.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are filed under this
Item, beginning on page F-1 of this Report. The financial statement schedules
required under Regulation S-X are filed pursuant Item 14 of this Report,
beginning on page F-14 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 regarding directors is incorporated by
reference from the Company's definitive proxy statement for its 1999 Annual
Meeting of Stockholders under the caption "Election of Directors." The
information relating to the Company's executive officers is included under the
heading "Executive Officers of the Registrant" in Part I of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to compensation of executive officers and directors
required by Item 11 is incorporated by reference from the Company's definitive
proxy statement for its 1999 Annual Meeting of Stockholders under the captions
"Executive Compensation" and "Election of Directors--Compensation of
Directors."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference from the
Company's definitive proxy statement for its 1999 Annual Meeting of
Stockholders under the caption "Voting Securities and Principal Holders
Thereof."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the
Company's definitive proxy statement for its 1999 Annual Meeting of
Stockholders under the caption "Certain Relationships and Related
Transactions."
45
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
(a)(1) Financial Statements and Report of Ernst & Young LLP,
Independent Auditors
Report of Independent Auditors.................................. F-2
Financial Statements:
Balance Sheets as of December 31, 1998 and 1997................. F-3
Statements of Operations for the period April 1, 1997
(Inception) to December 31, 1997 and the year ended December 31,
1998............................................................ F-4
Statements of Cash Flows for the period April 1, 1997
(Inception) to December 31, 1997 and the year ended December 31,
1998............................................................ F-5
Statements of Changes in Stockholders' Equity (Deficit) for the
period April 1, 1997 (Inception) to December 31, 1997 and the
year ended December 31, 1998.................................... F-6
Notes to Financial Statements................................... F-7
(a)(2) Schedule II--Valuation and Qualifying Accounts.................. F-14
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
period covered by this Report.
(c) Exhibits
The Exhibit Index appearing on page 48 of this Report is
incorporated into this Item 14(c) by reference.
</TABLE>
46
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
UBID, INC.
Dated: March 29, 1999 By: /s/ Gregory K. Jones
-------------------------------------
Gregory K. Jones
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Gregory K. Jones Chairman of the Board, March 29, 1999
____________________________________ President and Chief
Gregory K. Jones Executive Officer (Principal
Executive Officer)
/s/ Thomas E. Werner Vice President and Chief March 29, 1999
____________________________________ Financial Officer (Principal
Thomas E. Werner Financial and Accounting
Officer)
/s/ Frank F. Khulusi Director March 29, 1999
____________________________________
Frank F. Khulusi
/s/ Howard A. Tullman Director March 29, 1999
____________________________________
Howard A. Tullman
/s/ Norman H. Wesley Director March 29, 1999
____________________________________
Norman H. Wesley
/s/ Mark C. Layton Director March 29, 1999
____________________________________
Mark C. Layton
</TABLE>
47
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
3.1** Restated Certificate of Incorporation of the Company
3.2** Amended and Restated By-Laws of the Company
4.1** Form of the Company's Common Stock Certificate
4.2** Registration Rights Agreement by and between the Company and the
Parent, dated as of December 7, 1998
4.3** Registration Rights Agreement by and between the Company and Frank
Khulusi and Sam Khulusi, dated as of December 7, 1998
10.1** Separation and Distribution Agreement by and between the Company and
Parent dated as of December 7, 1998
10.2** Services Agreement by and between the Company and Parent, dated as of
December 7, 1998
10.3 Tax Indemnification and Allocation Agreement by and between the
Company and Parent, dated as of December 7, 1998, as amended
10.4** Joint Marketing Agreement by and between the Company and the Parent,
dated as of December 7, 1998
10.5** Internet/Telecommunications Agreement by and between the Company and
the Parent, dated as of December 7, 1998
10.6** Employment Agreement between the Company and Gregory K. Jones*
10.7** uBid, Inc. 1998 Stock Incentive Plan*
10.8** Sublease Agreement between the Company and the Parent, dated as of
July 1, 1998
10.9 [intentionally omitted]
10.10** Agreement Restricting Transfer of Assets and Letter Agreement dated as
of September 23, 1998 by and between Deutsche Financial Services
Corporation and the Parent and the Company
10.11** Letter Agreement dated November 30, 1998 by and between the Parent and
Paul Colton
10.12** Letter Agreement dated September 9, 1998 by and between the Parent and
David Matthews
10.13** Assignment and License Agreement by and between the Company and the
Parent, dated as of November 30, 1998
10.14 Form of Indemnification Agreement, entered into as of February 12,
1999, between the Company and each of its directors and executive
officers
23 Consent of Ernst & Young LLP
27 Financial Data Schedule (for Commission use only)
</TABLE>
- --------
* The referenced exhibit is a compensatory contract, plan or arrangement.
** Incorporated by reference to the exhibit with the same number to the
Company's Registration Statement on Form S-1 (No. 333-58477), on file with
the Securities and Exchange Commission.
48
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors........................................... F-2
Balance Sheets as of December 31, 1997 and December 31, 1998............. F-3
Statements of Operations for the Period April 1, 1997 (Inception) to
December 31, 1997 and the Year Ended December 31, 1998.................. F-4
Statements of Cash Flows for the Period April 1, 1997 (Inception) to
December 31, 1997 and the Year Ended December 31, 1998.................. F-5
Statements of Changes in Stockholders' Equity (Deficit) for the Period
April 1, 1997 (Inception) to December 31, 1997 and the Year Ended
December 31, 1998....................................................... F-6
Notes to Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
uBid, Inc.
Elk Grove Village, IL
We have audited the accompanying balance sheets of uBid, Inc. as of December
31, 1997 and 1998, and the related statements of operations, cash flows and
changes in stockholders' equity for the period from April 1, 1997 (Inception)
to December 31, 1997 and the year ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of uBid, Inc. at December 31,
1997 and 1998, and the results of its operations and its cash flows for the
period from April 1, 1997 (Inception) to December 31, 1997 and the year ended
December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Chicago, Illinois
January 22, 1999
F-2
<PAGE>
UBID, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1998
------ -------
<S> <C> <C>
ASSETS
Current assets:
Cash.......................................................... $ -- $26,053
Accounts receivable, net of allowances of $20 at December 31,
1998......................................................... 9 623
Merchandise inventories....................................... 2 7,235
Prepaid expenses and other.................................... 20 195
------ -------
Total current assets...................................... 31 34,106
Fixed assets, net............................................. 327 519
------ -------
Total assets.............................................. $ 358 $34,625
====== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................. $ -- $ 9,013
Accrued expenses and other current liabilities................ -- 2,371
Due to Parent................................................. -- 1,277
------ -------
Total current liabilities................................. -- 12,661
Note payable to the Parent.................................... 670 3,331
------ -------
Stockholders' equity (deficit):
Preferred Stock; $.001 par value; 5,000,000 shares authorized;
no shares issued or outstanding.............................. -- --
Common Stock; $.001 par value; 20,000,000 shares authorized;
7,329,833 shares issued and outstanding as of December 31,
1997 and 9,146,833 shares issued and outstanding as of
December 31, 1998............................................ 1 2
Additional paid-in-capital.................................... -- 37,138
Deferred compensation......................................... -- (8,025)
Accumulated deficit........................................... (313) (10,482)
------ -------
Total stockholders' equity (deficit)...................... (312) 18,633
------ -------
Total liabilities and stockholders' equity (deficit)...... $ 358 $34,625
====== =======
</TABLE>
See notes to the financial statements.
F-3
<PAGE>
UBID, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 1, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
-------------- ------------
<S> <C> <C>
Net revenues...................................... $ 9 $ 48,232
Cost of revenues.................................. 8 44,257
--------- ---------
Gross profit...................................... 1 3,975
Operating expenses:
Sales and marketing............................. 10 2,829
Technology and development...................... 66 1,022
General and administrative...................... 212 4,856
--------- ---------
Total operating expenses...................... 288 8,707
--------- ---------
Loss from operations before stock based
compensation..................................... (287) (4,732)
Stock based compensation.......................... -- 5,267
--------- ---------
Loss from operations.............................. (287) (9,999)
Interest income................................... -- (74)
Interest expense to Parent........................ 26 244
--------- ---------
Loss before income taxes.......................... (313) (10,169)
Provision for income taxes........................ -- --
--------- ---------
Net loss.......................................... $ (313) $ (10,169)
========= =========
Basic and diluted net loss per share.............. $ (0.04) $ (1.36)
========= =========
Shares used to compute basic and diluted net loss
per share........................................ 7,329,883 7,461,061
</TABLE>
See notes to the financial statements.
F-4
<PAGE>
UBID, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 1, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
-------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss......................................... $ (313) $(10,169)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.................... 4 155
Non cash compensation expense.................... -- 5,267
Changes in operating assets and liabilities:
Accounts receivable, net....................... (9) (614)
Prepaid expenses............................... (20) (175)
Merchandise inventories, net................... (2) (7,233)
Accounts payable............................... -- 9,013
Advances from Parent, short term............... -- 1,277
Accrued expenses and other current
liabilities................................... -- 2,371
------ --------
Net cash (used in) provided by operating
activities........................................ (340) (108)
Cash flows from investing activities:
Purchases of property and equipment.............. (331) (347)
------ --------
Net cash used in investing activities.............. (331) (347)
Cash flows from financing activities:
Issuance of common stock to the Parent........... 1 --
Advances from the Parent......................... 670 (670)
Note payable to the Parent....................... -- 3,331
Proceeds from initial public offering of common
stock........................................... -- 23,847
------ --------
Net cash provided by financing activities.......... 671 26,508
------ --------
Net change in cash and cash equivalents............ -- 26,053
Cash and cash equivalents at beginning of period... -- --
------ --------
Cash and cash equivalents at end of period......... $ -- $ 26,053
====== ========
</TABLE>
See notes to the financial statements.
F-5
<PAGE>
UBID, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------- PAID-IN DEFERRED ACCUMULATED
SHARES AMOUNT CAPITAL COMPENSATION DEFICIT TOTAL
------ ------ ---------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock
to the Parent.......... 7,330 $ 1 $ -- $ -- $ -- $ 1
Net loss for the
period................. -- -- -- -- (313) (313)
----- ----- ------- ------- -------- --------
Balance at December 31,
1997................... 7,330 $ 1 $ -- $ -- $ (313) $ (312)
Issuance of common stock
in IPO................. 1,817 1 23,846 -- -- 23,847
Stock based
compensation........... -- -- 13,292 (13,292) -- --
Amortization of stock
based compensation..... -- -- 5,267 -- 5,267
Net loss for the year... -- -- -- -- (10,169) (10,169)
----- ----- ------- ------- -------- --------
Balance at December 31,
1998................... 9,147 $ 2 $37,138 $(8,025) $(10,482) $ 18,633
===== ===== ======= ======= ======== ========
</TABLE>
See notes to the financial statements.
F-6
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE DATA)
1. DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF COMPANY
uBid is engaged in the retail sale of excess merchandise, including close-
out and refurbished products, utilizing an interactive online auction. The
Company currently specializes in selling primarily brand name computer,
consumer electronics and home and leisure products over the World Wide Web to
consumers and small and medium-sized businesses.
The Company, a majority-owned, indirect subsidiary of Creative Computers,
Inc. ("Parent"), a publicly-traded corporation, was incorporated on September
19, 1997. Beginning on April 1, 1997 ("Inception"), prior to the formation of
the Company, the Parent began funding certain startup and development costs
related to the Company's business. For the period from Inception to September
19, 1997, incorporation of the Company, such costs aggregated approximately
$127 of which approximately $49 were capitalized. The net loss for the period
Inception to September 19, 1997 was approximately $78. On September 19, 1997,
assets and liabilities related to the Company were recorded by the Company at
the Parent's basis. The financial statements have been prepared as if the
Company operated as a stand-alone entity since Inception.
REVENUE RECOGNITION
The Company sells merchandise from vendors under one of two types of sales
transactions. The Company either purchases merchandise and sells it to
customers or sells merchandise to customers under consignment-type revenue
sharing agreements with vendors. For the year ended December 31, 1998, the
Company's sales of purchased inventory comprised approximately 96% of
revenues, with consignment-type revenue sharing representing approximately 4%
of revenues.
CASH EQUIVALENTS
All highly liquid debt instruments purchased with a maturity of three months
or less are considered cash equivalents.
SALES-PURCHASED INVENTORY
For sales of merchandise owned and warehoused by the Company, the Company is
responsible for conducting the auction, billing the customer, shipping the
merchandise to the customer, processing merchandise returns and collecting
accounts receivable. The Company recognizes the gross sales amount as revenue
upon verification of the credit card transaction authorization and shipment of
the merchandise. In instances where the credit card authorization has been
received but the merchandise has not yet been shipped, the Company defers
revenue recognition until the merchandise is shipped. The Company had no
deferred revenue at December 31, 1997 or December 31, 1998.
SALES-REVENUE SHARING AGREEMENTS
For sales of merchandise under revenue sharing agreements, the Company
either takes physical possession of the merchandise or the vendor retains
physical possession of the merchandise. In either case, the Company is not
obligated to take title to the merchandise nor does it take title unless it
successfully sells the merchandise at auction. Upon completion of an auction,
the Company purchases the inventory, takes title to the merchandise, charges
the customer's credit card and either ships the merchandise directly or
arranges for a third party to complete delivery to the customer. The Company
records the gross sales amount as revenue upon verification of the credit card
authorization and shipment of the merchandise. In instances where credit card
authorization has been received but the merchandise has not been shipped, the
Company defers revenue recognition until the merchandise is shipped. The
Company had no deferred revenue at December 31, 1997 or December 31, 1998.
F-7
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
MERCHANDISE RETURN POLICY
The Company's return policy is that merchandise sold by the Company is sold
on an "as is" basis and is not returnable. However, the Company, although not
obligated to do so, may accept merchandise returns if a product is defective
or does not conform to the specifications of the item sold at auction, and
attempts to work with its customers to resolve complaints about merchandise.
The Company provides for allowances for estimated future returns at the time
of shipment based on historical experience.
MERCHANDISE INVENTORY
The Company accounts for merchandise inventory under the first-in first-out
method. Inventory is carried at lower of cost or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method based on the estimated useful lives of the assets
which range from three to five years.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived assets and certain intangible assets for
impairment when events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable. In the event the sum of the
expected undiscounted future cash flows resulting from the use of the asset is
less than the carrying amount of the asset, an impairment loss equal to the
excess of the asset's carrying value over its fair value is recorded. The
Company has recognized no such losses.
SOFTWARE DEVELOPMENT COSTS
In accordance with SOP 98-1, internal and external costs incurred to develop
internal-use computer software are expensed during the preliminary project
stage and capitalized during the application development stage and amortized
over three years. During the period ended December 31, 1997 and the year ended
December 31, 1998, $39 and $0 was expensed, respectively. As of December 31,
1997 and December 31, 1998, capitalized software net of accumulated
amortization was $264 and $176, respectively.
ADVERTISING COSTS
Advertising costs are charged to expense as incurred. Advertising expense
was $0 and $2,669 for the periods ended December 31, 1997 and December 31,
1998, respectively.
INCOME TAXES
Deferred income taxes are recognized by applying enacted statutory tax rates
applicable to future years to differences between the tax bases and financial
reporting amounts of existing assets and liabilities. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized.
The operations of the Company are included in the consolidated tax return of
the Parent. The tax provision presented in these financial statements was
determined as if the Company filed a separate return.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock options as prescribed by APB Opinion No. 25
and includes pro forma information in the Stock options footnote, as permitted
by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation.
F-8
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
NET LOSS PER SHARE
Basic net loss per share excludes dilution and is computed by dividing net
loss by the weighted average number of common shares outstanding during the
reported periods. Diluted net loss per share reflects the potential dilution
that could occur if stock options and other commitments to issue common stock
were exercised. During the periods ended December 31, 1997 and December 31,
1998, options to purchase 458,118 and 1,107,278 common shares were anti-
dilutive and have been excluded from the weighted average share computation.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of accounts receivable from individuals
and merchants located in the United States. Sales are generally made through
credit cards and are pre-approved. The Company maintains an allowance for
doubtful accounts receivable based upon the expected collectibility of
accounts receivable and potential credit losses. Such losses have been
immaterial.
CONCENTRATION OF VENDORS
The Company is dependent upon vendors to supply it with merchandise for sale
through the Company's Internet auctions. For the period from Inception to
December 31, 1997 one vendor, the Parent, accounted for approximately 100% of
net revenues from related product sales. For the twelve-month period ended
December 31, 1998, the Parent accounted for approximately 6% of net revenues
from related product sales.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
respective reporting periods. Actual results could differ from those
estimates.
STOCK SPLITS
On June 25, 1998, the Company effected a 100,000-for-1 split of its common
stock. On November 30, 1998, the Company effected a .7329883-for-1 reverse
split of its common stock. All common shares and per share data have been
retroactively adjusted to reflect these stock splits.
2. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
<S> <C> <C>
Computer, machinery and equipment................. $ 64 $ 372
Computer software................................. 267 306
----- -----
331 678
Less accumulated depreciation and amortization.... (4) (159)
----- -----
$ 327 $ 519
===== =====
</TABLE>
F-9
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
3. RELATED PARTY TRANSACTIONS
Since Inception, the Parent has provided advances to the Company for working
capital and fixed asset purchases of $670 and $3,331 through December 31, 1997
and December 31, 1998, respectively. Upon consummation of the Offering the
$3,331 was converted to a note payable to the Parent. The outstanding balance
on the note bears interest at the prime rate and will be repaid in June 2000.
Interest expense on intercompany advances and notes payable was $26 and $244
for the period ended December 31, 1997 and the year ended December 31, 1998,
respectively. In addition, from the date of the IPO until December 31, 1998,
the Parent advanced the Company an additional $1,277 in short-term non-
interest bearing advances. The advances relate to cash disbursements made by
the Parent on behalf of the Company during the transition period while the
Company establishes its own cash management programs. These advances are
settled on at least a monthly basis. During the transition period, the Company
will continue to participate in the Parent's cash management process. In
connection therewith, cash receipts related to the Company's business are
applied directly to reduce the Advances from the Parent.
In addition, the Parent provides various services such as administration
(accounting, human resources, legal), warehousing and distribution,
Internet/telecom and joint marketing to the Company. In consideration for
those services, the Parent has historically allocated a portion of its
overhead costs related to such services to the Company. The charges for these
services were:
<TABLE>
<CAPTION>
PERIOD FROM
APRIL 1, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1998
-------------- ------------
<S> <C> <C>
Administrative.................................. $ 36 $ 481
Warehousing and distribution.................... -- 550
Internet/telecom and joint marketing............ 172 773
---- ------
$208 $1,804
==== ======
</TABLE>
Administration costs for services provided by the Parent to the Company were
determined by identifying all of the Parent's personnel who supported the
Company. Their pay, based on the number of hours of service provided,
benefits, plus an allocation of overhead, was used to calculate these costs.
Credit card processing for transactions above a certain dollar amount was
based on $1.50 per order. Prior to June 30, 1998, warehousing and distribution
was charged at $4.00 per order and was based on the Parent's fully burdened
cost per order for warehousing and distribution. Effective July 1, 1998 the
Company began subleasing 50,000 square feet of warehouse space from the Parent
at the Parents marginal cost. In October 1998, the sublease was increased to
100,000 square feet on the same terms. The Company is also charged a pro-rata
share, based on square footage, of the warehouse utilities, property taxes,
and other warehouse costs. Direct labor to operate the warehouse was charged
directly to the Company. Internet/telecom service costs includes an allocation
of monthly depreciation for all hardware and software based on usage by the
Company, as well as monthly rates for telecommunication expenses consumed by
the Company. Management asserts that the methods to identify and allocate
costs to the Company for these services provided by the Parent are reasonable.
The Company and the Parent entered into on or prior to the consummation of
the IPO, certain agreements governing various interim and ongoing
relationships, including subleasing a portion of the Parent's warehouse,
between the Company and the Parent after the completion of the anticipated IPO
and subsequent Distribution. The terms of such agreements generally provide
for services to be rendered by the Parent similar to those described above.
The costs of general accounting services, payroll and benefits administration,
and internet/telecommunications are charged based on the Parent's cost plus
10%. Credit services are charged at
F-10
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
$1.50 per transaction. For warehousing and distribution, effective July 1,
1998, the Company is subleasing a portion of the Parent's distribution
facility pursuant to a sublease agreement and is being charged a pro rata
portion of the Parent's occupancy costs for this facility. Pursuant to the
Sublease Agreement, future minimum lease payments to the Parent are $275
annually in 1999 through 2002 and $206 in 2003. The rates or amounts to be
paid by the Company under these agreements are not expected to be materially
different than the rates or amounts currently being charged to the Parent. The
agreement pursuant to which the Parent provides the Company with certain
administrative and transactional services will be terminated upon completion
of the Separation and the Distribution.
One of the Company's directors also serves as an officer and a director of
the Parent.
4. INCOME TAXES
No tax benefit has been provided for the periods ended December 31, 1997 and
December 31, 1998 pretax losses due to the uncertainty of realization of these
benefits in future years.
The provision for income taxes differed from the amount computed by applying
the U.S. federal statutory rate to income (loss) before income taxes due to
the effects of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1998
------ ------
<S> <C> <C>
Expected taxes at federal statutory tax rate............... 34% 34 %
Nonrecognition of tax benefits............................. (34) (34)
------ ------
-- % -- %
====== ======
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<CAPTION>
DECEMBER 31,
---------------
1997 1998
------ ------
<S> <C> <C>
Deferred tax assets:
Start-up and development costs............................. $ 105 $ 84
Net operating loss....................................... 10 1,990
Stock based compensation................................. -- 2,107
Other.................................................... 10 12
------ ------
125 4,193
------ ------
Valuation allowance...................................... (125) (4,193)
====== ======
$ -- $ --
====== ======
</TABLE>
The cumulative amount of the deferred tax attributes for the Company at
December 31, 1997 and 1998 is $125 and $4,193, respectively. Of this amount
$10 and $1,990 relates to the total cumulative net operating losses incurred
by the Company through December 31, 1997 and 1998, respectively.
5. EMPLOYEE BENEFITS
401(K) SAVINGS PLAN
The Parent has a 401(k) Savings Plan which covers substantially all Company
full-time employees. Participants may make tax-deferred contributions of up to
15% of annual compensation (subject to other
F-11
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
limitations specified by the Internal Revenue Code). Administrative and
matching costs, which are charged to the Company by the Parent, were not
significant for the period from Inception to December 31, 1997 and for the
twelve-month period ended December 31, 1998.
EMPLOYEE STOCK OPTION PLANS
The Company has granted non-qualified options to certain employees and
directors of the Company to purchase common stock. Each option agreement
provides that options may not be exercised prior to the earlier of (i) the day
following the distribution of all Company stock held by the Parent to its
shareholders or (ii) 18 months from the closing date of the Company's IPO.
Accordingly, no options were exercisable at December 31, 1998.
The terms of the options provide for vesting, generally over a 5-year
period, except for options to purchase 183,247 shares of common stock at
December 31, 1998 which vested as to the first 20% of the shares covered by
such options upon completion of the Company's IPO. The options expire 10 years
from the date of grant.
The following table summarizes stock option activity:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER EXERCISE PRICE
--------- --------------
<S> <C> <C>
Granted............................................ 458,118 $0.27
Canceled........................................... --
Exercised.......................................... --
---------
Outstanding at December 31, 1997................. 458,118 $0.27
Granted............................................ 651,725 $4.62
Canceled........................................... (2,565) $0.27
Exercised.......................................... --
---------
Outstanding at December 31, 1998................. 1,107,278 $2.79
---------
</TABLE>
The options outstanding at December 31, 1997 all have an exercise price of
$0.27. Of the options granted during the year ended December 31, 1998, options
to purchase 370,526, 18,325, 109,948, 1,832, 79,529 and 69,000 common shares
are outstanding and have exercise prices of $0.27, $6.82, $8.87, $10.20,
$11.79 and $15.00, respectively. Options at December 31, 1998 have a weighted
average estimated remaining life of 5.95 years.
The Company commenced its IPO on December 4, 1998 causing a measurement date
to occur and requiring the Company to compute compensation expense based upon
the difference between the exercise price of the options and the IPO price.
Based upon the difference between the IPO price of $15.00 per share and the
exercise prices of the 1,038,278 options outstanding at December 4, 1998, the
total compensation charge will be approximately $13.3 million, which will be
recognized over the vesting period, approximately $5.3 million of which was
recognized in December 1998.
F-12
<PAGE>
UBID, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
The fair value of each stock option grant has been estimated pursuant to SFAS
No. 123 on the date of grant using the minimum value method for those options
granted prior to the IPO, and the Black-Scholes option pricing method for those
options issued concurrent with the IPO, with the following weighted average
assumptions:
<TABLE>
Minimum Value Black-Scholes
Assumptions Assumptions
-------------- -------------
<S> <C> <C>
Risk free interest rate.............. 6.3% 4.89%
Expected dividend yield.............. none none
Expected lives....................... 6 years 6 years
Expected volatility.................. 100% 142%
</TABLE>
The weighted average grant date fair values of options granted during the
twelve months ended December 31, 1998 and the period from Inception to
December 31, 1997 were $4.03 and $0.08, respectively.
Had the Company accounted for stock options under SFAS No. 123, reported net
loss for the year ended December 31, 1998 would have been $5,172 and net loss
per share would have been $0.69. The effect of applying SFAS No. 123 on net
income and earnings per share is not likely to be representative of the effect
on reported net income and earnings per share for future years.
1998 STOCK INCENTIVE PLAN
In August 1998, the Company's Board of Directors adopted the 1998 Stock
Incentive Plan (the "1998 Plan") and reserved 1,832,470 shares of common stock
for issuance thereunder. The plan authorized the award of options, stock
appreciation rights, restricted stock awards and performance based stock
awards (each an "Award"). The maximum number of shares with respect to options
and stock appreciation rights granted to any employee in any fiscal year is
476,442 shares. Options granted under the Plan may be either incentive stock
options ("ISOs") or non-qualified stock options ("NSOs"). ISOs may be granted
only to employee (including officers and directors who are also employees).
Awards other than ISOs may be granted to employees, directors and consultants,
as defined.
Options under the Plan may be granted for periods up to ten years and at
prices no less than 85% of the fair value of the shares on the date of grant
provided, however, that the exercise price of an ISO may not be less than 100%
of the fair market value of the shares on the date of grant and the exercise
price of an ISO granted to a 10% shareholder may not be less than 110% of the
fair market value of the shares on the date of grant.
There have been no options granted under the 1998 Plan through December 31,
1998.
6. INITIAL PUBLIC OFFERING OF COMMON STOCK
In December 1998, the Company completed its Initial Public Offering of
1,817,000 shares common stock ("IPO"). Based on the offering price of $15.00
per share, the gross proceeds from the offering were $27,255. After
commissions paid to the underwriters, and other offering costs, the net
proceeds were $23,846. Following the completion of the IPO, the Parent owns
approximately 80% of the Company's outstanding common stock and as a result,
continues to control the Company. The Parent also announced that, subsequent
to the completion of the IPO, it intends to distribute to the Parent's
shareholders in 1999, subject to certain conditions and consents, all of the
Parent's remaining equity interest in the Company.
7. SEGMENT INFORMATION
In 1998, the Company adopted Statement of Financial Accounting Standards No.
131 "Disclosure about Segments of an Enterprise and Related Information" (SFAS
No. 131). This statement requires companies to
F-13
<PAGE>
uBid, Inc.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except share data)
report financial and descriptive information about its reportable operating
segments, including segment profit or loss, certain specific revenue and
expense items, and segment assets, as well as information about the revenues
derived from the Company's products or services, the countries in which the
Company earns revenues and holds assets, and major customers. This statement
also requires companies that have a single reportable segment to disclose
information about products and services, information about geographic areas,
and information about major customers. The statement requires the use of the
management approach to determine the information to be reported. The
management approach is based on the way management organizes the enterprise to
assess performance and make operating decisions regarding the allocation of
resources. It is management's opinion that the Company has several operating
segments, however only one reportable segment. The following discussion sets
forth the required single segment information.
The Company operates as a single reportable segment as an online auction for
computer, consumer electronics and housewares, and sports and recreation
products in the United States. The Company's revenues are divided into two
categories; sales of merchandise that has been purchased by the Company
(approximately 96% of revenues) and sales of merchandise under consignment-
type revenue sharing agreements with vendors (approximately 4% of revenues).
The Company sources its products from over 150 vendors and offers, on average,
over 1,000 items in each of its auctions. Product offerings are divided into
the following four categories, with their corresponding percentage of net
revenues for the year ended December 31, 1998:
<TABLE>
<S> <C>
Computer Products - including desktops, portable computers, computer 83%
accessories, disk drives, modems, monitors/video equipment, components,
printers, scanners, digital cameras, software and home office products.
Consumer Electronics - including home theater equipment, home audio 11%
equipment, speakers, televisions, camcorders, VCR's, DVD players, portable
audio players and automobile audio equipment.
Housewares - including kitchen appliances, vacuum cleaners, personal care 6%
devices, furniture, gifts, photography, jewelry and sunglasses.
Sports and Recreation - including sports memorabilia, golf and tennis, 0%
health and fitness, outdoor sports, bicycles, water sports, and team
sports equipment.
All of the Company's revenues in 1997 were in the computer products
category.
</TABLE>
F-14
<PAGE>
SCHEDULE II
UBID, INC.
VALUATION AND QUALIFYING ACCOUNTS
PERIOD APRIL 1, 1997 (INCEPTION) TO DECEMBER 31, 1997
AND THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCES AT ADDITIONS BALANCE
BEGINNING CHARGED AT END
OF PERIOD TO OTHER (1) DEDUCTIONS OF PERIOD
----------- ------------ ---------- ---------
<S> <C> <C> <C> <C>
Year Ended December 31, 1998:
Allowances for doubtful
accounts--trade receivables.... $ 0 $20 $ 0 $20
=== === === ===
Period April 1, 1997 (Inception)
to December 31, 1997:
Allowances for doubtful
accounts--trade receivables.... $ 0 $ 0 $ 0 $ 0
=== === === ===
</TABLE>
- --------
(1) The amount represents the allowance for doubtful accounts balance on the
balance sheet for uBid at the end of the 1998 fiscal year.
F-15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 32,495
<SECURITIES> 0
<RECEIVABLES> 43,472
<ALLOWANCES> 3,697
<INVENTORY> 47,971
<CURRENT-ASSETS> 129,638
<PP&E> 14,910
<DEPRECIATION> 0
<TOTAL-ASSETS> 158,266
<CURRENT-LIABILITIES> 86,833
<BONDS> 0
0
0
<COMMON> 10
<OTHER-SE> 82,361
<TOTAL-LIABILITY-AND-EQUITY> 158,266
<SALES> 690,238
<TOTAL-REVENUES> 690,238
<CGS> 616,245
<TOTAL-COSTS> 616,245
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 461
<INCOME-PRETAX> (24,027)
<INCOME-TAX> (5,034)
<INCOME-CONTINUING> (17,795)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17,795)
<EPS-PRIMARY> (1.75)
<EPS-DILUTED> (1.75)
</TABLE>
