- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 000-25577
----------------
AUTOWEB.COM, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0412737
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3270 Jay Street, Building 6
Santa Clara, California 95054
(Address of principal executive offices, including zip code)
(408) 554-9552
(Registrant's telephone number, including area code)
----------------
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 month (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 [_]
As of July 31, 1999, there were 25,050,156 shares of the Registrant's common
stock outstanding.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AUTOWEB.COM, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1: Condensed Financial Statements:
Condensed Balance Sheets as of June 30, 1999 and December 31,
1998.......................................................... 2
Condensed Statements of Operations for the three months and six
months ended June 30, 1999 and 1998........................... 3
Condensed Statements of Cash Flows for the six months ended
June 30, 1999 and 1998........................................ 4
Notes to Condensed Financial Statements........................ 5
ITEM 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................... 7
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk..... 22
PART II. OTHER INFORMATION
ITEM 1: Legal Proceedings.............................................. 23
ITEM 2: Changes in Securities and Use of Proceeds...................... 23
ITEM 3: Defaults upon Senior Securities................................ 23
ITEM 4: Submission of Matters to a Vote of Security Holders............ 23
ITEM 5: Other Information.............................................. 23
ITEM 6: Exhibits and Reports on Form 8-K............................... 23
Signatures.............................................................. 24
PART I: FINANCIAL INFORMATION
ITEM 1: CONDENSED FINANCIAL STATEMENTS
AUTOWEB.COM, INC.
CONDENSED BALANCE SHEETS
(in thousands)
June 30, December 31,
1999 1998
----------- ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents....................... $ 25,201 $ 2,714
Short-term investments.......................... 46,231 --
Accounts receivable, net........................ 3,166 2,147
Prepaid expenses and other current assets....... 1,837 1,162
-------- --------
Total current assets.......................... 76,435 6,023
Property and equipment, net....................... 1,380 1,162
-------- --------
Total assets.................................. $ 77,815 $ 7,185
======== ========
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE
PREFERRED STOCK, AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Account payable and other accrued expenses...... $ 5,274 $ 2,557
Accrued payroll and related expenses............ 1,646 624
Deferred revenue................................ 1,105 1,739
Current portion of notes and capital lease
obligations payable............................ 298 303
-------- --------
Total current liabilities..................... 8,323 5,223
Notes payable and capital lease obligations, net
of current portion............................... 546 654
-------- --------
Total liabilities............................. 8,869 5,877
-------- --------
Mandatorily redeemable convertible preferred
stock............................................ -- 12,969
-------- --------
Stockholders' equity (deficit):
Common stock.................................... 18 2
Additional paid-in capital...................... 99,601 11,371
Unearned stock-based compensation............... (7,651) (5,406)
Accumulated deficit............................. (23,022) (17,628)
-------- --------
Total stockholders' equity.................... 68,946 (11,661)
-------- --------
Total liabilities, mandatorily redeemable
convertible preferred stock, and stockholders'
equity (deficit)................................. $ 77,815 $ 7,185
======== ========
The accompanying notes are an integral part of these financial statements.
AUTOWEB.COM, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
1999 1998 1999 1998
--------- --------- -------- --------
(unaudited)
Net revenues......................... $ 7,021 $ 2,811 $ 12,765 $ 4,967
Cost of net revenues................. 652 156 1,300 267
--------- --------- -------- --------
Gross profit....................... 6,369 2,655 11,465 4,700
--------- --------- -------- --------
Operating expenses:
Sales and marketing................ 7,329 3,686 12,380 6,340
Product development................ 624 136 1,179 266
General and administrative......... 1,623 958 2,928 1,913
Stock-based compensation........... 538 11 1,202 15
--------- --------- -------- --------
Total operating expenses......... 10,114 4,791 17,689 8,534
--------- --------- -------- --------
Loss from operations................. (3,745) (2,136) (6,224) (3,834)
Interest and other income (expense),
net................................. 791 2 830 --
--------- --------- -------- --------
Net loss............................. (2,954) (2,134) (5,394) (3,834)
Accretion of mandatorily redeemable
convertible preferred stock to
redemption value.................... -- (206) -- (340)
--------- --------- -------- --------
Net loss attributable to common
stockholders........................ $ (2,954) $ (2,340) $ (5,394) $ (4,174)
========= ========= ======== ========
Net loss per share:
Basic and diluted.................. $ (0.12) $ (0.30) $ (0.31) $ (0.53)
========= ========= ======== ========
Weighted average shares--basic and
diluted........................... 24,810 7,845 17,345 7,834
========= ========= ======== ========
The accompanying notes are an integral part of these financial statements.
AUTOWEB.COM, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
Six Months
Ended
June 30,
----------------
1999 1998
------- -------
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................... $(5,394) $(3,834)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................ 446 215
Write-down of intangible assets.......................... -- 13
Provision for doubtful accounts.......................... 144 183
Stock-based compensation expense for employee options
granted................................................. 1,210 15
Issuance of common stock options/warrants in exchange for
services................................................ 181 79
Change in assets and liabilities:
Accounts receivable.................................... (1,163) (1,274)
Prepaid expenses and other current assets.............. (675) (681)
Accounts payable and other accrued expenses............ 2,717 823
Accrued payroll and related expenses................... 1,022 205
Deferred revenue....................................... (634) 37
------- -------
Net cash used in operating activities................ (2,146) (4,219)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments........................ (46,231) --
Redemption of Series A preferred stock..................... -- (1,000)
Acquisition of property and equipment...................... (664) (506)
------- -------
Net cash used in investing activities................ (46,895) (1,506)
------- -------
CASH FLOW FROM FINANCING ACTIVITIES:
Principal payments under notes payable and capital lease
obligations .............................................. (245) (445)
Proceeds from borrowing under debt facilities.............. 132 934
Proceeds from issuance of Series C preferred stock, net of
costs..................................................... -- 4,965
Proceeds from issuance of common stock, net of costs....... 71,641 10
------- -------
Net cash provided by financing activities............ 71,528 5,464
------- -------
Net increase (decrease) in cash and cash equivalents......... 22,487 (261)
Cash and cash equivalents, at the beginning of year.......... 2,714 1,819
------- -------
Cash and cash equivalents, at end of period.................. $25,201 $ 1,558
======= =======
Supplemental disclosure of noncash investing and financing
activities:
Unearned stock-based compensation related to employee stock
option grants............................................. $ 3,456 $ 192
Accretion of mandatorily redeemable convertible preferred
stock..................................................... $ -- $ 340
Revenue and advertising expense from barter transactions... $ 572 $ 233
Acquisition of intangibles in exchange for common stock.... $ -- $ 13
Issuance of common stock in exchange for note receivable... $ 786 $ --
The accompanying notes are an integral part of these financial statements.
AUTOWEB.COM, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
Note 1--The Company
Autoweb.com, Inc. (the "Company") was incorporated in California on October
3, 1995 as Downtown Web, Inc. and reincorporated in Delaware on March 16, 1999.
The Company provides a consumer automotive Internet service, whereby its Web
site enables consumers to select new or pre-owned vehicles from member dealers.
In addition, the Company offers services that enable consumers to purchase
automotive-related products and services such as insurance and financing. The
Company markets and sells its services primarily in North America and operates
in one business segment.
Note 2--Summary of Significant Accounting Policies
Basis of Preparation
The accompanying condensed financial statements as of June 30, 1999, and for
the three and six months ended June 30, 1999 and 1998, are unaudited. The
unaudited interim condensed financial statements have been prepared on the same
basis as the annual financial statements and, in the opinion of management,
reflect all adjustments, which include only normal recurring adjustments,
necessary to present fairly the Company's financial position, results of
operations and cash flows as of June 30, 1999 and for the three and six months
ended June 30, 1999 and 1998. These condensed financial statements and notes
thereto are unaudited and should be read in conjunction with the Company's
financial statements included in the Company's Prospectus, as amended, filed
with the Securities and Exchange Commission on March 22, 1999. The results for
the three and six months ended June 30, 1999 are not necessarily indicative of
the expected results for the year ending December 31, 1999.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash, cash equivalents, short-term
investments and accounts receivable. Cash, cash equivalents, and short-term
investments are deposited with six high credit quality financial institutions
in the United States. The Company maintains allowances for potential credit
losses, and such losses have been within management's expectation.
Fair Value of Financial Instruments
Carrying amounts of certain of the Company's financial instruments,
including cash and cash equivalents, short-term investments, accounts
receivable, accounts payable and other accrued liabilities, approximate fair
value due to their short maturities.
Marketable Securities
The Company considers all highly liquid investments purchased with original
maturities of ninety days or less to be cash equivalents. Cash equivalents
consist primarily of deposits in money market funds.
At June 30, 1999, the Company's short-term investments are made up entirely
of investments in commercial paper, are classified as "available for sale", and
are reported at fair market value, which approximates cost. Realized gains and
losses are based on the book value of the specific securities sold and were
immaterial for the three and six months ended June 30, 1999.
Stock-Based Compensation
In 1997, the Company adopted the disclosure provisions of Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-based
4
AUTOWEB.COM, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
Compensation." The Company has elected to continue accounting for stock-based
compensation issued to employees using Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25,
compensation expense is based on the difference, if any, on the date of the
grant between the fair value of the Company's stock and the exercise price.
Stock issued to non-employees has been accounted for in accordance with SFAS
No. 123 and valued using the Black-Scholes model.
Net Loss Per Share
The Company computes net loss per share in accordance with SFAS No. 128,
"Earning per Share". Under the provisions of SFAS No. 128, basic net loss per
share is computed by dividing the net loss available to common stockholders for
the period by the weighted average number of common shares outstanding during
the period. Diluted net loss per share is computed by dividing the net loss for
the period by the weighted average number of common and common equivalent
shares outstanding during the period. Common equivalent shares, composed of
unvested restricted common stock and incremental common shares issuable upon
the exercise of stock options and warrants and upon conversion of Series A,
Series B and Series C mandatorily redeemable convertible preferred stock, are
included in the diluted net loss per share computation to the extent such
shares are dilutive.
Three Months Ended, Six Months
June 30, Ended June 30,
-------------------- ----------------
1999 1998 1999 1998
--------- --------- ------- -------
(In thousands, except per share
amounts)
Numerator:
Net loss.......................... $ (2,954) $ (2,134) $(5,394) $(3,834)
Accretion of mandatorily
redeemable convertible preferred
stock to redemption value........ -- (206) -- (340)
--------- --------- ------- -------
Net loss attributable to common
stockholders..................... $ (2,954) $ (2,340) $(5,394) $(4,174)
========= ========= ======= =======
Denominator:
Weighted average shares--basic and
diluted.......................... 24,810 7,845 17,345 7,834
--------- --------- ------- -------
Net loss per share--basic and
diluted.......................... $ (0.12) $ (0.30) $ (0.31) $ (0.53)
========= ========= ======= =======
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
quarters of all years beginning after June 15, 1999. SFAS No. 133 requires that
all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether a
derivative is designed as part of a hedge transaction and, if it is, the type
of hedge transaction. The Company does not expect that the adoption of SFAS No.
133 will have a material impact on its condensed financial statements. In June
1999, the FASB issued SFAS No. 137, which delayed the effective date of SFAS
No. 133 to fiscal years beginning after June 15, 2000.
Note 3--Common Stock
Initial Public Offering, Conversion of Preferred Stock
In March 1999, the Company completed its initial public offering and issued
5,550,000 shares of its Common Stock at a price of $14.00 per share. The
Company received approximately $71.1 million in cash, net of underwriting
discounts and commissions and other offering costs. Simultaneously with the
closing of the initial public offering, the shares of mandatorily redeemable
convertible preferred stock outstanding at that time were automatically
converted into approximately 10.9 million shares of common stock.
5
AUTOWEB.COM, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
Unearned Stock-Based Compensation
In connection with certain employee stock option grants during the three and
six months ended June 30, 1999 and 1998, the Company recognized unearned
compensation and related amortization expense as displayed in the table below.
Amortization expense is being recognized over the vesting periods of the
related options.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
1999 1998 1999 1998
--------- --------- --------- --------
Unearned compensation................. $ -- $ 118 $ 3,456 $ 192
Amortization expense.................. $ 546 $ 11 $ 1,210 $ 15
Note 4--Related Party Transactions
At June 30, 1999, the Company had full recourse promissory notes receivable
totaling $982,000 from stockholders who are also related parties. The loan
receivable from the President totaling $922,000 was made in connection with the
exercise of certain stock options. The loan is interest-free, is collateralized
by approximately 595,000 shares of common stock, and is due on the earlier of
the sale of sufficient shares to repay the loan or January 22, 2002.
Note 5--Commitments
During the second quarter of 1999, the Company entered into new agreements
with global Internet media companies to maintain certain exclusive promotional
rights and linkage with the media companies and to provide for certain
advertising. As of June 30, 1999, the agreements required remaining minimum
future payments of approximately $40 million over the next two years.
Note 6--Subsequent Event
On July 9, 1999, the Company entered into an agreement to acquire certain
software products and certain other intangible and tangible assets from
SalesEnhancer.com, Inc. for approximately $3.7 million in cash.
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This document contains forward-looking statements, the accuracy of which
involves risk and uncertainties. We use words such as "anticipates,"
"believes," "plans," "expects," "future" and "intends" and similar expressions
to identify forward-looking statements. You should not place undue reliance on
these forward-looking statements, which apply only as of the date of this
document. Our actual results could differ materially from those anticipated in
our forward-looking statements for many reasons, including the risks described
in "Risk Factors" included in our Registration Statement No. 333-71177, as
amended, filed with the Securities and Exchange Commission and elsewhere in
this document.
Overview
Autoweb.com is a leading consumer automotive Internet service. Our Web site
centralizes an extensive collection of automotive-related commerce, content and
community offerings to assist consumers in researching, evaluating and buying
new and pre-owned vehicles. In addition, our Web site enables consumers to
conveniently purchase automotive-related products and services such as
insurance and financing. We began selling our services to automobile dealers
and launched the Autoweb.com Web site for consumer use in October 1995. Since
that time, we have increased our network to approximately 5,000 member dealers
(where each franchise location for a particular vehicle manufacturer is defined
as a member dealer), including approximately 1,600 pre-owned vehicle locations.
We originally charged our member dealers based on a subscription model,
where each member dealer paid a flat monthly fee in exchange for our directing
consumer purchase inquiries to them. Because the number of purchase inquiries
directed to member dealers varied widely, due to factors such as their location
and franchise type, the cost per purchase inquiry under this model differed
substantially from member dealer to member dealer. In February 1998, we changed
our pricing model and began selling our services to new dealers using a "pay
for performance" model. Under this arrangement, a member dealer pays us a fee
only for a qualified purchase inquiry that it actually receives. We believe our
"pay for performance" model enables our member dealers to maximize their return
from, and enhances their satisfaction with, our services. In February 1998, we
also began converting our existing member dealer subscription contracts to
contracts utilizing the pay for performance model. As of June 30, 1999,
approximately 2% of our member dealer contracts utilized the subscription
model. We expect that there will be almost no subscription paying member deals
by the end of 1999.
We derive the majority of our revenues from fees charged to our member
dealers in exchange for qualified purchase inquiries and expect to continue to
do so for the foreseeable future. The revenue related to each fee is recognized
at the time the qualified purchase inquiry is provided to the member dealer. We
maintain a returns reserve against purchase inquiries that are later deemed not
to have been "qualified." In December 1996, we began providing online
advertising space on the Autoweb.com site and recognizing revenues from fees
paid by these advertisers. Revenues from advertising contracts, which typically
have terms of less than three months, are recognized as the contracts are
fulfilled. We expect that this component of our revenues will continue to
increase in absolute dollar terms. In February 1997, we began offering
automotive-related services on the Autoweb.com Web site through agreements with
third-party vendors. We derive revenues from certain of these agreements where
a third party pays us for the right to provide its consumer services, such as
automobile financing and insurance, on our Web site. Revenues from these
agreements are generally recognized ratably over the terms of the agreements.
We expect that this component of our revenues will continue to increase both in
absolute dollar terms and as a percentage of net revenues.
Our recent growth has placed and is expected to continue to place a
significant strain on our managerial, operational and financial resources. To
manage our potential growth, we must continue to implement and improve our
operational and financial systems, and must expand, train and manage our
employee base. Our Chief Technology Officer and our Vice President, Product
Management have been with us only since February 1999. Our Senior Vice
President, Sales and Member Services has been with us only since January 1999.
Our
7
Chief Executive Officer and our Vice President, Business Development and
Advertising Sales joined us during December 1998. In addition, our Vice
President, Dealer Operations has been with us since January 1998 and our Chief
Financial Officer has been with us for less than two years. Our Vice President,
Marketing resigned July 30, 1999, and was replaced by our Chief Marketing
Officer on August 2, 1999. We cannot assure you that we will be able to manage
the expansion of our operations effectively, that our systems, procedures or
controls will be adequate to support our operations or that our management will
be able to fully exploit the market opportunity for our services. Any inability
to manage growth effectively could have a material adverse effect on our
business, results of operations and financial condition.
Results of Operations
The following table sets forth, for the periods presented, certain data
derived from our unaudited condensed statements of operations as a percentage
of net revenues. The operating results for the three and six months ended June
30, 1999 are not necessarily indicative of the results that may be expected for
any future period.
Three Months Six Months
Ended Ended
June 30, June 30,
---------------- --------------
1999 1998 1999 1998
------ ------ ----- -----
Net revenues........................... 100 % 100 % 100 % 100 %
Cost of net revenues................... 9 6 10 5
------ ------ ----- -----
Gross profit........................... 91 94 90 95
------ ------ ----- -----
Operating expenses:
Sales and marketing.................. 104 131 97 128
Product development.................. 9 5 9 5
General and administrative........... 23 34 23 39
Stock-based compensation............. 8 -- 10 --
------ ------ ----- -----
Total operating expenses........... 144 170 139 172
------ ------ ----- -----
Loss from operations................... (53) (76) (49) (77)
Interest, and other income (expense),
net................................... 11 -- 7 --
------ ------ ----- -----
Net loss............................... (42)% (76)% (42)% (77)%
====== ====== ===== =====
Net Revenues
Our net revenues increased to $7.0 million in the three months ended June
30, 1999 (the second quarter of 1999) from $2.8 million in the three months
ended June 30, 1998 (the second quarter of 1998), an overall increase of 150%.
Approximately 62% of the increase in net revenues was due to higher levels of
net dealer fee revenues. Revenues derived from insurance referrals and
advertisers accounted for most of the remaining increase in net revenues for
these periods. Our net revenues increased to $12.8 million in the six months
ended June 30, 1999 from $5.0 million in the six months ended June 30, 1998, an
overall increase of 157%. Approximately 64% of the increase in net revenues was
due to higher levels of net dealer fee revenues. Revenues derived from
insurance referrals and advertisers accounted for most of the remaining
increase in net revenues for these periods. Dealer fee revenues increased as a
result of increases in the size of our member dealer network and the number of
purchase inquiries that we provided to our member dealers. As described above,
we began to change our pricing model in February 1998 from a subscription-based
model to a "pay for performance" model.
Cost of Net Revenues
Cost of net revenues increased to $652,000 in the second quarter of 1999
from $156,000 in the second quarter of 1998. Approximately 51% of the increase
represented revenue-sharing expenses, related to the
8
operation of our co-branded and affiliate sites. Approximately 41% of the
increase was due to increased costs of web site operations, including
personnel, equipment, depreciation, and occupancy cost. The remainder of the
increase came from the cost of providing site content. For the six months ended
June 30, 1999, cost of net revenues increased to $1.3 million compared to
$267,000 in the first six months of 1998. Approximately 47% of the increase
represented revenue-sharing expenses related to the operation of our co-branded
and affiliate sites. Approximately 38% of the increase was due to increased
cost of web site operations, including personnel, equipment, depreciation, and
occupancy cost. The remainder of the increase came from the cost of providing
site content. We believe that the cost of net revenues will increase in
absolute terms over the remainder of the year, due to anticipated increases in
revenue-sharing expenses and in the costs of web site operations.
Sales and Marketing
Our sales and marketing expenses increased to $7.3 million in the second
quarter of 1999 from $3.7 million in the second quarter of 1998. Approximately
90% of the increase in sales and marketing expenses was due to increases
primarily in online advertising and, to a lesser extent, our spending on public
relations, advertising in the traditional media, trade shows and other
promotions. Approximately 8% of the increase in sales and marketing expenses
was due to increased personnel costs caused by additions to headcount,
primarily salespersons focused on enrolling member dealers. For the six months
ended June 30, 1999, sales and marketing expenses increased to $12.4 million
from $6.3 million in the six months ended June 30, 1998. Approximately 82% of
the increase in sales and marketing expenses was due to increases primarily in
online advertising and, to a lesser extent, our spending on public relations,
advertising in the traditional media, trade shows and other promotions such as
the NADA trade show. Approximately 12% of the increase in sales and marketing
expenses was due to increased personnel costs caused by additions to headcount,
primarily salespersons focused on enrolling member dealers. We believe that
sales and marketing expenses will increase both in absolute terms and as a
percent of net revenues over the remainder of the year, due to anticipated
increases in media advertising both on the Internet and in traditional media
sources.
Product Development
Our product development expenses increased to $624,000 in the second quarter
of 1999 from $136,000 in the second quarter of 1998, and for the six months
ended June 30, 1999, product development expenses increased to $1.2 million
from $266,000 in the first six months of 1998. For both the three and six
months ended June 30, 1999, these expenses increased primarily as a result of
increased hiring of product development personnel and, to a lesser extent, as a
result of increased occupancy costs. We believe that product development
expenses will increase both in absolute terms and as a percent of net revenues
over the remainder of the year.
General and Administrative
Our general and administrative expenses increased to $1.6 million in the
second quarter of 1999 from $958,000 in the second quarter of 1998.
Approximately 44% of the increase in general and administrative expenses was
due to increases in personnel costs resulting from increased hiring of
administrative personnel. Approximately 32% of the increase was due to
increases in information technology support related to administrative functions
and occupancy costs. For the six months ended June 30, 1999, general and
administrative expenses increased to $2.9 million from $1.9 million in the
first six months of 1998. Approximately 49% of the increase in general and
administrative expenses was due to increases in personnel costs resulting from
increased hiring of administrative personnel. Approximately 33% of the increase
was due to increases in information technology support related to
administrative functions and occupancy costs. We believe that general and
administrative expense will increase in absolute terms over the remainder of
the year.
Stock-Based Compensation
Our stock-based compensation expense increased to $538,000 in the second
quarter of 1999 from $11,000 in the second quarter of 1998, primarily due to
the increased level of stock option grants and increases in the deemed fair
market value of the underlying common stock in the second quarter of 1999
compared with the
9
second quarter of 1998. The increase in the six months ended June 30, 1999 from
the six months ended June 30, 1998 was also due primarily to the increased
level of stock option grants and increases in the deemed fair market value of
the underlying common stock in those respective periods. We believe that stock-
based compensation expense will decrease slightly over the remainder of the
year.
Interest and Other Income (Expense), Net
For both the three and six months ended June 30, 1999, the increase in
interest and other income (expense), net, over comparable prior year periods,
represents interest income earned on greater levels of cash, cash equivalents,
and short-term investment balances, partially offset by interest expense on
borrowings under capital leases and our credit facilities.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
quarters of all years beginning after June 15, 1999. SFAS No. 133 requires that
all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether a
derivative is designed as part of a hedge transaction and, if it is, the type
of hedge transaction. The Company does not expect that the adoption of SFAS No.
133 will have a material impact on its condensed financial statements. In June
1999, the FASB issued SFAS No. 137, which delayed the effective date of SFAS
No. 133 to fiscal years beginning after June 15, 2000.
Liquidity and Capital Resources
Prior to March 1999, we financed our operations primarily from sales of
preferred stock and, in 1998 to a significantly lesser extent, borrowings under
a long-term debt facility. In March 1999, we raised $71.1 million (net of
underwriters' discounts and commissions and other costs) in our initial public
offering.
Net cash used in operating activities was $2.1 million in the six months
ended June 30, 1999 compared to $4.2 million in the six months ended June 30,
1998. Net cash used in operating activities in the six months ended June 30,
1999 was primarily due to the net loss for the period, partially offset by
changes in other assets and liabilities, in particular the increase in accounts
payable and other accrued expenses. Net cash used in operating activities in
the six months ended June 30, 1998 was primarily due to the net loss for the
period. Our "days sales outstanding" in accounts receivable (calculated using
the net revenues for the quarter and the ending accounts receivable balance for
that quarter) decreased to 41 days for the second quarter of 1999, from 45 days
for the first quarter of 1999, and from 49 days for the second quarter of 1998.
We believe that our days' sales outstanding in accounts receivable could
increase to greater than 45 days sales outstanding in the remainder of the
year, based on our invoicing cycles and customer payment patterns. Our
allowance for doubtful accounts, which was 19% of accounts receivable at
December 31, 1998, decreased to 17% of accounts receivable at June 30, 1999.
Net cash used in investing activities was $46.9 million in the first six
months of 1999, compared to $1.5 million in the first six months of 1998. This
increase was primarily due to the purchase of short-term investments as we
continued to invest the proceeds of our initial public offering. We anticipate
that our purchases of short-term investments will increase over the balance of
the year, and that our property and equipment purchases for the remainder of
1999 will be at higher levels than the first six months of 1999.
Net cash provided by financing activities was $71.5 million in the first six
months of 1999 compared to $5.5 million in the first six months of 1998 due
almost entirely to the proceeds of the initial public offering completed in
March 1999.
At June 30, 1999, the total of our cash, cash equivalents and short-term
investments were $71.4 million. During the second quarter of 1999, we initiated
a new commitments for exclusive promotional rights, linkage and certain
advertising that will require us to pay approximately $40 million over the next
two years. We initiated no new material commitments for purchases of equipment
during the second quarter of 1999. We believe that our current cash position
together with anticipated future revenues and the availability of additional
10
funds under our line of credit will be sufficient to meet our cash requirements
for at least the next 12 months. Depending on our rate of growth and cash
requirements, we may require additional equity or debt financing to meet future
working capital or capital expenditure needs. There can be no assurance that
such additional financing will be available or, if available, that such
financing can be obtained on terms satisfactory to us.
RISKS THAT COULD AFFECT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We are an early stage company.
We were incorporated in October 1995. Therefore, we have a limited operating
history upon which to base an evaluation of our current business and prospects.
Moreover, our business model is evolving and depends on our ability to generate
revenues from multiple sources through our Web site. In particular, we face the
following challenges:
. maintaining and increasing our consumer base;
. maintaining and increasing our network of member dealers;
. managing the quality of services delivered by member dealers and
automotive-related vendors;
. generating continuing revenues through our Web site from consumers,
member dealers and other commercial vendors;
. competing effectively with existing and potential competitors;
. developing further our unproven business model;
. developing further Autoweb.com awareness and brand loyalty;
. anticipating and adapting to the evolving e-commerce market;
. continuing to develop our technology infrastructure to handle greater
Internet traffic efficiently
. managing expanding operations;
. broadening our service offerings and attracting and retaining
additional automotive-related vendors and content providers to enable
us to expand our service offerings; and
. attracting and retaining qualified personnel.
We may not successfully implement any of our strategies or successfully address
these risks and uncertainties.
Our quarterly financial results are subject to significant fluctuations.
Our results of operations have varied widely in the past, and we expect that
they will continue to vary significantly from quarter to quarter due to a
number of factors described below.
Our revenue growth rates may not be sustainable. Any shortfall in our
revenues would immediately increase our operating losses and would adversely
affect the market price of our common stock. We expect that over time our
revenues will come from a mix of fees from member dealers, automotive-related
vendors and advertisers. However, we expect to be substantially dependent on
member dealer fees. Therefore, our quarterly revenues and operating results are
likely to be particularly affected by the level of member dealer fees in each
quarter. We plan to increase our operating expenses significantly, based on our
expectations of future revenues. If revenues fall below our expectations, we
will not be able to reduce our spending rapidly in response to such a
shortfall. This will adversely affect our operating results.
We believe that we may experience seasonality in our business. The seasonal
patterns of Internet usage and vehicle purchasing do not completely overlap.
Internet usage typically declines during the summer and
11
certain holiday periods, while vehicle purchasing in the United States is
strongest in the late spring and summer months. Because of our limited
operating history, we do not know which seasonal pattern, if any, will
predominate.
Due to the foregoing factors and factors described elsewhere in this
document, we believe that quarter-to-quarter comparisons of our results of
operations are not a good indication of our future performance. It is likely
that our results of operations in some future quarter may be below the
expectations of public market analysts and investors. In this event, the price
of our common stock is likely to decline.
We have a history of net losses and expect net losses for the foreseeable
future.
We have incurred net losses in each fiscal year since our inception,
including a net loss of $11.5 million in 1998, and we had an accumulated
deficit of $17.6 million as of December 31, 1998. During the six months ended
June 30, 1999, we incurred a net loss of $5.4 million, and, as of June 30,
1999, we had an accumulated deficit of $23.0 million. We expect to have
increasing net losses and negative cash flows for the next several quarters and
net losses and continued negative cash flows at least through the end of 2000.
The size of these net losses will depend, in part, on the rate of growth in our
revenues from member dealer fees, other commercial vendor fees, advertising
sales and other electronic-commerce ("e-commerce") activities. It is critical
to our success that we continue to expend financial and management resources to
develop Autoweb.com brand awareness and loyalty through marketing and
promotion, expansion of our member dealer network, development of our online
content and expansion of our other services. As a result, we expect that our
operating expenses will increase significantly during the next several years,
especially in sales and marketing. With increased expenses, we will need to
generate significant additional revenues to achieve profitability. As a result,
we may never achieve or sustain profitability, and, if we do achieve
profitability in any period, we may not be able to sustain or increase
profitability on a quarterly or annual basis.
We have a new and unproven business model.
The manner in which we conduct our business and charge for our services is
new and unproven. The model depends upon our ability to generate revenue
streams from multiple sources through our Web site, including:
. fees paid by member dealers for consumer referrals;
. fees paid by companies in industries related to vehicles such as
insurance and financing industries;
. advertising fees paid by manufacturers and other companies that want
access to vehicle purchasers; and
. fees paid by individuals who want to advertise their vehicles for
sale.
In order for us to be successful, we must have consumers visit our Web site
regularly to increase the likelihood that they will use our service when they
are interested in buying a vehicle or a related product or service. Therefore,
we must not only develop services that directly generate revenue, but also
provide information and community offerings that attract consumers to our Web
site frequently. We will need to develop new offerings in each of these areas
as consumer preferences change and new competitors emerge. We cannot assure you
that we will be able to provide consumers with an acceptable blend of services,
informational and community offerings. We provide information and community
offerings without charge, and we may not be able to generate sufficient
services revenue to pay for these offerings. Accordingly, we are not sure our
business model will be successful or that we can sustain revenue growth or be
profitable.
The online market for automotive services is new and rapidly developing. As
is typical for any new, rapidly evolving market, demand and market acceptance
for recently introduced products and services are subject to a high level of
uncertainty and risk. For example, in 1998 we changed our pricing model from a
12
fixed-rate, subscription-based pricing model to a "pay for performance" pricing
model under which each member dealer pays a fee for each qualified purchase
inquiry that we deliver to it from a pre-selected geographic radius. In 1998,
we also changed our pricing levels. These changes may not prove to be
successful. It is also difficult to predict the market's future growth rate, if
any. Because of the low barriers to entry, the market is characterized by an
increasing number of market entrants. If the market fails to develop, develops
more slowly than expected or becomes saturated with competitors, or our
services do not achieve or sustain market acceptance, our business, results of
operations and financial condition could be materially and adversely affected.
We must reduce our allowances for doubtful accounts.
In 1998, we changed our pricing model and began selling our services to new
dealers using a "pay for performance" model instead of a subscription-based
pricing model. The increased risk of non-collection associated with a greater
scrutiny by member dealers of the validity of each purchase inquiry and
possibly the longer dealer credit cycle under the "pay for performance" model
have resulted in allowances for doubtful accounts increasing from 13% of
accounts receivable at December 31, 1997 to 19% of accounts receivable at
December 31, 1998. As of June 30, 1999, allowance for doubtful accounts had
decreased to 17% of accounts receivable. If we are unable to continue to reduce
our allowances for doubtful accounts in the future, it could have a material
adverse effect on our business, results of operations and financial condition.
We are in an intensely competitive market.
The market for the purchase of vehicles and automotive-related products and
services is intensely competitive, and we expect competition to increase
significantly, particularly on the Internet. Barriers to entry on the Internet
are relatively low, and we may face competitive pressures from numerous
companies. Currently, we believe our most significant competitors are
Microsoft's CarPoint, Autobytel.com and AutoConnect. There are also a number of
Web sites that offer vehicles, particularly vehicle manufacturers' own Web
sites and sites for electronic classifieds, and vehicle-related products and
services. In addition, there are numerous Web sites that offer vehicle
information and other content, as well as community offerings, directly to the
vehicle buying consumer generally or to targeted audiences such as car
collectors. We could face competition in the future from vehicle manufacturers,
large dealer groups or traditional media companies, such as newspaper,
television and radio companies, many of which currently operate a Web site. In
addition to direct competitors, we also compete indirectly with vehicle
brokerage firms, discount warehouse clubs and automobile clubs. Several auction
Web sites have also recently announced their intention to auction vehicles on
the Internet.
Many of our existing and potential competitors have longer operating
histories in the Internet market, greater name recognition, larger consumer
bases and significantly greater financial, technical and marketing resources
than we do. Additionally, the e-commerce market is new and rapidly evolving,
and we expect competition among e-commerce companies to increase significantly.
We cannot assure you that Web sites maintained by our existing and potential
competitors will not be perceived by consumers, vehicle dealers, other
potential automotive- related vendors or advertisers as being superior to ours.
We also cannot assure you that we will be able to maintain or increase our Web
site traffic levels, purchase inquiries and click-throughs or that competitors
will not experience greater growth in these areas than we do.
Our business is dependent on the economic strength of the automotive industry.
The economic strength of the automotive industry impacts significantly the
revenues we derive from our member dealers and other automotive-related
vendors, advertising revenues and consumer traffic to our Web site. The
automotive industry is cyclical, with sales of vehicles changing due to changes
in national and global economic forces. Since our incorporation, sales of
vehicles in the United States have been at historically high levels. We cannot
assure you that sales of vehicles will stay at their current levels, and a
decrease in the current level of vehicle sales could have a material adverse
effect on our business, results of operations and financial condition.
13
We rely heavily on member dealers.
We derive the majority of our revenues from member dealer fees (payments
from member dealers for each consumer inquiry that we provide to them), and we
expect to continue to do so for the foreseeable future. Member dealer fees
represented approximately 85% of our net revenues in 1997, approximately 70% of
our net revenues in 1998, and approximately 68% of our net revenues for the six
months ended June 30, 1999. Consequently, our business is highly dependent on
consumers' use of Autoweb.com to purchase vehicles so that member dealers will
achieve a satisfactory return on their investment in the Autoweb.com program.
The success of our business strategy depends on our member dealers'
adherence to the Autoweb.com purchase process, including responding to consumer
purchase inquiries within 24 hours, providing a competitive, firm quote to
consumers during the initial communication, explaining the Autoweb.com purchase
process to the consumer and answering any consumer questions. We devote
significant efforts and resources to certifying and supporting participating
member dealers in these practices that are intended to increase consumer
satisfaction. Our inability to certify and support member dealers effectively,
or member dealers' failure to adopt such practices, respond rapidly and
professionally to vehicle purchase inquiries, or sell vehicles in accordance
with our marketing strategies, could result in low consumer satisfaction and
materially adversely affect our business, results of operations and financial
condition.
We must reduce our high member dealer turnover.
To maintain and increase our network of member dealers, we must reduce the
rate of turnover of our member dealers. Commencing in February 1998, we
introduced a new "pay for performance" pricing model and began actively to
convert our existing member dealers to this model. Prior to that time, all of
our member dealers were on a subscription model under which they paid a fixed
amount per month regardless of the number of purchase inquiries that we
provided to them. During 1998, we lost approximately 60% of the member dealers
that we had at the beginning of the year and converted approximately 30% to the
new pricing model. As of June 30, 1999, there were approximately 111 member
dealers (approximately 2% of the total) that were on the subscription model,
but we anticipate that there will be almost no subscription-based member
dealers by the end of 1999.
During 1998, we lost approximately 22% of the performance-based member
dealers that we converted or with which we first entered into a contract in
1998. We believe there were three primary reasons for this attrition:
. a number of our member dealers were not satisfied with our service as
subscription-based member dealers;
. a number of member dealers were unwilling to adequately devote the
resources required to obtain results from the performance-based
model, such as contacting consumers who submitted a purchase inquiry
within 24 hours and dedicating a person at the dealer to ensure
compliance with the Autoweb.com purchase process; and
. a number of member dealers were inadequately trained and supported by
us, due to our inability to focus our resources adequately.
Attrition remains unacceptably high. We believe that we can reduce our
attrition rate over time as our member dealer network stabilizes, due to the
efforts of our Dealer Development and Support Group and due to reduced
conversion activity. We are undertaking several initiatives to reduce our
attrition. Nevertheless, we cannot assure you that we will be able to reduce
the level of this attrition, and our failure to do so could materially and
adversely affect our business, results of operations and financial condition.
We need to build strong brand loyalty.
We believe that establishing and maintaining our brand loyalty is critical
to attract consumers, member dealers, automotive-related vendors and
advertisers. Furthermore, we believe that the importance of brand
14
loyalty will increase as low barriers to entry encourage the proliferation of
Web sites. In order to attract and retain consumers, member dealers,
advertisers and partners, and in response to competitive pressures, we intend
to increase spending substantially to create and maintain brand loyalty among
these groups. We plan to accomplish this by expanding our current online
advertising campaigns and by conducting advertising campaigns in traditional
forms of media, such as newspaper, radio and television. We believe that
advertising rates, and the cost of our online advertising campaigns in
particular, could increase substantially in the future. If our branding efforts
are not successful, our business, results of operations and financial condition
will be materially and adversely affected.
Promotion and enhancement of the Autoweb.com brand will also depend, in
part, on our success in consistently providing a high-quality consumer
experience for purchasing vehicles and related products, relevant and useful
information and a quality "community experience." If consumers, other Internet
users, member dealers, automotive-related vendors and advertisers do not
perceive the Autoweb.com service offerings to be of high quality, or if we
introduce new services or enter into new business ventures that are not
favorably received by such groups, the value of our brand could be impaired or
diluted. Such brand impairment or dilution could decrease the attractiveness of
Autoweb.com to one or more of these groups, which could materially and
adversely affect our business, results of operations and financial condition.
We depend on third-party relationships.
We have entered into agreements with various commercial vendors, some of
which require us to feature them exclusively in certain sections of our Web
site. For example, we have entered into agreements with State Farm Mutual
Automobile Insurance Company ("State Farm"), pursuant to which State Farm has
the exclusive right to offer insurance services on our Web site through
September 1999 and vehicle financing on our Web site through January 2000.
Existing and future exclusive arrangements may prevent us from entering into
other content agreements, advertising or sponsorship arrangements or other
commercial relationships. Many companies that we may pursue for a commercial
relationship may also offer competing services. As a result, these competitors
may be reluctant to enter into commercial relationships with us. Our business
could be adversely affected if we do not maintain our existing commercial
relationships on terms as favorable as currently in effect, if we do not
establish additional commercial relationships on commercially reasonable terms
or if our commercial relationships do not result in the expected increased use
of our Web site.
We also depend on establishing and maintaining a number of commercial
relationships with high-traffic Web sites to increase traffic on Autoweb.com.
We currently have agreements with America Online, Yahoo!, Netscape
Communications, CNET's Search.com and Hotbot. There is intense competition for
placements on these sites, and in the future we may not be able to enter into
distribution relationships on commercially reasonable terms or at all. Even if
we enter into distribution relationships with these Web sites, they themselves
may not attract significant numbers of consumers. Therefore, our Web site may
receive less than the number of additional consumers we expect from these
relationships. Moreover, we may have to pay significant fees to establish or
renew these relationships.
We also depend on establishing and maintaining a number of commercial
relationships with other companies. Our current relationships include:
. New Car Test Drive and Automotive Service Excellence, under which we
purchase content for use by our consumers;
. America Online's Digital City, Car and Driver and USA Today, under
which we share the revenue generated from automotive and related
purchase inquiries submitted by consumers and directed to our Web
site through links between our Web site and the other company's Web
site; and
. members of the Autoweb.com Affiliates Program, each of which receives
a commission from us for each new or pre-owned vehicle purchase
inquiry or classified ad delivered to us through a link to the
affiliate's Web site.
15
We cannot assure you that we will be able to establish new agreements or
maintain existing agreements or that the above agreements can be renewed on
commercially acceptable terms.
We also may not be able to maintain relationships with third parties that
supply us with the software or products that are crucial to our success, and
the vendors of these software or products may not be able to sustain any third-
party claims or rights against their use. Furthermore, we cannot assure you
that the software, services or products of those companies that provide access
or links to our services or products will achieve market acceptance or
commercial success. In addition, we cannot assure you that our existing
relationships will result in sustained business arrangements, successful
service or product offerings or the generation of significant revenues for us.
Failure of one or more of our relationships to achieve or maintain market
acceptance or commercial success or the termination of one or more relationship
could have a material adverse effect on our business, results of operations and
financial condition.
We need to continue to develop Autoweb.com content and service offerings.
To remain competitive we must continue to enhance and improve the ease of
use, responsiveness, functionality and features of the Autoweb.com site and
develop new services in addition to continuing to improve the consumer
purchasing experience. These efforts may require the development or licensing
of increasingly complex technologies. We may not be successful in developing or
introducing new features, functions and services, and these features, functions
and services may not achieve market acceptance or enhance our brand loyalty. If
we fail to develop and introduce new features, functions or services
effectively, it could have a material adverse effect on our business, results
of operations and financial condition.
We need to manage our growth.
Our recent growth has placed, and is expected to continue to place, a
significant strain on our managerial, operational and financial resources.
Several executive officers joined us recently. Any inability to manage growth
effectively could have a material adverse effect on our business, results of
operations and financial condition.
We are dependent on certain key personnel.
Our future success is substantially dependent on our senior management and
key technical personnel. If one or more of our key employees decided to leave
us, join a competitor or otherwise compete directly or indirectly with us, this
could have a material adverse effect on our business, results of operations and
financial condition.
Our future success depends on our continuing ability to retain and attract
highly qualified technical and managerial personnel. As of June 30, 1999, we
had 126 full-time employees, and we anticipate that the number of employees
will increase significantly during the next 12 months. Wages for managerial and
technical employees are increasing and are expected to continue to increase in
the foreseeable future due to the competitive nature of the current employment
market, particularly in Northern California. We may be unable to retain key
technical and managerial personnel or to attract and retain additional highly
qualified technical and managerial personnel in the future. We have experienced
difficulty from time to time attracting the personnel necessary to support the
growth of our business, and we may experience similar difficulty in the future.
Inability to attract and retain the technical and managerial personnel
necessary to support the growth of our business could have material adverse
effect upon our business, results of operations and financial condition.
We face risks associated with possible regulation under state or federal
franchise laws.
If our relationships or written agreements with our member dealers are found
to constitute "franchises" under federal or state franchise laws, we would be
subject to regulations, such as franchise disclosure, registration requirements
and limitations on our ability to effect changes in our relationships with our
member dealers. We believe that neither our relationship with our member
dealers nor our member dealer subscription
16
agreements constitute "franchises" under state or federal franchise laws.
However, we have not received legal advice on this matter.
The state of Texas has challenged our pricing model under their Motor Vehicle
Code.
In May 1998, the Texas Department of Transportation notified us that, in
their opinion, our performance-based pricing model is illegal, because it makes
us a broker under Texas law. They have taken the position that the fee paid to
us by member dealers for each qualified purchase inquiry is equivalent to a
finder's or broker's fee and that we are arranging for two persons to meet and
enter into a transaction that involves the sale of a motor vehicle. We
currently intend to challenge this decision and have engaged counsel to advise
us in this matter. We presently are seeking the Texas Attorney General's
opinion that the operation of a Web site in the manner that we operate does not
constitute us as a "broker" under the Texas Motor Vehicle Code. However, if we
are not successful in challenging this decision of the Department of
Transportation, we not only may have to pay significant fines, but also will
have either to cease doing business in Texas or to change our pricing model for
member dealers in Texas from performance-based to subscription-based.
We generally face risks associated with possible regulation under vehicle
brokerage, insurance, financing or other laws.
Other states, substantially all of which have laws that broadly define
brokerage activities, could also determine that we are acting as a broker. If
this occurs, we may be required to comply with burdensome licensing
requirements or terminate our operations in those states. In either case, our
business, results of operations and financial condition could be materially and
adversely affected. We believe that our service does not qualify as a vehicle
brokerage activity and therefore that state broker licensing requirements do
not apply to us. However, we have not sought a legal opinion regarding whether
our service, in general, or our performance-based pricing, in particular, would
qualify us as a vehicle brokerage activity in any state. State regulatory
requirements may also include us within an industry-specific regulatory scheme,
such as those for the vehicle insurance or vehicle financing industries. In the
event that individual states' regulatory requirements change or additional
requirements are imposed on us, we may be required to modify aspects of our
business in those states in a manner that might undermine the attractiveness of
the Autoweb.com purchase process to consumers, member dealers, automotive-
related vendors or advertisers or require us to terminate operations in that
state, either of which could have a material adverse effect on our business,
results of operations and financial condition.
We face risks associated with government regulation and legal uncertainties
associated with the Internet.
There are numerous state laws regarding the sale of vehicles. In addition,
government authorities may take the position that state or federal insurance
licensing laws, motor vehicle dealer laws or related consumer protection or
product liability laws apply to aspects of our business. As we introduce new
services and expand our operations to other countries, we will need to comply
with additional licensing and regulatory requirements.
A number of legislative and regulatory proposals under consideration by
federal, state, local and foreign governmental organizations may lead to laws
or regulations concerning various aspects of the Internet, including, but not
limited to, online content, user privacy, taxation, access charges, liability
for third-party activities and jurisdiction. Additionally, it is uncertain as
to how existing laws will be applied to the Internet. The adoption of new laws
or the application of existing laws may decrease the growth in the use of the
Internet, which could in turn decrease the demand for our services, increase
our cost of doing business or otherwise have a material adverse effect on our
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
Information Act was
17
signed into law placing a three-year moratorium on new state and local taxes on
Internet commerce. However, we cannot assure you 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 our business, results of operations and financial condition.
Certain local telephone carriers have asserted that the increasing
popularity and use of the Internet has burdened the existing telecommunications
infrastructure, and that many areas with high Internet use have begun to
experience interruptions in telephone service. These carriers have petitioned
the Federal Communications Commission to impose access fees on Internet service
providers and online service providers. If such access fees are imposed, the
costs of communicating on the Internet could increase substantially,
potentially slowing the increasing use of the Internet, which could in turn
decrease demand for our services or increase our cost of doing business, and
thus have a material adverse effect on our business, results of operations and
financial condition.
We depend on increased use of the Internet.
Consumers and businesses will likely widely accept and adopt the Internet
for conducting business and exchanging information only if the Internet
provides these consumers and businesses with greater efficiencies and
improvements in commerce and communication. Our future success and revenue
growth depends substantially upon continued growth in the use of the Internet.
In addition, e-commerce generally, and the purchase of automotive and
automotive related products and services on the Internet in particular, must
become widespread. The Internet may prove not to be a viable commercial
marketplace generally, or, in particular, for vehicles and related products and
services. If use of the Internet does not continue to increase, our business,
results of operations and financial condition would be materially and adversely
affected.
We depend on continued improvements in our systems and the Internet
infrastructure.
Our ability to retain and attract consumers, member dealers, automotive-
related vendors and advertisers, and to achieve market acceptance of our
services and our brand, depends significantly upon the performance of our
systems and network infrastructure. Any system or network failure that causes
interruption or slower response time of our services could result in less
traffic to our Web site and, if sustained or repeated, could reduce the
attractiveness of our services to consumers, member dealers, automotive-related
vendors and advertisers. An increase in the volume of our Web site traffic
could strain the capacity of our technical infrastructure, which could lead to
slower response times or system failures. This would cause the number of
purchase inquiries, advertising impressions, other revenue producing e-commerce
offerings and our information and community offerings to decline, any of which
could hurt our revenue growth and our brand loyalty. In addition, if traffic
increases, we cannot assure you that our technical infrastructure, such as a
reliable network backbone with the necessary speed and data capacity and the
development of complementary products such as high-speed modems, will be able
to increase accordingly, and we face risks related to our ability to scale up
to expected consumer levels while maintaining performance. Further, security
and authentication concerns regarding the transmission of confidential
information over the Internet, such as credit card numbers, may continue. Any
failure of our server and networking systems to handle current or higher
volumes of traffic would have a material adverse effect on our business,
results of operations and financial condition.
The recent growth in Internet traffic has caused frequent periods of
decreased performance, requiring Internet service providers and users of the
Internet to upgrade their infrastructures. If Internet usage continues to
increase rapidly, the Internet infrastructure may not be able to support the
demands placed on it by this growth and its performance and reliability may
decline. If outages or delays on the Internet occur frequently, overall
Internet usage or usage of our Web site could increase more slowly or decline.
Our ability to increase the speed with which we provide services to consumers
and to increase the scope of such services is limited by and dependent upon the
speed and reliability of the Internet. Consequently, the emergence and growth
of the market for our services is dependent on future improvements to the
entire Internet.
18
In addition, our operations depend upon our ability to maintain and protect
our computer systems, all of which are located at our corporate headquarters in
Santa Clara, California. We currently do not have a backup disaster recovery
program or fully redundant systems for our service at an alternate site. The
system therefore is vulnerable to damage from fire, floods, earthquakes, power
loss, telecommunications failures and similar events. Although we maintain
insurance against fires, floods, earthquakes and general business
interruptions, the amount of coverage may not be adequate in any particular
case. The occurrence of such an event could have a material adverse effect on
our business, results of operations and financial condition.
The Internet industry is characterized by rapid technological change.
Rapid technological developments, evolving industry standards and consumer
demands, and frequent new product introductions and enhancements characterize
the market for Internet products and services. These market characteristics are
exacerbated by the emerging nature of the market and the fact that many
companies are expected to introduce new Internet products and services in the
near future. Our future success will significantly depend on our ability to
continually improve the vehicle purchasing experience, the addition of new and
useful services and content to our Web site, and the performance, features and
reliability of our Web site. In addition, the widespread adoption of developing
multimedia-enabling technologies could require fundamental and costly changes
in our technology and could fundamentally affect the nature, viability and
measurability of Internet-based advertising, which could adversely affect our
business, results of operations and financial condition.
We could face liability for information retrieved from or transmitted over the
Internet and liability for products sold over the Internet.
We could be exposed to liability with respect to third-party information
that may be accessible through our Web site, or content and materials that may
be posted by consumers through our AutoTalk service. Such claims might assert,
among other things, that, by directly or indirectly providing links to Web
sites operated by third parties, we should be liable for copyright or trademark
infringement or other wrongful actions by such third parties through such Web
sites. It is also possible that, if any third-party content information
provided on our Web site contains errors, consumers could make claims against
us for losses incurred in reliance on such information.
We also enter into agreements with other companies under which any revenue
that results from the purchase of services through direct links to or from our
Web site is shared. Such arrangements may expose us to additional legal risks
and uncertainties, including local, state, federal and foreign government
regulation and potential liabilities to consumers of these services, even if we
do not provide the services ourselves. We cannot assure you that any
indemnification provided to us in our agreements with these parties, if
available, will be adequate.
Even to the extent such claims do not result in liability to us, we could
incur significant costs in investigating and defending against such claims. The
imposition on us of potential liability for information carried on or
disseminated through our system could require us to implement measures to
reduce our exposure to such liability, which might require the expenditure of
substantial resources or limit the attractiveness of our services to consumers,
member dealers, automotive-related vendors and others.
Our general liability insurance and our communications liability insurance
may not cover all potential claims to which we are exposed and may not be
adequate to indemnify us for all liability that may be imposed. Any imposition
of liability that is not covered by insurance or is in excess of insurance
coverage could have a material adverse effect on our business, results of
operations and financial condition.
Our intellectual property protection may be inadequate.
Legal standards relating to the validity, enforceability and scope of
protection of certain proprietary rights in Internet-related businesses are
uncertain and still evolving, and we can give no assurance regarding the future
viability or value of any of our proprietary rights. Despite the precautions we
have taken, it may be
19
possible for a third party to copy or otherwise obtain and use our proprietary
information without authorization or to develop similar technology
independently.
Although we have not conducted any comprehensive searches, we are aware that
the name "Autoweb" is already in use in several regions in the United States
and in Australia. Due to our resource constraints and the perceived priority of
this issue, we have not yet researched the effect of the use of the name
"Autoweb" by other companies on our trademark or the impact of this use on our
ability to obtain the mark in other countries. As a result, we cannot guarantee
that we will be able to continue to use the name "Autoweb" in the future. If in
the future we were required to change our name and adopt a new trademark, we
would incur significant expenses related to marketing a replacement trademark,
and such a change would likely have a materially adverse effect on our
business.
We face risks associated with litigation.
Litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets or trademarks or to determine the
validity and scope of the proprietary rights of others. Such litigation might
result in substantial costs and diversion of resources and management
attention. Furthermore, our business activities may infringe upon the
proprietary rights of others and other parties may assert infringement claims
against us, including claims that arise from directly or indirectly providing
hyperlink text links to Web sites operated by third parties. Moreover, from
time to time, we may be subject to claims of alleged infringement by us or our
member dealers of the trademarks, service marks and other intellectual property
rights of third parties. Such claims and any resultant litigation, should it
occur, might subject us to significant liability for damages, might result in
invalidation of our proprietary rights and, even if not meritorious, could
result in substantial costs and diversion of resources and management attention
and have a material adverse effect on our business, results of operations and
financial condition.
We depend on third party technology.
We currently license from third parties certain technologies and information
incorporated into our Web site. As we continue to introduce new services that
incorporate new technologies and information, we may be required to license
additional technology and information from others. We cannot assure you that
these third-party technology and information licenses will continue to be
available to us on commercially reasonable terms, if at all. Additionally, we
cannot assure you that the third parties from which we currently license our
technology and information will be able to defend their proprietary rights
successfully against claims of infringement. Any failure to obtain any of these
technology and information licenses could result in delays or reductions in the
introduction of new features, functions or services. It could also adversely
affect the performance of our existing services until equivalent technology or
information can be identified, obtained and integrated.
We may particularly be affected by general economic conditions.
Purchases of new vehicles are typically discretionary for consumers and may
be particularly affected by negative trends in the general economy. The success
of our operations depends to a significant extent upon a number of factors
relating to discretionary consumer spending, including economic conditions (and
perceptions of such conditions by consumers) affecting disposable consumer
income (such as employment, wages and salaries, business conditions, interest
rates, availability of credit and taxation) for the economy as a whole and in
regional and local markets where we operate. In addition, because the purchase
of a vehicle is a significant investment and is relatively discretionary, any
reduction in disposable income in general may affect us more significantly than
companies in other industries. In addition, our business strategy relies on
advertising by and agreements with other Internet companies. Any significant
deterioration in general economic conditions that adversely affects these
companies could also have a material adverse effect on our business, results of
operations and financial condition.
20
We have security risks.
On occasion, some experienced programmers have attempted to penetrate our
network security ("hackers"). We expect that these attempts, some of which have
succeeded, will continue to occur from time to time. Because a hacker who
penetrates our network security could misappropriate proprietary information or
cause interruptions in our services, we might be required to expend significant
capital and resources to protect against, or to alleviate, problems caused by
hackers. Additionally, we may not have a timely remedy against a hacker who is
able to penetrate our network security. In addition to purposeful security
breaches, the inadvertent transmission of computer viruses could expose us to
litigation or to a material risk of loss. Such security breaches and
inadvertent transmissions could have a material adverse effect on our business,
results of operations and financial condition.
In offering certain online payment services, we may increasingly rely on
technology licensed from third parties to provide the security and
authentication necessary to effect secure transmission of confidential
information, such as consumer credit card numbers. Advances in computer
capabilities, new discoveries in the field of cryptography, or other events or
developments may result in a compromise or breach of the algorithms that we use
to protect our consumers' transaction data or our software vendors' products.
Any well-publicized compromise of security could deter use of the Internet in
general or use of the Internet to conduct transactions that involve
transmitting confidential information or downloading sensitive materials.
We have risks associated with international operations and expansions.
A part of our long-term strategy is to establish Autoweb.com in
international markets. However, the Internet, or our commerce, content and
community services model, may not become widely accepted in any market. In
addition, we expect that the success of any additional foreign operations we
initiate will be substantially dependent upon our member dealers, automotive-
related vendors and content services. We may experience difficulty in managing
international operations as a result of failure to locate an effective foreign
partner, competition, technical problems, local laws and regulations, distance
and language and cultural differences. Our international partners may not be
able to successfully market and operate our community model in foreign markets.
There are also certain risks inherent in doing business internationally,
including:
. cultural and business practices differences;
. fluctuations in currency exchange rates;
. political;
. legal and economic instability;
. seasonal reductions in business activity in certain other parts of
the world; and
. potentially adverse tax consequences.
One or more of such factors might have a material adverse effect on our
future international operations and, consequently, on our business, results of
operations and financial condition.
Certain existing stockholders own a large percentage of our voting stock.
Our officers, directors and 5% or greater stockholders beneficially own or
control, directly or indirectly, more than 70% of the outstanding shares of
common stock. As a result, if such persons act together, they will have the
ability to control all matters submitted to our stockholders for approval,
including (1) the election and removal of directors and (2) any merger,
consolidation or sale of all or substantially all of our assets.
We face Year 2000 risks.
The Year 2000 issue involves the potential for system and processing
failures of date-related data and is the result of the computer-controlled
systems using two digits rather than four to define the applicable year. For
21
example, computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities. We may be
affected by Year 2000 issues related to non-compliant information technology
("IT") systems or non-IT systems operated by us or by third parties. We have
completed our assessment of our internal and external (third-party) IT systems
and non-IT systems. Based upon our assessment, we believe we will require
upgrades, or patches, from certain vendors, including Microsoft Corporation,
which have provided certain software that we have included in our Web site.
Although none of these vendors has informed us of any specific delivery
schedule for receipt of their upgrades, we expect to receive their upgrades
later in 1999. At this point in our assessment, we believe we will become Year
2000 compliant shortly after receiving the necessary upgrades, or patches, from
certain vendors. We do not have a contingency plan. The costs associated with
remediating our noncompliant IT systems and non-IT systems have not been
material to date and we do not anticipate that such costs will be material in
the future, although we cannot assure you that such costs will not be material.
To the extent that our assessment is finalized without identifying any material
noncompliant IT systems operated by us or by third parties, the most reasonably
likely worst case Year 2000 scenario is a systematic failure beyond our
control, such as a prolonged telecommunications or electrical failure. Such a
failure could prevent us from operating our business, prevent users from
accessing our Web site, or change the behavior of advertising consumers or
persons accessing our Web site. We believe that the primary business risks, in
the event of such failure, would include lost advertising revenues, increased
operating costs, loss of consumers or persons accessing our Web site, and
claims of mismanagement, misinterpretation or breach of contract. Any of these
eventualities could have a material adverse effect on our business, results of
operations and financial condition.
Future sales of our common stock may depress our stock price.
Of the 25,050,156 shares of our common stock outstanding on June 30, 1999,
approximately 5,875,000 are freely tradable. Almost all of the remaining shares
of common stock are subject to lockup agreements prohibiting their disposition
until September 20, 1999. Sales of a substantial number of these shares in the
public market after the lockup period ends could cause the market price of our
common stock to decline.
Our Certificate of Incorporation and Bylaws and Delaware law contain provisions
that could discourage a takeover.
Certain provisions of Delaware law and our Certificate of Incorporation and
Bylaws could have the effect of delaying or preventing a change in control.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We considered the provisions of Financial Reporting Release No. 48,
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and
Qualitative Information about Market Risk Inherent in Derivative Financial
Instruments, Other Financial Instruments and Derivative Commodity Instruments."
We had no holdings of derivative financial or commodity instruments at June 30,
1999. However, we are exposed to financial market risks, including changes in
foreign currency exchange rates and interest rates. Much of our revenue,
expenses and capital expenditures are transacted in U. S. dollars.
22
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Sales of Registered Securities and Use of Proceeds
On March 23, 1999, the Company sold 5,550,000 shares of Common Stock in its
initial public offering at a price of $14.00 per share pursuant to a Form S-1
Registration Statement, No. 333-71177, which became effective March 22, 1999.
The principal underwriters for the offering were Credit Suisse First Boston
Corporation, Hambrecht and Quist, LLC, BancBoston, Robertson Stephens Inc., and
U.S. Bancorp Piper Jaffray, Inc. The Company received gross proceeds from the
offering of $77.7 million from which the Company paid $5.4 million for
underwriting discounts and commissions and the Company paid $1.2 million for
other offering expenses, none of which was paid directly or indirectly to any
directors, officers, persons owning ten percent or more of any class of equity
securities of the Company or any affiliates of the Company. From the effective
date of the Registration Statement through June 30, 1999, the Company invested
$46.2 million of the proceeds in commercial paper and applied the balance to
working capital.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report:
10.28 Advertising and Promotion Agreement dated June 14, 1999
between Registrant and Yahoo! Inc. *
10.29 Advertising and Promotion Agreement dated June 30, 1999
between Registrant and America Online, Inc. *
27.01 Financial Data Schedule (EDGAR version only)
(b) There were no reports on Form 8-K filed during the quarter ended
June 30, 1999.
* Confidential treatment has been requested with regard to certain
portions of this document. Such portions have been omitted from this filing and
have been filed separately with the Securities and Exchange Commission.
23
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
AUTOWEB.COM, INC.
/s/ Dean A. DeBiase
Date: August 16, 1999 By: _________________________________
Dean A. DeBiase
President and Chief Executive
Officer
Date: August 16, 1999 /s/ Samuel M. Hedgpeth III
By: _________________________________
Samuel M. Hedgpeth III
Chief Financial Officer
24