UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 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: 000-29518
SHOPPING.COM
(Exact name of Registrant as specified in its charter)
CALIFORNIA 33-0733679
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2101 EAST COAST HIGHWAY, CORONA DEL MAR, CALIFORNIA 92625
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 640-4393
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
As of December 8, 1998, there were 6,013,664 shares of the Registrant's no par
value common shares outstanding.
1
FORM 10-QSB
For the Quarterly Period Ended October, 1998
Item Page
- ---- ----
PART I. FINANCIAL INFORMATION
1. FINANCIAL STATEMENTS (condensed) 4
Balance Sheet at October 31, 1998 4
Statements of Operations for the nine months
ended October 31, 1997 and 1998 5
Statements of Cash Flows for the nine months
ended October 31, 1997 and 1998 6
Notes to Financial Statements 7
2. MANAGEMENT DISCUSSION AND ANALYSIS 19
Forward Looking Statements 20
Overview 20
Results of Operations 22
Liquidity and Capital Resources 26
Employees 29
Factors That May Affect Future Performance 29
PART II. OTHER INFORMATION
1. Legal Proceedings 46
2. Changes in Securities 51
3. Defaults Upon Senior Securities 63
4. Submission of Matters to a Vote of Security Holders 63
2
5. Other Information 63
6. Exhibits and Reports on Form 8-K 64
Signatures 65
Exhibit Index 66
3
PART I - FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
--------------------
SHOPPING.COM
BALANCE SHEET
As of October 31, 1998
(Unaudited)
-----------
ASSETS
------
Current assets
Cash and cash equivalents $ 336,319
Accounts/ advances receivable, net 74,904
Other receivables 19,778
Prepaid expenses 507,794
Inventories 46,163
Current portion of loan origination fees 1,150,246
-----------
Total current assets 2,135,204
Furniture and equipment, net 2,957,455
Deposits 504,041
Other assets 29,534
-----------
Total assets $ 5,626,234
===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities
Current portion of capital lease obligation $ 224,527
Accounts payable 2,032,973
Subordinated notes payable 1,325,000
Notes payable 900,000
Secured promissory note 300,000
Convertible promissory note 500,000
Accrued legal fees and related costs 323,535
Accrued termination and severance 260,000
Other accrued liabilities 729,470
-----------
Total current liabilities 6,595,505
Capital lease obligation, net of current portion 151,682
8% convertible debentures 2,500,000
-----------
Total liabilities 9,247,187
-----------
Commitments and contingencies
Shareholders' equity (deficit)
Preferred stock, no par value, 5,000,000 share
authorized, shares issued and outstanding - none --
Common stock, no par value, 20,000,000 shares
authorized, 4,404,601 shares issued and outstanding 21,049,706
Accumulated deficit (24,670,659)
-----------
Total shareholders' equity (deficit) (3,620,953)
-----------
Total liabilities and shareholders' equity $ 5,626,234
============
The accompanying notes are an integral part of these financial statements.
4
SHOPPING.COM
STATEMENTS OF OPERATIONS
(UNAUDITED)
3 MONTHS ENDED 9 MONTHS ENDED
OCTOBER 31, OCTOBER 31,
---------------------------- ------------------------------
1998 1997 1998 1997
Net sales $ 2,056,850 $ 321,281 $ 4,008,467 $ 376,822
Cost of sales 2,274,428 306,738 4,196,451 357,246
----------- ------------ ------------ -----------
Gross profit (deficit) (217,578) 14,543 (187,984) 19,576
Operating expenses:
Advertising and marketing 732,618 262,504 3,183,925 274,107
Product development 663,595 258,677 2,734,707 523,419
General and administrative 2,366,922 778,926 10,129,343 1,572,789
----------- ------------ ------------ -----------
Total operating expenses 3,763,135 1,300,107 16,047,975 2,370,315
----------- ------------ ------------ -----------
Loss from operations (3,980,713) (1,285,564) (16,235,959) 2,350,739
Other income (expense):
Loss on disposition of assets -- -- (89,913) --
Interest Income 6,141 -- 54,127 --
Interest Expense (1,681,414) ( 36,811) (2,675,188) (43,349)
----------- ------------ ------------ -----------
Total other income (expense) (1,675,273) ( 36,811) (2,710,974) (43,349)
----------- ------------ ------------ -----------
Net Loss $(5,655,986) $ (1,322,375) $(18,946,933) $(2,394,088)
=========== ============ ============ ===========
Basic Loss Per Share $ (1.32) $ (.98) $ (4.67) $ (1.83)
=========== ============ ============ ===========
Diluted Loss Per Share $ (1.32) $ (.98) $ (4.67) $ (1.83)
=========== ============ ============ ===========
Weighted Average Shares Outstanding 4,298,814 1,350,217 4,053,523 1,305,321
=========== ============ ============ ===========
The accompanying notes are an integral part of these financial statements.
5
SHOPPING.COM
STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED OCTOBER 31,
1998 1997
------------- ------------
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities
Net loss $(18,946,933) $(2,394,088)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation of furniture and equipment 477,151 71,622
Common stock issued for advertising 1,596,600 --
Amortization of loan origination fees 181,608 65,361
Amortization of deferred financing costs
related to beneficial conversion feature
of debentures 1,240,300 --
Amortization of deferred financing costs related
to beneficial conversion feature of convertible
debentures 262,500 --
Expense recognized from issuing below-market
stock options 2,812,626 --
Expense recognized from issuing warrants
below market value 1,017,318 --
Expense recognized from issuing common stock
below market value -- 6,000
Loss on disposition of assets 89,913
Other 86,233
Issuance of Common Stock to pay expenses -- 48,000
Decrease (Increase) in prepaid expenses 561,627 (263,672)
Decrease (Increase) in inventories (46,163) --
Decrease (Increase) in other assets (333,834) (101,858)
Decrease (Increase) in accounts/advances receivable 72,480 (174,747)
Decrease (Increase) in other receivables (2,221) --
Increase (Decrease) in accounts payable 1,183,259 973,191
Increase (Decrease) in other accrued liabilities 1,087,942 (20,577)
------------ -----------
Net cash used in operating activities (87,599,594) (1,790,768)
------------ -----------
Cash flows from investing activities
Purchase of furniture and equipment (799,757) (1,370,816)
------------ -----------
Net cash used in investing activities (799,757) (1,370,816)
------------ -----------
Cash flows from financing activities -- --
Payments on note payable - related party -- (50,000)
Proceeds from the issuance of notes payable 3,225,000 1,960,000
Payments on Notes Payable (200,000) --
Payments of loan origination fees (395,000) (234,000)
Payments on capital lease obligations (63,510) 5,842
Proceeds from the issuance of preferred stock,
Series A -- 200,000
Proceeds from the issuance of preferred stock,
Series B -- 1,489,781
Proceeds from the issuance of 8% convertible debentures 2,500,000 --
Payment of offering costs -- (57,226)
Proceeds from the issuance of common stock -- 25,000
------------ -----------
5,066,490
Net cash provided (used) by financing activities -- 3,327,713
------------ -----------
Net increase (decrease) in cash (4,492,861) 166,129
Cash, beginning of period 4,829,180 63
------------ -----------
Cash, end of period $ 336,319 $ 166,192
============ ===========
The accompanying notes are an integral part of these financial statements.
6
SHOPPING.COM
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
- ------
The accompanying condensed financial statements have been prepared in conformity
with generally accepted accounting principles for interim financial information
as contemplated by the SEC under Item 310(b) of Regulation S-B. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles. In the opinion of management, all normal,
recurring adjustments considered necessary for a fair presentation have been
included. The interim financial statements should be read in conjunction with
the Company's January 31, 1998 annual report on Form 10-KSB. The results of
operations for the nine months ended October 31, 1998 are not necessarily
indicative of the operating results that may be expected for the fiscal year
ending January 31, 1999.
NOTE 2: FURNITURE AND EQUIPMENT
- ------
Furniture and equipment consist of the following:
October 31, 1998
----------------
Computer hardware $1,943,637
Computer software 1,297,882
Furniture & equipment 297,248
Leasehold improvements 102,708
----------
3,641,475
Less: Accumulated depreciation 684,020
----------
$2,957,455
==========
In October 1998, the Company purchased computer equipment for $40,000 from
Waldron and Company, Inc., the underwriter for the Company's initial public
offering.
NOTE 3: ADVANCES - RELATED PARTIES
- ------
During the quarter ended October 31, 1998, an officer was advanced $367 from the
Company of which $367 was repaid during the quarter ended October 31, 1998.
Total advances to related parties as of October 31, 1998 were $19,240 which was
included in "Other receivables" in the balance sheet.
7
NOTE 4: CONSULTING FEES - RELATED PARTY
- ------
For the three months ended October 31, 1998, the Company retained the services
of certain consultants, which were also shareholders. Consulting expenses
amounted to approximately $126,748 of which $40,348 was unpaid as of October 31,
1998.
NOTE 5: SHAREHOLDERS' EQUITY
- ------
In September 1998, the Company executed an agreement whereby it issued 66,667
shares of common stock for $1,000,000 of radio advertising based on the average
fair market value of the common stock as of that date. The $596,600 of
advertisements were aired during the three months ending October 31, 1998,and
accordingly, $596,600 was expensed during the quarter ended October 31, 1998.
The remaining balance of $403,400 of advertisements will be aired in subsequent
quarters and will be expensed when aired. Up to 133,333 additional shares of
common stock may be issuable under the radio advertising agreement on the one-
year anniversary of the agreement, if on such date the average closing price of
the Company's common stock for the previous ten days is less than $15.00 per
share (as adjusted for any stock splits or recapitalizations).
NOTE 6: PROMISSORY NOTES
- ------
On May 15, 1998 the Company issued $1,225,000 of Promissory Notes, which have a
due date of six months from the date of issuance. In addition, on June 30, 1998
the Company issued a $100,000 Promissory Note that is also due six months from
the date of issuance. The Promissory Notes are unsecured, subordinated and carry
an interest rate of 10% per annum. The Promissory Notes include issuances to
certain existing shareholders of the Company.
In connection with the issuance of the $1,225,000 of Promissory Notes, warrants
to purchase 122,500 shares of Common Stock were issued which warrants are
exercisable until May 15, 2001 at a below-market exercise price of $14.00 per
share of Common Stock. In addition, warrants to purchase 10,000 shares of
Common Stock were issued relating to the $100,000 Promissory Note dated June 30,
1998 which are exercisable until June 8, 2001 at a below-market exercise price
of $14.00 per share of Common Stock. The exercise price of these warrants were
below market at the time of issuance and will therefore result in additional
interest charges of approximately $837,500 over the term of the Promissory Notes
of which $331,875 was expensed as interest during the quarter ended July 31,
1998.
In addition, the Company issued warrants to purchase 20,000 shares of Common
Stock at a then below-market exercise price of $14.00 per share of Common Stock
to Waldron & Co., Inc. for acting as the placement agent. These below-market
warrants will result
8
in additional interest charges of approximately $80,000 over the term of the
Promissory Notes of which $39,999 was expensed as interest during the quarter
ended October 31, 1998.
NOTE 7: CONVERTIBLE PROMISSORY NOTE
- -------
On August 25, 1998, the Company issued a $500,000 Convertible Promissory Note
which has a due date of six months from the date of issuance. The Convertible
Promissory Note carries an interest rate of 8% per annum and may be converted
for the principal and accrued interest into common stock at $10.00 per share. In
connection with the issuance of the Convertible Promissory Note, the Company
issued 50,000 warrants to purchase shares of common stock at an exercise price
of $10.00 per share when the Company's common stock was trading at $15.25 per
share. The warrants expire on August 20, 2001. Subsequently, on November 5,
1998, the Company agreed to revise the Convertible Promissory Note, Warrant
Agreement, and Subscription Agreement to reflect an exercise price of $3.30 per
share and a conversion price of $3.30 per share when the Company's common stock
was trading at $1.97 per share. The Company also issued warrants to purchase
10,000 shares of common stock to Waldron for acting as the placement agent. The
warrants issued to Waldron were issued under the same terms and conditions as
the warrants issued with the Convertible Promissory Note. The exercise prices of
these warrants was below market at the time of issuance and will therefore
result in additional interest charges of approximately $315,000 over the term of
the Convertible Promissory Note of which $131,250 was expensed as interest
during the quarter ending October 31, 1998. In addition, the conversion price
was below market at the time of the issuance and resulted in an additional
charge of $262,500 on August 25, 1998 as the Convertible Promissory Note was
available for conversion immediately upon the Company issuing the note.
NOTE 8: SECURED PROMISSORY NOTE
- -------
On September 15, 1998, the Company issued a Promissory Note in the amount of
$500,000 which is due at the earlier of the Company receiving $500,000 in
additional financing from another source or October 14, 1998. On October 13,
1998, the Company repaid $200,000. On November 2, 1998, the Company renegotiated
the outstanding balance of $300,000 and entered into a new Note which is due at
the earlier of the Company receiving $300,000 in additional financing from
another source or December 2, 1998. Currently the Company is attempting to
renegotiate the terms of the Note as the amount remains unpaid as of December
21, 1998. In connection with the previous negotiations and issuance of the
$300,000 Promissory Note, the Company also issued 30,000 additional warrants to
purchase shares of the Company's common stock at an exercise price of $1.65 when
the Company's common stock was trading at $1.81 per share. These warrants expire
on November 2, 2003. The exercise price of these warrants was below market at
the time of issuance and will therefore result in additional interest charges of
$4,860. One of the Company's directors is also a member of the Board of
Directors of the corporation to which the Company issued the Promissory Note.
The Promissory Note carries an interest rate of 10% per annum and is secured by
a Non-Recourse Guaranty and Pledge Agreement by Mr. Robert J. McNulty, a
consultant of the Company. In connection with the issuance of the original
9
$500,000 Promissory Note, the Company also issued 30,000 warrants to purchase
shares of common stock at an exercise price of $2.25 per share. The warrants
expire on September 15, 2003.
On October 1, 1998, the Company borrowed $900,000 from three accredited
investors. On November 10, 1998, this amount was repaid out of the proceeds
received from the issuance of 8% Convertible Debentures in the principal amount
of $2,500,000 that were received from the above transaction during November,
1998.
NOTE 9: 8% CONVERTIBLE DEBENTURES
- ------
In June, 1998 the Company entered into an agreement whereby the Company issued
8% Convertible Debentures due May 31, 2000 in the principal amount of
$1,250,000. In addition, in July, 1998 the Company entered into an agreement
whereby the Company issued 8% Convertible Debentures due July 10, 2000 in the
principal amount of $1,250,000. The Company completed the second and final
tranche of Debenture financing of $2,500,000 for a total of $5,000,000 during
November 1998. The 8% Convertible Debentures (the "Debentures") are convertible
into shares of Common Stock at a conversion price (the "Conversion Rate") not to
exceed $16.00 per share (the "Base Rate"). The holders of the Debentures will
receive one warrant to purchase a share of Common Stock for each two shares of
Common Stock issued in connection with the corresponding conversion of the
Debentures (the "Warrants"). The Warrants attributable to each conversion shall
have an exercise price equal to the lesser of (a) 120% of the lowest market
price for any three trading days prior to conversion or (b) 125% of the Base
Rate. The Warrants expire on June 5, 2003. In connection with the issuance of
the 8% Convertible Debentures, the Company issued certain below-market warrants
and common stock to the placement agents and affiliates of the placement agents
and made certain payments to placement agents, which resulted in the Company
capitalizing such financing costs as loan origination fees on the balance sheet.
These loan origination fees will be amortized as additional interest expense
ratably over the term of the Debenture agreements, or until the Debentures are
converted to common stock, at which time a charge to interest expense for the
balance of any unamortized loan origination fees will be recorded as additional
interest expense. The subsequent issuance of warrants by the Company allows the
holders of the Debentures to convert at 90% of the Conversion Rate and to
require the Company to redeem the Debentures or any portion of them for cash.
The Company has the right to redeem all or any portion of the Debentures,
subject to certain "Redemption Premium" provisions of the agreement. The holder
of the Debentures may require the Company to redeem the outstanding portion of
this Debenture if certain breaches occur.
On November 16, 1998, the Company issued 300,000 warrants in connection with the
issuance of 8% Convertible Debentures to purchase shares of the Company's common
stock at an exercise price of $2.00 when the Company's common stock was trading
at $7.25 per share. The exercise price of these warrants was below market at
the time of issuance and will therefore result in additional interest charges of
approximately $1,575,000.
Subsequently in December 8% Convertible Debentures in the amount of $2,500,000
and the corresponding interest accrued thereon has been converted into shares of
Common Stock in the aggregate amount of 1,790,389 shares of Common Stock.
10
NOTE 10: STOCK OPTIONS
- -------
As of October 31, 1998, the Company had outstanding options and warrants to
purchase an aggregate of 3,056,436 shares of Common Stock without giving
consideration to any warrants that may be issued upon conversion of the 8%
Convertible Debentures.
NOTE 11: WARRANTS
- -------
On September 24, 1998, the Company agreed to issue warrants to purchase 10,000
shares of the Company's common stock at an exercise price of $2.00 per share as
consideration to Typhoon Capital Consultants for its services related to
securing additional capital for the Company.
NOTE 12: COMMITMENTS AND CONTINGENCIES
- -------
CONSULTING AGREEMENTS
On August 1, 1998, the Company entered into a one-year Consulting Agreement with
Lorica Ltd. (the "Lorica Ltd. Agreement"). Pursuant to the Lorica Ltd.
Agreement, Lorica Ltd. will receive $3,500 per month plus reimbursement for out-
of-pocket expense for providing general consulting services relating to the
merchandising operations and specifically relating to the sourcing of toys and
games. Mr. Matthew Hill is the President of Lorica Ltd. and the son of Mr. Paul
Hill, a Director of the Company. This agreement was subsequently terminated on
October 1, 1998.
EMPLOYMENT AND RESIGNATION AGREEMENTS
On August 1, 1998, the Company entered into an agreement with Mr. Howard
Schwartz to serve as Executive Vice President. The term of the agreement is for
three years and is automatically renewed for one-year terms unless terminated by
either party with written notice given by June 1 of any year beginning June 1,
2001. The agreement provides for a bi-weekly base salary of $5,385 for the
first year, $7,692 for the second year and $8,461 for the third year. The
agreement also provides that Mr. Schwartz will participate in a formula based
bonus program to be approved annually by the Board of Directors and provides the
opportunity to receive up to an amount equal to his base compensation for
11
exceeding the Company's annual business plan net profit. In addition, Mr.
Schwartz will receive an automobile allowance of $1,000 per month. On December
2, 1998 Mr. Schwartz resigned as the Company's Executive Vice President, Finance
and Administration.
On August 31, 1998, Mr. Michael Miramontes resigned his employment effective
June 12, 1998. Pursuant to a Resignation Agreement dated August 31, 1998
between the Company and Mr. Miramontes, Mr. Miramontes will receive one year's
salary in the total amount of $162,000 of which $160,000 was accrued on the
Company's Balance Sheet as of July 31, 1998 and the remaining $2,000 was
additionally accrued during the quarter ended October 31, 1998. The Company
will make equal installments of $13,067 beginning September 1, 1998 for a period
of ten months.
On September 30, 1998, Mr. Douglas Hay resigned as Executive Vice President and
as a director effective September 30, 1998. Pursuant to a Resignation Agreement
dated September 30, 1998 between the Company and Mr. Douglas Hay, Mr. Hay will
receive a total amount of $80,000 which was accrued on the Company's Balance
Sheet as of October 31, 1998. The Company agreed to make two equal payments of
$20,000 payable on October 1 and November 1 and the remaining $40,000 will be
paid equally on the first of each month December 1, 1998 through March 1, 1999.
LEGAL PROCEEDINGS
As more fully described in Part I of the Company's Annual Report on Form 10-KSB
for the fiscal year ended January 31, 1998, Part II of the Company's Quarterly
Report on Form 10-QSB for the quarterly period ended April 30, 1998 and Part II
of this Form 10-QSB, the Company is subject to various litigation and SEC
investigations.
In March of 1998, the Company became aware that the Securities and Exchange
Commission (the "SEC") had initiated a private investigation to determine
whether the Company, Waldron & Co., Inc. ("Waldron"), then the principal market
maker in the Company's stock, or any of their officers, directors, employees,
affiliates or others had engaged in activities in connection with transactions
in the Company's stock in violation of the federal securities laws. The SEC
suspended trading in the Company's stock from 9:30 a.m. EST, March 24, 1998
through 11:59 p.m. EDT on April 6, 1998 pursuant to Section 12(k) of the
Securities Exchange Act of 1934. On April 30, 1998, the National Association of
Securities Dealers ("NASD") permitted the Company's Common Stock to resume
trading on the electronic bulletin boards beginning on April 30, 1998. Because
the SEC has not alleged any violations, it is difficult to predict the outcome
of their investigation. The Company continues, however, to fully cooperate with
the SEC inquiry. Nevertheless, the investigation by the SEC and the attendant
adverse publicity may not only reduce significantly the liquidity of that stock
but also make it difficult for the Company to raise additional capital to
continue its development and expansion. The inability of the Company to raise
additional capital would have material adverse effect on the Company's business,
prospects, financial condition and results of operations and may prevent the
Company from carrying out its business plan.
12
On May 6, 1998 Steven T. Moore on behalf of all persons who purchased shares of
the Company's stock between November 25, 1997 and March 26, 1998 filed suit in
United States District Court for the Central District of California alleging
violations of the federal securities laws by the Company, Robert McNulty,
Douglas Hay, Waldron and one other broker-dealer and two of those firm's
executives. The complaint charges that the defendants "participated in a scheme
and wrongful course of business to manipulate the price of [the Company's]
stock, which included: (i) defendant Waldron's refusal to execute sell orders;
(ii) the use of illegal stock parking; (iii) the use of illegal above-market
buy-ins to intimidate and dissuade potential short sellers from selling
[Company] stock short; (iv) the sale of [Company] shares to discretionary
accounts without regard to suitability; and (v) the dissemination of materially
false and misleading statements about [the Company's] operating performance and
its future prospects." The complaint further alleges that the Company "secretly
arranged to sell $250,000 of product to Waldron as part of defendants' effort to
have [the Company] post revenue growth prior to the [Company's] planned [initial
public offering]," that such sales constituted almost 25% of the Company's
revenues between its inception and March 26, 1998 and that the Company did not
disclose such sales or their significance in the Prospectus used in the
Company's initial public offering. The plaintiff seeks compensatory damages in
an unspecified amount, attorneys' fees and costs, injunctive relief,
disgorgement or restitution of the proceeds of the Company's IPO and the
defendants' profits from trading in the Company's stock, and the imposition of a
constructive trust over the Company's revenues and profits. By order dated
December 4, 1998, the plaintiffs were granted leave to file a second amended
consolidated complaint on behalf of each of the federal court actions. The
amended complaint has since been filed.
On April 28, 1998, Abraham Garfinkel on behalf of all persons who purchased
shares of the Company's stock between November 25, 1997 and March 26, 1998,
filed suit in the United States District Court for the Central District of
California alleging violation of the federal securities laws by the Company,
Robert McNulty, Douglas Hay, Waldron and Cery Perle, an affiliate of Waldron.
The complaint alleges that defendants acted in concert with each other to
manipulate the price of the Company's stock by, inter alia, "work[ing] closely
with defendant McNulty on a weekly basis whereby defendant McNulty would pass
the supposedly confidential information of those who had 'hit' or contacted
Shopping's website." The complaint alleges that the defendants also manipulated
the market by engaging in conduct similar to that alleged in the Martucci and
Moore actions. The complaint also alleges that the Company's prospectus was
misleading by the failure to disclose sales to Waldron as discussed above. The
plaintiffs seek damages similar to that sought by Martucci and Moore. By order
dated December 4, 1998, the plaintiffs were granted leave to file a second
amended consolidated complaint on behalf of each of the federal court actions.
The amended complaint has since been filed.
13
The second amended consolidated complaint filed in each of the federal court
actions expands the class period from the period beginning November 25, 1997 and
ending March 26, 1998 to the period beginning November 25, 1997 and ending
August 30, 1998. Further, the second amended complaint has added counts for
violation of sections 11 and 12(2) of the Securities Act of 1933, as amended, as
well as section 9 of the Securities Exchange Act of 1934.
On July 1, 1998, Mr. Garfinkel filed a companion state court complaint in the
Orange County Superior Court based on virtually the same operative facts as the
federal court claim . The state court action alleges claims for negligent
misrepresentation, common law fraud and deceit as well as violation of sections
25400, 25402 and 25500 of the California Corporations Code.
On April 16, 1998, Michael A. Martucci on behalf of all persons who purchased
shares of the Company's stock between November 25, 1997 and March 26, 1998,
filed suit in the California Superior Court for the County of Orange alleging
violations of the California securities laws by the Company, Robert McNulty,
Douglas Hay, Waldron and one other broker-dealer and two of those firm's
executives. The complaint charges that the defendants "participated in a scheme
and wrongful course of business to manipulate the price of [the Company's]
stock, which included: (i) defendant Waldron's refusal to execute sell orders;
(ii) the use of illegal stock parking; (iii) the use of illegal above-market
buy-ins to intimidate and dissuade potential short sellers from selling
[Company] stock short; (iv) the sale of [Company] shares to discretionary
accounts without regard to suitability; and (v) the dissemination of materially
false and misleading statements about [the Company's] operating performance and
its future prospects." The complaint further alleges that the Company "secretly
arranged to sell $250,000 of product to Waldron as part of defendants' effort to
have [the Company] post revenue growth prior to the [Company's] planned [initial
public offering]," that such sales constituted almost 25% of the Company's
revenues between its inception and March 26, 1998 and that the Company did not
disclose such sales or their significance in the Prospectus used in the
Company's initial public offering. The plaintiff seeks compensatory damages in
an unspecified amount, attorneys' fees and costs, injunctive relief,
disgorgement or restitution of the proceeds of the Company's IPO and the
defendants' profits from trading in the Company' s stock, and the imposition of
a constructive trust over the Company's revenues and profits. By order dated
December 4, 1998, the plaintiffs were granted leave to file a second amended
consolidated complaint on behalf of each of the federal court actions. The
amended complaint has since been filed.
14
On May 13, 1998, Kate McCarthy, on behalf of all persons who purchased shares of
the Company's stock between November 25, 1997 and March 26, 1998, filed suit in
the Orange County Superior Court alleging violation of the California securities
laws by the Company, Robert McNulty, Douglas Hay, Waldron and Cery Perle. The
complaint alleges that defendants acted in concert with each other to manipulate
the price of the Company's stock by, inter alia, "work[ing] closely with
defendant McNulty on a weekly basis whereby defendant McNulty would pass the
supposedly confidential information of those who had 'hit' or contacted
Shopping's website." The complaint alleges that the defendants also manipulated
the market by engaging in conduct similar to that alleged in the Martucci and
Moore actions. The complaint also alleges that the Company's prospectus was
misleading by the failure to disclose sales to Waldron as discussed above. The
plaintiffs seek damages similar to that sought by Martucci and Moore.
The individual actions in Orange County superior Court have been consolidated as
well. The plaintiffs have filed a second amended complaint which increased the
class period to the period beginning November 25, 1997 and ending August 30,
1998. The amended pleading added causes of action for violation of California
Corporations Code sections 25401 and 25501 against all defendants as well as
sections 25504 and 25504.1 against defendants Robert J. McNulty and Douglas R.
Hay.
On or about March 27, Gladstone filed a complaint against the company as well as
its underwriters in the United States District Court for the Southern district
of New York contending that the Company's common stock was being manipulated in
violation of federal securities laws. The plaintiffs seeks equitable relief in
the form of a temporary restraining order and order to show cause regarding the
issuance of a preliminary injunction to enjoin certain trading of the Company's
stock. The plaintiffs also requested that they be given the right to conduct
expedited discovery. On March 30, 1998, the federal court, the Hon. Edelstein
presiding, denied the temporary restraining order, denied order to show cause,
denied the request for expedited discovery and ordered the case transferred to
the United States District Court for the Central District of California. The
plaintiffs have filed a first amended complaint against the Company and Mr.
McNulty in the United States District Court for the Central District of
California which alleges the same claims as the New York federal court action.
The Company has yet to respond to the amended pleading but will vigorously
defend the same.
The Company denies that it engaged in any of the acts alleged in any of the
above complaints and intends to defend against these actions vigorously.
Nonetheless, and despite the Company's insurance coverage for such actions,
these class action suits may be very harmful to the Company. Diversion of
management time and effort from the Company's operations and the implementation
of the Company's business plan at this crucial time in the Company's development
may adversely and significantly affect the Company and its business. The
continued pendency of this litigation may make it difficult for the Company to
raise additional capital to continue its development and expansion and to
attract and retain talented executives. The inability of the Company to raise
additional capital would have material adverse effect on the Company's business,
prospects, financial condition and results of operations and may prevent the
Company from carrying out its business plan.
15
On July 8, 1997, Brian Leneck, a former officer of the Company, resigned. By
letter dated July 10, 1997, Robert McNulty, the former Chief Executive Officer
of the Company, tendered payment to Leneck to buy back 140,000 shares of Common
Stock of the Company pursuant to a shareholder agreement. Leneck rejected the
tender, claiming that the amount was not the fair market value of the shares.
On March 17, 1998, Leneck filed a lawsuit in Orange County Superior Court of
California against the Company, Robert McNulty and three members of the Board of
Directors at the time, Bill Gross, Edward Bradley and Paul Hill. Leneck's
lawsuit seeks damages for breach of contract, conversion, and breach of
fiduciary duty with respect to 70,000 shares. The Company believes that it has
meritorious defenses, as well as affirmative claims, against Leneck and intends
to vigorously protect its rights in this matter. On March 27, 1998, the Company
filed a lawsuit in Orange County Superior Court against Leneck asserting, inter
-----
alia, breach of contract, breach of implied covenant of good faith and fair
- ----
dealing, fraud and deceit, declaratory relief and specific performance.
Subsequently, the charges against Bill Gross, Edward Bradley and Paul Hill were
dismissed with prejudice.
On November 23, 1998 Ray Fisk filed a complaint against the Company for breach
of contract arising out of that certain Unsecured Promissory Note dated May 15,
1998 in the principal sum of $50,000 due and payable on or about November 15,
1998. The Company does not dispute its obligation under the terms of the note.
In a similar circumstance, the Company received correspondence dated December
17, 1998 from counsel to Daniel Kern, a noteholder who demanded payment on the
principal sum of $100,000 together with accrued interest. The Company does not
dispute this obligation. The noteholder also claims that the quiet filing of the
Company's registration statement on Form S-1 is misleading because it fails to
disclose that the Company could not or would not make payment on the note. The
Company vigorously disputes this contention.
Though a formal complaint has not been filed, Lewis, D'Amato, Brisbois &
Bisgaard, the Company's former counsel, forwarded on March 10, 1998, a "Notice
of Client's Right to Arbitration" in connection with legal services performed on
behalf of the Company. The law firm claims legal fees and costs in the amount
of $328,818.97 are due. The Company disputes the amount of fees owed and is in
the process of exploring whether the matter can be informally resolved.
However, the Company has accrued the claimed amount as of January 31, 1998.
Though settlement negotiations have occurred, it is more probable than not that
the Company will proceed with its election to have the matter submitted to
arbitration before the Los Angeles County Bar Association.
By written contracts dated December 12, 1997, the Company retained SoftAware,
Inc. to provide facilities and services relative to the maintenance, location
and supply of T1 lines to the Company's servers. Subsequent to the execution of
the contracts, SoftAware, Inc. experienced a prolonged electrical outage which
resulted in the disruption of Internet access and communications. Based upon
this and other factors, the Company determined that SoftAware, Inc. was
incapable of performing under the agreements and declined to proceed. By letter
dated May 22, 1998, SoftAware, Inc.'s counsel made written demand upon the
Company for $120,000.00 which purportedly reflected the compensatory damages
SoftAware suffered as a direct and proximate result of the Company's refusal to
proceed with performance under the contract. The Company rejected this demand
and offered to reimburse SoftAware, Inc. for reasonable costs incurred in
reliance on the contracts in an amount less than $3,000. SoftAware, Inc. has
rejected this offer and the parties are continuing settlement negotiations.
16
On September 12, 1998 the Company was served with a summons and complaint by
MTS, Incorporated filed in Sacramento County Superior Court of California for
damages arising out of the Company's as well as two other merchants' sale of the
video "Titanic" at below cost thereby purportedly constituting violation of
section 17043 and 17044 of California's Business and Professions Code as well as
the California Unfair Business Practices Act (Cal. Bus. & Prof. Code section
17200 et. seq.). The complaint alleges damages in excess of $25,000.00, that
sum trebled should a statutory violation be established, and attorneys' fees and
costs. The Company has not had an opportunity to investigate the allegations of
the complaint. Accordingly, a reasonable assessment of the Company's potential
exposure cannot be made until such time as discovery is completed. The action
will, however, require the engagement of defense counsel; and it is estimated
that substantial attorney fees may be incurred should litigation proceed to
trial.
On December 4, 1998, the Company received correspondence from counsel for Yahoo!
Inc. alleging breach of contract arising out of two agreements. Despite
acknowledging receipt of $200,000 from the Company in connection with these
contracts, it is contended that the alleged breach of the agreements entitles
Yahoo! Inc. to recover damages in excess of $2 million. Though the Company has
not had the opportunity to fully investigate Yahoo!'s demands, the entitlement
and measure of damages are disputed. Nevertheless, a reasonable assessment of
the Company's potential liability cannot be made at this time.
The Company is involved in two other labor related disputes. Although it is not
possible to predict the outcome of these disputes, or any future claims against
the Company related hereto, the Company believes that such disputes will not,
either individually or in the aggregate, have a material adverse effect on its
financial condition or results of operations.
As the outcome of these matters is uncertain and damages, if any, are not
estimable and the Company believes its insurance coverage is adequate to cover
any resulting liability, the Company did not maintain any reserves for such
matters at October 31, 1998.
17
TERMINATION AND BUY-OUT AGREEMENT
On June 1, 1998 Mr. McNulty resigned as President, Chief Executive Officer and
Director of Shopping.com. Pursuant to a Termination and Buy-Out Agreement dated
as of June 1, 1998 between the Company and Mr. McNulty, Mr. McNulty will receive
$500,000, with $100,000 payable on or before July 31, 1998 and the balance due
in $50,000 increments on or before each succeeding fiscal quarter end beginning
October 31, 1998 until fully paid. Amounts payable under this agreement are
payable on demand in one lump-sum payment at the option of Mr. McNulty upon
thirty days written notice to the Company in the event a majority of the current
members of the Board of Directors are replaced by new members. During the three
month period ended October 31, 1998, $10,000 was paid in cash as of October 31,
1998 pursuant to Mr. McNulty's Termination and Buy-out Agreement thus leaving an
unpaid balance of $40,000.
On September 25, 1998, the Company approved the conversion of $350,000 of its
liability related to the Robert McNulty Termination and Buy Out Agreement, as
previously discussed in Note 4, for common stock at a market price of $1.37 (the
stock price on September 25, 1998), resulting in an issuance by the Company of
255,474 common shares. In addition the remaining $40,000 liability as of
October 31, 1998 was paid on December 7, 1998.
NOTE 13: SUBSEQUENT ISSUANCES OF SECURITIES
- -------
On October 1, 1998, the Company borrowed $900,000 from three accredited
investors. On November 10, 1998, this amount was repaid out of the proceeds
received from the issuance of 8% Convertible Debentures in the principal amount
of $1,000,000 that was received during November, 1998.
On November 16, 1998, the Company issued 300,000 warrants in connection with the
issuance of 8% Convertible Debentures to purchase shares of the Company's common
stock at an exercise price of $2.00 when the Company's common stock was trading
at $7.25 per share. The exercise price of these warrants was below market at
the time of issuance and will therefore result in additional interest charges of
approximately $1,575,000.
On December 8, 1998 Robert McNulty, the Company's former Chief Executive Officer
and founder was issued warrants to purchase 130,000 shares of the Company's
common Stock at an exercise price of $8.00 per share, the market price on the
date of issuance. The warrants were issued to Robert McNulty, the Company's
former CEO and founder who is a consultant to and affiliate of the Company, in
consideration for a pledge of Mr. McNulty's stock as security for the $2,500,000
Promissory Note described below.
On December 7, 1998 the Company entered into a Secured Promissory Note (the
Note") in the amount of $2,500,000 which has been received net of related fees
and commissions
18
for which the proceeds are being used to fund ongoing operations. The Note is
secured by the intellectual property of the Company and certain shares of the
Company's Common Stock held by Robert McNulty, the Company's former Chief
Executive Officer and founder. The Note carries a 10% interest rate per annum
and is due and payable thirty (30) days from the date of the Note; provided
however, if within thirty (30) days from the date of this Note, certain
conditions are met the Payee would have the right at its option until January
10, 1999 to convert the principal amount of the Note together with all accrued
but unpaid interest into preferred stock. The Company issued warrants to
purchase 500,000 shares of Common Stock at an exercise price of $7.00 per share
in connection with the Secured Promissory Note. The warrants have a term of
three years.
In December 1998 the Company issued 1,790,389 shares of Common Stock pursuant to
terms of conversion related to the 8% Convertible Debentures in the principal
amount of $2.5 million and accrued interest thereon.
In addition, on December 10, 1998 the Company entered into an Agreement for A
Private Equity Line of Common Stock and Warrants Pursuant to Regulation D. The
commitment amount is $60 million, with an optional $40 million add-on, with
Swartz Private Equity, LLC.
On November 6, 1998 warrants to purchase 18,767 shares of the Company's Common
Stock were granted to Mark Asdourian, the Company's General Counsel. The
warrants have an exercise price of $1.781 per share which was the market price
on the date of grant. The warrants expire on November 6, 2003.
On November 6, 1998, Frank Denny, the Company's Chairman of the Board was
granted options to purchase 1,000,000 shares of the Company's Common Stock as
compensation for services to the Company. The options have an exercise price of
$1.781 per share which was the market price on the date of grant. One-third of
the options vest fully upon issuance, one-third vest on the first anniversary of
the date of grant and the remainder vest on the second anniversary of the date
of grant. The options expire five years from the date of grant.
On November 6, 1998 options to purchase 25,000 shares of the Company's Common
Stock were granted to each of Paul Hill, Ed Bradley and John Markley, each a
Director of the Company. The options have an exercise price of $1.781 per share
which was the market price on the date of grant. The options are fully vested
upon issuance and have a term of five years.
On November 6, 1998, options to purchase 347,000 shares of the Company's Common
Stock were granted to certain employees, including senior management, under the
Company's Stock Option Plan of 1997, as amended June 1998. The options have an
exercise price of $1.781 per share which was the market price on the date of
grant. Options to purchase 200,000 shares are fully vested upon issuance and the
remainder vest one-fourth on each anniversary of the date of grant for four
years.
As of December 14, 1998 (the "Date of Issuance"), the Company issued warrants to
purchase 490,385 shares of the Company's common stock at an exercise price of
$8.375 per share to Swartz Private Equity, LLC ("Swartz") in consideration for
Swartz entering into the Regulation D Common Stock Private Equity Line
Subscription Agreement (hereinafter referred to as "Private Equity Line of
Common Stock and Warrants Pursuant to Regulation D"). The warrants expire seven
years after the Date of Issuance.
ITEM 2. 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 financial
statements and the related notes thereto appearing elsewhere herein.
19
FORWARD LOOKING STATEMENTS
The following statements contained in this "Management's Discussion and Analysis
of Financial Condition and Results of Operations" include "forward looking"
information within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended,
and are subject to the safe harbor created by those sections. The forward
looking statements are based on current expectations, estimates and projections
about the Company's industry, management's beliefs and certain assumptions made
by management. All statements, trends, analyses and other information contained
in this report relative to the actual future results of the Company could differ
materially from those projected in the forward looking information. For a
discussion of certain factors that could cause actual results to differ
materially from those projected by the forward looking information, see "Factors
That May Affect Future Performance" herein. Except as required by law, the
Company undertakes no obligation to update any forward-looking statement,
whether as a result of new information, future events or otherwise. Readers,
however, should carefully review the factors set forth in other reports or
documents that the Company files from time to time with the SEC.
OVERVIEW
Shopping.com (the "Company") began operations in February, 1996, was
incorporated on November 22, 1996 and commenced selling on the Internet on July
11, 1997. The Company is an innovative Internet-based electronic retailer ("E-
retailer") specializing in retail marketing a broad range of products and
services at wholesale prices to both consumer and trade customers. Utilizing
proprietary technology, the Company has designed a fully-scalable systems
architecture for the Internet shopping marketplace.
The Company's management team combines the experiences of:
. Executives with extensive background in both retail and
warehouse/discount store formats.
. Executives who have experience in computer and information systems
design and development.
. Directors with entrepreneurial skills who currently oversee and manage
their own existing companies.
The Company began generating sales on July 11, 1997. For the nine months
ended October 31, 1998, the Company has generated sales of $4,009,314. The
Company anticipates that sales from the Company's site on the Internet on the
World Wide Web ("Web Site") will constitute substantially all of the Company's
sales. Over the next twelve
20
months, the Company intends to increase its revenues by pursuing an aggressive
advertising and marketing campaign aimed at attracting customers to shop on its
Web Site and to co-brand with other commercial partners which will help increase
the Company's brand name recognition as well as increase traffic on the
Company's Web Site. The Company must seek additional financing estimated at $14
million over the next twelve months in order to sustain operations or achieve
planned expansion. This figure is lower than previously anticipated due to the
Management's change in the Company's choice of advertising media. Previously,
the Company had used portal advertising which Management has subsequently
determined is not as effective as using "referral site" advertising. Therefore,
Management has changed its planned advertising expenditures and program to
primarily utilize referral site advertising thus reaping the benefits of
substantially lower advertising costs. The funding is anticipated to come from
the Company entering into an agreement on December 10, 1998 for a Private Equity
Line of Common Stock and Warrants Pursuant to Regulation D. The commitment
amount is $60 million, with an optional $40 million add-on, with Swartz Private
Equity, LLC. There can be no assurance that such additional funds will be
available or that, if available, such additional funds will be on terms
acceptable to the Company.
The Company anticipates that its operations will incur significant
operating losses for the foreseeable future. The Company believes that its
success will depend upon its ability to increase obtain sales on its Web Site
significantly over the next twelve months, which cannot be assured. The
Company's ability to generate sales is subject to substantial uncertainty. The
Company's 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
online commerce. Such risks for the Company include, but are not limited to, an
evolving and unpredictable business model and the management of growth. To
address these risks, the Company must, among other things, obtain a customer
base, implement and successfully execute its business and marketing strategy,
continue to develop and upgrade its technology and transaction-processing
systems, improve its Web Site, provide superior customer service and order
fulfillment, respond to competitive developments, and attract, retain and
motivate qualified personnel. There can be no assurance that the Company will
be successful in addressing such risks; and the failure to do so could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations. Additionally, the Company's lack of an
operating history makes predictions of future operating results difficult to
ascertain. Accordingly, there can be no assurance that the Company will be able
to generate sales, or that the Company will be able to achieve or maintain
profitability. Since inception, the Company has incurred significant losses
and, as of October 31, 1998, had an accumulated deficit of approximately $25
million. The Company substantially increased its operating expenses over the
past quarter in order to, among other things, fund increased advertising and
marketing efforts, expand and improve its Internet operations and user support
capabilities, and develop new Internet content and applications. The Company
expects to continue to incur significant operating expenses
21
on a quarterly and annual basis for the foreseeable future. To the extent such
increases in operating expenses are not offset by revenues, the Company will
continue to incur significant losses.
The Company's quarterly operating results may fluctuate significantly as a
result of a variety of factors, many of which are outside of the Company's
control. See "Factors That May Affect Future Performance - Unpredictability Of
Future Revenues; Potential Fluctuations In Quarterly Operating Results;
Seasonality."
In seeking to effectively implement its business plan, the Company may
elect, from time to time, to make certain marketing or acquisition decisions
that could have a material adverse effect on the Company's business, prospects,
financial condition and results of operations. Due to all of the foregoing
factors, it is likely that in some future quarters, the Company's results of
operations may be below the expectations of securities analysts and
shareholders. In such event, the price of the Company's Common Stock could be
materially adversely affected.
RESULTS OF OPERATIONS
The following is a discussion of the results of operations for the three months
ended October 31, 1998. While the Company is providing some comparisons of its
results of operations with the prior year, such comparisons may have a limited
utility as the Company only commenced selling products over the Internet on July
11, 1997.
Net Sales
Quarter Ended Nine Months
------------- -----------
Ended
-----
- ---------------------------------------------------------------------------------------------------
October 31, 1998 October 31, 1997 % Change October 31, 1998 October 13, 1997 % Change
- ------------------- ---------------- -------- ---------------- ----------------- --------
- ---------------------------------------------------------------------------------------------------
2,056,850 321,281 540 4,008,467 376,822 964
- ---------------------------------------------------------------------------------------------------
Although the Company commenced operations in February 1996, it did not begin
selling products and services on its Web Site until July 11, 1997 prior to which
time it was still in the process of evaluating the technical features of its Web
Site. For the nine months ended October 31, 1998, the Company generated net
sales of $4,008,467. Net sales are composed of the selling price of merchandise
sold by the Company, net of returns, and includes freight charged to the
Company's customers. Growth in net sales reflects a significant increase over
the prior year primarily due to the growth of the Company's customer base, as
well as reflecting a full nine months of sales whereas in 1997 the Company only
began selling on the Internet July 11, 1997. The sole source of funds for the
Company from the date of inception through October 31, 1998, other than the sale
of equity and debt securities, has been from sales of products. For the three
months ended
22
October 31, 1998, sales of $1,758, which was less than 1% of the Company's net
sales during the quarter ended October 31, 1998, were sales to Waldron & Co.,
Inc. ("Waldron"), the Company's former underwriter and market maker. Such sales
consisted primarily of computer equipment and office supplies and some of these
transactions allowed the Company to generate higher gross margins. The Company
had sales to various shareholders which each were less than 1% of net sales of
the Company for the three months ended October 31, 1998. The Company believes
that it is not dependent upon Waldron or any other customer, related or
otherwise, and that the loss of Waldron as a customer would not have a material
adverse impact on the Company. The Company expects the sales to any one
customer will continue to decline as a percentage of total sales. The Company's
business model is based on a low profit margin coupled with a large volume of
sales to a broad customer base. The Company records sales at the time products
are shipped to customers, which includes the retail sales price of the product
and any shipping and handling charges billed to its customers.
Cost of Sales
Quarter Ended Nine Months
------------- -----------
Ended
-----
- ---------------------------------------------------------------------------------------------------
October 31, 1998 October 31, 1997 % Change October 31, 1998 October 31, 1997 % Change
- ------------------- ---------------- -------- ---------------- ----------------- --------
- ---------------------------------------------------------------------------------------------------
$2,274,428 $306,738 641 $4,196,451 $357,246 1,075
- ---------------------------------------------------------------------------------------------------
Cost of sales include the actual cost the Company pays its vendors for the
products and the actual shipping and handling charges incurred by the Company to
ship products to its customers. The cost of sales for the three months ending
October 31, 1998 was $2,274,428 or approximately 110.6% of net sales. The
Company's gross profit deficit was approximately a negative 10.6% for the three
months ended October 31, 1998. The Company experienced a negative gross margin
due, in part, from the unavailability of certain products as well as the
inability and unwillingness of certain vendors to extend adequate credit to
handle the increased volume. These products were obtained through other channels
of distribution and from alternate suppliers at higher prices. In addition, the
Company encountered additional price competition from other E-commerce retailers
in several product categories. Finally, the decline in the Company's gross
margin was due primarily to an overall increase in the percentage of sales for
those products and categories which had highly promotional pricing such as
computers and consumer electronics. The failure to generate sales with
sufficient margins to cover its operating expenses will result in losses and
could have a material adverse effect on the Company's business, prospects,
financial condition and results of operations.
23
Advertising and Marketing Expenses
Quarter Ended Nine Months
------------- -----------
Ended
-----
- ---------------------------------------------------------------------------------------------------
October 31, 1998 October 31, 1997 % Change October 31, 1998 October 31, 1997 % Change
- ------------------- ---------------- -------- ---------------- ----------------- --------
- ---------------------------------------------------------------------------------------------------
$ 732,618 $262,504 179 $3,183,925 $274,107 1,062
- ---------------------------------------------------------------------------------------------------
Advertising and marketing expenses consist primarily of media costs related to
advertising, promotion and marketing literature. Advertising and marketing
expenses incurred by the Company for the three months ending October 31, 1998
were $732,618 or approximately 35.6% of net sales. Of this amount, $596,000 was
paid by issuing shares of the Company's Common Stock. The Company intends to
significantly increase its advertising and marketing expenses in future periods,
including utilizing the remaining balance of advertising purchased with the
issuance of Common Stock in exchange for $1,000,000 of advertising to run during
the fourth quarter ending January 31, 1999. While the Company is hopeful that
its net sales will also increase in future periods so that its advertising and
marketing expense will represent a decreasing percentage of net sales, the
Company is not able to predict whether its sales will increase by a sufficient
amount for this to occur. Furthermore the Company anticipates that it will take
advantage of referral site advertising. No assurance can be given that the
Company will achieve increased net sales or that marketing expense will decrease
as a percentage of sales.
Product Development Expenses
Quarter Ended Nine Months
---------------- ----------------
Ended
-----
- --------------------------------------------------------------------------------------------------
October 31, 1998 October 31, 1997 % Change October 31, 1998 October 31, 1997 % Change
- ------------------- ---------------- -------- ---------------- ---------------- --------
- --------------------------------------------------------------------------------------------------
$ 663,595 $258,677 157 $2,734,707 $523,419 422
- --------------------------------------------------------------------------------------------------
Product development expenses consist primarily of costs incurred by the Company
to develop and enhance its Web Site. Product development expenses include
compensation and related expenses, depreciation and amortization of computer
hardware and software, and the cost of acquiring, designing, developing and
editing Web Site content. Product development expenses incurred by the Company
for the three months ended October 31, 1998 were approximately $663,595 or
approximately 32.3% of net sales. The increase of product development expenses
from the same periods in prior years was primarily related to the utilization of
additional temporary personnel to enhance features, content and functionality of
the Company's Web Site, transaction processing systems and proprietary customer
service software. However, utilization of such personnel and, as a result,
product development expense have decreased from the quarter ended July 31, 1998.
The Company believes that significant investments in enhancing its Web Site will
be necessary to become and remain competitive. As a result, the Company may
continue to incur, or increase the level of, product development expenses.
24
General and Administrative Expenses
Quarter Ended Nine Months
------------- -----------
Ended
-----
- --------------------------------------------------------------------------------------------------
October 31, 1998 October 31, 1997 % Change October 31, 1998 October 31, 1997 % Change
- ------------------- ---------------- -------- ---------------- ---------------- --------
- --------------------------------------------------------------------------------------------------
$2,366,922 $778,926 204 $10,129,343 $1,572,789 544
- --------------------------------------------------------------------------------------------------
General and administrative expenses consist primarily of compensation, rent
expense, fees for professional services and other general corporate expenses.
General and administrative expenses incurred by the Company for the three
months ended October 31, 1998 were $2,366,922, or approximately 115.1% of net
sales. The Company recorded $80,000 of nonrecurring expenses related to the
resignation of the Company's former Executive Vice President, of which $60,000
remains payable as of October 31, 1998. The increase in such expenses from the
previous year resulted primarily from the Company commencing actual sales
including hiring additional personnel to handle the increased volume. General
and administrative expenses should significantly increase in future periods if
the Company is successful in raising additional capital and able to, among other
things, increase hiring and expansion of facilities. In addition, the Company
experienced an increase in expenses related to legal and other professional fees
incurred by the Company from prior periods.
Interest Income and Expense
Quarter Six Months
------- ----------
Ended Ended
----- -----
- ------------------------------------------------------------------------------------------
October October October October
31, 31, % 31, 31, %
1998 1997 Change 1998 1997 Change
----------- ----------- ------- ----------- ----------- ----------
- ------------------------------------------------------------------------------------------
Interest
Expense $1,681,414 $36,811 4,468 $2,675,188 $43,349 6,071
- ------------------------------------------------------------------------------------------
Interest
Income $ 6,141 -0- N/A $ 54,127 -0- N/A
- ------------------------------------------------------------------------------------------
Interest income on cash and cash equivalents was $6,141 or approximately .30% of
net sales. Interest income earned was due to the Company having certain
interest-bearing cash and cash equivalents accounts and decreased from the
previous quarter due to lower cash and cash equivalent balances.
Interest expense for the three months ended October 31, 1998 was $1,681,414 or
approximately 81.7% of net sales and is partially attributable to accrued
interest on Promissory Notes and 8% Convertible Debentures. In addition the
noncash charge related to the issuance of below market stock warrants along with
the charge for the below market beneficial conversion associated with the 8%
Convertible Debentures. In addition the Company has had to incur additional
general and administrative expenses related to professional fees related to
being a public company, defending actions brought against the Company and
expertise required to raise additional capital.
25
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity were cash and cash equivalents
derived from public and private sales of the Company's equity and debt
securities. The sole source of funds for the Company from the date of inception
through October 31, 1998, other than the sale of equity and debt securities, has
been from sales of product.
Capital expenditures from February 1, 1998 through October 31, 1998, were
$799,757. The Company has current and long-term capital lease obligations for
certain office equipment, the aggregate amount of which, as of October 31, 1998
was $376,208. The Company anticipates a substantial increase in its capital
expenditures in 1998 consistent with its anticipated growth; provided that the
Company is able to raise sufficient capital to fund that growth.
The Company experienced a net loss of $18,946,933 and generated net sales
of $4,008,467 for the nine month period ended October 31, 1998. THE COMPANY'S
ABILITY TO SURVIVE AND GROW FOR THE IMMEDIATE FUTURE WILL DEPEND ON THE
COMPANY'S ABILITY TO RAISE ADDITIONAL CAPITAL FROM PUBLIC OR PRIVATE EQUITY OR
DEBT SOURCES. IN ADDITION, THE COMPANY BELIEVES THAT IT WILL NEED TO PROMPTLY
RAISE ADDITIONAL FUNDS IN ORDER TO AVAIL ITSELF OF ANY UNANTICIPATED
OPPORTUNITIES (SUCH AS MORE RAPID EXPANSION, ACQUISITIONS OF COMPLEMENTARY
BUSINESSES OR THE DEVELOPMENT OF NEW PRODUCTS OR SERVICES), TO REACT TO
UNFORESEEN DIFFICULTIES (SUCH AS THE LOSS OF KEY PERSONNEL OR THE REJECTION BY
INTERNET USERS OF THE COMPANY'S WEB SITE CONTENT) OR TO OTHERWISE RESPOND TO
UNANTICIPATED COMPETITIVE PRESSURES. THE COMPANY HAS USED RATHER THAN PROVIDED
CASH FROM ITS OPERATIONS. THESE FACTORS RAISE A SUBSTANTIAL DOUBT ABOUT THE
COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN. IN VIEW OF THE MATTERS
DESCRIBED ABOVE, RECOVERABILITY OF A MAJOR PORTION OF THE COMPANY'S RECORDED
ASSET AMOUNTS IS DEPENDENT UPON THE COMPANY'S ABILITY TO RAISE SUFFICIENT
CAPITAL TO FUND ITS WORKING CAPITAL REQUIREMENTS UNTIL THE COMPANY CAN GENERATE
SUFFICIENT SALES VOLUME TO COVER ITS OPERATING EXPENSES.
Given its lack of operating history and the uncertainty of the Company's
ability to continue as a going concern, certain vendors of products sold by the
Company are not prepared to advance normal levels of credit to the Company. In
addition, a lack of available cash on hand has forced the Company to delay
payment to most of its vendors exacerbating the unwillingness of vendors to
extend credit to the Company. Such unwillingness to extend credit along with a
substantial increase in product volume has caused the Company to exceed its
current credit limits, resulting in some vendors refusing to ship to the
Company's customers prior to payment. This has in turn slowed delivery to
customers, putting the Company at a competitive disadvantage and increasing
customer complaints. While the Company has increased its credit lines with some
of its vendors and is working to resolve its credit problems with most of its
vendors, a lack of capital to finance the Company's operations along with a
large volume of sales may cause the Company to once again exceed its current
credit limits.
Subsequent to October 31, 1998, the Company entered into various agreements
related to the issuance of debt and equity securities which include the issuance
of a $500,000 Convertible Promissory Note on August 25, 1998 which has a due
date of six months from the date of issuance. The Convertible Promissory Note
carries an interest rate of 8% per annum and may be converted for the principal
and accrued interest into common stock at $10.00 per share. In connection with
the issuance of the Convertible Promissory Note, the Company issued 50,000
warrants to purchase shares of common stock at an exercise price of $10.00 per
share when the Company's common stock was trading at $15.25 per share. The
warrants expire on August 20, 2001. Subsequently, on November 5, 1998, the
Company agreed to revise the Convertible Promissory Note, Warrant Agreement, and
Subscription Agreement to reflect an exercise price of $3.30 per
26
share and a conversion price of $3.30 per share when the Company's common stock
was trading at $1.97 per share. The Company also issued warrants to purchase
10,000 shares of common stock to Waldron for acting as the placement agent. The
warrants issued to Waldron were issued under the same terms and conditions as
the warrants issued with the Convertible Promissory Note but were subsequently
revised. The exercise price of these warrants were below market at the time of
issuance and will therefore result in additional interest charges of
approximately $315,000 over the term of the Convertible Promissory Note. In
addition, the conversion price was below market at the time of the issuance and
resulted in an additional charge of $262,500 on August 25, 1998 as the
Convertible Promissory Note is available for conversion immediately upon the
issuance of the Note.
On September 15, 1998, the Company issued a Promissory Note in the amount
of $500,000 which became due at the earlier of the Company receiving $500,000 in
additional financing from another source or October 14, 1998. During October,
1998, the Company repaid $200,000. On November 2, 1998, the Company
renegotiated the outstanding balance of $300,000 and entered into a new Note
which is due at the earlier of the Company receiving $300,000 in additional
financing from another source or December 2, 1998. In connection with the
renegotiations and issuance of the $300,000 Promissory Note, the Company also
issued 30,000 additional warrants to purchase shares of the Company's common
stock at an exercise price of $1.65 when the Company's common stock was trading
at $1.81 per share. These warrants expire on November 2, 2003. The exercise
price of these warrants was below market at the time of issuance and will
therefore result in additional interest charges of $4,860. As of December 21,
1998 the Company has not repaid the $300,000 and is currently negotiating to
extend the terms of the $300,000 Promissory Note. One of the Company's
directors is also a member of the Board of Directors of the corporation to which
the Company issued the Promissory Note. The Promissory Note carries an interest
rate of 10% per annum and is secured by a Non-Recourse Guaranty and Pledge
Agreement by Mr. Robert J. McNulty, a consultant of the Company. In connection
with the issuance of the original $500,000 Promissory Note, the Company also
issued 30,000 warrants to purchase shares of common stock at an exercise price
of $2.25 per share. The warrants expire on September 15, 2003.
The Company's 10% unsecured Promissory Notes in the principal amount of
$1,225,000 were due on November 15, 1998 together with accrued interest thereon.
In addition, the Company had a $100,000 Promissory Note come due in December
1998. The Company has not paid the amounts due, which constitutes an Event of
Default under the terms of the Notes. The Company is negotiating with certain of
the noteholders to either extend the term of the Notes or convert the Notes to
equity. A few noteholders have expressed an interest in converting their notes
to equity, while others remain insistent upon payment.
On November 16, 1998, the Company issued 300,000 warrants in connection
with the issuance of 8% Convertible Debentures to purchase shares of the
Company's common stock at an exercise price of $2.00 when the Company's common
stock was trading at $7.25 per share. The exercise price of these warrants was
below market at the time of issuance and will therefore result in additional
interest charges of approximately $1,575,000.
As of October 31 1998, the Company's available cash and cash equivalents
was minimal. Subsequent to October 31, 1998, the Company issued an additional
$2,500,000 of 8% Convertible Debentures (the "Debentures) to existing Debenture
holders. The Company received net proceeds of approximately $2,175,000 of which
$900,000 was
27
used to repay certain existing debts and the balance was used to fund
ongoing operations. At the present time, the Company's available cash and cash
equivalents is sufficient to sustain operations through the Company's fiscal
year ending January 31, 1999.
On December 7, 1998 the Company entered into a Secured Promissory Note (the
"Note") in the amount of $2,500,000 which has been received net of related fees
and commissions, the proceeds of which are being used to fund ongoing
operations. The Note is secured by the intellectual property of the Company and
certain shares of the Company's Common Stock held by Robert McNulty, the
Company's former Chief Executive Officer and founder. The Note carries a 10%
interest rate per annum and is due and payable thirty (30) days from the date of
the Note; provided, however, if within thirty (30) days from the date of this
Note, certain conditions are met, the Payee would have the right at its option
until January 10, 1999 to convert the principal amount of the Note together with
all accrued but unpaid interest into preferred stock. Mr. McNulty, currently a
consultant to and affiliate of the Company, was granted warrants to purchase
130,000 shares of the Company's Common Stock at an exercise price of $8.00 per
share in consideration for his pledge of his Common Stock as security for the
Note.
In addition, on December 10, 1998 the Company entered into an Agreement for
A Private Equity Line of Common Stock and Warrants Pursuant to Regulation D. The
commitment amount is $60 million, with an optional $40 million add-on, with
Swartz Private Equity, LLC ("Swartz"). Pursuant to such agreement and subject to
some limitations, the Company may periodically require Swartz to purchase a
number of shares equal to as much as 25% of the sum of the daily reported
trading volumes in the outstanding Common Stock on the OTC Bulletin Board over a
twenty trading day period following the date designated in the Company's
election to draw down on the line. However, the Company may only require such a
purchase after a registration statement for the resale of such shares becomes
effective. It is not anticipated that proceeds from this agreement will be
available to repay the Secured Promissory Note in the principal amount of
$2,500,000 when such note becomes due and payable on January 6, 1999. The
Company is currently seeking additional financing to meet that obligation. The
Management of the Company believes that its current cash on hand will be
sufficient to sustain current operations for the fiscal year ending January 31,
1999 excluding repayment of debt. The Company anticipates that if it can satisfy
the conditions to the funding of the Private Equity Line of Common Stock and
Warrants, it will have sufficient cash flow to sustain operations for the fiscal
year ending January 31, 2000. However, if it is unable to satisfy those
conditions, the Company would need to seek additional funds in order to sustain
its ongoing operations. There can be no assurance that such capital resources
will be available or, if available, that such funding will be on terms
acceptable to the Company. In addition, the pendency of lawsuits and the
attendant adverse publicity and the recent volatility in the market price of the
Company's common stock may not only reduce significantly the liquidity of the
Company's stock but also make it difficult for the Company to raise additional
capital to sustain its operations and achieve its planned expansion. See
"Factors That May Affect Future Performance - SEC Investigation, Interruption Of
Trading and Shareholder Litigation."
If additional funds are raised through the issuance of equity or
convertible debt securities, the percentage ownership of the Company's then
existing shareholders will be reduced. Moreover, shareholders may experience
additional and significant dilution, and
28
such equity securities may have rights, preferences or privileges senior to
those of the Company's Common Stock. These factors raise a substantial doubt
about the Company's ability to continue as a going concern. In view of the
matters described above, recoverability of a major portion of the Company's
recorded asset amounts is dependent upon the Company's ability to raise
sufficient capital to fund its working capital requirements until the Company
can generate sufficient sales volume to cover its operating expenses.
EMPLOYEES
As of December 11, 1998, the Company employed 121 full-time and 19 part-
time employees. This is an increase from January 31, 1998, when the number of
employees was 67 full time and 9 part time employees. The Company believes that
its future success will depend in part on its ability to attract, hire and
maintain qualified personnel. However, the Company believes there will not be a
significant increase in employees over the next twelve months. Competition for
such personnel in the on-line industry is intense. None of the Company's
employees are represented by a labor union, and the Company has never
experienced a work stoppage. The Company believes its relationship with its
employees to be good.
FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
The Company's business, financial condition and results of operations may be
impacted by a number of factors including, without limitation, the factors
discussed below.
The Need for Additional Capital
- -------------------------------
The Company must seek additional financing in order to sustain operations
or achieve planned expansion. The Company anticipates that it needs to raise at
least $14 million during the next twelve months in the form of debt and/or
equity investments in the Company's securities in order to sustain operations or
achieve planned expansion. This figure is lower than previously anticipated due
to Management's change in the Company's choice of advertising media.
Previously, the Company had used portal advertising, which Management has
subsequently determined is not as effective as using "referral site"
advertising. Therefore, Management has changed its planned advertising
expenditures and program to primarily utilize referral site advertising thus
reaping the benefits of substantially lower advertising costs.
In addition, the Company must seek additional financing in order to repay
debt now due and payable or coming due in fiscal 1999. Subsequent to October 31,
1998 the Company had $1,325,000 of unsecured promissory notes (the "Notes") come
due which remains unpaid at this time. Currently the Company is negotiating with
several of the promissory note holders to extend the terms of their notes or
convert their notes to equity. The Company does not expect that all the holders
will be willing to convert their notes. The Notes were due in November 15, 1998.
As of December 20, 1998 the total arrearage on the Notes including interest was
approximately $1,468,000.
The Company is also negotiating with USFI regarding extending the terms of
their secured promissory note in the amount of $300,000 which came due December
2, 1998. As of December 2, 1998 the total arrearages on the USFI note was
approximately $305,000. In addition, the Secured Promissory Note in the
principal amount of $2,500,000 becomes due and payable on January 6, 1999.
There can be no assurance that such additional funds will be available or
that if available, such additional funds will be on terms acceptable to the
Company.
29
Limited Operating History; Accumulated Deficit; Anticipated Losses; Ability to
- ------------------------------------------------------------------------------
Continue as a Going Concern
- ---------------------------
The Company commenced operations in February, 1996, was incorporated on
November 22, 1996 and began selling products on its Web Site on July 11, 1997.
Accordingly, the Company has a limited operating history on which to base an
evaluation of its business and prospects. The Company's 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 expanding markets such as online commerce. Such
risks for the Company include, but are not limited to, an evolving and
unpredictable business model and the management of growth. To address these
risks, the Company must, among other things, obtain a customer base, implement
and successfully execute its business and marketing strategy, continue to
develop and upgrade its technology and transaction-processing systems, improve
its Web Site, provide superior customer service and order fulfillment, respond
to competitive developments, and attract, retain and motivate qualified
personnel. There can be no assurance that the Company will be successful in
addressing such risks, and the failure to do so could have a material adverse
effect on the Company's business, prospects, financial condition and results of
operations.
Since inception, the Company has incurred significant losses, and as of
October 31, 1998 had an accumulated deficit of approximately $25 million. The
Company believes that its success will depend in large part on its ability to
(i) obtain wide-spread name recognition, (ii) provide its customers with an
outstanding value and a superior shopping experience, (iii) achieve sufficient
sales volume to realize economies of scale, and (iv) successfully coordinate the
fulfillment of customer orders without the need to maintain expensive real
estate warehousing facilities and personnel. Accordingly, the Company intends
to invest heavily in marketing and promotion, site development and technology
and operating infrastructure development. The Company also intends to offer
attractive pricing programs, which will result in low or even negative gross
margins from time to time. Because the Company has relatively low gross
margins, achieving profitability depends upon the Company's ability to generate
and sustain substantially increased sales levels. As a result, the Company
believes that it will incur substantial operating losses for the foreseeable
future, and that the rate at which such losses will be incurred may increase
significantly from current levels based primarily on marketing expenditures and
the timing of those expenditures.
The Company incurred a net loss of $201,697 and had negative cash flows
from operations during the year ended January 31, 1997 of $136,546, and had a
shareholders deficit of $78,647 as of January 31, 1997. For the year ended
January 31, 1998 the Company had net losses totaling $5,522,029, negative cash
flows from operations of $4,842,628 and an accumulated shareholder's equity of
$6,580,236. Management raised capital during 1997 and 1998 through private
placement offerings of equity and debt
30
securities and completed an initial public offering in the latter part on 1997,
which provided funding to continue present operations, marketing and development
activities.
The Company has used a portion of the net proceeds of its initial public
offering to fund its operating losses. As of January 31, 1998, the Company had
approximately $4.8 million remaining of the net proceeds as of April 30, 1998,
the Company had approximately $1.4 million remaining. As of July 31, 1998, the
Company had used all of the proceeds from the Company's initial public offering.
For the nine months ended October 31, 1998, the Company had net losses totaling
$18,946,933, negative cash flows from operations of $8,759,594 and an
accumulated deficit of $24,670,659. Although the Company has obtained additional
financing subsequent to its initial public offering, the proceeds of such
financing, together with cash generated by operations, will be insufficient to
fund the Company's anticipated operating losses and repay its current debt until
its sales increase to a sufficient level to cover operating expenses.
Accordingly, in order to continue to sustain operations and implement its
business plan, the Company must raise additional funds. There can be no
assurance that such financing will be available, if at all, in amounts or on
terms acceptable to the Company. In addition, the investigation by the SEC of
trading in the Company's stock, the pendency of several class action suits
against the Company, and related adverse publicity may also make it difficult
for the Company to raise additional capital to continue its development. See
"Legal Proceedings."
Unpredictability of Future Revenues; Potential Fluctuations in Quarterly
- ------------------------------------------------------------------------
Operating Results; Seasonality
- ------------------------------
As a result of the Company's limited operating history and the emerging
nature of the markets in which it competes, the Company is unable to accurately
forecast its revenues. The Company's current and future expense levels are
based largely on its investment plans and estimates of future revenues. Sales
and operating results generally depend on the volume of, timing of, and ability
to fulfill orders received, which are difficult to forecast. The Company
anticipates its revenues will be insufficient to fund its operations on an
ongoing basis until revenues grow substantially. Furthermore, the Company will
not be able to adjust spending in a timely manner to compensate for the
anticipated revenue shortfall. Accordingly, any significant shortfall in
revenues in relation to the Company's planned expenditures could have an
immediate adverse effect on the Company's business, prospects, financial
condition and results of operations.
The Company expects to experience significant fluctuations in its future
quarterly operating results due to a variety of factors, many of which are
outside the Company's control. Factors which may adversely effect the Company's
quarterly operating results include: (i) the Company's ability to obtain and
retain customers, attract new customers at a steady rate, maintain customer
satisfaction and establish consumer confidence in conducting transactions on the
Internet environment, (ii) the Company's ability to manage fulfillment
operations electronically and without warehouse facilities and to establish
31
competitive gross margins, (iii) the announcement or introduction of new Web
Sites, services and products by the Company and its competitors, (iv) price
competition or higher vendor prices coupled with fluctuations in payment terms,
(v) the level of use and consumer acceptance of the Internet and other online
services for the purchase of consumer products such as those offered by the
Company, (vi) the Company's ability to upgrade and develop its systems and
infrastructure and attract new personnel in a timely and effective manner, (vii)
the level of traffic on the Company's Web Site, (viii) technical difficulties,
system downtime or Internet brownouts, (ix) the amount and timing of operating
costs and capital expenditures relating to the expansion of the Company's
business, operations and infrastructure, (x) delays in revenue recognition at
the end of a fiscal period as a result of shipping or logistical problems, (xi)
the level of merchandise returns expected by the Company, (xii) governmental
regulation and taxation, (xiii) economic conditions specific to the Internet and
online commerce, and (xiv) general economic conditions. Further, as a strategic
response to changes in the competitive environment, the Company may from time to
time make certain pricing, service or marketing decisions that could have a
material adverse effect on its business, prospects, financial condition and
results of operations.
The Company expects that it will experience seasonality in its business,
reflecting a combination of seasonal fluctuations in Internet usage and
traditional retail seasonality patterns. Internet usage and the rate of
Internet growth may be expected to decline during the summer. Further, sales in
the traditional retail industry are significantly higher in the quarter of each
year ending January 31 than in the preceding three quarters.
Due to the foregoing factors, in one or more future quarters, the Company's
operating results may fall below the expectations of securities analysts and
investors. In such event, the trading price of the Common Stock would likely be
materially adversely affected.
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 on, and use of, its Web Site. Accordingly, the satisfactory
performance, reliability and availability of the Company's Web Site,
transaction-processing systems and network infrastructure are critical to the
Company's reputation and its ability to attract and retain customers, as well as
maintain adequate customer service levels. The Company's revenues depend on the
number of visitors who shop on its Web Site and the volume of orders it
fulfills. Any systems interruptions that result in the unavailability of the
Company's Web Site or reduced order fulfillment process would reduce the volume
of goods sold and the attractiveness of the Company's product and service
offerings. The Company may experience periodic systems interruptions from time
to time. Currently, the Company is experiencing a significant increase in
customer telephone inquiries
32
regarding pending orders resulting in an overload of its telephone system. The
telephone system requires major enhancements immediately to handle the current
telephone volume. Any substantial increase in the volume of traffic on the
Company's Web Site or the number of orders placed by customers will require the
Company to expand and upgrade further its technology, transaction-processing
systems and network infrastructure. There can be no assurance that the Company
will be able to accurately project the rate or timing of increases, if any, in
the use of its Web Site or timely expand and upgrade its systems and
infrastructure to accommodate such increases.
The Company uses a combination of industry supplied software and internally
developed software and systems for its Web Site, search engine, and
substantially all aspects of transaction processing, including order management,
cash and credit card processing, shipping and accounting and financial systems.
Any substantial disruptions or delays in any of its systems would have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations.
Risk of System Failure; Single Site and Order Interface
- -------------------------------------------------------
The Company's success, in particular its ability to successfully receive
and fulfill orders and provide high-quality customer service, largely depends on
the efficient and uninterrupted operation of its computer and communications
hardware systems. Substantially all of the Company's computer and communications
hardware is located at a single leased facility in Corona del Mar, California.
Although the Company has redundant and back-up systems onsite and a disaster
recovery plan, the Company's systems and operations may be vulnerable to damage
or interruption from fire, flood, power loss, telecommunications failure, break-
ins, earthquake and similar events. The Company does not carry business
interruption insurance sufficient to compensate fully for any or all losses from
any or all such occasions. Despite the implementation of network security
measures by the Company, including a proprietary firewall, its servers may be
vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions, which could lead to interruptions, delays, loss of data or the
inability to accept and fulfill customer orders. The occurrence of any of the
foregoing risks could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
Management of Potential Growth; New Management Team;
- ----------------------------------------------------
Limited Senior Management Resources
- -----------------------------------
The Company has rapidly and significantly expanded its operations, and
anticipates that further significant expansion will be required to address
potential growth in its customer base and market opportunities. This expansion
has placed, and is expected to continue to place, a significant strain on the
Company's management, operations and financial resources. From January 31, 1997
to January 31, 1998, the Company expanded
33
from 4 employees to 67 full time and 9 part time employees, respectively, and
has since grown to 121 full time and 19 part time employees as of December 11,
1998. Some of the Company's senior management joined the Company within the last
year, and some officers have no prior senior management experience at public
companies. The Company's new employees include a number of managerial, technical
and operations personnel who have not yet been fully integrated into the
Company's operations. To manage the increase in personnel and the expected
growth of its operations, the Company will be required to improve existing, and
implement new, transaction-processing, operational and financial systems,
procedures and controls, and to train and manage its already expanded employee
base. Although the Company believes that there will not be a significant
increase in the number of employees over the next twelve months, the Company may
be required to increase its finance, administrative and operations staff.
Further, the Company's management will be required to maintain and expand its
relationships with various manufacturers, distributors, freight companies, other
Web Sites, other Internet Service Providers and other third parties necessary to
the Company's operations. There can be no assurance that the Company's current
and planned personnel, systems, procedures and controls will be adequate to
support the Company's future operations, that management will be able to hire,
train, retain, motivate and manage required personnel or that the Company's
management will be able to successfully identify, manage, and exploit existing
and potential market opportunities. If the Company is unable to manage growth
effectively, its business, prospects, financial condition and results of
operations would be materially adversely affected.
Dependence of Continued Growth of Online Commerce
- -------------------------------------------------
The Company's future revenues and any future profits are substantially
dependent upon the widespread acceptance and use of the Internet and other
online services as an effective medium of commerce by consumers. Rapid growth
in the use of and interest in the Web, the Internet and other online services is
a recent phenomenon, and there can be no assurance that acceptance and use will
continue to develop or that a sufficiently broad base of consumers will adopt,
and continue to use, the Internet and other online services as a medium of
commerce. Demand and market acceptance for recently introduced products and
services over the Internet are subject to a high level of uncertainty, and there
exist few proven services and products. The Company relies, and will continue
to rely, on consumers who have historically used traditional means of commerce
to purchase merchandise. For the Company to be successful, these consumers must
accept and utilize novel ways of conducting business and exchanging information.
In addition, the Internet and other online services may not be accepted as
a viable commercial marketplace for a number of reasons, including potentially
inadequate development of the necessary network infrastructure or delayed
development of enabling technologies and performance improvements. To the
extent that the Internet and other online services continue to experience
significant growth in the number of users, their
34
frequency of use or an increase in their bandwidth requirements, there can be no
assurance that the infrastructure for the Internet and other online services
will be able to support the demands placed on them. In addition, the Internet or
other online services could lose their viability due to delays in the
development or adoption of new standards and protocols required to handle
increased levels of Internet or other online service activity, or due to
increased governmental regulation. Changes in or insufficient availability of
telecommunications services to support the Internet or other online services
could also result in slower response times and adversely affect usage of the
Internet and other online services generally and Shopping.com in particular. If
use of the Internet and other online services does not continue to grow or grows
more slowly than expected, if the infrastructure for the Internet and other
online services does not effectively support growth that may occur, or if the
Internet and other online services do not become a viable commercial
marketplace, the Company's business, prospects, financial condition, and results
of operations would be materially adversely affected.
Rapid Technological Change
- --------------------------
To remain competitive, the Company must continue to enhance and improve the
responsiveness, functionality and features of the Shopping.com online store.
The online commerce industry is characterized by rapid technological change,
changes in user and customer requirements and preferences, frequent new product
and service introductions embodying new technologies and the emergence of new
industry standards and practices that could render the Company's existing Web
Site and proprietary technology and systems obsolete. The Company's future
success will depend, in part, on its ability to license leading technologies
useful in its business, enhance its existing services, develop new services and
technologies that address the increasingly sophisticated and varied needs of its
prospective customers, and respond to technological advances and emerging
industry standards and practices on a cost-effective and timely basis. The
development of a Web Site and other proprietary technology entails significant
technical and business risks. There can be no assurance that the Company will
successfully use new technologies effectively or adapt its Web Site, proprietary
technology and transaction-processing systems to customer requirements or
emerging industry standards. If the Company is unable, for technical, legal,
financial or other reasons, to adapt in a timely manner in response to changing
market conditions or customer requirements, its business, prospects, financial
condition and results of operations would be materially adversely affected.
Year 2000
- ---------
The Company will be interacting with certain computer programs in
connection with credit card transactions and programs used by the Company's
vendors and suppliers. These programs may refer to annual dates only by the last
two digits, e.g., "97" for "1997." Problems are anticipated to arise for many
of these programs in the year 2000
35
("Year 2000 Problems"). The Company has taken this problem into account with
respect to its own internal programs and believes that its own internal software
is not susceptible to Year 2000 Problems. However, the Company has not made a
formal assessment of programs used by service providers or other third parties,
including the financial institutions processing credit card transactions, with
which the Company may have to interact, nor the Company's vulnerability which
may result from any such party's failure to remediate their own Year 2000
issues. There can be no guarantee that the systems of other companies on which
the Company relies will be converted timely and will not have an adverse effect
on the Company's systems and the Company's business, prospects, financial
condition and results of operations.
All of the information systems that have been designed and integrated into
the Company's infrastructure were built to be Year 2000 compliant. The company
believes that at the present time, substantially all of its information systems
are year 2000 compliant and that additional costs to bring the systems to full
compliance will not be significant. The Company is in the process of
implementing a general ledger and financial accounting software package which
has received Year 2000 certification.
The Company recognizes that it could be exposed to some risk arising from
vendors or suppliers who may not be Year 2000 compliant. In these instances,
the Company may have to implement system modifications to handle these issues
when data is exchanged. The Company believes that the additional costs to
implement such system modifications will not be significant. The Company
currently does business with over four hundred vendors and suppliers. The
Company believes that due to its ongoing practice of multiple product sourcing,
no one vendor or supplier would have a material effect on the Company's
business, results of operations, or financial condition if they do not timely
become Year 2000 compliant.
SEC Investigation and Shareholder Litigation
- --------------------------------------------
The Company is party to an ongoing investigation by the Securities and
Exchange Commission ("SEC") and various lawsuits, each discussed more fully
herein under "Legal Proceedings." The Company is devoting management time and
effort in its cooperation with the SEC investigation and its vigorous defense of
the lawsuits to which it is a party. Diversion of management time and effort
from the Company's operations and the implementation of the Company's business
plan may adversely and significantly affect the Company and its business. The
continued pendency of litigation may make it difficult for the Company to raise
additional capital to continue its development and expansion and to attract and
retain talented executives.
36
Debentures, Warrants and Options; Potential Dilution and
- --------------------------------------------------------
Adverse Impact on Additional Financing
- --------------------------------------
As of December 8, 1998, the Company had outstanding options and warrants to
purchase an aggregate of 5,998,146 shares of Common Stock. The Company is also
obligated to issue a currently indeterminate number of shares of Common Stock
upon conversion of the Debentures and exercise of the warrants issued in
connection with the Debentures (the "Warrants"). The exact number of shares of
Common Stock issuable pursuant to such conversion cannot be estimated with
certainty because, generally, such issuances of Common Stock will vary inversely
with the market price of the Common Stock at the time of such conversion. The
Debentures are also subject to various adjustments to prevent dilution resulting
from stock splits, stock dividends or similar transactions. Further, the
Company may, at its election, choose to issue additional shares of Common Stock
in lieu of cash payments of accrued interest due to the holders of the
Debentures. If all of the Debentures had been converted and the Warrants
issued to the holders of the Debentures had been exercised on October 31, 1998,
the Company would have been obligated to issue 7,500,000 shares of Common Stock
in respect thereto, exclusive of interest on the Debentures and shares issuable
upon exercise of the Warrants issued to the placement agent. Between November
25, 1998 and December 8, 1998, Debentures in the aggregate principal amount of
$2,500,000 were converted, principal and interest, for an aggregate total of
1,790,389 shares of Common Stock.
Each holder of the Debentures has agreed contractually not to convert the
Debentures to the extent that such conversion would result in such holder and
its affiliates beneficially owning more than 9.99% of the then outstanding
Common Stock unless at such time the Company is in default under any provision
of the Debentures or under the relevant Securities Purchase Agreement between
the Company and the holder of the Debentures, or any of the agreements
contemplated therein.
The issuance of securities subsequent to the issuance of the Debentures and
prior to the end of an agreed upon period allows the holders of the Debentures
to convert into Common Stock at 90% of the conversion rate originally agreed
upon. In addition, the holders of the Debentures may require the Company to
immediately redeem all outstanding Debentures or any portion outstanding in
cash.
The volatility of the trading price of the Company's Common Stock may
affect dilution associated with the exercise of warrants or conversion of
convertible securities. Even if exercise prices and conversion rates are fixed
at or in relation to the market price at the time of issuance, they are
frequently adjusted in the event that securities are subsequently issued at a
lower price. As the trading price fluctuates and the Company continues to rely
on equity financing, the Company may be required to issue securities at prices
which cause such adjustments to exercise prices or conversion rates and possibly
increase the dilution of the interests of the Company's shareholders upon the
exercise or conversion of any such convertible securities. See "--Volatility of
Stock Price."
To the extent that such options and warrants are exercised, shares of
Common Stock are issued in lieu of payment of accrued interest or the Debentures
are converted, substantial dilution of the interests of the Company's
shareholders is likely to result and the market price of the Common Stock may be
materially adversely affected. Such dilution will be greater if the future
market price of the Common Stock decreases. For the life of the warrants,
options and Debentures, the holders will have the opportunity to profit from a
rise in the price of the Common Stock. The existence of the warrants, options
and Debentures is likely to affect materially and adversely the terms on which
the Company can obtain additional financing and the holders of the warrants,
options and Debentures can be expected to exercise them at a time when the
Company would otherwise, in all likelihood, be able to obtain additional capital
by an offering of its unissued capital stock on terms more favorable to the
Company than those provided by the warrants, options and Debentures.
37
Dependence on Key Personnel; Need for Additional Personnel
- ----------------------------------------------------------
The Company's performance is substantially dependent on the continued
services and on the performance of its senior management and other key
personnel, particularly Frank Denny, the Chairman of the Board of Directors, and
Mark S. Winkler, its Chief Information and Technology Officer. The Company's
performance also depends on the Company's ability to retain and motivate its
other officers and key employees. The loss of the services of any of its
executive officers or other key employees could have a material adverse effect
on the Company's business, prospects, financial condition and results of
operations. The Company has entered into written employment agreements with Mr.
Markley for three years terminating on May 31, 2001, and with Mr. Winkler for
one year ending May 20, 1998 which subsequently renewed for one year pursuant to
an automatic renewal provision therein. Under his employment agreement, Mr.
Winkler may only be terminated for "cause." The Company has decided not to
maintain a $1,000,000 "key man" life insurance policy on the life of Mr.
Markley. The Company's future success depends on its ability to identify,
attract, hire, train, retain and motivate highly skilled technical, managerial,
editorial, merchandising, marketing and customer service personnel. Competition
for such personnel is intense, and there can be no assurance that the Company
will be able to successfully attract, assimilate and retain sufficiently
qualified personnel. In particular, the Company may encounter difficulties in
attracting and retaining a sufficient number of software developers for its Web
Site and transaction-processing systems, and there can be no assurance that the
Company will be able to retain and attract such developers. The investigation by
the SEC, the pending class action litigation, and the attendant adverse
publicity may also make it difficult for the Company to attract such developers
and other qualified personnel to the Company. See "Legal Proceedings." The
failure to attract and retain the necessary technical, managerial, editorial,
merchandising, marketing and customer service personnel could have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations.
Online Commerce Security Risks
- ------------------------------
A significant barrier to online commerce and communications is the need for
secure transmission of confidential information over public networks. The
Company relies on encryption and authentication technology licensed from third
parties to provide the security and authentication necessary to effect secure
transmission of confidential information, such as credit card numbers. 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. A party who is able to circumvent the Company's security
measures could misappropriate confidential information or cause interruptions in
the Company's operations. The Company may be required to expend significant
capital and other resources to protect against such security breaches or to
38
alleviate problems caused by such breaches. If any such compromise of the
Company's security were to occur, it could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations.
Concerns over the security of transactions conducted on the Internet and
other online services as well as users' desires for privacy may also inhibit the
growth of the Internet and other online services generally, and the Web in
particular, especially as a means of conducting commercial transactions. The
activities of the Company and third-party contractors involve the storage and
transmission of proprietary information, such as credit card numbers and other
confidential information. Any such security breaches could damage the Company's
reputation and expose the Company to a risk of loss, litigation and/or 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, prospects,
financial condition and results of operations.
Merchants on the Internet are subject to the risk of credit card fraud and
other types of theft and fraud perpetrated by hackers and online thieves.
Credit card companies may hold merchants fully responsible for any fraudulent
purchases made when the signature cannot be verified. Although credit card
companies and others are in the process of developing anti-theft and anti-fraud
protections, and while the Company itself is continually monitoring this problem
and developing internal controls, at the present time the risk from such
activities could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
Risks of International Expansion
- --------------------------------
The Company is currently contemplating expanding its presence in Europe and
other foreign markets. To date, the Company has limited experience in sourcing,
marketing and distributing products on an international basis and in developing
localized versions of its Web Site and other systems. In the event that the
Company should seek to expand its operations overseas, the Company believes that
it would incur significant costs in establishing international facilities and
operations, in promoting its name internationally, in developing localized
versions of its Web Site and other systems and in sourcing, marketing and
distributing products in foreign markets. There can be no assurance that the
Company's international efforts would be successful. If the revenues resulting
from international activities were inadequate to offset the expense of
establishing and maintaining foreign operations, such inadequacy could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations. In addition, there are certain risks
inherent in doing business on an international level, such as unexpected changes
in regulatory requirements, export and import restrictions, tariffs and other
trade barriers, difficulties in staffing and managing foreign operations, longer
payment cycles, political instability, fluctuations in currency exchange rates,
seasonal
39
reductions in business activity in other parts of the world and potentially
adverse tax consequences, any of which could adversely impact the success of the
Company's international operations. There can be no assurance that one or more
of such factors would not have a material adverse impact on the Company's future
international operations and, consequently, on the Company's business,
prospects, financial condition and results of operations.
Competition
- -----------
The online commerce industry, particularly on the Internet, is new, rapidly
evolving and intensely competitive. The Company expects such competition to
intensify in the future. Barriers to entry are minimal, allowing current and
new competitors to launch new Web Sites at a relatively low cost. The Company
currently or potentially competes with a variety of other companies. These
competitors include: (i) various online vendors of other consumer and trade
products and services such as CUC International, Amazon.com, ONSALE, Peapod,
Netgrocer, iMALL, Internet Shopping Network, Micro Warehouse, CDNow, QVC and
Home Shopping Network; (ii) a number of indirect competitors that specialize in
online commerce or receive a substantial portion of their revenues from online
commerce, including America Online, Microsoft Network, Prodigy, and Compuserve;
(iii) mail order catalog operators such as Spiegel, Lands End, and Sharper
Image; (iv) retail and warehouse/discount store operators such as Wal-Mart, Home
Depot, Target and Price/Costco; and (v) other international retail or catalog
companies which may enter the online commerce industry. Both Wal-Mart and Home
Depot have announced their intention to devote substantial resources to online
commerce at discount prices, which, if successful, could have a material adverse
effect on the Company's business, prospects, financial condition and results of
operations. However, the Company believes that retail and discount/warehouse
operators will be somewhat restricted in their ability to lower prices by the
need to protect their own pricing strategy to avoid cannibalizing their own
store margins.
The Company believes that the principal competitive factors in its market
are price, speed of fulfillment, name recognition, wide selection, personalized
services, ease of use, 24-hour accessibility, customer service, convenience,
reliability, quality of search engine tools, and quality of editorial and other
site content. Many of the Company's current and potential competitors have
longer operating histories, larger customer bases, greater brand name
recognition and significantly greater financial, marketing and other resources
than the Company. In addition, online retailers may be acquired by, receive
investments from or enter into other commercial relationships with larger, well-
established and well-financed companies as use of the Internet and other online
services increases. Certain of the Company's competitors may be able to secure
merchandise from vendors on more favorable terms, devote greater resources to
marketing and promotional campaigns, adopt more aggressive pricing or inventory
availability policies and devote substantially more resources to Web Site and
systems development than the Company.
40
Increased competition may result in reduced operating margins, loss of market
share and a diminished franchise value. There can be no assurance that the
Company will be able to compete successfully against current and future
competitors, and competitive pressures faced by the Company may have a material
adverse effect on the Company's business, prospects, financial condition, and
results of operations. Further, as a strategic response to make changes in the
competitive environment, the Company may, from time to time, make certain
pricing, service or marketing decisions or acquisitions that could have a
material adverse effect on its business, prospects, financial condition and
results of operations. New technologies and the expansion of existing
technologies may increase the competitive pressures on the Company. In addition,
companies that control access to transactions through network access or Web
browsers could promote the Company's competitors or charge the Company a
substantial fee for inclusion.
Reliance on Certain Suppliers and Shippers
- ------------------------------------------
Unlike retail and warehouse/discount store operators and certain online
commerce providers, the Company, as an E-retailer, carries no inventory, has no
warehouse employees or facilities, and relies on rapid fulfillment from its
vendors. The Company has no long term contracts or arrangements with any of its
vendors or shippers that guarantee the availability of merchandise, the
continuation of particular payment terms, the extension of credit limits or
shipping schedules. There can be no assurance that the Company's current vendors
will continue to sell merchandise to, or that shippers will be able to provide
delivery service for, the Company on current terms or that the Company will be
able to establish new, or extend current, vendor and shipper relationships to
ensure acquisition and delivery of merchandise in a timely and efficient manner
and on acceptable commercial terms. If the Company were unable to develop and
maintain relationships with vendors and shippers that would allow it to obtain
sufficient quantities of merchandise on acceptable commercial terms, or in the
event of labor disputes or natural catastrophes, its business, prospects,
financial condition and results of operations would be materially adversely
affected.
Availability of Merchandise; Vendor Credit for the Company
- ----------------------------------------------------------
Although the Company's merchandising division maintains relationships with
vendors which it believes will offer competitive sources of supply, and believes
that other sources are available for most of the merchandise it will sell or may
sell in the future, there can be no assurance that Shopping.com will be able to
obtain the quantity of brand or quality of items that management believes are
optimum. The unavailability of certain product lines could adversely impact the
Company's operating results. Given its lack of operating history and the
uncertainty of the Company's ability to continue as a going concern, certain
vendors of products sold by the Company are not prepared to advance normal
levels of credit to the Company. In addition, a lack of available cash on hand
has forced the Company to delay payment to most of its vendors exacerbating the
unwillingness of vendors to extend credit to the Company. Such unwillingness to
extend credit along with a substantial increase in product volume has caused the
Company to exceed its current credit
41
limits, resulting in some vendors refusing to ship to the Company's customers
prior to payment. This has in turn slowed delivery to customers, putting the
Company at a competitive disadvantage and increasing customer complaints. While
the Company has increased its credit lines with some of its vendors and is
working to resolve its credit problems with most of its vendors, a lack of
capital to finance the Company's operations along with a large volume of sales
may cause the Company to once again exceed its current credit limits. The
interruption of the trading of the Company's stock on the over-the-counter
bulletin board during March and April, 1998 made vendors reluctant to extend
credit to the Company. In addition, the investigation by the SEC and the
continuation of the attendant adverse publicity may continue to make vendors
reluctant to extend credit to the Company.
Risks Associated with Entry into New Business Areas
- ---------------------------------------------------
The Company may choose to expand its operations by developing new Web
Sites, promoting new or complementary products or sales formats, expanding the
breadth and depth of products and services offered or expanding its market
presence through relationships with third parties. Although it has no present
understandings, commitments or agreements with respect to any material
acquisitions or investments, the Company may pursue the acquisition of new or
complementary businesses, products or technologies. There can be no assurance
that the Company would be able to expand its efforts and operations in a cost-
effective or timely manner or that any such efforts would increase overall
market acceptance. Furthermore, any new business or Web Site launched by the
Company that is not favorably received by consumer or trade customers could
damage the Company's reputation or the Shopping.com brand name. Expansion of the
Company's operations in this manner would also require significant additional
expenses and development, operations and editorial resources and would strain
the Company's management, financial and operational resources. The lack of
market acceptance of such efforts or the Company's inability to generate
satisfactory revenues from such expanded services or products could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations.
Limited Protection of Intellectual Property and Proprietary Rights
- ------------------------------------------------------------------
The Company regards its Shopping.com name and related technology as
proprietary and relies primarily on a combination of copyright, trademark, trade
secret and confidential information laws as well as employee and third-party
non-disclosure agreements and other methods to protect its proprietary rights.
There can be no assurance that these protections will be adequate to protect
against technologies that are substantially equivalent or superior to the
Company's technologies. The Company does not currently hold any patents or have
any patent applications pending for itself or its products and has not obtained
federal registration for any of its trademarks. The Company enters into non-
disclosure and invention assignment agreements with certain of its employees and
also enters into non-disclosure agreements with certain of its consultants and
subcontractors. However, there can be no assurance that such measures will
protect the Company's proprietary technology, or that its competitors will not
develop software with features based upon, or otherwise similar to, the
Company's software or that the Company will be able to prevent competitors from
developing similar software.
42
The Company believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third parties. The Company
has been displaying its Web Site on the Internet without receiving claims from
third parties that its products or names infringe on any proprietary rights of
other parties. However, the Company is a recent entrant in the sale of
merchandise on the Internet, and there can be no assurance that third parties
will not assert infringement claims against the Company in the future with
respect to current or future products, trademarks or other Company works. Such
assertion may require the Company to enter into royalty arrangements or result
in costly litigation. The Company is also dependent upon obtaining additional
technology related to its operations. To the extent new technological
developments are unavailable to the Company on terms acceptable to it, or at
all, the Company may be unable to continue to implement its business and any
such inability would have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
Governmental Regulation and Legal Uncertainties
- -----------------------------------------------
The Company is not currently subject to direct regulation by any domestic
or foreign governmental agency, other than regulations applicable to businesses
generally, and laws or regulations directly applicable to access to online
commerce. However due to the increasing popularity and use of the Internet and
other online services, it is possible that a number of laws and regulations may
be adopted with respect to the Internet or other online services covering issues
such as user privacy, pricing, content, copyrights, distribution and
characteristics and quality of products and services. Furthermore, the growth
and development of the market for online commerce may prompt calls for more
stringent consumer protection laws that may impose additional burdens on those
companies conducting business online. The adoption of any additional laws or
regulations may decrease the growth of the Internet or other online services,
which could, in turn, decrease the demand for the Company's products and
services and increase the Company's cost of doing business, or otherwise have a
material adverse effect on the Company's business, prospects, financial
condition, and results of operations. Moreover, the applicability to the
Internet and other online services of existing laws in various jurisdictions
governing issues such as property ownership, sales and other taxes, libel and
personal privacy is uncertain and may take years to resolve. Any such new
legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to the Company's business, or
the application of existing laws and regulations to the Internet and other
online services could have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
Permits or licenses may be required from federal, state or local government
authorities to operate or to sell certain products on the Internet. No
assurances can be made that such permits or licenses will be obtainable. The
Company may be required to comply with future national and/or international
legislation and statutes regarding
43
conducting commerce on the Internet in all or specific countries throughout the
world. No assurances can be made that the Company will be able to comply with
such legislation or statutes.
Sales and Other Taxes
- ---------------------
The Company does not currently collect sales or other similar taxes with
respect to shipments of goods to consumers into states other than California.
However, one or more states may seek to impose sales tax collection obligations
on out-of-state companies such as the Company, which engage in online commerce.
In addition, any new operation in states outside California could subject
shipments into such states to state sales taxes under current or future laws. A
successful assertion by one or more states or any foreign country that the
Company should collect sales or other taxes on the sale of merchandise could
have a material adverse effect on the Company's business, prospects, financial
condition and results of operations.
Risks Associated with Domain Names
- ----------------------------------
The Company currently holds various Web domain names relating to its brand,
including the "Shopping.com" domain name. The acquisition and maintenance of
domain names generally is regulated by governmental agencies and their
designees. For example, in the United States, the National Science Foundation
has appointed Network Solutions, Inc. as the exclusive registrar for the ".com",
".net", and ".org" generic top-level domains. The regulation of domain names in
the United States and in foreign countries is subject to change. Governing
bodies may establish additional top-level domains, appoint additional domain
name registrars or modify the requirements for holding domain names. As a
result, there can be no assurance that the Company will be able to acquire or
maintain relevant domain names in all countries in which it conducts business.
Furthermore, the relationship between regulations governing domain names and
laws protecting trademarks and similar proprietary rights is unclear. The
Company, therefore, may be unable to prevent third parties from acquiring domain
names that are similar to, infringe upon or otherwise decrease the value of its
trademarks and other proprietary rights. Any such inability could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations.
Risks of Business Combinations and Strategic Alliances
- ------------------------------------------------------
The Company may choose to expand its operations or market presence by
entering into business combinations, investments, joint ventures or other
strategic alliances with third parties. Any such transactions would be
accompanied by the risks commonly encountered in such transactions. These
include, among others, the difficulty of assimilating operations, technology and
personnel of the combined companies, the potential disruption of the Company's
ongoing business, the inability to retain key
44
technical and managerial personnel, the inability of management to maximize the
financial and strategic position of the Company through the successful
integration of acquired businesses, additional expenses associated with
amortization of acquired intangible assets, the maintenance of uniform
standards, controls and policies and the impairment of relationships with
existing employees and customers. There can be no assurance that the Company
would be successful in overcoming these risks or any other problems encountered
in connection with such business combinations, investments, joint ventures or
other strategic alliances, or that such transactions will not have a material
adverse effect on the Company's business, prospects, financial condition and
results of operations.
Volatility of Stock Price
- -------------------------
The trading price of the Common Stock has been highly volatile and subject
to wide fluctuations and is likely to remain so in response to factors such as
actual or anticipated variations in quarterly operating results, announcements
of technological innovations, new sales formats or new products or 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, online service or retail
companies, announcements by the Company of significant acquisitions, strategic
partnerships, joint ventures or capital commitments, additions or departures of
key personnel, sales of Common Stock and other events or factors, many of which
are beyond the Company's control. In addition, the stock market in general, and
the market for Internet-related and technology companies in particular, has
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of such companies. The trading
prices of many technology companies' stocks reflect price earnings ratios
substantially above historical levels. There can be no assurance that these
trading prices and price earnings ratios will be sustained. These broad market
and industry factors may materially and adversely affect the market price of the
Common Stock, regardless of the Company's operating performance. 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 that
company. Additional 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, prospects, financial
condition and results of operations.
Shares Eligible for Future Sale
- -------------------------------
Sales of substantial amounts of the Company's Common Stock in the public
market after any conversion of the 8% Convertible Debentures into shares of the
Company's Common Stock and any registration of such shares could adversely
affect prevailing market prices for the Common Stock. Such shares of Common
Stock will be freely tradeable without restriction in the public market. As a
consequence, the ability of the Company to raise any additional financing which
may be needed by the Company or the
45
ability to raise such additional financing on terms acceptable to the Company
may be adversely affected.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In March of 1998, the Company became aware that the Securities and Exchange
Commission (the "SEC") had initiated a private investigation to determine
whether the Company, Waldron & Co., Inc. ("Waldron"), then the principal market
maker in the Company's stock, or any of their officers, directors, employees,
affiliates or others had engaged in activities in connection with transactions
in the Company's stock in violation of the federal securities laws. The SEC
suspended trading in the Company's stock from 9:30 a.m. EST, March 24, 1998
through 11:59 p.m. EDT on April 6, 1998 pursuant to Section 12(k) of the
Securities Exchange Act of 1934. On April 30, 1998, the National Association of
Securities Dealers ("NASD") permitted the Company's Common Stock to resume
trading on the electronic bulletin boards beginning on April 30, 1998. Because
the SEC has not alleged any violations, it is difficult to predict the outcome
of their investigation. The Company continues, however, to fully cooperate with
the SEC inquiry. Nevertheless, the investigation by the SEC, and the attendant
adverse publicity may not only reduce significantly the liquidity of that stock
but also make it difficult for the Company to raise additional capital to
continue its development and expansion. The inability of the Company to raise
additional capital would have material adverse effect on the Company's business,
prospects, financial condition and results of operations and may prevent the
Company from carrying out its business plan.
On May 6, 1998 Steven T. Moore on behalf of all persons who purchased
shares of the Company's stock between November 25, 1997 and March 26, 1998 filed
suit in United States District Court for the Central District of California
alleging violations of the federal securities laws by the Company, Robert
McNulty, Douglas Hay, Waldron and one other broker-dealer and two of those
firm's executives. The complaint charges that the defendants "participated in a
scheme and wrongful course of business to manipulate the price of [the
Company's] stock, which included: (i) defendant Waldron's refusal to execute
sell orders; (ii) the use of illegal stock parking; (iii) the use of illegal
above-market buy-ins to intimidate and dissuade potential short sellers from
selling [Company] stock short; (iv) the sale of [Company] shares to
discretionary accounts without regard to suitability; and (v) the dissemination
of materially false and misleading statements about [the Company's] operating
performance and its future prospects." The complaint further alleges that the
Company "secretly arranged to sell $250,000 of product to Waldron as part of
defendants' effort to have [the Company] post revenue growth prior to the
[Company's] planned [initial public offering]," that such sales constituted
almost 25% of the Company's revenues between its inception and March 26, 1998
and that the Company did not disclose such sales or their significance in the
Prospectus used in the Company's initial public offering. The plaintiff seeks
compensatory damages in an unspecified amount, attorneys' fees and costs,
injunctive relief, disgorgement or restitution of the proceeds of the Company's
IPO and the defendants' profits from trading in the Company's stock, and the
imposition of a constructive trust over the Company's revenues and profits. By
order dated December 4, 1998, the plaintiffs were granted leave to file a second
amended consolidated complaint on behalf of each of the federal court actions.
The second amended complaint has since been filed.
46
On April 28, 1998, Abraham Garfinkel on behalf of all persons who purchased
shares of the Company's stock between November 25, 1997 and March 26, 1998,
filed suit in the United States District Court for the Central District of
California alleging violation of the federal securities laws by the Company,
Robert McNulty, Douglas Hay, Waldron and Cery Perle, an affiliate of Waldron.
The complaint alleges that defendants acted in concert with each other to
manipulate the price of the Company's stock by, inter alia, "work[ing] closely
with defendant McNulty on a weekly basis whereby defendant McNulty would pass
the supposedly confidential information of those who had 'hit' or contacted
Shopping's website." The complaint alleges that the defendants also manipulated
the market by engaging in conduct similar to that alleged in the Martucci and
Moore actions. The complaint also alleges that the Company's prospectus was
misleading by the failure to disclose sales to Waldron as discussed above. The
plaintiffs seek damages similar to that sought by Martucci and Moore. By order
dated December 4, 1998, the plaintiffs were granted leave to file a second
amended consolidated complaint on behalf of each of the federal court actions.
The second amended complaint has since been filed.
The second amended consolidated complaint filed in each of the federal
court actions expands the class period from the period beginning November 25,
1997 and ending March 26, 1998 to the period beginning November 25, 1997 and
ending August 30, 1998. Further, the second amended complaint has added counts
for violation of sections 11 and 12(2) of the Securities Act of 1933, as
amended, as well as section 9 of the Securities Exchange Act of 1934.
47
On July 1, 1998, Mr. Garfinkel filed a companion state court complaint in
the Orange County Superior Court based on virtually the same operative facts as
the federal court claim. The state court action alleges claims for negligent
misrepresentation, common law fraud and deceit as well as violation of sections
25400, 25402 and 25500 of the California Corporations Code.
On April 16, 1998, Michael A. Martucci on behalf of all persons who
purchased shares of the Company's stock between November 25, 1997 and March 26,
1998, filed suit in the California Superior Court for the County of Orange
alleging violations of the California securities laws by the Company, Robert
McNulty, Douglas Hay, Waldron and one other broker-dealer and two of those
firm's executives. The complaint charges that the defendants "participated in a
scheme and wrongful course of business to manipulate the price of [the
Company's] stock, which included: (i) defendant Waldron's refusal to execute
sell orders; (ii) the use of illegal stock parking; (iii) the use of illegal
above-market buy-ins to intimidate and dissuade potential short sellers from
selling [Company] stock short; (iv) the sale of [Company] shares to
discretionary accounts without regard to suitability; and (v) the dissemination
of materially false and misleading statements about [the Company's] operating
performance and its future prospects." The complaint further alleges that the
Company "secretly arranged to sell $250,000 of product to Waldron as part of
defendants' effort to have [the Company] post revenue growth prior to the
[Company's] planned [initial public offering]," that such sales constituted
almost 25% of the Company's revenues between its inception and March 26, 1998
and that the Company did not disclose such sales or their significance in the
Prospectus used in the Company's initial public offering. The plaintiff seeks
compensatory damages in an unspecified amount, attorneys' fees and costs,
injunctive relief, disgorgement or restitution of the proceeds of the Company's
IPO and the defendants' profits from trading in the Company' s stock, and the
imposition of a constructive trust over the Company's revenues and profits. By
order dated December 4, 1998, the plaintiffs were granted leave to file a second
amended consolidated complaint on behalf of each of the federal court actions.
The second amended complaint has since been filed.
On May 13, 1998, Kate McCarthy, on behalf of all persons who purchased
shares of the Company's stock between November 25, 1997 and March 26, 1998,
filed suit in the Orange County Superior Court alleging violation of the
California securities laws by the Company, Robert McNulty, Douglas Hay, Waldron
and Cery Perle. The complaint alleges that defendants acted in concert with
each other to manipulate the price of the Company's stock by, inter alia,
"work[ing] closely with defendant McNulty on a weekly basis whereby defendant
McNulty would pass the supposedly confidential information of those who had
'hit' or contacted Shopping's website." The complaint alleges that the
defendants also manipulated the market by engaging in conduct similar to that
alleged in the Martucci and Moore actions. The complaint also alleges that the
Company's prospectus was misleading by the failure to disclose sales to Waldron
as discussed above. The plaintiffs seek damages similar to that sought by
Martucci and Moore.
48
The individual actions in Orange County superior Court have been
consolidated as well. The plaintiffs have filed a second amended complaint
which increased the class period to the period beginning November 25, 1997 and
ending August 30, 1998. The amended pleading added causes of action for
violation of California Corporations Code sections 25401 and 25501 against all
defendants as well as sections 25504 and 25504.1 against defendants Robert J.
McNulty and Douglas R. Hay.
On or about March 27, Gladstone, et al. filed a complaint against the
company as well as its underwriters in the United States District Court for the
Southern district of New York contending that the Company's common stock was
being manipulated in violation of federal securities laws. The plaintiffs seeks
equitable relief in the form of a temporary restraining order and order to show
cause regarding the issuance of a preliminary injunction to enjoin certain
trading of the Company's stock. The plaintiffs also requested that they be given
the right to conduct expedited discovery. On March 30, 1998, the federal court,
the Hon. Edelstein presiding, denied the temporary restraining order, denied
order to show cause, denied the request for expedited discovery and ordered the
case transferred to the United States District Court for the Central District of
California. The plaintiffs have filed a first amended complaint against the
Company and Mr. McNulty in the United States District Court for the Central
District of California which alleges the same claims as the New York federal
court action. The Company has yet to respond to the amended pleading but will
vigorously defend the same.
The Company denies that it engaged in any of the acts alleged in any of the
above complaints and intends to defend against these actions vigorously.
Nonetheless, and despite the Company's insurance coverage for such actions, the
class action suits may be very harmful to the Company. Diversion of management
time and effort from the Company's operations and the implementation of the
Company's business plan at this crucial time in the Company's development may
adversely and significantly affect the Company and its business. The continued
pendency of this litigation may make it difficult for the Company to raise
additional capital to continue its development and expansion and to attract and
retain talented executives. The inability of the Company to raise additional
capital would have material adverse effect on the Company's business, prospects,
financial condition and results of operations and may prevent the Company from
carrying out its business plan.
On July 8, 1997, Brian Leneck, a former officer of the Company, resigned.
By letter dated July 10, 1997, Robert McNulty, the former Chief Executive
Officer of the Company, tendered payment to Leneck to buy back 140,000 shares of
Common Stock of the Company pursuant to a shareholder agreement. Leneck rejected
the tender, claiming that the amount was not the fair market value of the
shares. On March 17, 1998, Leneck filed a lawsuit in Orange County Superior
Court of California against the Company, Robert McNulty and three members of the
Board of Directors at the time, Bill Gross, Edward Bradley and Paul Hill.
Leneck's lawsuit seeks damages for breach of contract, conversion, and breach of
fiduciary duty with respect to 70,000 shares. The Company believes that it has
meritorious defenses, as well as affirmative claims, against Leneck and intends
to vigorously protect its rights in this matter. On March 27, 1998, the Company
filed a lawsuit in Orange County Superior Court against Leneck asserting, inter
alia, breach of contract, breach of implied covenant of good faith and fair
dealing, fraud and deceit, declaratory relief and specific performance.
Subsequently, the charges against Bill Gross, Edward Bradley and Paul Hill were
dismissed with prejudice.
On November 23, 1998 Ray Fisk filed a complaint against the Company for
breach of contract arising out of that certain Unsecured Promissory Note dated
May 15, 1998 in the principal sum of $50,000 due and payable on or about
November 15, 1998. The Company does not dispute its obligation under the terms
of the note. In a similar circumstance, the Company received correspondence
dated December 17, 1998 from counsel to Daniel Kern, a noteholder who demanded
payment on the principal sum of $100,000 together with accrued interest. The
Company does not dispute this obligation. The noteholder also claims that the
quiet filing of the Company's registration statement on Form S-1 is misleading
because it fails to disclose that the Company could not or would not make
payment on the note. The Company vigorously disputes this contention.
49
Though a formal complaint has not been filed, Lewis, D'Amato, Brisbois &
Bisgaard, the Company's former counsel, forwarded on March 10, 1998, a "Notice
of Client's Right to Arbitration" in connection with legal services performed on
behalf of the Company. The law firm claims legal fees and costs in the amount
of $328,818.97 are due. The Company disputes the amount of fees owed and is in
the process of exploring whether the matter can be informally resolved.
However, the Company has accrued the claimed amount as of January 31, 1998.
Though settlement negotiations have occurred, it is more probable than not that
the Company will proceed with its election to have the matter submitted to
arbitration before the Los Angeles County Bar Association.
By written contracts dated December 12, 1997, the Company retained
SoftAware, Inc. to provide facilities and services relative to the maintenance,
location and supply of T1 lines to the Company's servers. Subsequent to the
execution of the contracts, SoftAware, Inc. experienced a prolonged electrical
outage which resulted in the disruption of Internet access and communications.
Based upon this and other factors, the Company determined that SoftAware, Inc.
was incapable of performing under the agreements and declined to proceed. By
letter dated May 22, 1998, SoftAware, Inc.'s counsel made written demand upon
the Company for $120,000.00 which purportedly reflected the compensatory damages
SoftAware suffered as a direct and proximate result of the Company's refusal to
proceed with performance under the contract. The Company rejected this demand
and offered to reimburse SoftAware, Inc. for reasonable costs incurred in
reliance on the contracts in an amount less than $3,000. SoftAware, Inc. has
rejected this offer and the parties are continuing settlement negotiations.
On September 12, 1998 the Company was served with a summons and complaint
by MTS, Incorporated filed in Sacramento County Superior Court of California for
damages arising out of the Company's as well as two other merchants' sale of the
video "Titanic" at below cost thereby purportedly constituting violation of
section 17043 and 17044 of California's Business and Professions Code as well as
the California Unfair Business Practices Act (Cal. Bus. & Prof. Code section
17200 et. seq.). The complaint alleges damages in excess of $25,000.00, that sum
trebled should a statutory violation be established, and attorneys' fees and
costs. The Company has not had an opportunity to investigate the allegations of
the complaint. Accordingly, a reasonable assessment of the Company's potential
exposure cannot be made until such time as discovery is completed. The action
will, however, require the engagement of defense counsel and it is estimated
that substantial attorney fees may be incurred should litigation proceed to
trial.
50
On December 4, 1998, the Company received correspondence from counsel for
Yahoo! Inc. alleging breach of contract arising out of two agreements. Despite
acknowledging receipt of $200,000 from the Company in connection with these
contracts, it is contended that the alleged breach of the agreements entitles
Yahoo! Inc. to recover damages in excess of $2 million. Though the Company has
not had the opportunity to fully investigate Yahoo!'s demands, the entitlement
and measure of damages are disputed. Nevertheless, a reasonable assessment of
the Company's potential liability cannot be made at this time.
The Company is involved in two other labor related disputes. Although it
is not possible to predict the outcome of these disputes, or any future claims
against the Company related hereto, the Company believes that such disputes will
not, either individually or in the aggregate, have a material adverse effect on
its financial condition or results of operations.
Item 2. Changes in Securities
---------------------
The following are all securities sold by Registrant within the past three
(3) years without registering the securities under the Securities Act/1/:
DATE TITLE AMOUNT
(1) (a) March 1997-June 1997 Common Stock 1,282,500 Shares
(b) There were no underwriters used in connection with this offering.
1,150,000 shares of Common Stock were offered and sold to Robert J. McNulty, CEO
of the Registrant. Subsequently, Mr. McNulty gifted an aggregate of 325,000 of
such shares to various employees of the Company for no consideration. In
addition, the Company
______________________
/1/ All share amounts and related information reflect a one-for-two reverse
stock split effective upon the effective date of the Company's initial
public offering. The warrants to purchase 122,500 shares of the Company's
Common Stock issued to Waldron & Co., Inc. as the Underwriters'
Representative are not included because such warrants were registered in
connection with the Company's initial public offering. As of December 8,
1998, the Company had issued 2,605,250 options, largely to employees,
officers and directors.
51
offered and sold shares of Common Stock to idealab!, a company controlled by
Bill Gross, a former director of Registrant (100,000 shares); Alvin S. Morrow,
(2,500 shares); and 30,000 shares to an independent consultant who provided the
Registrant's Web Site address; all of whom were accredited investors and
residents of the State of California.
(c) The securities were sold for two cents ($.02) per share except for the
30,000 shares issued to an independent consultant which were valued at $.20 per
share for an aggregate consideration of $30,650.
(d) The issuer relied on Section 4(2) and 3(a)(11) of the Securities Act of
1933, as amended.
(e) Not Applicable.
DATE TITLE AMOUNT
(2) (a) March 1997-April 1997 Series A Preferred Stock 750,000 Shares
Warrants for 375,000 Warrants
Common Stock
(b) There were no underwriters used in connection with this offering. The
securities were offered and sold only to two accredited investors, Cyber Depot,
Inc., a corporation controlled by Robert J. McNulty, President and CEO of the
issuer, and idealab! a corporation controlled by Bill Gross, a director of
Registrant. One Warrant was issued for each two shares.
(c) The securities were sold for forty cents ($.40) per share of Series A
Stock.
(d) The issuer relied on Rule 506 under Regulation D based on the fact that
all offerees were accredited investors under Rule 501.
(e) The Warrants are convertible into one share of the Company's Common
Stock at an exercise price of $3.00 per share. The Warrants expire five years
from the date of issuance.
DATE TITLE AMOUNT
(3) (a) April 1997 Series B Preferred Stock 536,500 Shares
-September 1997 Warrants for 268,250 Warrants
Common Stock
(b) There were no underwriters used in connection with 536,500 shares of
this offering. Waldron & Co., Inc. acted as placement agents for 200,000 shares
of this
52
offering and received fees of $78,000. The securities were offered and sold only
to accredited investors. One Warrant was issued for each two shares of Series B
Stock.
(c) The securities were sold for Three Dollars ($3.00) per share for an
aggregate consideration of $1,609,500. The Warrants are exercisable for five
years for the purchase of one share of Common Stock at a strike price of $3.00.
(d) The issuer relied on Rule 506 under Regulation D based on the fact
that all offerees were accredited investors under Rule 501.
(e) Not applicable.
DATE TITLE AMOUNT
(4) (a) June 1997-Sept. 1997 Promissory Notes $1,150,000
Warrants for 382,950 Warrants
Common Stock
(b) No underwriters were used in connection with $50,000 principal amount
of such Notes. Waldron & Co., Inc., acted as placement agents in connection
with the placement of the $1,100,000 principal amount of such Notes, and
received fees of $143,000. The securities were offered and sold only to
qualified and accredited investors. 333 Warrants were issued for each $1,000 in
principal amount of such Notes.
(c) The Notes were sold for an aggregate consideration of $1,150,000. The
accompanying Warrants are exercisable for five years for the purchase of one
share of Common Stock at an exercise price of $6.00 per share.
(d) The issuer relied on Rule 506 under Regulation D based on the fact
that all offerees were accredited investors under Rule 501.
(e) The Warrants are exercisable for five years for the purchase of one
share of Common Stock at an exercise price of $6.00 per share. As of December 7,
1998, 83,250 Warrants had been exercised in a "cashless" exercise and 44,575
shares of the Company's Common Stock had been issued.
DATE TITLE AMOUNT
(5) (a) April 1997 Common Stock 8,000 Shares
(b) There were no underwriters used in connection with this private
placement. The securities were offered and sold to Typhoon Capital Consultants,
LLC in exchange for consulting services.
53
(c) The securities were valued at $6.00 per share and were exchanged for
business consulting services, for an aggregate consideration valued at $48,000.
(d) The issuer relied on Section 4(2) of the Securities Act of 1933, as
amended.
(e) Not applicable.
DATE TITLE AMOUNT
(6) (a) September 1997 Common Stock 125,000 Shares
Promissory Note $600,000
Warrants for 199,800 Shares
Common Stock
(b) Waldron & Co., Inc. acted as placement agent in connection with this
private placement and was paid $78,000 in fees therefor. The securities were
issued to En Pointe Technologies, Inc., an accredited investor.
(c) The Common Stock was valued at $6.00 per share and was issued as
consideration for a 5 year license to the Company to use En Pointe's EPIC
software. The Notes were issued at face value for a $600,000 loan to the
Company. 333 Warrants were issued for each $1,000 principal amount of the Note.
The Warrants are exercisable for five years for the purchase of one share of
stock at a strike price of $4.50 per share.
(d) The issuer relied on Rule 506 under Regulation D based on the fact
that En Pointe is an accredited investor.
(e) The Warrants are exercisable for five years for the purchase of one
share of stock at a strike price of $4.50 per share.
DATE TITLE AMOUNT
(7) (a) February 1998 Common Stock 47,059 Shares
(b) There were no underwriters used in connection with this offering. The
shares were offered pursuant to a Subscription Agreement between the Company and
Premiere Radio Network, Inc., a Delaware corporation ("PRN"), dated February 19,
1998.
(c) PRN agreed to purchase the shares in consideration of radio advertising
valued at $1,000,000.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Securities Act of 1933, as
amended.
54
(e) In the event that the average closing price of the Company's Common
Stock for the ten days prior to February 19, 1999 is less than $21.25 per share,
the Company will issue to PRN up to 52,941 additional shares.
DATE TITLE AMOUNT
(8) (a) May 1998 Warrants for 132,500 Shares
Common Stock
Promissory Notes $1,325,000
(b) Waldron & Co., Inc. acted as placement agent in connection with this
private placement and was paid 7% of the total amount raised plus an expense
allowance of 3%.
(c) The shares were offered pursuant to Subscription Agreements,
Promissory Notes and Warrant Agreements between the Company and individual
investors, each dated May 15, 1998 (except Mr. Kern's dated June 8, 1998).
Pursuant to the Subscription Agreements, each investor purchased units
consisting of a promissory Note in the principal amount of $25,000 bearing
interest at an annual rate of 10% interest and principal payable November 15,
1998 and warrants to purchase 2,500 shares of the Company's Common Stock at an
exercise price of $14.00 per share. The units were sold to Ray Fisk (two
units), Mike Weikamp (four units), Jon Aubry (twenty units), William Schweitzer
(two units), Zahra Khiaban (three units), Carlos Beharie (sixteen units), Tony
Nikolich (two units) and Daniel E. Kern (four units). A total consideration of
$1,325,000 was paid in this offering.
(d) The Company relied on Section 4(2) and Regulation D Rule 505
promulgated by the Securities and Exchange Commission as the exemption from
registration. The investors were all accredited investors.
DATE TITLE AMOUNT
(9) (a) June, July and 8% Convertible $5,000,000
November 1998 Debentures Due
in 2 years
Warrants for 1 share for every
Common Stock 2 shares issued upon
conversion of the
Debenture
(b) Trautman, Kramer & Company, Incorporated ("Trautman") acted as
placement agent in connection with this private placement, receiving 9% of the
net proceeds for the first tranche and 15% of the net proceeds for the second
tranche with the proceeds going to or on behalf of Trautman or affiliates of
Trautman. In addition,
55
Waldron received 1% of the net proceeds of the first tranche. The Debentures in
the aggregate amount of $5,000,000 were sold to ten accredited investors.
Subject to certain restrictions on the ability of the holders of the Debentures
to convert, the Debentures are convertible into shares of the Company's Common
Stock at a conversion price for each share of Common Stock equal to the lower of
(i) the lowest market price for any three trading days selected by the Debenture
holder from the thirty trading days prior to the conversion, or (ii) $16.00.
(c) The total consideration was $5,000,000.
(d) The issuer relied on Section 4(2) and Regulation D Rule 506
promulgated by the Securities and Exchange Commission as the exemption from
registration. Each investor was an accredited investor.
DATE TITLE AMOUNT
(10) (a) June 1998 Warrants for Common 300,000 Shares
Stock
(b) There were no underwriters used in connection with this offering. The
warrants were issued to Ladenberg Thalmann & Co., Inc. pursuant to the
Company's retainer of Ladenberg as its investment banker and financial
advisor. The warrants are exercisable after December 15, 1998 until
June 15, 2003 at $21.92 per share.
(c) The warrants were issued to Ladenberg Thalmann & Co., Inc. pursuant to
the Company's retainer of Ladenberg as its investment banker and
financial advisor.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Act.
(e) The warrants are exercisable after December 15, 1998 until June 15,
2003 at $21.92 per share.
56
DATE TITLE AMOUNT
(11) (a) June 1998 Warrants for Common 33,000 Shares
Stock
(b) There were no underwriters in connection with this offering. The
placement agent for the private placement of the 8% Convertible
Debentures and its affiliates were issued the warrants.
(c) The warrants were issued as consideration for the placement agent's
services.
(d) The Company relied on Section 4(2) of the Securities Act of 1993, as
amended, and Regulation D promulgated under the Act.
(e) The warrants are exercisable at $24.00 per share until June 30, 2003.
DATE TITLE AMOUNT
(12) (a) July 1998 Common Stock 7,500 Shares
Warrants for Common 20,000 Shares
Stock
(b) There were no underwriters in connection with this offering. The
placement agent for the private placement of the 8% Convertible
Debentures and its affiliates were issued the warrants.
(c) The Common Stock and warrants were issued as consideration for the
placement agent's services and for waiver of certain of its contractual
rights.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Act.
(e) The warrants are exercisable at $16.00 per share until July 31, 2003.
57
DATE TITLE AMOUNT
(13) (a) August 1998 Warrants for Common 2,936
Stock
(b) There were no underwriters in connection with this offering. The
warrants were issued to companies providing equipment leasing
facilities to the Company.
(c) The consideration was the provision of computer equipment leasing.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Act.
(e) 1,079 shares are exercisable at $22.25 until February 2, 2000. 1,857
shares are exercisable at $14.75 until December 18, 1999.
DATE TITLE AMOUNT
(14) (a) August 1998 Warrants for
Common Stock 60,000 shares
Convertible
Promissory Note $500,000
(b) Waldron & Co., Inc. acted as placement agent in connection with this
private placement and received 10% of the total amount raised, $50,000,
and warrants to purchase 10,000 shares of Common Stock. The securities
were sold to an accredited investor.
(c) The shares were offered pursuant to a Subscription Agreement and
Convertible Promissory Note dated August 25, 1998 and Warrant Agreement
dated as of August 20, 1998. Pursuant to the Subscription Agreement,
the investor purchased 20 units consisting of a promissory note in the
principal amount of $25,000 and warrants to purchase 2,500 shares of
the Company's Common Stock at an exercise price of $10.00 per share.
The Convertible Promissory Note bears interest at an annual rate of 8%
and the principal amount, plus any accrued interest, is payable six
months from the date of the note. The promissory note may be converted
at the option of the investor into a number of shares of Common Stock
equal to the quotient of the principal amount divided by the Conversion
Price. The initial Conversion Price is $10.00 per share.
58
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, as the exemption from registration.
(e) The warrants issued to Waldron & Co., Inc. are exercisable for $10.00
per share and have all the rights and privileges received by the
investor. The all warrants issued in the offering expire August 20,
2001.
DATE TITLE AMOUNT
(15) (a) August 1998 Common Stock 66,667 Shares
(b) There were no underwriters used in connection with this offering. The
shares were offered pursuant to a Subscription Agreement between the
Company and Premiere Radio Network, Inc., a Delaware corporation
("PRN"), dated August 12, 1998.
(c) PRN agreed to purchase the shares in consideration of radio advertising
valued at $1,000,000.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Securities Act of 1933, as
amended.
(e) In the event that the average closing price of the Company's Common
Stock for the ten days prior to August 12, 1999 is less than $15.00 per share,
the Company will issue to PRN up to 133,333 additional shares.
DATE TITLE AMOUNT
(16) (a) September 1998 Warrants for 10,000 Shares
Common Stock
(b) There were no underwriters in connection with that offering. The
warrants were issued to a consultant retained to assist the Company in securing
additional capital.
(c) The consideration was the provision of consulting services.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Act.
(e) The warrants are exercisable at $2.00 per share until October 1, 2003.
59
DATE TITLE AMOUNT
(17) (a) September 1998 Common Stock 255,474 Shares
(b) There were no underwritings in connection with that offering.
(c) The consideration was conversion of $350,000 of debt owed to Robert
McNulty at a price of $1.37 per share.
(d) The Company relied on Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D promulgated under the Act.
DATE TITLE AMOUNT
(18) (a) October and Warrants for Common 300,000 Shares
November 1998 Stock
(b) There were no underwriters in connection with this offering. The
placement agent for the private placement of the 8% Convertible Debentures and
its affiliates and designees were issued the warrants.
(c) The warrants were issued as consideration for the placement agent's
services.
(d) The Company relied on Section 4(2) of the Securities Act of 1993, as
amended, and Regulation D promulgated under the Act.
(e) The warrants are exercisable at $2.00 per share for five years from
their issuance.
DATE TITLE AMOUNT
(19) (a) November 1998 Promissory Note $300,000
Warrants for 30,000 Shares
Common Stock
(b) There were no underwriters used in connection with this offering.
The securities were issued to USFI Holdings, Inc. in connection with partial
repayment of a loan to the Company. Robert McNulty, the former Chief Executive
Officer of the Company, is a director of the note holder.
60
(c) The Note was issued at face value for the outstanding balance of a
loan to the Company. One warrant was issued for each $10 principal amount of the
Note.
(d) The issuer relied on Section 4(2) of the Securities Act of 1933, as
amended.
(e) The Warrants are exercisable for five years for the purchase of one
share of stock at a strike price of $1.65 per share.
DATE TITLE AMOUNT
(20) (a) November - Common Stock 1,790,339 shares
December 1998 Warrants 865,943 shares
(b) There were no underwriters used in connection with this offering.
(c) The securities were issued to holders of the 8% Convertible
Debentures ("Debentures") upon conversion of Debentures in the principal amount
of $2,500,000.
(d) The issuer relied on Section 4(2) of the Act, and Regulation D, Rule
506 promulgated under the Act.
(e) Warrants to purchase 782,608 shares have an exercise price of $1.725
and Warrants to purchase 83,335 shares have an exercise price of $1.80. The
Warrants expire after five years following the initial closing date of the
Debentures converted.
DATE TITLE AMOUNT
(21) (a) December 1998 Warrants to purchase 130,000 shares
Common Stock
(b) There were no underwriters used in connection with this offering.
(c) The securities were issued to Robert McNulty, a consultant to and
affiliate of the Company, in consideration for a pledge of Mr. McNulty's stock
as security for the $2,500,000 Promissory Note.
(d) The issuer relied on Section 4(2) of the Act.
(e) The warrants have an exercise price of $8.00 per share.
61
DATE TITLE AMOUNT
(22) (a) December 1998 Secured Promissory Note $2,500,000
Warrants to purchase 500,000 shares
Common Stock
(b) Trautman, Kramer & Company, Incorporated acted as placement agent and
received 10% of the face amount of the note.
(c) The warrants were issued to the holder of the Secured Promissory Note,
John Gainsford, in consideration for the $2,500,000 principal amount of the
Secured Promissory Note.
(d) The issuer relied on Section 4(2) of the Act.
(e) The Secured Promissory Note carries an interest rate of 10% per annum
and is due and payable thirty days from December 7, 1998; provided, however,
that the holder may, upon the occurrence of certain conditions, convert the
balance owed under the Secured Promissory Note, principal and interest, into
shares of the Company's Common Stock. The warrants have an exercise price of
$7.00 per share and a term of three years.
DATE TITLE AMOUNT
(23) (a) December 1998 Warrants to purchase 490,385 shares
Common Stock
(b) Wall & Broad Equities acted as a finder and will receive from the
Company 2% of the total price per share paid by Swartz pursuant to the
Regulation D Common Stock Private Equity Line Subscription Agreement
(hereinafter referred to as "Private Equity Line of Common Stock and Warrants
Pursuant to Regulation D").
(c) The warrants were issued to Swartz Private Equity, LLC ("Swartz") in
consideration for Swartz entering into the Private Equity Line of Common Stock
and Warrants Pursuant to Regulation D. The warrants expire seven years after
the Date of Issuance. the $2,500,000 principal amount of the Secured Promissory
Note.
(d) The issuer relied on Section 4(2) of the Act.
(e) The warrants have an exercise price of $8.375 per share and a term of
seven years.
Date Title Amount
(24) (a) November 1998 Warrants to Purchase 18,767 shares
Common Stock
(b) There were no underwriters used in connection with this placement.
(c) The warrants were issued to Mark Asdourian, legal counsel to the
Company, as compensation for services rendered.
(d) The Company relied on the exemption in Section 4(2) of the Act.
(e) The warrants have an exercise price of $1.781 per share, which was the
market price on the date of grant, and expire on November 6, 2003.
62
Item 3. Defaults Upon Senior Securities
-------------------------------
Subsequent to October 31, 1998 the Company had $1,325,000 of unsecured
promissory notes (the "Notes") come due which remains unpaid at this time.
Currently the Company is negotiating with several of the promissory note holders
to extend the terms of their notes or convert their notes to equity. The Company
does not expect that all the holders will be willing to convert their notes. The
Notes were due in November 15, 1998. As of December 20, 1998 the total arrearage
on the Notes including interest was approximately $1,468,000.
The Company is also negotiating with USFI regarding extending the terms of
their secured promissory note in the amount of $300,000 which came due December
2, 1998. As of December 2, 1998 the total arrearages on the USFI note was
approximately $305,000.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 5. Other Information
-----------------
On August 31, 1998, Mr. Michael Miramontes resigned his employment
effective June 12, 1998. Pursuant to a Resignation Agreement dated August 31,
1998 between the Company and Mr. Miramontes, Mr. Miramontes will receive one
year's salary in the total amount of $162,000 of which $160,000 was accrued on
the Company's Balance Sheet as of July 31, 1998 and the remaining $2,000 was
additionally accrued during the quarter ended October 31, 1998. The Company
will make equal installments of $13,067 beginning September 1, 1998 for a period
of ten months.
On September 30, 1998, Mr. Douglas Hay resigned as Executive Vice President
and as a director effective September 30, 1998. Pursuant to a Resignation
Agreement dated September 30, 1998 between the Company and Mr. Douglas Hay, Mr.
Hay will receive a total amount of $80,000 which was accrued on the Company's
Balance Sheet as of October 31, 1998. The Company agreed to make two equal
payments of $20,000 payable on October 1 and November 1 and the remaining
$40,000 will be paid equally on the first of each month December 1, 1998 through
March 1, 1999.
On December 2, 1998 Howard Schwartz tendered his resignation as Executive
Vice President, Finance and Administration citing personal reasons.
63
Item 6. Exhibits an, Reports on Form 8-K
--------------------------------
(a) Exhibits:
4.1 Form of Secured Promissory Note in the principal amount of
$2,500,000.
4.2 Form of Common Stock Purchase Warrant for the purchase of 500,000
shares of Common Stock at an exercise price of $7.00.
4.3 Warrant to Purchase Common Stock dated as of December 14, 1998 in
the name of Swartz Private Wquity, LLC.
4.4 Form of Investor Purchase Warrant
10.1 Pledge Agreement between Robert McNulty and Krieger & Prager, as
Agent dated December, 1998.
10.2 Form of Security Agreement.
10.3 Regulation D Common Stock Private Equity Line Subscription
Agreement between Shopping.com and Swartz Private Equity, LLC
dated December 14, 1998.
10.4 Registration Rights Agreement between Shopping.com and Swartz
Private Equity, LLC dated December 15, 1998.
27.1 Financial Data Schedule/2/
(b) Reports on Form 8-K
None
- ----------------
/2/ This exhibit is being filed electronically in the electronic format
specified by EDGAR.
64
SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SHOPPING.COM
December 22, 1998 /s/ FRANK W. DENNY
---------------------------
Frank W. Denny,
Chairman of the Board
December ___, 1998
---------------------------
John H. Markley,
Chief Executive Officer, President and Director
December 22, 1998 /s/ KRISTINE E. WEBSTER
---------------------------
Kristine E. Webster,
Senior Vice President, Chief Financial Officer
and
Secretary
December ___, 1998
---------------------------
Paul J. Hill,
Director
December ___, 1998
---------------------------
Edward F. Bradley,
Director
65
EXHIBIT INDEX
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION NUMBERED PAGE
4.1 Form of Secured Promissory Note in the principal amount of $2,500,000.
4.2 Form of Common Stock Purchase Warrant for the purchase of 500,000
shares of Common Stock at an exercise price of $7.00.
4.3 Warrant to Purchase Common Stock dated as of December 14, 1998 in the
name of Swartz Private Equity, LLC.
4.4 Form of Investor Purchase Warrant.
10.1 Pledge Agreement between Robert McNulty and Krieger & Prager, as
Agent dated December, 1998.
10.2 Form of Security Agreement.
10.3 Regulation D Common Stock Private Equity Line Subscription Agreement
between Shopping.com and Swartz Private Equity, LLC dated December 14,
1998.
10.4 Registration Rights Agreement between Shopping.com and Swartz Private
Equity, LLC dated December 15, 1998.
27.1 Financial Data Schedule/1/
- --------------------
/1/ This exhibit is being filed electronically in the electronic format
specified by EDGAR.
66