SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period from June 28, 1998 to September 26, 1998
------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_________________ to ___________________
Commission File Number 0-16930
EGGHEAD.COM, INC.
-----------------
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1296187
---------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
EAST 22705 MISSION
LIBERTY LAKE, WASHINGTON 99019
------------------------ -----
(Address of principal executive offices) (Zip Code)
(509) 922-7031
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO __
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock:
Outstanding at
Class October 24, 1998
----- ----------------
Common Stock 24,395,044
$.01 par value shares
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
EGGHEAD.COM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
SEPTEMBER 26, MARCH 28,
1998 1998
----------- -----------
(unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 59,523 $ 67,381
Accounts receivable, net of allowance for
doubtful accounts of $1,783 and $2,611, respectively 2,721 5,670
Merchandise inventories, net 16,671 12,923
Prepaid expenses and other current assets 789 999
Property held for sale 1,224 8,224
-------- --------
Total current assets 80,928 95,197
-------- --------
Property and equipment, net of accumulated depreciation of
$4,086 and 3,225 3,536 2,394
Goodwill, net 32,490 33,225
Other assets 299 336
-------- --------
$117,253 $131,152
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 13,015 $ 15,834
Accrued liabilities 11,559 12,002
Reserves and liabilities related to restructuring 8,865 17,226
-------- --------
Total current liabilities 33,439 45,062
-------- --------
Other long-term liabilities - 3
-------- --------
Total liabilities 33,439 45,065
-------- --------
Commitments and contingencies - -
Shareholders' equity :
Common stock, $.01 par value:
50,000,000 SHARES AUTHORIZED; 24,395,044 AND
23,492,502 shares issued and outstanding, respectively 244 235
Additional paid-in capital 171,135 160,669
Retained deficit (87,565) (74,817)
-------- --------
Total shareholders' equity 83,814 86,087
-------- --------
$117,253 $131,152
======== ========
See Notes to Consolidated Financial Statements.
2
EGGHEAD. COM, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Operations
(Amounts in thousands, except per share data)
13 Weeks Ended 26 weeks Ended
--------------------------- --------------------------
(unaudited) (unaudited)
September September September September
26, 27, 26, 27,
1998 1997 1998 1997
---------- --------- ------------ ---------
Net sales:
Retail $ - $50,655 $ - $102,724
Ongoing 35,054 12,635 64,574 16,727
------- ------- -------- --------
35,054 63,290 64,574 119,451
Cost of sales
Retail - 41,923 - 85,556
Ongoing 31,342 10,092 57,805 13,382
------- ------- -------- --------
31,342 52,015 57,805 98,938
Gross margin 3,712 11,275 6,769 20,513
Selling and marketing expense 6,920 10,745 12,689 19,746
General and administrative expense 3,687 4,918 6,754 8,585
Amortization of goodwill 429 184 848 184
Depreciation expense 507 1,161 872 2,415
------- ------- -------- --------
Operating loss (7,831) (5,733) (14,394) (10,417)
Interest income 934 885 1,866 1,883
Other income (expense) (302) (57) (220) (29)
------- ------- -------- --------
Loss before income taxes (7,199) (4,905) (12,748) (8,563)
Income tax benefit - - - -
------- ------- -------- --------
Net loss $(7,199) $(4,905) $(12,748) $ (8,563)
======= ======= ======== ========
Basic loss per share $ (0.30) $ (0.24) $ (0.53) $ (0.45)
======= ======= ======== ========
Weighted average common shares
outstanding 24,281 20,127 23,925 18,859
======= ======= ======== ========
See Notes to Consolidated Financial Statements.
3
EGGHEAD.COM, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------
Consolidated Statements of Shareholders' Equity
(Amounts in thousands)
Additional
Common Stock Paid-in Retained
------------
Shares Amount Capital Deficit Total
-------------------- ---------- -------- --------
Balance, March 28, 1998 23,493 $235 $160,669 $(74,817) $ 86,087
Stock issued for cash, pursuant
to employee stock purchase
plan 14 -
Stock issued for cash, pursuant
to stock option plan 888 9 10,466 10,475
Net loss (12,748) (12,748)
------ ---- ---------- -------- --------
Balance, September 26, 1998 24,395 $244 $171,135 $(87,565) $ 83,814
====== ==== ========== ======== ========
(unaudited)
See Notes to Consolidated Financial Statements.
4
EGGHEAD.COM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(DOLLARS IN THOUSANDS)
26 Weeks Ended
------------------------------
(unaudited)
September 26, September 27,
1998 1997
-------- --------
Cash flows from operating activities:
Net loss $(12,748) $ (8,563)
-------- --------
Adjustments to reconcile net income (loss) to
net cash provided (used) by operating activities:
Depreciation and amortization 1,720 2,276
Deferred rent (3) (195)
(Gain) loss on disposition of assets (275) (1)
Reserves recorded in connection with CGE disposal - (1,788)
Changes in assets and liabilities:
Accounts receivable, net 2,949 7,385
Merchandise inventories (3,748) (18,891)
Prepaid expenses and other current assets 210 (151)
Other assets (76) (727)
Accounts payable (2,819) 510
Accrued liabilities (443) 1,309
Discontinued Operations - (3,761)
Reserves and liabilities related to restructuring (8,596)
-------- --------
Total adjustments (11,081) (14,034)
-------- --------
Net cash (used) provided by operating activities (23,829) (22,597)
-------- --------
Cash flows from investing activities:
Additions to property and equipment (1,606) (793)
Proceeds from sale of property and equipment 7,102 7
-------- --------
Net cash (used) provided by investing activities 5,496 (786)
-------- --------
Cash flows from financing activities:
Payments on capital lease obligations - (125)
Payments on notes payable - (6,000)
Proceeds from stock issuances 10,475 166
-------- --------
Net cash (used) provided by financing activities 10,475 (5,959)
-------- --------
Net increase (decrease) in cash (7,858) (29,342)
Cash and cash equivalents at beginning of period 67,381 83,473
-------- --------
Cash and cash equivalents at end of period $ 59,523 $ 54,131
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH PAID (RECEIVED):
Interest $ 6 $ 24
Income taxes $ (233) $ -
See Notes to Consolidated Financial Statements.
5
EGGHEAD.COM, INC. AND SUBSIDIARIES
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Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial information and pursuant to the rules and regulations of the
Securities and Exchange Commission. While these statements reflect the
adjustments which are, in the opinion of management, necessary to fairly
state the results of the interim periods, they do not include all the
information and footnotes required by generally accepted accounting
principles for complete financial statements. These adjustments are of a
normal and recurring nature. These financial statements should be read in
conjunction with the Company's audited financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year
ended March 28, 1998. The results of operations for the three and six
month periods ended September 26, 1998 are not necessarily indicative of
the results to be expected for any subsequent quarter or for the year
ending April 3, 1999.
FISCAL YEARS
The Company uses a 52/53 week fiscal year, ending on the Saturday nearest
March 31 of each year. Fiscal quarters are such that the first three
quarters consist of 13 weeks and the fourth quarter consists of the
remaining 13/14 weeks. Fiscal 1999 will consist of 53 weeks. Fiscal 1998
had 52 weeks.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform with the
current period presentation. These reclassifications had no effect on
retained earnings or net income as previously reported.
INCOME STATEMENT CAPTIONS
During fiscal 1998, Egghead.com closed its remaining retail stores as a
part of a strategic restructuring. The retail store operations do not meet
the requirements of a "discontinued operation" under Accounting Principles
Board Opinion No. 30. However, the Company has split its sales and cost of
sales amounts between retail store operations and the ongoing business,
consisting of Internet, direct response and catalog sales.
NOTE 2 EARNINGS (LOSS) PER SHARE
Basic loss per share amounts are computed by dividing the net loss by the
weighted average number of shares of common stock outstanding during the
year. Diluted earnings per common share are not disclosed as potentially
dilutive securities would have been anti-dilutive to the loss per share
calculation for the 13 and 26 week periods ended September 26, 1998 and
September 27, 1997. Effective December 27, 1997, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share." Prior earnings per common share amounts were not affected by the
adoption of SFAS No. 128.
6
EGGHEAD.COM, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 3 INCOME TAXES
Egghead.com determines its income tax accounts in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 109. Deferred income taxes
result primarily from temporary differences in the recognition of certain
items for income tax and financial reporting purposes.
Given its recent losses, Egghead.com determined that its deferred tax
assets no longer meet the realization criteria of SFAS No. 109. Under SFAS
109, the realization of the deferred tax assets depends on generating
future taxable income. Until Egghead.com has determined that its existing
net operating losses, which expire 15 years after origination, are
realizable, it will not record a tax charge or benefit for future operating
results.
NOTE 4 LEASES
The Company leases corporate offices and distribution facilities under
operating leases with remaining lives on most leases ranging from one to
three years. As of September 26, 1998 the future minimum rental payments
under these noncancelable operating leases for headquarters and
distribution facilities and equipment consisted of the following (in
thousands):
Fiscal Year Operating
----------- ---------
1999 $ 410
2000 505
2001 302
2002 4
Thereafter 1
------
Total minimum payments $1,222
======
7
EGGHEAD.COM, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (continued)
(Unaudited)
NOTE 5 RECENT ACCOUNTING PRONOUNCEMENTS
During June 1998, the Financial Accounting Standards Board issues Statement
of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities. The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured
at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. Due to the
Company's minimal use of derivatives, the new standard is expected to have
no material impact on its financial position or results of operations.
SFAS 133 will be effective for the Company's fiscal year 2001.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1
provides guidance for determining whether computer software is internal-use
software and on accounting for proceeds of computer software originally
developed or obtained for internal use and then subsequently sold to the
public. It also provides guidance on capitalization of the costs incurred
for computer software developed or obtained for internal use. The Company
does not believe that SOP 98-1 will have a significant effect on the
Company's financial statements.
NOTE 6 RESTRUCTURING AND REORGANIZATION
In the fourth quarter of fiscal 1998, Egghead.com announced plans to
reorganize its operations involving, among other things, closing the
remaining Egghead.com stores, a significant reduction in its headquarters
staff and the closure of its Sacramento, California distribution center.
The fiscal 1998 fourth quarter charge of $37.6 million included
approximately $17.1 million for retail lease terminations and related fixed
asset disposals, $10.0 million for store closing costs, $6.2 million for
the liquidation of inventory, $2.1 million for the closure of the
Sacramento distribution center and $2.2 million in severance, fixed asset
disposal and other miscellaneous expenses related to the reduction of the
Company's headquarters operation. Egghead.com anticipates that the
settlement of the remaining liabilities related to the retail store
closures, consisting at September 26, 1998 of primarily $6.3 million in
lease obligations and $1.4 million in severance and other claims, will be
substantially completed by the end of fiscal 1999.
In the fourth quarter of fiscal 1997, Egghead.com recorded a $24.0 million
restructuring and impairment charge to reorganize its operations. This
plan involved among other things, closing 70 of the 156 Egghead.com stores,
a significant reduction in its headquarters staff and the closure of its
Lancaster, Pennsylvania distribution center. The Company anticipates that
the remaining payables related to the restructure, consisting at September
26, 1998 primarily of $0.7 million in lease obligations and $0.4 million in
severance, will be substantially settled by the third quarter of fiscal
1999.
8
EGGHEAD.COM, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (continued)
(Unaudited)
NOTE 7 RECAPITALIZATION OF SUBSIDIARY
On November 11, 1997 Egghead.com recapitalized its wholly owned subsidiary
Elekom. Corporation ("Elekom") As part of the recapitalization, certain venture
capitalists invested capital in Elekom, reducing the Company's ownership
percentage to approximately 24% as of September 26, 1998. Prior to
recapitalization, income and expenses of Elekom were recorded in the Company's
operating results. After recapitalization, the Company's share of the results
of operations of Elekom were included using the equity method of accounting and
are reflected in the other income (expense) in the Company's consolidated
statements of operations.
NOTE 8 ACQUISITION
On August 14, 1997, the Company acquired Surplus Software, Inc. d/b/a Surplus
Direct, of Hood River, Oregon, by issuing 5,310,888 shares of common stock and
289,112 options to purchase common stock of Egghead.com, Inc. The transaction
included payment of $6.0 million of Surplus Direct debt. Surplus Direct is
engaged in the direct marketing of previous version computer hardware and
software. This acquisition was recorded under the purchase method of
accounting and operating results of Surplus Direct are included in the statement
of operations from the date of acquisition. An excess purchase price of
approximately $34.2 million has been determined based on the fair values of
assets acquired and liabilities assumed. Amortization of goodwill will be over
a period of 20 years.
NOTE 9 PROPERTY HELD FOR SALE
On May 1, 1998, the Company sold its previous headquarters building located in
Liberty Lake, Washington, for approximately $7.5 million. The building was
recorded in the Property Held for Sale on the Company's Balance Sheet as of
March 28, 1998. The Company will lease approximately 7,000 square feet of the
building over a lease term of one year, including extensions. The Company
recorded a gain of approximately $270,000 on this sale.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
GENERAL
RESULTS OF OPERATIONS
OVERVIEW
- --------
Egghead.com, Inc. ("Egghead.com" or the "Company") is one of the leading on-line
resellers of personal computer ("PC") hardware, software, peripherals and
accessories to consumers and businesses. The Company sells a broad selection of
PC hardware and software products, as well as other consumer merchandise,
through three Internet websites, the Egghead.com site, the Surplusdirect.com
site and the Surplusauction.com site, and a direct response division. These
products consist of current and off-price merchandise including excess, close-
out, refurbished, and reconditioned goods. In order to enhance its Internet
presence and expand its product offering, Egghead.com acquired Surplus Software,
Inc. ("Surplus Direct") on August 14, 1997. On January 28, 1998, the Company
announced that it would change its name to Egghead.com, Inc.; shift its business
emphasis to Internet commerce; close its remaining retail network of 80 stores;
close its distribution center in Sacramento, California; and combine its
management and operations with those of Surplus Direct. Unless the context
indicates otherwise, references to Egghead.com or the Company include
Egghead.com and its wholly owned subsidiaries.
Egghead.com operates three electronic commerce sites, Egghead.com,
Surplusdirect.com and Surplusauction.com, which in the aggregate were ranked as
the eighth most visited at-home and at work shopping site on the Internet during
September 1998 according to Media Metrix, a leading independent market research
firm. These interlinked web sites represent Egghead.com's Internet
"superstore," where customers can choose from a large assortment of products,
sourced, priced and configured to meet a wide variety of needs. The Company's
websites reported sequential growth from the fourth quarter of fiscal 1998 to
the second quarter of fiscal 1999 in the number of registered auction site
bidders from 96,000 to 242,094, respectively, and in the number of visits to the
websites from 14 million to 21 million, respectively. The customer e-mail
database grew to 2.3 million names as of September 26, 1998. The Company is in
the process of consolidating and integrating these web sites on a common Oracle
technology platform. The new and updated web sites are expected to be launched
in November 1998.
The Egghead.com web site offers over 40,000 products, which are primarily
current version PC hardware, software, peripherals and accessories. Egghead.com
offers electronic delivery of selected software products, which permits a
customer to place an order and have the software product transmitted directly
electronically onto his or her PC. Egghead.com customers can use the Internet
commerce site to search for software titles, browse merchandise categories and
products and view demonstrations of selected software programs before placing an
order. The majority of the products offered on the Egghead.com web site are
available for shipment within 24 hours through third-party distribution
facilities.
10
The Surplusdirect.com web site is a leading reseller of primarily name brand,
off-price PC hardware, software and peripherals. These products are primarily
special purchases of excess, closeout, refurbished and reconditioned
merchandise. Through its merchandising organization, Egghead.com is able to
provide consumers and businesses the unique values created through the
opportunistic acquisition of goods. Customers may place orders directly on the
Surplus Direct home page, and products are generally shipped to customers the
same day orders are placed.
The Surplusauction.com web site sells all of the aforementioned categories of
goods through interactive online auctions. The auction format allows customers
to bid competitively against each other in an interactive online environment.
The web site currently offers simultaneous auctions in the form of daily
auctions (24-hours), hyper auctions (one hour) and mega auctions (Friday through
Monday), selling quantities of one to more than 1,500 of each item. Customers
can bid online 24 hours a day, seven days a week. By comparison to the
traditional fixed price formats of online catalogs, the auction format enables
the customers to impact the price through auction-style bidding. At the
designated closing time, the Company selects the winning bidders and sends an e-
mail message to them confirming their purchases. In addition to offering an
exciting forum for Internet purchases, the auction site allows vendors to
dispose of excess merchandise efficiently and effectively. The site was
launched in July 1997 and has over 242,000 registered bidders as of September
26, 1998.
Egghead.com also operates a 1-800 customer service center which responds to
inbound telephone calls and inquiries from consumers, as well as corporate,
government, reseller and educational institution customers, and takes orders for
the same hardware and software products that are offered on the Company's web
sites. These inquiries are mainly generated by the Company's promotional
efforts which include both online and traditional advertising, principally
through the limited circulation of its catalogs. Egghead.com ships merchandise
purchased through the 1-800 service directly to the customer from Egghead.com's
distribution center in Vancouver, Washington or from third-party distributors.
The Company's web sites and 1-800 customer service center are referred to
"ongoing" operations in the following discussion of financial condition and
results of operations. "Continuing" operations includes the retail store network
during its existence and the ongoing operations, but excludes the corporate,
government and educational (`CGE") division which the Company sold in fiscal
year 1997. The CGE division is referred to as "discontinued" operations
11
This Report on Form 10-Q and the documents incorporated herein by reference
contain forward-looking statements based on current expectations, estimates and
projections about the Company's industry, management's beliefs and certain
assumptions made by management. When used in this report and elsewhere by
management, from time to time, the words "believes," "plans," estimates,"
"intends," "anticipates," "seeks," and "expects" and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict. Accordingly, actual
results may differ materially from those anticipated or expressed in such
statements. Potential risks and uncertainties include, among others, those set
forth under "Additional Factors That May Affect Future Results" in Egghead.com's
Annual Report on Form 10-K for fiscal year ended March 28, 1998. Particular
attention should be paid to the cautionary statements involving the Company's
limited Internet operating history, the rapid evolution of Internet commerce and
related technology, management of potential growth, the intensely competitive
nature of the business of selling PC software, hardware and related products,
and of the electronic commerce business, Egghead.com's dependence on vendors,
distributors and certain supply sources and risks associated with the closing of
the Company's retail store network and the combination of the management and
operations of the Company with those of Surplus Direct. Readers are cautioned
not to place undue reliance on the forward-looking statements, which speak only
as of the date made. 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 Securities and Exchange Commission ("SEC").
RESULTS OF OPERATIONS
- ---------------------
Egghead.com reported a total net loss for the quarter ended September 26, 1998
of $7.2 million compared to a total net loss of $4.9 million for the quarter
ended September 27, 1997. The net loss from continuing operations for the six
months ended September 26, 1998 and September 27, 1997 were $12.7 million and
$8.6 million, respectively.
CONTINUING OPERATIONS
- ---------------------
NET LOSS. The Company's loss includes the results of the Internet commerce
operations, including Surplusdirect.com, Surplusauction.com and other Surplus
Direct activities from acquisition on August 14, 1997, the direct response unit,
and the retail store network through its closure on February 28, 1998. The
following table shows the relationship of certain items relating to continuing
operations included in Egghead.com's Consolidated Statements of Operations
expressed as a percentage of net sales:
SECOND QUARTER YEAR-TO-DATE
13 WEEKS ENDING 26 WEEKS ENDING
----------------------------------------------------------------------------
SEPT. 26, 1998 Sept. 27, 1997 Sept. 26, 1998 Sept. 27, 1997
-------------- ---------------- ---------------- -----------------
Net sales..................................
Retail................................... -% 80.0% -% 86.0%
Ongoing.................................. 100.0 20.0 100.0 14.0
------- ----- ------ -----
Total net sales............................ 100.0 100.0 100.0 100.0
------- ----- ------ -----
12
Cost of sales:.............................
Retail................................... - 66.0 - 71.3
Ongoing.................................. 89.4 16.2 89.5 11.5
------- ----- ------ -----
Total cost of sales........................ 89.4 82.2 89.5 82.8
------- ----- ------ -----
Gross margin............................... 10.6 17.8 10.5 17.2
Selling and marketing expense.............. 19.8 17.0 19.7 16.5
General and administrative expense......... 10.5 7.8 10.5 7.2
Depreciation and amortization expense...... 2.6 2.1 2.6 2.2
------- ----- ------ -----
Operating loss............................. (22.3) (9.1) (22.3) (8.7)
Other income, net.......................... 1.8 1.3 2.6 1.5
------- ----- ------ -----
Loss before income taxes................... (20.5)% (7.8)% (19.7)% (7.2)%
======= ===== ====== =====
NET SALES. The Company's total revenues for the second quarter of fiscal 1999
were $35.1 million, a 73 percent increase from the proforma ongoing revenue of
$20.2 million for the comparable period of fiscal 1998. Proforma ongoing
revenues for the second quarter of fiscal 1998 exclude retail store revenue of
$50.7 million attributable to retail stores closed February 28, 1998 and include
revenues of $7.6 million attributable to Surplus Direct for the period prior to
its acquisition on August 14, 1997. The increase in proforma revenues is
primarily due to an increase in Internet revenues, partially offset by a managed
decrease in catalog and call center operations. Total revenues for the six
months ended September 26, 1998 were $64.6 million, a 67 percent increase from
the proforma ongoing revenue of $38.6 million for the same period in fiscal
1998. Proforma ongoing revenues for the six-month period ending September 27,
1998 exclude retail store revenue of $102.7 million and include revenue of $21.9
million attributable to Surplus Direct for the period prior to its acquisition.
These increases are due to significant investments in marketing programs
designed to promote and maintain brand awareness of the Company; an increase in
the number of daily and weekly auctions; an increase in the customer base; and
an increase in the categories and amount of merchandise obtained from vendors.
During the quarter, Egghead.com's registered auction bidders increased 44
percent from 168,000 at June 27, 1998 to 242,000 at September 26, 1998. The
Company's e-mail customer database expanded 14 percent from 2.0 million at the
beginning of the quarter to 2.3 million as of September 26, 1998. Further,
Egghead.com entered into marketing agreements with AOL, Netscape, Microsoft,
ZDNet, CNET's Shopper.com and ebay.com and also selectively canceled certain
other on-line agreements. The sales for the three-month and six-month periods
ending September 26, 1998 decreased $28.2 million and $54.9 million,
respectively, from the comparable periods in fiscal year 1998. These decreases
are primarily attributable to the closure of the retail store chain partially
offset by the increase in on-line revenues.
GROSS MARGIN. Gross margin consists of net sales minus cost of sales. Gross
margin is primarily affected by sales volume and the mix of PC products sold, as
well as vendor rebates, freight and obsolescence charges. Gross margin as a
percentage of net sales may also be significantly affected by industry-wide
pricing pressure related to both competitors' pricing and vendors' pricing.
Gross margin from ongoing operations was 10.6% for the second quarter of fiscal
1999, an increase of 20 basis points from the first quarter of fiscal 1999. The
gross margin from ongoing operations for the second quarter and first six-month
period of fiscal 1999 as compared to the second quarter and the first six-month
period of fiscal 1998, decreased 8.1 percent and 7.7 percent, respectively. The
fiscal 1999 gross margin percentages reflect a managed reduction in
13
call center and catalog sales as compared to the same periods in fiscal 1998. In
addition, the fiscal 1998 gross margin percentages do not include the operations
of Surplus Direct prior to its acquisition on August 14, 1997. In view of
Egghead.com's limited Internet operating history, the Company believes that
period-to-period comparisons of its operating results, including the Company's
gross margin and operating expense as a percentage of net sales, are not
necessarily meaningful and should not be relied upon as an indication of future
performance. The decreases in gross margin dollars and percentages for the
three-month and six-month periods ending September 26, 1998 from the comparable
periods in fiscal year 1998 are primarily attributable to the closure of the
retail store chain.
SELLING AND MARKETING EXPENSE. Selling and marketing expense consists primarily
of operating expenses, including call center, Internet commerce, customer
service, distribution, and marketing expense. Such operating expenses include
payroll and benefits, telecommunications, credit card processing costs, bad
debts, and supplies in addition to the occupancy costs, for periods before
closure, of the retail stores. The selling and marketing expenses for the second
quarter of fiscal 1999 were $6.9 million, an increase from the first quarter of
fiscal 1999 of $1.2 million. Selling and marketing expenses as a percentage of
net sales increased to 19.8 percent for the second quarter of fiscal 1999 as
compared to 19.5 percent for the first quarter of fiscal 1999. The increase in
selling and marketing expense is related to the expansion of promotion and
marketing activities and the costs associated with the enhancing of the features
and functionality of the web sites and related systems. The fiscal 1999 three-
month and six-month periods ended September 26, 1998 reflect decreases of $3.8
million and $7.1 million, respectively, in selling and marketing expenses from
the comparable periods in fiscal year 1998, primarily due to the closure of the
retail store chain. The Company believes that continued expansion of its
selling and marketing expenses is essential to expanding its web site
capabilities, enhancing its brand name and increasing its market share.
However, there can be no assurance that the increase in such expenses will
actually result in expanded web site capabilities, enhanced brand name
recognition or increased market share.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense consists
primarily of payroll and related expenses of headquarters support functions such
as executive, merchandising, purchasing, accounting, recruiting, facilities
expenses and other general corporate expenses. The general and administrative
expenses of $3.7 million, or 10.5 percent of net sales, for the second quarter
of fiscal 1999 is higher than the fiscal 1999 first quarter expense of $3.1
million or 10.4 percent of net sales in that quarter. The dollar increase in
general and administrative expense from the first quarter of fiscal 1999 is
primarily attributable to the hiring of personnel and expenses related to the
consolidation of headquarters operations in Vancouver, Washington. The general
and administrative expenses have declined $1.2 million and $1.8 million for the
three-month and six-month periods ended September 26, 1998, respectively, from
the comparable periods in fiscal year 1998. This decrease is primarily due to
the closure of the retail store chain. The Company anticipates the general and
administrative costs to decline from prior year levels as Egghead.com adjusts
its overhead functions for the elimination of the retail store operations.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense primarily
includes depreciation of Egghead.com's capital equipment and amortization of the
goodwill recorded with the acquisition of Surplus Direct in August 1997. The
depreciation expense of $507,000 and $872,000 for the three-month and six-month
periods ended September 26, 1998, respectively, declined compared to $1.2
million and $2.4 million for the comparable periods in fiscal year
14
1998, primarily due to the closure of the remaining retail stores in February
1998. Amortization expense of $429,000 and $848,000 in the three-month and six-
month periods ended September 26, 1998 reflects the amortization of the goodwill
recorded for the Surplus Direct acquisition in August 1997.
OTHER INCOME, NET. Interest income was $934,000 and $885,000 for the second
quarters of fiscal 1999 and 1998, respectively. Interest income was $1.9
million for the first six-month periods of fiscal 1999 and 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased to $59.5 million as of September 26, 1998 as
compared to $67.4 million at March 28, 1998. The decrease in the cash balance
was primarily due to the net operating loss of $12.7 million, the decrease in
restructure liabilities of $8.6 million and the increase in merchandise
inventories of $3.8 million, partially offset by net proceeds of $7.1 million
from the sale of the Company's former headquarters building and $10.5 million in
stock issuances. Egghead.com expects these cash balances will be adequate to
meet future cash requirements for operations for the foreseeable future.
Cash flows used by operating activities of $23.8 million for the six months
ended September 26, 1998 were primarily attributable to the net loss of $12.7
million, a decrease in restructure liabilities of $8.6 million and an increase
in merchandise inventories of $3.8 million, partially offset by a decrease in
accounts receivable of $2.9 million.
Net cash provided by investing activities was $5.5 million for the first six
months of fiscal 1999 and primarily consisted of net proceeds of $7.1 million
from the sale of the former headquarters building partially offset by capital
expenditures of $1.6 million primarily related to the upgrading of the web site
software platforms and related hardware.
Cash flows provided by financing activities of $10.5 million for the six months
ended September 26, 1998 consisted of proceeds from stock issuances under the
Company's stock option amd stock purchase plans.
As of September 26, 1998, the Company's principal source of liquidity was $59.5
million of cash. As of that date, Egghead.com principal commitments consisted
of obligations in connection with operating leases and commitments for
advertising and promotional arrangements. Although the Company has no material
commitments for capital expenditures, it anticipates future purchases related to
the redesign of the web sites to improve functionality and navigation,
incorporating features which are intended to improve the customer shopping
experience, and scalability and performance of the sites. In the event of a
growth in operations, these types of expenditures could be substantial.
15
The Company believes that current cash and cash equivalent balances will be
sufficient to meet its anticipated cash needs for the foreseeable future.
However, any projections of future cash needs and cash flows are subject to
substantial uncertainty. If cash generated from operations is insufficient to
satisfy the Company's liquidity requirements, the Company may seek to sell
additional equity or debt securities or to obtain a line of credit. The sale of
additional equity or debt securities could result in additional dilution to the
Company's stockholders. There can be no assurance that financing will be
available in amounts or on terms acceptable to the Company, if at all. In
addition, the Company will, from time to time, consider the acquisition of or
investment in complementary businesses, products and technologies, which might
increase the Company's liquidity requirements or cause the Company to issue
additional equity or debt securities. The Company does not currently use
derivative financial instruments.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue exists because many computer systems and application use
two-digit fields to designate a year. Date-sensitive computer systems and
programs may fail to recognize or correctly process the year 2000 as the century
date change approaches or occurs. This inability to properly recognize or treat
the year 2000 may cause systems to process information incorrectly and could
result in systems failures or miscalculations causing a disruption of
operations, including, among other things, an inability to process transaction
or engage in similar normal business activities.
As a company engaged in Internet commerce, Egghead.com relies on computer
programs and systems in connection with: internal and external communication
networks and systems (including transmissions of information over the Internet);
the operation of its web sites; customer use of its web sites; order processing
and fulfillment; accounting and financial systems; and other business functions.
Since the Company's internal systems and software are relatively new and the
majority are covered by maintenance agreements with third-party vendors, the
Company does not expect that the Year 2000 cost issues relating to its own
internal systems will be significant. The Company's plan for addressing Year
2000 issues that may effect its business primarily involves three phases: (1)
identification and evaluation; (2) development of plans for addressing the
issues and prioritization of such plans; and (3) implementation of plans and
verification of effectiveness. The Company has identified and evaluated its
major internal information technology and data processing systems for Year 2000
compliance. Certain critical internal information technology and data processing
systems have already been modified, upgraded or replaced to remedy Year 2000
issues. The Company is currently completing a plan to address its remaining
significant internal systems for Year 2000 compliance. This planning phase is
expected to be substantially complete by the end of calendar year 1998.
Management intends to complete the implementation and verification phases for
its remaining major internal systems by October 1999.
Due to the Company's retail industry focus, the Company's reliance on
significant non-information technology systems is primarily limited to
telecommunications equipment, voicemail systems and property security systems.
The Company has recently replaced its telecommunications equipment and voicemail
systems with systems that the vendors state are Year 2000 compliant. The
Company is currently evaluating its property security systems for Year 2000
compliance, but does not believe that any problems with this system would
materially affect the Company's business operations and, therefore, does not
anticipate the related Year 2000 costs to be material.
16
The Company's business is dependent upon the satisfactory performance and
reliability of the external communication and computer networks, systems and
services integral to the Internet. These external networks, systems and services
are maintained or provided by third parties and affect the ability of customers
to access, use and process transactions on the Company's web sites on the
Internet. In addition, the Company relies on other systems and services
provided to its customers by third parties. As a result, the success of the
Company's plan to address the Year 2000 issues depends in part on parallel
efforts being undertaken by other third party entities on whose networks, system
and services the Company's business relies. Egghead.com has begun to identify
and initiate communications with third party entities whose networks, systems or
services are critical to the Company's business to determine the status of these
entities' Year 2000 compliance. There can be no assurance that all such
entities will provide accurate and complete information, or that all their
networks, systems, or services will achieve full Year 2000 compliance. In an
attempt to partially mitigate the risk of the possibility of non-compliance by
certain critical service providers, the Company has begun to diversify its use
of certain services among several providers. However, there can be no assurance
that this diversification will mitigate the risk of non-compliance, and any
failure of third party networks, systems, or services might have a material
adverse impact on the Company's systems, business, financial condition or
results of operations.
Costs related to the Company's project to address Year 2000 issues have been
expensed as incurred and have not been material to date. The Company expects to
fund the Year 2000 related costs through operation cash flows and does not
expect these costs to have a material adverse effect on the Company's liquidity
or results of operations. The cost of the project is based on the Company's
estimates, which make numerous assumptions about future events. However, there
can be no assurance that these estimates will be correct and actual costs could
differ materially from these estimates.
Although the Company is taking steps to achieve Year 2000 compliance of its
internal systems and to evaluate the compliance of third-party service providers
on which aspect of the Company's business depend, the most reasonably likely
worst case scenario if Year 2000 compliance were not achieved sufficiently is
that the customer's ability to satisfactorily access, use or process
transactions would be disrupted, reduced or eliminated for a period of time.
The impact of any such occurrences would depend on their extent and duration,
but could have a material adverse effect on the Company's business, financial
condition or results of operations. As the compliance of third-party global,
national and local communications networks as well as the compliance of
individual Internet service providers is not within the control of the Company,
a contingency plan for this worst case scenario does not exist and the Company
does not foresee the ability to develop one. The Company, however, has begun to
diversify its uses of certain services among several providers to attempt to
partially mitigate this risk. There can be no assurance, however, that the
Company's attempt will mitigate the risk of non-compliance, and any failure of
third party networks, systems or services might have a material adverse impact
on the Company's business, financial condition or results of operations.
The Company believes it is taking the necessary steps regarding Year 2000
compliance with respect to matters within its control to seek to minimize the
impact of Year 2000 issues on the Company. Egghead.com currently expects its
Year 2000 project to be completed in 1999. However, no assurance can be given
that the Company's systems will be Year 2000 compliant in
17
a timely manner, that the Company will not incur significant additional expenses
for Year 2000 issues, that third party entities upon which the Company's
business partially depends will achieve Year 2000 compliance, or that the Year
2000 problem will not have a material adverse impact on the Company's business,
financial condition or results of operations.
18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Egghead.com, Inc.'s Annual Meeting of Shareholders was held on September 2,
1998 ("Meeting"), at which the directors below were elected to three-year
terms. The votes were cast as set forth below:
Nominee For Withheld
------- --- --------
C. Scott Gibson 18,385,273 32,669
Robert T. Wall 18,385,747 32,195
Karen White 18,385,786 32,156
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
10.1 Egghead.com, Inc. Amended and
Restated Nonemployee Director
Stock Option Plan.
27 Financial Data Schedule.
b. Reports on Form 8-K
A Form 8-K was filed by the Company on October 1, 1998 to report, under
Item 5 of Form 8-K, that elected to the Board of Directors of Egghead,com,
Inc. on September 2, 1998 were three new directors, C. Scott Gibson, Robert
T. Wall and Karen White, and that Richard P. Cooley and Samuel N. Stroum
retired from the Board of Directors of the Company on September 2, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized, in the
city of Liberty Lake, State of Washington, on November 9, 1998.
EGGHEAD.COM, INC.
By /s/ George P. Orban
--------------------------------------------------
George P. Orban
Chief Executive Officer, Chairman of the Board
/s/ Brian W. Bender
--------------------------------------------------
Brian W. Bender
Chief Accounting Officer, Chief Financial Officer
19
EXHIBIT INDEX
Exhibit Number Title
- -------------- -----
10.1 Egghead.com, Inc. Amended and Restated Nonemployee
Director Stock Option Plan
27 Financial Data Schedule