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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
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COMMISSION FILE NUMBER 0-28977
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VARSITYBOOKS.COM INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 54-1876848
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
2020 K STREET, N.W., 6TH FLOOR
WASHINGTON, D.C. 20006
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (202) 667-3400
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.0001 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [_] No[X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of common stock held by non-affiliates of the
registrant was $43,284,361 based on the last reported sale price of $5.75 on
The Nasdaq National Market on March 27, 2000.
As of March 27, 2000, there were 15,680,872 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement for its Annual
Meeting of Stockholders pursuant to Regulation 14A within 120 days of the end of
the fiscal year ended December 31, 1999. Portions of such proxy statement are
incorporated by reference into Part III of this report.
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K ("Form 10-K") contains certain
forward-looking statements within the meaning of Section 27A of the Securities
and Exchange Act of 1934, which statements can be identified by the use of
forward looking terminology, such as "may", "will", "expect", "anticipate",
"estimate", or "continue" or the negative thereof or other variations thereon or
comparable terminology. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth elsewhere in this Form 10-K. See the
"Risk Factors" section of Item 1 "Business" for cautionary statements
identifying important factors with respect to such forward-looking statements,
including certain risks and uncertainties, that could cause actual results to
differ materially from results referred to in forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL
We are a leading online retailer of new college textbooks and we provide
marketing services for businesses interested in reaching the college market.
Recently, we expanded our online offerings to include scholarship opportunities,
free e-mail, and job and career information. According to Media Metrix, our Web
site had over one million unique visitors in January 2000, making
VarsityBooks.com the most-visited college-oriented Web site during the peak
back-to-school period. According to Student Monitor, a nationally syndicated
market research company, VarsityBooks.com had the "most visited," "most
heard-of," and "most often-visited" Web site in the entire college market during
fall 1999. Using the Internet, we are able to provide our customers with a
convenient purchasing process and reduced prices and build our brand by saving
students time and money while providing a high level of customer service.
In addition to building VarsityBooks.com's brand online with college
students, we have developed our brand directly on-campus as well. As of February
29, 2000, we operated a marketing network of over 2,700 student representatives
on over 600 college campuses nationwide. This carefully selected and trained
network of student representatives customizes marketing to each campus and
reaches students on a peer-to-peer basis, enabling us to promote our products
and brand. We plan to continue to use this network of student representatives
and our student-focused Web site not only to promote the products and services
we offer, but also to provide marketing services for other businesses seeking to
reach this demographic.
To date, VarsityBooks.com has reached marketing services agreements with
several companies, including SallieMae and AOL's ICQ. Companies like SallieMae
recognize that VarsityBooks.com is able to reach college students where they
spend most of their time - online and on-campus - through our Web site and
student representative network. To take advantage of this, SallieMae will pay
VarsityBooks.com $2 million over the two-year term of the agreement to help
SallieMae develop its brand with this demographic.
INDUSTRY BACKGROUND
The college student market is large and growing, according to the National
Center for Educational Statistics. Student Monitor reports show that there were
approximately 15 million full-time and part-time undergraduate and graduate
students at more than 3,600 colleges and universities in the United States as of
spring 1999. College enrollment will increase to approximately 16 million
students by 2008, predicts the National Center for Educational Statistics.
The college student market is actively using the Internet and is
increasingly purchasing goods and services online. According to Student Monitor,
during the Spring 1999 semester, 95% of college students used the Internet,
spending an average of seven hours a week online. Approximately 57% of these
students accessed the Internet one or more times daily and, during a one year
period ending in the spring of 1999, approximately 26% of these students made
online purchases, up from a cumulative total of 10% through December 31, 1997.
Online commerce complements students' lifestyles, generally providing them the
convenience of 24 hour shopping and a lower cost alternative for their
purchases.
College students are powerful retail consumers. Although the college market
is large and diverse, students still have common needs. For instance, students
must buy expensive school-related goods and services such as textbooks and
school supplies. In fact, textbooks are most students' single largest
school-related expenditure after tuition, room and board. Based on statistics
published by the National Association of College Stores, new textbook sales were
approximately $5 billion in 1998.
Purchasing new textbooks through traditional retailers tends to be
expensive and inconvenient. The new textbook market is presently dominated by
campus bookstores, with most schools either operating their own bookstore or
contracting these services to a third party. Most campus bookstores face little
competition, have significant overhead, and are crowded at the beginning of each
semester, forcing students to endure high prices, long lines, and frequent
out-of-stock inventory problems. Online commerce provides a new opportunity to
better serve and more efficiently reach the college student market.
As powerful retail consumers, college students have become attractive to
companies across the business spectrum. In 1998, college students spent over
$105 billion on goods and services, excluding tuition, room and board, according
to Student Monitor.
We believe that for a variety of reasons few businesses have succeeded in
offering students a unified marketplace to meet their varied needs in a
convenient and cost-effective manner. Students are geographically dispersed and
frequently change their addresses, which makes them difficult to target with
traditional direct marketing. While national and regional media campaigns build
brand recognition, they are not a cost-effective method of targeting college
students. Although students do watch television
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and read newspapers and magazines, we believe they tend to be more influenced by
the opinions and actions of their peers than by traditional media advertising.
As a result, we believe there is a significant market opportunity for an
online destination that aggregates college students for two main purposes: to
sell products to them and to market other businesses's products and services to
them. We also believe that this online presence is complemented effectively by
an on-campus presence where VarsityBooks.com can market to college students on a
peer-to-peer basis.
THE VARSITYBOOKS.COM SOLUTION
As a leading online retailer of college textbooks, we are becoming a
trusted online resource for students. We selected textbooks as our initial
product offering because they are an expensive purchase that students are
required to make each semester. By addressing inefficiencies in the textbook
market and providing increased convenience and low prices to students, we are
building our brand, growing market share in the textbook industry, and
attracting college students to our Web site. In addition, service offerings
such as scholarships, job and career information, and free e-mail have further
attracted students to VarsityBooks.com. We have also established a platform for
marketing to college students through our Web site and campus representative
network on behalf of other businesses.
Our solution is comprised of four components: our retail and marketing
businesses and our online and offline assets which allow us to effectively reach
the college market.
- - The Retail Market. We provide students with a reliable, cost-saving
alternative to the traditional campus shopping experience. We
significantly reduce the overhead associated with textbook sales
because we do not maintain individual stores and we outsource our
ordering, inventory, warehousing and fulfillment needs through our
relationship with Baker & Taylor, a leading distributor of books,
videos and music products. We pass these savings on to our customers
by offering discounted prices. In addition to providing new textbooks
at reduced prices, we are committed to providing top quality customer
service. Our customer service center is available by telephone and
e-mail 24 hours a day, seven days a week, and we increase our service
center staffing during our peak periods to ensure a timely response to
our customers' questions.
Through our Partnership program, we provide an opportunity for schools
to maximize their limited resources and offer increased convenience
and reduced prices to their students by outsourcing new textbook sales
to us. We believe that for many schools, including traditional
four-year colleges as well as community colleges, private high schools
and distance learning programs, the expense and inconvenience of
maintaining a bookstore exceeds the schools' financial return. In
addition to maximizing their limited resources, we offer our
partnership schools a percentage of the revenue generated by their
students on our Web site.
- - Marketing Services to the College Market. Through our online and
offline assets, we are able to market on behalf of other companies to
the college demographic. We use the combination of our
highly-trafficked Web site, email, sponsorship programs, and other
online means to reach college students where they spend so much of
their time - on the Internet. And we are able to offer these tools to
other companies who are trying to reach this elusive market. In
addition, we are able to put our student representative network to use
for other companies, marketing on a peer-to-peer basis on campus in a
proven and effective manner.
In addition, because our advertising and our student representatives
drive traffic to our Web site, we are able to aggregate the fragmented
student market. As our customers conduct transactions on our Web site,
we collect their contact information as well as data on their majors
and schools. We also retain their transactional histories.
- - Online: Aggregating Students on the Web. We aggregate college students
on our Web site effectively. According to Media Metrix,
VarsityBooks.com had over one million unique visitors in January,
2000, making VarsityBooks.com the most-visited college-oriented Web
site during the peak back-to-school period. Several products and
services attract students to the site -- discounted textbooks, general
interest books, scholarship opportunities, free e-mail, and job and
career information. We also make the textbook-buying process very
easy. Our customers avoid the over-crowding and long lines
characteristic of peak season shopping at campus bookstores. We post
booklists for hundreds of colleges and universities, which enable
students to view the prescribed reading list for their courses and
then order their books directly from us.
- - Offline: Our Network of Student Representatives. As of February 29,
2000, we had a network of over 2,700 student representatives on the
campuses of over 600 colleges, universities and graduate schools. As
enrolled students at their respective schools, our representatives
provide us feedback on their peers' needs and lifestyles, allowing us
to customize our marketing approach to each campus. Student
representatives reach our potential customers and our business
clients' potential customers wherever students gather: in classrooms,
student organizations, dormitories and fraternities and sororities. We
believe using our student representative network, combined with our
online capacity, more effectively builds brand awareness and drives
more traffic than a traditional national or regional marketing
campaign would alone.
STRATEGY
Our goal is to become the leading online college retailer and provider of
marketing services for businesses targeting the college demographic. Our success
in selling textbooks online has allowed us to compile our customers'
demographics and build a growing customer base that will enable us to sell
additional goods and services directly to the student market. Our network of
student representatives allows us to market directly to students, both on our
own behalf and on behalf of advertisers and other businesses. In pursuing our
goal, we use the following strategies:
Aggressively Build Our Brand. We intend to establish VarsityBooks.com as
the leading college-oriented brand through a variety of marketing and
promotional techniques, including the use of our student representative
network and a national media campaign featuring radio, print, e-mail and
online advertisements. We continue to differentiate ourselves based on the
reliability, quality and cost-efficiency of our products and services. In
addition to focusing on college students, we intend to extend our reach
to high school students, primarily through expanding our Partnership
program, and graduate students, as well as continue to aggressively
market to professors, teaching assistants, dorm resident assistants and
parents who influence our ultimate target audience, college students.
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Leverage and Grow Our Network of Student Representatives. We believe that
our network of student representatives is a significant competitive
advantage. We intend to use our carefully selected, trained and growing
network of student representatives to expand awareness of our product
offerings and to provide marketing services for other businesses. We
believe that our campus presence allows us to customize our marketing
strategy and that our peer-to-peer marketing, together with our traditional
marketing campaign, enables us to reach college students more effectively
than a traditional marketing campaign alone. We intend to continue to
devote substantial efforts to building a talented student representative
base and to attracting recognized student leaders to our team.
Expand Marketing Services for Other Companies. We intend to build our
growing business of marketing on behalf of other companies to the college
demographic. By continuing to develop our online assets - our
highly-trafficked Web site, free e-mail, sponsorship programs, and other
offerings - we will be able to offer additional Web tools to other
companies that are trying to reach this elusive market. We will also
continue to develop our student representative network so as to expand our
ability to market on a peer-to-peer basis on campus for other businesses
as well.
Capitalize on Our Growing Customer Database. We intend to capitalize on our
growing customer database to provide targeted product, service and
promotional offerings, both by us and other businesses. We plan to use our
customer information and transactional histories to assist us in planning
our product and service line expansions. As we broaden our product and
service offerings, we will learn more about our customers and will be in a
position to become an infomediary, serving both students and the companies
that seek to reach them. We believe that by tailoring the marketing of our
products and services, we will increase sales through our Web site.
Add Partnership Schools. We intend to expand our Partnership program to
further extend our reach into traditional four-year and community colleges,
graduate schools, private high schools that require students to purchase
their textbooks, distance learning programs and continuing and professional
education programs. We work closely with all participating schools in our
Partnership program, providing them with dedicated customer service and
support. Through these relationships, we are endorsed as the exclusive new
textbook retailer at our Partnership schools. As a result, we gain direct
access to their students, enabling us to build brand awareness and market
our other products and services.
Extend the Breadth and Depth of Our Offerings. We intend to capitalize on
our brand recognition, college marketing experience and extensive customer
base to offer additional products and services. We recently launched our
scholarship service, free e-mail, and job and career center. We plan, among
other things, to increase our payment options, develop a loyalty program
and begin offering services geared to students' needs and interests.
THE VARSITYBOOKS.COM EXPERIENCE
Our Web site, www.varsitybooks.com, offers several benefits to students
including convenience, ease of use and depth of product selection. Key aspects
of our Web site include:
Finding Books. When logging on to our Web site, visitors are presented with
several shopping options, including:
Searching by School. Students can use our customized map to locate
their school. Once they find their school, if they attend one of over
400 colleges or universities for which we post booklists, they can
link from a list of departments to a list of classes organized by
professor and to the specific booklists for the particular courses
they are taking. Alternatively, students can search directly by
professor or course name. Our customers have the option of placing all
the textbooks for a particular class in their shopping cart with a
single click or selecting only those titles that interest them.
Searching for Books. If we have not posted a specific school's
booklist, our customers can still easily search for the books they
need by author, title, keyword, publisher or ISBN number. Our Web site
offers additional book verification for many selections, including
pictures of jacket art, editor's name, volume number, table of
contents and other identifying characteristics,
Browsing. Visitors to our Web site may browse our available selections
of over 1,500 subject matter categories, such as business and finance,
dance and theatre, social sciences and humanities, natural sciences
and classic literature. In addition, visitors can also browse pages
specifically dedicated to law, business and medical school textbooks,
study aids and student travel materials.
Ordering and Delivery. When our customers are ready to place an order, they
can proceed through our shopping cart function directly to our checkout page. We
presently accept American Express, Discover, MasterCard and Visa as payment for
our products, and we plan to expand the payment options we accept. At our
partnership schools, we also accept personal checks and debit student accounts.
During the ordering process, we ask our customers for basic information about
themselves, which we maintain in our customer database. Once a customer places
an order, he or she immediately receives an e-mail that includes a unique order
number and confirms that the order has been received and processed. We do not
accept orders for out-of-stock items. However through our BookPager option,
students can request that we notify them by e-mail for up to 21 days if the
desired book becomes available. After the order is shipped, the customer
receives a second e-mail that includes a UPS tracking number and a link to a
page on our Web site where they can follow their order through the delivery
process. We use UPS Second Day Air to take advantage of UPS's guaranteed
delivery and to ensure our customers will receive their orders within three
business days. For faster delivery, our customers may choose to pay for UPS
overnight service.
Product Selection. In addition to providing students with discounted,
easy-to-purchase textbooks, our on line experience includes other products and
services that address key needs of today's college students. Our Varsity
scholarship program helps students address the escalating costs of higher
education. Our free e-mail source makes communication for college students
easier. And our career and job center helps college students find full-time and
part-time jobs, internships, and study-abroad opportunities.
Customer Service. We are committed to delivering superior customer service.
Our customers can easily access our customer service center at any time during
their visits to our Web site. The customer service page of our Web site offers
answers to frequently asked questions and enables our customers to ask their own
questions through e-mail. We also have a toll-free number that is staffed 24
hours a day, seven days a week. We increase our service center staffing during
our peak periods to ensure a fast response time to our customers' queries. We
also maintain separate toll-free numbers dedicated to our partnership schools.
Membership. Anyone who visits our Web site can open a free membership
account with VarsityBooks.com by providing basic school-related and other
information including shipping and billing addresses. Members can store the
products they are considering in their shopping cart until they are ready to
make a purchase. Each time they sign on, they have the opportunity to review
their shopping cart and determine which items they want to buy. We store their
shipping and billing addresses to facilitate easy ordering every time they
return to our Web site. We also allow them to view their past purchases and
print
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receipts for their own records. We provide our members with regular newsletters
and marketing material via e-mail.
Find a Job. The find a job section of our site enables a search for
full-time and part-time jobs as well as internships. In addition, we provide job
interview tips and industry and company information. Also, we offer relocation
tools to assist job seekers in evaluating opportunities.
MARKETING
Our goal is to be the leading online college retailer and provider of
marketing services for businesses targeting the college demographic. As such, we
believe it is critical that college students are exposed to our Web site,
www.varsitybooks.com. Our marketing strategy is designed to increase awareness
of the VarsityBooks.com brand name, increase customer traffic to our Web site,
build strong brand loyalty, acquire more customers, maximize repeat customers
and develop incremental revenue opportunities. We advertise our Web site through
our student representatives and through a comprehensive media plan featuring
radio, print, e-mail and online banner advertisements. In addition to targeting
college students, we market to professors, teaching assistants, dorm resident
assistants and parents to have them encourage students to visit our Web site.
The marketing services we have developed are as follows:
- Student Representatives. To penetrate the difficult-to-reach college
student market, we have created a network of student representatives, employing
over 2,700 as of February 29, 2000. A portion of our full time staff is
dedicated to selecting, training, managing and monitoring our growing network of
student representatives. We actively scout college campuses to determine names
of student leaders on campus. We then recruit and rigorously screen these
students for our lead student representative positions. Our lead student
representatives are responsible for hiring and managing a campus team consisting
of up to fifteen student representatives. We conduct regular training sessions
for our lead representatives, during which we teach them about our company,
marketing techniques and how to select a student representative team. We provide
each lead student representative with a comprehensive marketing kit that they
use to market directly to classrooms, student organizations and dormitories,
depending on what they consider to be the best method for their campus. We pay
our representatives an hourly wage and offer sales-based commissions. We also
grant stock options to our lead representatives.
- Off-line Advertising and Public Relations. We combine the active
marketing of our student representatives with a comprehensive media campaign to
emphasize our brand and ensure our reach is broad enough to raise awareness
among key student influencers such as parents. We engage in a coordinated
program of print advertising in college, specialized and general circulation
newspapers and magazines as well as a radio advertising campaign in targeted
markets. We increase our marketing in the period before classes start and
through the prime book buying season. As a result of our own public relations
activities, as well as unsolicited invitations, we have been featured in a
variety of television shows, newspaper and magazine articles and radio programs
including CNN, The New York Times, The Wall Street Journal and National Public
Radio.
- Online Advertising. We place advertisements on other high-profile and
high-traffic college-oriented Web sites. These advertisements usually take the
form of banners that encourage readers to click through directly to
www.varsitybooks.com. In addition, we obtain lists of e-mail addresses of
college students who have consented to receive relevant information and send
e-mails to these students directing them to our Web site.
- Awareness Program. We market to college students before the beginning of
each school year through awareness programs which target incoming students. We
send our student representative teams to freshman orientations, and advertise on
the radio at major student summer destinations to reach students on the way back
to school.
- Affiliate Programs. We offer student organizations, such as fraternities,
sororities and other clubs, a fundraising opportunity through our affiliate
program. Organizations can work with us to market our brand by creating links
from their Web site to ours and through direct marketing. We track the customers
who reach our Web site through affiliate lines and we pay our affiliates a
sales-based commission.
ALLIANCES AND RELATIONSHIPS
We have arrangements with a number of college-oriented Web sites and other
organizations to provide a link to www.varsitybooks.com. We believe this
enhances our marketing efforts and allows us to capitalize on the recognition of
other noncompeting Web sites:
AOL's ICQ. We entered into a three-year interactive marketing agreement
with AOL's ICQ pursuant to which we are the exclusive college-targeted commerce
partner on the ICQ instant messaging service as well as its Web site,
www.icq.com. We will act as the exclusive third-party targeted advertiser and a
marketer of the ICQ service and ICQ.com on U.S. college campuses. Our
exclusivity provisions expire on December 31, 2000, and the agreement itself is
scheduled to expire on December 22, 2002 unless earlier terminated because of
breach, insolvency, or change of control affecting us.
Sallie Mae. We entered into both a marketing services agreement and a
product promotion agreement with Sallie Mae, Inc., an educational loan delivery
organization. Pursuant to the marketing services agreement, Sallie Mae will pay
us $2.0 million over the two year term. In exchange, we will customize a
marketing plan for Sallie Mae to reach the college market. In addition, we
entered into a product promotion agreement with Sallie Mae under which we will
pay Sallie Mae referral fees based on a percentage of any revenue generated by
its customers during the term of the arrangement. Sallie Mae will promote our
products to its customers. Sallie Mae will also actively promote our partnership
program to the schools to which it sells and promotes its products. In addition,
Sallie Mae will maintain links on its Web site to our Web site and we will be
the exclusive textbook retailer on the Sallie Mae site. In exchange, we granted
Sallie Mae a warrant to purchase up to 616,863 shares of common stock, which
represented 3.5% of our aggregate common stock outstanding and reserved for
issuance immediately prior to the completion of our initial public offering, at
a price of $10 per share. Of these shares, 352,493 are currently vested and the
remaining 264,370 shares will vest over the two year term of the agreement
depending on the number of customer transactions and partnership school
referrals Sallie Mae delivers during that period. Both of these agreements will
expire on February 1, 2002 unless earlier terminated because of breach,
insolvency, or change of control affecting us.
edu.com. We are currently the only online retailer of textbooks for
edu.com, a Web site that offers discounts on hardware, software and other
products exclusively to students. edu.com verifies that its customers are
enrolled at a higher education institution before selling any products. Once
students are members of edu.com, they can initiate a textbook search by author,
title, ISBN number or keyword directly on the edu.com Web site. Once a search is
initiated, the student is linked to a VarsityBooks.com page to continue the
shopping and ordering process. The written agreement we have entered into with
edu.com is
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scheduled to expire on August 20, 2000 unless both parties agree to its renewal.
The agreement provides that edu.com will receive a percentage of the revenue
generated from the co-branded edu.com/VarsityBooks.com Web site.
Book Tech. We have a partnership with Book Tech, Inc., a custom publisher
of digitally printed and copywritten material. Under the agreement, Book Tech
provides co-branded course packets, which we offer on our Web site. The written
agreement we have entered into with Book Tech is scheduled to expire on June 30,
2000, but will extend automatically for one-year terms unless either party
elects not to renew. The agreement provides that Book Tech will receive a
percentage of revenue from our sales of books that originated from Book Tech's
Web site.
Kaplan Educational Centers. We have a relationship with Kaplan Educational
Centers, under which Kaplan allows us to distribute flyers and market our
services in their learning centers. Kaplan is an educational and career service
company. We do not have a written agreement with Kaplan Educational Centers.
JobDirect.com. We have a relationship with JobDirect.com that enables
students who visit our Web site to search for part-time and full-time jobs and
internships. JobDirect.com is an online database for employers to target, search
and find prospective job candidates from the college market. Our agreement with
JobDirect.com terminates December 31, 2000, but is subject to cancellation with
60 days written notice.
As we add other product and service offerings, we plan to enter into
similar arrangements to support our growth.
PARTNERSHIP PROGRAM
As of March 27, 2000, we were the exclusive new textbook supplier for over
30 institutions. At these institutions, which include smaller, traditional
four-year colleges, private high schools, distance learning programs and
continuing and professional education programs, we work directly with our
partners to market our services to their students. By partnering with private
high schools, we reach students early, enabling us to extend our brand and
establish a customer relationship with students prior to their attending
college. Distance learning programs, in particular, represent a growing market
that the traditional campus bookstore cannot efficiently serve. According to
International Data Corporation, IDC, over 50% of college students have indicated
an interest in distance learning, a result, IDC estimates that over 84% of
higher education institutions will offer distance learning programs and that the
number of students taking such courses will increase by more than 30% per year
before 2002.
Our exclusive relationships generally are for a period of up to four years
and automatically renew on a year-to-year basis. For each school that has an
intranet, we create and maintain a "virtual" bookstore directly on their site.
When students click on the school's "virtual" bookstore, they link directly to a
co-branded Web site. Our partner schools receive a share of the revenues their
students generate. By taking advantage of the convenience and cost-savings of
this program, our partner schools provide a valuable service to their students.
FULFILLMENT
We fulfill all of our textbook orders through Baker & Taylor, a leading
distributor of books, videos and music products with whom we have a series of
written agreements, each of which are scheduled to expire on October 1, 2002
with automatic renewal for one year unless either party elects in writing not to
renew. The agreements are terminable upon up to 30 days' notice by either party
in the event of a default. Under these agreements with Baker & Taylor, we agree
to provide Baker & Taylor with our written demand forecasts for each upcoming
semester and we agree to use Baker & Taylor as our principal supplier of
textbooks and drop-ship and fulfillment services. We pay fees and expenses
related to the services Baker & Taylor provides and we purchase products from
Baker & Taylor at a discount to the suggested price. In return, Baker & Taylor
agrees not to provide drop-ship services to any online textbook retailer serving
students at colleges and universities or distance learning programs located in
the United States that require students to purchase textbooks, unless the
retailer was an existing customer of Baker & Taylor on or prior to June 10,
1998, the date we initially contracted with Baker & Taylor. Our agreements with
Baker & Taylor provide us access to and use of an electronic set of data
elements from Baker & Taylor's title file database which contains bibliographic
records. In addition, under these agreements, Baker & Taylor provides us with
promotional, customer service, and database management services.
As a result of the data access our agreements provide, information on
availability of book titles is automatically updated on our Web site on an
hourly basis from 8:00 a.m. to 10:00 p.m. eastern standard time based on a
direct feed from Baker & Taylor, ensuring our customers receive accurate
in-stock Inventory information. Orders placed on our Web site are automatically
transmitted to Baker & Taylor within twenty minutes of their receipt. At the
Baker & Taylor warehouse currently used for fulfillment, the order is processed,
packaged in a VarsityBooks.com branded box and shipped directly to our customers
via UPS so that it arrives within three business days of the placement of the
order. We extend a convenient return policy to our customers under which returns
are shipped directly to Baker & Taylor to expedite processing. Providing Baker &
Taylor with our demand forecasts for each semester helps to ensure they maintain
an adequate and relevant inventory to meet the demands of our customers.
TECHNOLOGY
We use an array of site management, search, customer interaction,
transaction-processing and fulfillment services and systems using a combination
of proprietary technologies and commercially available, licensed technologies.
Our strategy is to license commercially available technology whenever possible
rather than seek internally developed solutions.
Our technology environment is designed to provide:
- a satisfying customer experience;
- consistent system availability and good performance;
- high security for all transactions, particularly, our customers'
commerce transactions;
- scalability for continued growth; and
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- the collection, maintenance and security of valuable information.
We currently use a Microsoft Windows NT operating system platform and
multiple Compaq application servers that house our Web server and search engine
applications. These servers are able to handle applications including accepting
and validating customer orders, handling multiple shipment methods and
accepting, authorizing and charging customer credit cards. In addition, our
system maintains ongoing automated e-mail communications with customers
throughout the ordering process. These systems entirely automate many routine
communications, facilitate management of customer e-mail inquiries and allow
customers to, on a self-service basis, check order status and order history,
change their personal information and check subscriptions to personal
notification services.
We manage user requests and other traffic using load balancing devices that
work across the entire complement of our hardware. This strategy of balancing
traffic allows all customers and site users to enjoy favorable response times
and other performance measures, regardless of traffic fluctuations. Although we
own and maintain our hardware and software systems, GlobalCenter Inc. located
in Herndon, Virginia, hosts our two separate server environments and acts as our
Internet service provider and we lease the space in which our hardware system
resides from GlobalCenter Inc. A group of in-house systems administrators and
network engineers and GlobalCenter Inc. personnel monitor and operate our Web
site, network operations and transaction-processing systems.
Our agreement with GlobalCenter Inc. currently provides for service to
be provided on an annual basis, subject to renewal. We pay for the space in
which our hardware system resides and our Internet access based on our usage, on
a monthly basis. We may terminate this agreement on any annual renewal date
without penalty.
We have contracted with Exodus Communications to provide hosting services
in the event of a prolonged outage at GlobalCenter Inc. Fail-over capabilities
will be manually performed using load-balancing devices that work across
multiple hosting facilities.
We use the Microsoft suite of tools for our development environment,
including Site Server Commerce, InterDev and SQL SVR for the database engine.
Additionally, we have separate database servers that capture and retain
transaction "logs" of all activity that occurs on the site. These log databases
can, among other things, trace a transaction from its inception to its
completion. Our separate recording database generates and delivers reports and
interfaces for our marketing, operations and financial systems.
We employ SSL data encryption technology to protect credit card data while
it is passed from the customer through the site during a purchase transaction.
This prevents outside parties from intercepting the customer's credit card data
during transaction processing.
COMPETITION
The e-commerce, e-marketing, and online textbook markets are highly
competitive. Since the introduction of e-commerce to the Internet, the number of
e-commerce Web sites competing for customers' attention has increased rapidly,
and the market for online textbook sales is relatively new, intensely
competitive and rapidly changing. We expect future competition to intensify
given the relative ease with which new Web sites can be developed. We currently
or potentially compete, directly and indirectly, for customers, advertisers and
sponsors with the following categories of companies:
- traditional new textbook retailers, such as campus bookstores;
- traditional used college textbook retailers, some of which have or are
expected to begin online selling;
- Internet-based textbook retailers such as bigwords.com, ecampus.com
(affiliated with Wallace's Bookstores, Inc.), efollett.com (affiliated
with The Follett Corporation) and textbooks.com (affiliated with
Barnes & Noble College Bookstores, Inc.);
- Internet-based general booksellers such as Amazon.com,
barnesandnoble.com and Borders.com;
- college market-focused companies such as Student Advantage and
Youthstream;
- general purpose consumer online services such as America Online and
Microsoft Network, each of which provides access to student-related
content and services;
- vendors of college student information, merchandise, products and
services distributed through other means, including retail stores,
direct mail and schools; and
- Web sites targeted to students generally or to students of a
particular school, such as Web sites developed by Snowball, College
Club, CommonPlaces and Student.Net Publishing.
Part of our strategy is to offer additional products and services. For many
of these products and services, there are already other traditional and online
retailers offering these products.
We believe that the principal competitive factors in attracting and
retaining student customers are:
- convenience;
- discount pricing;
- selection of available products;
- customer service;
- quality of content and navigability tools;
- brand recognition; and
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- reliability and speed of fulfillment.
Our success will depend heavily upon our ability to provide a compelling
and satisfying shopping experience and advertising environment, as well as our
continued ability to attract and retain experienced personnel.
INTELLECTUAL PROPERTY
We regard our trademarks, service marks, trade dress, copyrights,
trade secrets, proprietary technology and similar intellectual property as
critical to our success. We rely on trademark and copyright law, trade secret
protection and confidentiality and license agreements with our employees,
customers, independent contractors, sponsors and others to protect our
proprietary rights. We have applied to register VarsityBooks.com as a service
mark with the United States Patent and Trademark Office. This application was
approved for publication by the Trademark Office on January 6, 2000. If no
oppositions are filed against our application, it will be "allowed" and we will
file evidence of use and be issued a registration.
We may be required to obtain licenses from others to refine, develop,
market and deliver new products and services. There can be no assurance that we
will be able to obtain any such license on commercially reasonable terms or at
all, or that rights granted pursuant to any licenses will be valid and
enforceable.
Domain names are the user's Internet "address." Domain names have been the
subject of significant trademark litigation in the United States. Domain names
derive value from the individual's ability to remember such names, therefore
there can be no assurance that our domain name will not lose its value if, for
example, users begin to rely on mechanisms other than domain names to access
online resources.
GOVERNMENT REGULATION
Internet Regulation in General. There are an increasing number of laws and
regulations pertaining to the Internet. In addition, a number of legislative and
regulatory proposals are under consideration by federal, state, local and
foreign governments and agencies. Laws or regulations may be adopted relating to
issues such as to liability for information retrieved from or transmitted over
the Internet, online content regulation, user privacy, taxation and quality of
products and services. Moreover, it may take years to determine whether and how
existing laws such as those governing intellectual property ownership and
infringement, privacy, libel, copyright, trade mark, trade secret, obscenity,
personal privacy, taxation and the regulation of the sale of other specified
goods and services apply to the Internet. The requirement that we comply with
any new legislation or regulation, or any unanticipated application or
interpretation of existing laws, may decrease the growth in the use of the
Internet, which could in turn decrease the demand for our Internet-based
services, increase our cost of doing business or otherwise materially harm our
business.
Privacy Concerns. Federal, state and foreign governments have enacted or
may enact laws or consider regulations regarding the collection and use of
personal identifying information obtained from individuals when accessing Web
sites, with particular emphasis on access by minors. Such regulations may
include requirements that companies establish procedures to:
- give adequate notice to consumers regarding information collection and
disclosure practices;
- provide consumers with the ability to have personal identifying
information deleted from a company's data;
- provide consumers with access to their personal information and with
the ability to rectify inaccurate information;
- clearly identify affiliations or a lack thereof with third parties
that may collect information or sponsor activities on a company's Web
site;
- obtain express parental consent prior to collecting and using personal
identifying information obtained from children; and
- the Federal Children's Online Privacy Act.
Such regulation may also include enforcement and redress provisions. While
we have implemented programs designed to enhance the protection of the privacy
of our users, including children, there can be no assurance that such programs
will conform with applicable laws or regulations. Moreover, even in the absence
of such regulations, the Federal Trade Commission has begun investigations into
the privacy practices of companies that collect information on the Internet. One
such investigation has resulted in a consent decree pursuant to which an
Internet company agreed to establish programs to implement the privacy
safeguards described above. We may become subject to such an investigation, or
the FTC's regulatory and enforcement efforts may adversely affect the ability to
collect demographic and personal information from users, which could have an
adverse effect on the our ability to provide highly targeted opportunities for
advertisers and e-commerce marketers. Any such developments could harm our
business.
It is also possible that "cookies" may become subject to laws limiting or
prohibiting their use. The term "cookies" refers to information keyed to a
specific server, file pathway or directory location that is stored on a user's
hard drive, possibly without the user's knowledge, and which is used to track
demographic information and to target advertising. Some of the currently
available Internet browsers allow users to modify their browser settings to
remove cookies or prevent cookies from being stored on their hard drives. In
addition, a number of Internet commentators, advocates and governmental bodies
in the United States and other countries have urged the passage of laws limiting
or abolishing the use of cookies. Limitations on or elimination of the use of
cookies could limit the effectiveness of our targeting of advertisements, which
could harm our ability to generate advertising revenue.
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We currently obtain and retain personal information about our Web site
users with their consent. We have a stringent privacy policy covering this
information. However, if third persons were able to penetrate our network
security and gain access to, or otherwise misappropriate, our users' personal
information, we could be subject to liability. Such liability could include
claims for misuses of personal information, such as for unauthorized marketing
purposes or unauthorized use of credit cards. These claims could result in
litigation, our involvement in which, regardless of the outcome, could require
us to expend significant financial resources.
Data Protection. Legislation pending in Congress, if passed, would afford
broader rights to owners of databases of information, such as stock quotes and
sports scores. Such protection already exists in the European Union. If enacted,
this legislation could result in an increase in the price of services that
provide data to Web sites. In addition, such legislation could create potential
liability for unauthorized use of such data.
Internet Taxation. A number of legislative proposals have been made at the
federal, state and local level, and by foreign governments, that would impose
additional taxes on the sale of goods and services over the Internet and some
states have taken measures to tax Internet-related activities. Although Congress
recently placed a three-year moratorium, due to expire in October 2001, on state
and local taxes on Internet access or on discriminatory taxes on e-commerce,
existing state or local laws were expressly excepted from this moratorium.
Further, once this moratorium is lifted, some type of federal or state taxes may
be imposed upon Internet commerce. Such legislation or other attempts at
regulating commerce over the Internet may substantially impair the growth of
commerce on the Internet and, as a result, adversely affect our opportunity to
derive financial benefit from such activities.
Jurisdiction. Due to the global reach of the Internet, it is possible that,
although our transmissions over the Internet originate primarily in the
Commonwealth of Virginia, the governments of other states and foreign countries
might attempt to regulate Internet activity and our transmissions or take action
against us for violations of their laws.
RISK FACTORS
WE HAVE A LIMITED OPERATING HISTORY UPON WHICH TO EVALUATE AN INVESTMENT IN OUR
COMPANY.
We were founded in December 1997 and began selling textbooks on our Web
site in August 1998. Due to the college calendar and the seasonality of textbook
sales, our peak selling periods are currently in August/September and
January/February, when new semesters begin and students purchase textbooks.
As a new company, we face risks and uncertainties relating to our ability to
successfully implement our strategy. You must consider the risks and
uncertainties that an early stage company like ours faces. If we are
unsuccessful in addressing these risks and uncertainties or are unable to
execute our strategy, our business would be harmed.
WE HAVE NOT BEEN PROFITABLE, HAVE GENERATED NEGATIVE CASH FLOWS AND WE EXPECT
OUR LOSSES AND NEGATIVE CASH FLOWS TO CONTINUE.
We have never been profitable. We base current and future expense levels on
our operating plans and our estimates of future revenues. If our revenues do not
materialize or grow at a slower rate than we anticipate, or if our spending
levels exceed our expectations or cannot be adjusted to reflect slower revenue
growth, we may not achieve profitability or positive cash flows. For the year
ended December 31, 1998, we incurred a loss from operations of approximately
$2.7 million and had negative cash flows from operations of approximately $1.2
million. For the year ended December 31, 1999, we incurred a loss from
operations of approximately $31.9 million and had negative cash flows from
operations of approximately $29.4 million. As of December 31, 1999, we had an
accumulated deficit of approximately $34.2 million. We expect to continue to
lose money and generate negative cash flows from operations in the foreseeable
future because we anticipate incurring significant expenses in connection with
building our brand, improving our services and increasing our product offerings.
We may find it necessary to accelerate expenditures relating to our marketing
and sales efforts, or otherwise to increase our financial commitment to creating
and maintaining brand awareness among college students, particularly during and
immediately prior to our peak seasons. In addition, we may find it necessary to
accelerate expenditures to further develop our Web site and information
technology. If we accelerate these expenditures and our revenues do not increase
proportionately, our rate of losses and negative cash flows would increase.
WE MAY NOT BE ABLE TO OBTAIN SUFFICIENT FUNDS TO GROW OUR BUSINESS AND ANY
ADDITIONAL FINANCING MAY BE ON TERMS ADVERSE TO YOUR INTERESTS.
We intend to continue to grow our business. We currently anticipate that
our available funds, together with our line of credit, will be sufficient to
meet our anticipated needs for the next twelve months. We expect to continue to
lose money and generate negative cash flows from operations for the foreseeable
future. We may need to raise additional funds in the future to fund more
aggressive marketing programs, to acquire or develop new technology, to increase
our staff to meet operational demands, to introduce new products or services or
to acquire complementary businesses or services or intellectual property rights.
Any required additional financing may be unavailable on terms favorable to us or
at all. If we raise additional funds by issuing equity securities, you may
experience significant dilution of your ownership interest and such securities
may have rights senior to those of the holders of our common stock. Obtaining
additional financing will be subject to a number of factors, including:
- market and economic conditions;
- our financial condition and operating performance; and
- investor sentiment.
These factors may make the timing, amount, terms and conditions of
additional financing unattractive for us. Currently, companies that are
considered primarily on-line retailers are not perceived well by the market. If
additional financing is not available when required or is not available on
acceptable terms, we may be unable to:
- fund our expansion;
- successfully promote our brand name;
- develop or enhance our products and services;
- develop or purchase new servers, software and other technology to
enable us to process increased transactions and service increased
traffic on our Web site;
- attract and retain the appropriate talent and a sufficient number of
employees to handle our increasing operations; and
- take advantage of business opportunities or respond to competitive
pressures.
OUR BUSINESS AND REVENUE MODEL IS UNPROVEN.
Our ability to generate significant revenues and profits from the sale of
textbooks and other products and services we may offer in the future is
uncertain. To be successful, we must attract and retain a significant number of
customers to our Web site at a reasonable cost. Any significant shortfall in the
expected number of purchases occurring through our Web site will negatively
affect our financial results by increasing or prolonging operating losses and
negative cash flows. Conversion of customers from traditional shopping methods
to electronic shopping may not occur as rapidly as we expect, if at all.
Therefore, we may not achieve the customer traffic we believe is necessary to
become successful. Specific factors which could prevent widespread customer
acceptance of our business and our ability to increase revenues include:
- lack of consumer awareness of our online presence;
- pricing that does not meet consumer expectations;
- consumer concerns about the security of online transactions;
- shipping charges, which do not apply to shopping at traditional retail
stores and are not always charged by some of our online competitors;
- delivery time associated with online orders, as compared to the
immediate receipt of products at traditional retail stores;
- product damage from shipping or shipments of the wrong products, which
may result in a failure to establish trust in purchasing our products
online;
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- delays in responses to consumer inquiries or in deliveries to
consumers; and
- difficulty in returning or exchanging orders.
We rely on our student representatives as a marketing channel for
www.varsitybooks.com. The employment of these representatives increases our
expenses, which will make it more difficult for us to achieve profitability and
positive cash flows. In addition, our ability to generate revenues through the
sale of online advertising and the use of our network of student representatives
by other businesses to market their goods and services will depend, in part, on
our ability to reach students with demographic characteristics attractive to
advertisers and other businesses.
WE MAY NOT BE ABLE TO ATTRACT BUSINESSES INTERESTED IN USING OUR SERVICES TO
MARKET TO COLLEGE STUDENTS.
Although we do not currently derive a substantial portion of our revenues
from allowing other businesses to reach the college market through our network
of student representatives, our business model depends in part on increasing the
amount of such revenue. We cannot be certain we will be able to attract
businesses interested in using our marketing services. If we cannot attract
these businesses, our business could be harmed.
YOU SHOULD NOT RELY ON OUR QUARTERLY OPERATING RESULTS AS AN INDICATION OF OUR
FUTURE RESULTS BECAUSE THEY ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
Our quarterly operating results may fluctuate significantly in the future
due to a variety of factors that could affect our revenues or our expenses in
any particular quarter. We expect to experience seasonality in our business
related to the college calendar and the corresponding demand for textbooks and
educational materials. Sales in the textbook industry traditionally are
significantly higher in the first and third calendar quarters of each year
compared with the second and fourth calendar quarters. We have begun to offer
additional services and may offer additional products through our Web site. We
cannot be sure that we will be able to generate significant sales of any product
other than new textbooks or generate revenues from additional services or that
such sales or revenues will not occur with textbook sales or in their own
seasonal pattern and, as a result, we may continue to experience such
fluctuations in operating results. Fluctuations in our quarterly operating
results could cause our stock price to decline. You should not rely on
sequential quarter-to-quarter comparisons of our results of operations as an
indication of future performance. Factors that may affect our quarterly results
include:
- seasonal trends in the textbook industry and in the buying habits of
college students;
- our ability to manage or influence inventory and fulfillment
operations;
- the level of merchandise returns we experience;
- our ability to attract new customers, retain existing customers and
maintain customer satisfaction;
- introduction of new products and services or enhancements, or a change
in pricing policies, by us or our competitors, or a change in pricing
policy by our sole fulfillment source;
- changes in the amount and timing of expenditures related to marketing,
booklist operations, information technology and other operating
expenses to support future growth;
- technical difficulties or system downtime affecting the Internet
generally or the operation of our Web site specifically;
- increasing consumer acceptance and use of the Internet and other
online services for the purchase of consumer products;
- potential acquisitions or strategic alliances either by us or our
competitors; and
- general economic conditions and economic conditions specific to the
Internet, online commerce and the book industry.
As a result of the seasonal fluctuations and because the online sale of
college textbooks and online selling in general is new and it is difficult to
predict consumer demand, it is possible that in some future periods our results
of operations may be below the expectations of public market analysts and
investors. In that event, it is likely that the price of our stock would
decline.
WE RELY ON ONE SUPPLIER TO MEET OUR FULFILLMENT DEMANDS.
We depend on Baker & Taylor, Inc. as our current sole supplier of the
textbooks we offer. Our relationship with Baker & Taylor is critical to our
success. If we were unable to rely on them for inventory maintenance and
shipping services, our business would be materially harmed.
We do not warehouse any of our own inventory, so we rely on Baker & Taylor
to maintain an adequate inventory and rapidly fill our customers' orders. We are
able to sell textbooks at reduced prices in part because we do not maintain our
own inventory. Prices we pay for promotional, customer service and database
management services and credits that we receive from Baker & Taylor are
currently based on volume and average cost requirements. Failure to meet these
benchmarks could increase our costs. If they do not maintain sufficient
inventory, or if they are unable to deliver the specific books our customers
order or deliver these books in a timely fashion, we would not be able to meet
our obligations to our customers, our revenues would decrease and we would
likely experience a reduction in the value of our brand. Baker & Taylor fills
orders for a number of textbook retailers. Baker & Taylor has advised us that it
fills all the orders it receives on a first-come, first-served basis without
providing preferential treatment for us or any of our competitors. If other
Baker & Taylor customer orders depleted Baker & Taylor's inventory, and Baker &
Taylor was unable to quickly replenish its inventory, our orders would not be
processed or filled in a timely manner. If our relationship with Baker & Taylor
is disrupted or does not continue for any reason and we are unable to establish
a comparable vendor relationship or open our own warehouse before the Baker &
Taylor relationship discontinues, we would not be able to fulfill our customers'
orders. We cannot be certain that we would be able to establish new vendor
relationships to ensure acquisition and distribution of textbooks in a timely
and efficient manner or on acceptable commercial terms. In such event, we may
determine that we need to maintain inventory, establish warehouse facilities and
provide
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distribution services, which would require us to change our business model. In
addition, approximately 22% of the books we purchased from Baker & Taylor in
1999 were supplied by a single publisher. If Baker & Taylor's relationship with
this publisher is disrupted or discontinued, our business would be harmed.
We benefit from the shipping discounts offered to Baker & Taylor by United
Parcel Service and we rely on UPS and other third party carriers for all
shipments to and from Baker & Taylor. If Baker & Taylor's relationship with UPS
is discontinued or disrupted for any reason, we cannot be certain we would be
able to affordably obtain comparable delivery services and might not be able to
deliver textbooks to our customers within our goal of three business days. In
addition, because we rely on third party carriers to ship products to and from
the single Baker & Taylor warehouse that our fulfillment is currently conducted
from, we are subject to the risks, including employee strikes and inclement
weather, that may prevent such third parties from meeting our fulfillment and
delivery needs. Failure to deliver products to our customers in a timely and
accurate manner would harm our reputation, our brand and our business.
WE WILL BE REQUIRED TO RECORD SIGNIFICANT EXPENSE BECAUSE OF TARGETS SET FORTH
IN OUR AGREEMENTS WITH THIRD PARTIES.
In December 1999, we granted AOL a warrant to purchase 493,246 shares of
our common stock with an exercise price equal to the initial public offering
price in this offering. In addition, in January and February 2000, we granted
AOL additional warrants to purchase an aggregate of 35,492 shares of our common
stock. Of the aggregate 528,738 shares subject to purchase under these warrants,
176,245 will be immediately exercisable and the remaining 352,493 shares will
vest over the next three years based on ICQ's performance under our interactive
marketing agreement. We believe that ICQ will be able to meet the criteria
needed to allow AOL to exercise the performance based portion of the warrants.
As a result, we will begin to recorded an expense for these warrants from the
date of issuance. Initially, we recorded a deferred charge during the year ended
December 31, 1999 equal to $1.2 million, which was the fair value of the vested
portion of the warrant issued in December on the date of issuance. The deferred
charge will be amortized on a straight-line basis over the three-year life of
the agreement. Expense of approximately $15,400 was recognized during the year
ended December 31, 1999.
In addition, in February 2000 we granted to Sallie Mae warrants to purchase
an aggregate of 616,863 shares of our common stock with an exercise price of $10
per share. Of these shares, 352,493 will be immediately exercisable and the
remaining 264,370 shares will vest over the next two years based on Sallie Mae's
performance under our product promotion agreement. We believe that Sallie Mae
will be able to meet the criteria needed to allow it to exercise the performance
based warrants. As a result, we will begin to record an expense for the warrants
from the date of issuance. Initially, we recorded a deferred charge during the
quarter ending March 31, 2000 of approximately $2.6 million, which was the fair
value of the vested portion of the warrant on the date of issuance. The deferred
charge will be amortized on a straight-line basis over the two-year life of the
agreement.
Going forward, during the period of time that either the AOL and Sallie Mae
warrants are outstanding, the fair value of the unvested portion of the warrants
will be remeasured each quarter and, if different from the fair value used in
determining the expense in the prior quarter, the difference will be reflected
as an additional charge or credit at that time. Accordingly, the higher our
stock price is at the time of remeasurement, the more significant will be the
non-cash charge we will be required to record. If we are required to record
significant expense, our results of operations for that period could fall below
the expectations of our investors or public market analysts, which could cause
the price of our common stock to fall substantially. At the time any portion of
either of the warrants vests, the fair value of the vested portion will be
remeasured for a final time and will not continue to be remeasured in subsequent
periods.
In April 1999, we entered into an agreement with Campus Pipeline under
which a warrant to purchase 25,000 shares of our common stock with an exercise
price of $6.00 per share was issued which will be exercisable upon the
achievement of contractual revenues of $30.0 million on or before December 31,
2000, with an additional warrant for 50,000 shares of our common stock with an
exercise price of $6.00 per share which will be exercisable if contractual
revenues equal or exceed $80.0 million on or before July 31, 2001. Since the
exercisability of these warrants is based on the achievement of uncertain future
revenue targets, we have not recorded any expense for these warrants. If and
when it becomes probable that our contractual revenues will reach the necessary
level for either of the warrants we issued to Campus Pipeline to vest, we would
begin to record an expense in the manner described above.
FAILURE TO COST-EFFECTIVELY DEVELOP AWARENESS OF OUR BRAND NAME COULD HARM OUR
FUTURE SUCCESS.
We believe that continuing to build awareness of the "VarsityBooks.com"
brand name is critical to achieving widespread acceptance of our business. We
believe brand recognition could become more important as competition in the
online textbook market increases. If we fail to successfully promote and
maintain our brand, incur significant expenses in promoting our brand or fail to
generate a corresponding increase in revenue as a result of our branding
efforts, our business could be harmed. To maintain and build our brand
awareness, we must succeed in our brand marketing efforts, provide high-quality
services to our customers and increase user traffic on our Web site. These
efforts have required, and will continue to require, significant expenses. From
January 1, 1998 to December 31, 1998, we incurred approximately $589,000 in
marketing and sales expenses. From January 1, 1999 to December 31, 1999, we
incurred approximately $20.8 million in marketing and sales expenses. We may
find it necessary to increase expenditures relating to our marketing and sales
efforts or otherwise increase our financial commitment to creating and
maintaining brand awareness among potential customers.
WE DEPEND ON OUR NETWORK OF STUDENT REPRESENTATIVES TO GENERATE AWARENESS OF OUR
BRAND.
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We depend on our network of student representatives to create awareness of our
brand and to drive traffic to our Web site. Our student representatives are
generally not experienced marketing people and we anticipate turnover due to
graduation and normal attrition. We cannot be certain that we will continue to
be able to attract, train and retain qualified student representatives. Our
sales and our ability to reach students at any institution may fluctuate from
year-to-year based on the efforts of our student representatives on their
particular campus. If our student representatives are unable to generate
interest on their campuses, our sales and our ability to reach students at those
institutions will likely neither materialize nor increase. Our student
representatives at each campus must comply with the specific rules governing
marketing on their individual campus. It is possible that these rules will
restrict their ability to market our products and services or those of other
businesses or that these rules will become more strict and thereby limit our
marketing opportunities.
WE FACE SIGNIFICANT COMPETITION, AND THAT COMPETITION MAY INCREASE SUBSTANTIALLY
BECAUSE OF THE LOW BARRIERS TO MARKET ENTRY.
The e-commerce, e-marketing and online text book markets, are new, rapidly
evolving and intensely competitive. We expect competition to intensify in the
future. Barriers to entry are minimal, and current and new competitors can
launch new Web sites at a relatively low cost. We currently compete with a
variety of other companies in the sale of textbooks, and if we are able to add
other product or service offerings we will have additional competition in those
markets. Our current and potential competition includes the following categories
of companies:
- traditional new textbook retailers, such as campus bookstores;
- traditional used college textbook retailers, some of which have or are
expected to begin online selling;
- Internet-based textbook retailers such as bigwords.com, ecampus.com
(affiliated with Wallace's Bookstores, Inc.), efollett.com (affiliated
with The Follett Corporation) and textbooks.com (affiliated with
Barnes & Noble College Bookstores, Inc.);
- Internet-based general booksellers such as Amazon.com,
barnesandnoble.com and Borders.com;
- college market focused companies such as Student Advantage and
Youthstream;
- general purpose consumer online services such as America Online and
Microsoft Network, each of which provides access to college
student-related content and services;
- vendors of information, merchandise, products and services to college
students distributed through other means, including retail stores,
direct mail and on campus; and
- Web sites targeted to students generally or to students of a
particular school, such as Web sites developed by Snowball,
CollegeClub, CommonPlaces and Student.Net Publishing.
We are not able to reliably estimate the number of our direct competitors.
Many of our current and potential competitors have longer general retail
operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing, technological, operational and other
resources than we do. Some of our competitors may be able to secure textbooks
from vendors on more favorable terms, devote greater resources to marketing and
promotional campaigns, adopt more aggressive pricing, shipping policies or
inventory availability policies and devote substantially more resources to Web
site and systems development than we can. As competition increases, we may
experience reduced operating margins, loss of market share and a diminished
brand franchise. To remain competitive, we may from time to time make pricing,
service or marketing decisions or acquisitions that could affect our financial
condition and results of operations. It is possible that our supply channel
(distributors and, indirectly, publishers) may enter the market and match our
pricing through direct retail centers or that either or both our supply channel
and traditional college bookstores may enter the online commerce market as our
competitors. It is also possible that companies that control access to
transactions through network access or Web browsers could promote our
competitors or charge us a substantial fee for inclusion. As Internet use
becomes increasingly prevalent, it is possible that the full text of books we
offer for sale will be available for viewing on the Web or on other electronic
devices such as virtual textbooks. If virtual textbooks become a reality and
students rely on them in lieu of purchasing hard copies of textbooks, our
business may decline.
WE ARE SUBJECT TO LITIGATION THAT MAY FORCE US TO CHANGE OUR ADVERTISING.
We have recently been sued by the National Association of College Stores,
or N.A.C.S., a trade association whose members are largely college bookstores.
The lawsuit claims that we engage in false and misleading advertising. Although
the lawsuit does not seek monetary damages, in the event the lawsuit were
adversely decided, we may have to change our advertising. Our inability to
advertise discounts could harm our business. In addition, to the extent the
litigation requires significant attention from management, their attention could
be diverted from our operations.
WE MAY NOT BE ABLE TO OBTAIN LISTS OF THE TEXTBOOKS REQUIRED FOR CLASSES AT OUR
TARGET SCHOOLS.
We obtain the prescribed reading lists for classes at colleges and
universities and post these "booklists" on our Web site to enable customers to
easily find the textbooks they will need and, if they choose, order their
textbooks before classes start. We may not be able to obtain these booklists in
the future or our competitors may obtain and post booklists. If we cannot obtain
and post booklists in advance of the start of a semester, or if our competitors
are able to do so, we will lose a significant competitive advantage and our
business may be harmed.
WE DEPEND ON SEVERAL MARKETING STRATEGIES TO ATTRACT USERS TO OUR WEB SITE.
In addition to our student representatives, we rely on a variety of
marketing and sales relationships to attract users to our Web site. We obtain
and post the booklists for a growing number of college and university courses,
enabling us to plan for anticipated demand. We also offer a partnership program,
under which we partner with schools to be their exclusive new textbook retailer.
In addition, we enter into agreements with other college-oriented Web sites to
provide a link from their Web site to ours. We believe that these relationships
result in increased traffic to our Web site, and we intend to enter into similar
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relationships with other entities, which we expect to generate increased traffic
to our Web site. Our ability to generate revenues from online commerce may
depend on the increased traffic, purchases, advertising and sponsorships that we
expect to generate through these and other relationships. There can be no
assurance that these relationships will be maintained beyond their initial terms
or that additional third-party alliances will be available to us on acceptable
terms or at all. Further, several of these entities compete with each other and
they may seek a similar relationship with one of our competitors rather than us
to differentiate themselves from their competitors. Our inability to enter into
new, and to maintain any one or more of our existing, significant marketing
alliances could harm our business.
LOSS OF ANY OF OUR KEY MANAGEMENT PERSONNEL OR THE INABILITY OF OUR KEY
MANAGEMENT PERSONNEL TO WORK TOGETHER EFFECTIVELY OR SUCCESSFULLY MANAGE OUR
GROWTH COULD NEGATIVELY AFFECT OUR BUSINESS.
Our future success depends to a significant extent on the continued service
and coordination of our management team, particularly Eric J. Kuhn, our
co-founder, Chief Executive Officer, President and Chairman of the Board. We
have entered into an agreement with Mr. Kuhn which provides, among other things,
that he be compensated in the event he is terminated without cause. We have
not entered into similar agreements with any other personnel. Nonetheless, the
loss or departure of any of our executive officers or key employees could harm
our ability to implement our business plan. We do not maintain key person
insurance on any member of our management team. In addition, a number of members
of our management team have joined us within the last year. These individuals
have not previously worked together and are becoming integrated into our
management team. They may not be able to work together effectively or
successfully manage our growth, resulting in adverse consequences to our
business.
OUR BUSINESS AND GROWTH WILL SUFFER IF WE ARE UNABLE TO SUCCESSFULLY HIRE AND
RETAIN KEY PERSONNEL.
Our future success depends on our ability to attract, train, motivate and
retain highly skilled employees and student representatives. We may be unable to
retain our key employees and student representatives or attract, assimilate or
retain other highly qualified employees or student representatives in the
future. The failure to attract and retain the necessary managerial, marketing,
merchandising, operational, customer service, technical, financial or
administrative personnel could harm our business. In addition, as we grow and
add additional product and service offerings, we anticipate a need to further
develop and expand our Web site. Competition for highly skilled and qualified
Web site and software developers is intense. We cannot be certain we will be
able to attract and retain a sufficient number of qualified software developers
or outside consultants for our Web site and transaction-processing systems.
WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR EXPANDING OPERATIONS.
We are experiencing a period of rapid growth. To execute our business plan,
we must continue to grow significantly. As of January 31, 1999, we had a total
of 20 employees and approximately 300 student representatives and, as of
February 29, 2000, we had approximately 200 employees and over 2,700 student
representatives. We expect that we will continue to increase the number of our
employees and student representatives for the foreseeable future. This growth
has placed, and our anticipated future growth will continue to place, a
significant strain on our management, training systems, resources and
facilities. Our inability to expand and effectively integrate these areas could
cause our expenses to grow and our revenues to increase more slowly than
expected or decline and could otherwise harm our business. We expect that we
will need to continue to improve our financial and managerial controls and
reporting and training systems and procedures. We will also need to continue to
expand and maintain close coordination among our marketing and sales,
operational, technical, accounting, finance and administrative organizations. We
may not succeed with these efforts.
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EXPANDING THE BREADTH AND DEPTH OF OUR PRODUCT OR SERVICE OFFERINGS IS EXPENSIVE
AND DIFFICULT, AND WE MAY RECEIVE NO BENEFIT FROM OUR EXPANSIONS.
We are expanding our operations by promoting new, complementary products,
expanding the breadth and depth of products and services we currently offer and
expanding our market presence through relationships with new schools and other
third parties. We cannot be certain that our current expansion and any potential
expansion would generate sufficient revenues to offset the costs involved.
Moreover, we may pursue the acquisition of new or complementary businesses,
products or technologies or other intellectual property rights, although we have
no present understandings, commitments or agreements with respect to any such
acquisitions. Expansion of our products and services will require significant
additional expenditures and could strain our management, financial and
operational resources. For example, we may need to incur significant marketing
expenses, develop relationships with new partners, manufacturers or distributors
or comply with new regulations. We cannot be certain we will be able to expand
our product and service offerings in a cost-effective or timely manner, and we
cannot be certain that any such efforts would receive market acceptance or
increase our overall market acceptance. The offering of new products and
services that are not favorably received by our customers could damage our
reputation and brand name. In addition, we may not be able to offer additional
products or services. If we are able to do so, we may not be able to offer these
products or services before our competition. For many of these products and
services, there are already other traditional and online retailers offering
these products and we may not be able to change our customers' purchasing
habits.
WE WILL ONLY BE ABLE TO EXECUTE THE ONLINE RETAIL ASPECT OF OUR BUSINESS MODEL
IF USE OF THE INTERNET AND ONLINE COMMERCE GROWS.
Our business would be adversely affected if Internet usage does not
continue to grow. Internet usage may be inhibited for any of the following
reasons:
- the Internet infrastructure may be unable to support increased demand
or its performance and reliability may decline as usage grows;
- the inability of Web sites to provide security and authentication of
confidential information contained in transmissions over the Internet;
- the quality of Internet products and services may not continue to
generate user interest;
- online commerce is at an early stage and buyers may be unwilling to
shift their traditional purchasing to online purchasing;
- increased government regulation or taxation of online commerce, at the
state or federal level, may adversely affect the viability of online
commerce;
- insufficient availability of telecommunication services or changes in
telecommunication services may result in slower response times; and
- Web sites may not have the ability to respond to privacy concerns of
potential users, including concerns related to the placement by Web
sites of information on a user's hard drive without the user's
knowledge or consent.
IF WE ARE UNABLE TO ADAPT AS INTERNET TECHNOLOGIES AND CUSTOMER DEMANDS CONTINUE
TO EVOLVE, OUR SERVICES AND PRODUCTS COULD BECOME LESS DESIRABLE.
A key element of our strategy is to generate a high volume of traffic to,
and use of, our Web site. Accordingly, the satisfactory performance, reliability
and availability of our Web site, transaction-processing systems and network
infrastructure are critical to our reputation and our ability to attract and
retain customers and maintain adequate customer service levels. An unanticipated
dramatic increase in the volume of traffic on our Web site or the number of
orders placed by our customers may force us to expand and upgrade our
technology, transaction-processing systems and network infrastructure. There can
be no assurance that we will be able to accurately project the rate or timing of
increases, if any, in the use of our Web site or timely expand and upgrade our
systems and infrastructure to accommodate such increases. To be successful, we
must adapt to our rapidly changing market by continually enhancing the
technologies used in our Internet products and services and introducing new
technology to address the changing needs of our business and customers. If we
are unable, for technical, legal, financial or other reasons, to adapt in a
timely manner in response to changing market conditions or business and customer
requirements, our business could be harmed.
AS AN INTERNET-BASED RETAILER, WE DEPEND HEAVILY ON OUR INFORMATION TECHNOLOGY
INFRASTRUCTURE AND OUR OPERATIONS COULD BE JEOPARDIZED BY ANY SYSTEM FAILURE OR
INADEQUACY.
Our operations are dependent on our ability to maintain our computer and
communications software and equipment in effective working order and to protect
our systems against damage from fire, natural disaster, power loss,
communications failure or similar events. In addition, the growth of our
customer base may strain or exceed the capacity of our computer and
communications systems and lead to degradations in performance or systems
failure. Our success, in particular our ability to successfully receive and
fulfill orders and provide high-quality customer service, largely depends on the
efficient and uninterrupted operation of our computer and communications
hardware systems. We use an internally developed system for our Web site, search
engine and substantially all aspects of transaction processing, including order
management, cash and credit card processing, purchasing, inventory management
and shipping.
Substantially all of our computer and communications hardware and software
systems are located at a single facility in Herndon, Virginia. That facility
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is owned, maintained and serviced by GlobalCenter Inc. Although we own and
maintain our hardware and software systems, including the software which is
central to the sales, ordering and shipping processes, we rely on GlobalCenter
Inc. to ensure our computer and communications hardware and software operate
efficiently and continuously. Although we have entered into an agreement with
Exodus Communication to operate our system in the event of a prolonged outage of
GlobalCenter Inc., we do not presently have fully redundant systems or a formal
disaster recovery plan and do not carry sufficient business interruption
insurance to compensate for losses that may occur. Despite our implementation of
network security measures, our servers are vulnerable to computer viruses,
physical or electronic break-ins, fire, flood, power loss, telecommunications
failure, break-ins, earthquake and similar disruptions, which could lead to
interruptions, delays, loss of data or the inability to accept and fulfill
customer orders. Any damage, failure or delay that causes interruptions in our
system operations could have a material adverse effect on our business.
In addition to our offsite software and hardware related to our Web site,
at our headquarters we maintain a local area network, or LAN, which we use for
our financial reporting systems, customer service operations, monitoring of our
customer orders, e-mails and other internal processes. Any loss of service or
other failure of this LAN, regardless of the availability of our Web site, would
significantly impair our ability to service our customers and monitor and
fulfill customer orders, which could have a material adverse effect on our
business.
The failure of either our Web site or our LAN or any other systems
interruptions that results in unavailability of our Web site or reduced order
fulfillment performance, especially during our peak sales periods of
August/September and January/February, could result in negative publicity or
could reduce the volume of goods sold and attractiveness of our Web site and
would seriously impair our ability to service our customers' orders, all of
which could negatively affect our revenues. Because our servers are located at a
third-party's facility and because some of the reasons for a systems
interruption may be outside of our control, we also may not be able to exercise
sufficient control to remedy the problem quickly or at all. Regardless of
whether we or a third-party controls or creates system failure, the occurrence
of system failure could adversely affect our reputation, seriously harm our
business and cause us to lose a significant and disproportionate amount of
revenues.
CONCERNS ABOUT SECURITY ON THE INTERNET MAY REDUCE THE USE OF OUR WEB SITE AND
IMPEDE OUR GROWTH.
A significant barrier to confidential communications over the Internet has
been the need for security. We rely on SSL encryption technology to prevent the
misappropriation of customer credit card data during the transaction process.
Under current credit card practices, a merchant is liable for fraudulent credit
card transactions where, as is the case with the transactions we process, that
merchant does not obtain a cardholder's signature. A failure to adequately
control fraudulent credit card transactions could reduce our collections and
harm our business. Internet usage could decline if any well-publicized
compromise of security occurred. Our site could be particularly affected by any
such breach because our online commerce model requires the entry of confidential
customer ordering, purchasing and delivery data over the Internet, and we
maintain a database of this historical customer information. Until more
comprehensive security technologies are developed, the security and privacy
concerns of existing and potential customers may inhibit the growth of the
Internet as a medium for commerce. We cannot be certain that advances in
computer capabilities, new discoveries in the field of cryptography or other
developments will not result in the compromise or breach of the algorithms we
use to protect content and transactions on our Web site or proprietary
information in our databases. Anyone who is able to circumvent our security
measures could misappropriate proprietary, confidential customer or company
information or cause interruptions in our operations. We may incur significant
costs to protect against the threat of such security breaches or to alleviate
problems caused by these breaches.
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATIONS AND LEGAL
UNCERTAINTIES AFFECTING THE INTERNET WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
To date, governmental regulations have not materially restricted use of the
Internet in our markets. However, the legal and regulatory environment that
pertains to the Internet is uncertain and may change. Uncertainty and new
regulations could increase our costs of doing business and prevent us from
delivering our products and services over the Internet. The growth of the
Internet may also be significantly slowed. This could delay growth in demand for
our online services and limit the growth of our revenues. In addition to new
laws and regulations being adopted, existing laws may be applied to the
Internet. New and existing laws may cover issues which include:
- sales and other taxes;
- user privacy;
- pricing controls;
- characteristics and quality of products and services;
- consumer protection;
- libel and defamation;
- copyright, trademark and patent infringement; and
- other claims based on the nature and content of Internet materials.
WE MAY BE UNABLE TO OBTAIN A UNITED STATES TRADEMARK REGISTRATION FOR OUR BRAND
OR TO PROTECT OUR OTHER PROPRIETARY INTELLECTUAL PROPERTY RIGHTS.
Our application to register the mark VarsityBooks.com has been approved for
publication by the Trademark Office. After the application is published, it will
be open to opposition by third parties for a period of 30 days. If we are unable
to secure the right to use the VarsityBooks.com mark and related derivative
marks, a key element of our strategy of promoting "VarsityBooks.com" as our
brand could be disrupted and, as a result, the value of your investment could be
reduced. Even if we are able to secure federal trademark registration for the
mark VarsityBooks.com, federal trademark laws only provide us with limited
protection because, for example, we would be unable to prevent the use of an
unregistered similar mark by a prior user or
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to prevent the use of a similar name in our markets or similar mark for products
and services we would like to offer.
The unauthorized reproduction or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology and brand
name without paying us for them. If this were to occur, our revenues and the
value of your investment could be reduced. The steps we have taken to protect
our proprietary rights may not be adequate to deter misappropriation of
proprietary information. We may not be able to detect unauthorized use of our
proprietary information or take appropriate steps to enforce our intellectual
property rights. In addition, the validity, enforceability and scope of
protection of intellectual property in Internet-related industries is uncertain
and still evolving. The laws of other countries in which we may market our
services in the future may afford little or no effective protection of our
intellectual property. If we resort to legal proceedings to enforce our
intellectual property rights, the proceedings could be burdensome and expensive.
DEFENDING AGAINST INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS COULD BE TIME
CONSUMING AND EXPENSIVE AND, IF WE ARE NOT SUCCESSFUL, COULD SUBJECT US TO
SIGNIFICANT DAMAGES AND DISRUPT OUR BUSINESS.
We cannot be certain that our products do not or will not infringe valid
patents, copyrights or other intellectual property rights held by third parties.
We expect that infringement claims in our markets will increase in number as
more participants enter the market. We may be subject to legal proceedings and
claims from time to time relating to the intellectual property of others in the
ordinary course of our business. We may incur substantial expenses in defending
against these third-party infringement claims, regardless of their merit.
Successful infringement claims against us may result in substantial monetary
liability or may materially disrupt the conduct of our business.
AS INTERNET TECHNOLOGY AND REGULATION ADVANCES, WE MAY NOT BE ABLE TO PROTECT
OUR DOMAIN NAMES.
We currently hold various Web domain names relating to our brand, including
the "VarsityBooks.com" domain name. The acquisition and maintenance of domain
names generally is regulated by governmental agencies and their designees. The
regulation of domain names in the generic category of domain names (i.e., .com,
.net and .org) is now controlled by a non-profit corporation, which may create
additional top-level domains. Requirements for holding domain names have also
been affected. As a result, there can be no assurance that we will be able to
acquire or maintain relevant domain names. Furthermore, the relationship between
regulations governing domain names and laws protecting trademarks and similar
proprietary rights is unclear. Therefore, we may be unable to prevent third
parties from acquiring domain names that are similar to, infringe upon or
otherwise decrease the value of our trademarks and other proprietary rights. Any
such inability could harm our business.
SOME STATES MAY IMPOSE A NEW SALES TAX ON OUR BUSINESS.
A 1992 Supreme Court decision confirmed that the commerce clause of the
United States Constitution prevents a state from requiring the collection of its
sales and use tax by a mail-order company unless such company has a physical
presence in the state. However there continues to be uncertainty due to
inconsistent application of the Supreme Court decision by state and federal
courts. We attempt to conduct our operations consistent with our interpretation
of the applicable legal standard, but there can be no assurance that such
compliance will not be challenged. In recent challenges, various states have
sought to require companies to begin collection of sales and use taxes and/or
pay taxes from previous sales. As of the date of this form, although we have not
received assessments from any state, we have received inquiries from two states
regarding our activity in their states. We currently collect and forward sales
tax on all shipments to Illinois and the District of Columbia. The Supreme Court
decision also established that Congress has the power to enact legislation which
would permit states to require collection of sales and use taxes by mail-order
companies. Congress has from time to time considered proposals for such
legislation. We anticipate that any legislative change, if adopted, would be
applied on a prospective basis. While there is no case law on the issue, we
believe that this analysis could also apply to our online business. Recently,
several states and local jurisdictions have expressed an interest in taxing
e-commerce companies who do not have any contacts with their jurisdictions other
than selling products online to customers in such jurisdictions. The Internet
Tax Freedom Act imposed a moratorium on new taxes or levies on e-commerce for a
three-year period due to expire in October 2001. However, there is a possibility
that Congress may not renew this legislation. Any such taxes could have an
adverse effect on online commerce, including our business.
OUR EXECUTIVE OFFICERS, DIRECTORS AND EXISTING STOCKHOLDERS, WHOSE INTERESTS MAY
DIFFER FROM OTHER STOCKHOLDERS, HAVE THE ABILITY TO EXERCISE SIGNIFICANT CONTROL
OVER US.
Our executive officers, directors and entities affiliated with them,
in the aggregate, beneficially own approximately 52.0% of our outstanding
common stock. These stockholders will be able to exercise significant influence
over all matters requiring stockholder approval, including the election of
directors, the approval of significant corporate transactions and the power to
prevent or cause a change of control. The interests of these stockholders may
differ from the interests of our other stockholders.
OUR STOCK PRICE MAY EXPERIENCE EXTREME PRICE AND VOLUME FLUCTUATIONS, AND
INVESTORS IN OUR STOCK MAY NOT BE ABLE TO RESELL THEIR SHARES AT OR ABOVE THE
PRICE YOU PAID TO PURCHASE SHARES OF OUR STOCK.
Prior to February 15, 2000 there was not a public market for our common
stock and an active public market for our common stock may not develop or be
sustained. We cannot predict the extent to which investors' interest in us will
lead to the development of a trading market or how liquid the market might
become. The stock market in general and the market prices of shares in newly
public technology companies, particularly those such as ours that offer
Internet-based products and services, have been extremely volatile and have
experienced fluctuations that have often been unrelated or disproportionate to
the operating performance of such companies. The trading prices of many
technology companies stocks are at or near historical highs and reflect price to
earnings or revenue ratios substantially above historical levels. We cannot be
certain that these trading prices or price to earnings or revenue ratios will be
sustained. The market price of our common stock could continue to be highly
volatile and subject to wide fluctuations in response to many factors which are
largely beyond our control. These factors include:
- quarterly variations in our results of operations;
- adverse business developments;
- changes in financial estimates by securities analysts;
- investor perception of us and online retailing services in general;
- announcements by our competitors of new products and services; and
- general economic conditions both in the United States and in foreign
countries.
Fluctuations in our common stock's price may affect our visibility and
credibility in our market. In the event of fluctuations in the market price of
our common stock, you may be unable to resell your shares at or above the
price you paid.
IF OUR STOCK PRICE IS VOLATILE, WE MAY BECOME SUBJECT TO SECURITIES LITIGATION
WHICH IS EXPENSIVE AND COULD RESULT IN A DIVERSION OF RESOURCES.
Securities class action litigation has often been brought against companies
that experience volatility in the market price of their securities. Litigation
brought against us could result in substantial costs to us in defending against
the lawsuit and a diversion of management's attention that could cause our
business to be harmed.
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FUTURE SALES OF OUR COMMON STOCK MAY NEGATIVELY AFFECT OUR STOCK PRICE.
We have a large number of shares of common stock outstanding and available
for resale beginning at various points in time in the future. Current
stockholders who, in the aggregate, hold approximately 11,500,000 shares of our
outstanding common stock; AOL, which holds warrants for the purchase of up to
528,738 shares of common stock; and Sallie Mae, which holds warrants for the
purchase of up to 616,863 shares of common stock, have the right to require us
to register their shares for sale or participate in future registrations of our
common stock. In addition, the holders of contingent warrants to purchase up to
75,000 shares of our common stock have the right to participate in future
registrations of our common stock if the warrants become exercisable and are
exercised. The market price of our common stock could decline as a result of
sales of a large number of shares of our common stock in the market, or the
perception that such sales could occur. These sales also might make it more
difficult for us to sell equity securities in the future at a time and at a
price that we deem appropriate.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY AND THIS COULD
DEPRESS OUR STOCK PRICE.
Delaware corporate law and our amended and restated certificate of
incorporation and our by-laws contain provisions that could have the effect of
delaying, deferring or preventing a change in control of VarsityBooks.com or a
change of our management that stockholders may consider favorable or beneficial.
These provisions could discourage proxy contests and make it more difficult for
you and other stockholders to elect directors and take other corporate actions.
These provisions could also limit the price that investors might be willing to
pay in the future for shares of our common stock. These provisions include those
which:
- authorize the issuance of "blank check" preferred stock, which is
preferred stock that can be created and issued by the board of
directors without prior stockholder approval, with rights senior to
those of common stock;
- provide for a staggered board of directors, so that it would take
three successive annual meetings to replace all directors;
- prohibit stockholder action by written consent; and
- establish advance notice requirements for submitting nominations for
election to the board of directors and for proposing matters that can
be acted upon by stockholders at a meeting.
EMPLOYEES
As of February 29, 2000, we had approximately 200 employees and over 2,700
student representatives, including over 600 lead student representatives. Each
semester our lead student representatives recruit up to 15 representatives each
to work on their campus teams. We hire temporary employees, particularly at the
beginning of each school semester, and contract service providers as necessary.
As we continue to grow and introduce additional products and services, we expect
to hire additional employees, particularly in sales and marketing, online
product development and booklist operations. None of our employees is
represented by a labor union or is the subject of a collective bargaining
agreement. We believe that relations with our employees are good.
ITEM 2. PROPERTIES.
Our headquarters are at 2020 K Street, N.W. in Washington, D.C. At this
headquarters site, we presently lease an aggregate of approximately 34,000
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square feet. Our current lease for this facility expires in February 2003. We
believe this space will be sufficient for our needs for approximately twelve
months.
ITEM 3. LEGAL PROCEEDINGS.
On October 29, 1999, the National Association of College Stores, or
N.A.C.S., sued us in the United States District Court for the District of
Columbia. In their complaint, N.A.C.S. alleged that we use false and misleading
advertisements in our efforts to sell textbooks. Specifically, the complaint
alleges that we falsely advertise discounts of 40% on textbooks on our Web site.
The complaint also alleges that there is no suggested retail price for textbooks
from which to calculate discounts. N.A.C.S. claims that, in making the alleged
false and misleading statements, we are implying that N.A.C.S. member stores
over charge students for their textbooks. The complaint requests that we be
prevented from claiming in any advertising or promotional material, packaging or
the like, or representing in any way, that we offer discounts or percentages off
of textbooks, unless we clearly and prominently identify the true basis for the
claimed discount, the source of the comparative price we use to determine the
discounts we offer and the true percentage of textbooks offered at the stated
discounted price. In addition, N.A.C.S. seeks to have us retract all prior
claims through prominent statements on our Web site. The complaint does not seek
monetary damages, other than attorneys' fees.
We believe these claims to be completely without merit. Our Web site and
our advertising truthfully state that we offer college textbooks at up to 40%
off suggested price. We also believe that the industry data we use to determine
the suggested price form which we calculate discounts is appropriate. We have
filed a motion to dismiss these claims and are awaiting a ruling on our motion.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On December 10, 1999, our shareholders approved an amendment to our charter
by written consent in lieu of a special meeting. The written consent concerned a
Sixth Amendment and Restatement of our Certificate of Incorporation, including
an increase in the option pool available under our 1998 Stock Option Plan, the
authorization of a reverse one-for-two stock split and an adoption of our
Employee Stock Purchase Plan. All of the matters submitted to the stockholders
were approved by the written consent of shareholders holding an aggregate of
17,785,727 shares (which number was calculated using capitalization numbers in
existence prior to the effectiveness of our 1 for 2 reverse stock split).
Shareholders holding an aggregate of 4,165,478 shares did not register a vote
with respect to the proposed matters, but were notified in writing of their
subsequent adoption.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) Market Price of and Dividends on our Common Stock and Related Stockholder
Matters.
Our common stock has been traded on the Nasdaq National Market under the
symbol VSTY since February 15, 2000. Prior to February 15, 2000, our common
stock was not publicly traded. For the period from February 15, 2000 to March
27, 2000, the high and low closing prices per share of our Common stock as
reported by the Nasdaq National Market were:
High Low
---- ---
Period from February 15, 2000 to March 27, 2000... $10.0625 $5.4375
On March 27, 2000 , the closing price per share of our common stock was
$5.75, as reported on The Nasdaq National Market and we had approximately 94
stockholders of record.
We have never declared or paid any cash dividends on our common stock and
we anticipate that we will continue to retain any earnings for the foreseeable
future for use in the operation of our business and the we will not pay any cash
dividends in the foreseeable future.
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RECENT SALES OF UNREGISTERED SECURITIES
The information required by this section is incorporated by reference to
Item 15 of the Company's Registration Statement on Form S-1 (File No.
333-89049).
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ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data presented below as of and for the fiscal years ended
December 31, 1998 and 1999 have been derived from the Company's audited
consolidated financial statements. This data should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations, the Company's Consolidated Financial Statements and Notes thereto,
and other financial information appearing elsewhere in this Form 10-K.
Years Ended December 31,
-----------------------
1998 1999
---- ----
(in thousands, except share and per share data)
Statement of Operations Data
Net sales:
Product ....................................................... $ 122 $ 9,885
Shipping....................................................... 10 674
Total net sales............................................. ---------- ----------
132 10,559
---------- ----------
Operating expenses:
Cost of product -- related party............................... 115 9,119
Cost of shipping -- related party ............................. 10 909
Equity transactions -- related party........................... 798 169
Marketing and sales:
Non-cash compensation .................................... $ 53 $ 787
Other marketing and sales ................................ 536 589 20,021 20,808
----- -------
Product development:
Non-cash compensation ...................................... 69 205
Other product development .................................. 627 696 4,505 4,710
----- -------
General and administrative:
Non-cash compensation ...................................... 24 1,586
Other general and administrative............................ 593 617 5,117 6,703
----- ---------- ------- ----------
Total operating expenses....................................... 2,825 42,418
---------- ----------
Loss from operations............................................ (2,693) (31,859)
Interest income, net ........................................... 4 351
---------- ----------
Net loss....................................................... (2,689) (31,508)
---------- ----------
Preferred stock dividends ...................................... -- 1,487
---------- ----------
Net loss applicable to common stockholders..................... $ (2,689) $ (32,995)
========== ==========
Net loss per share:
Basic and diluted ............................................ $ (1.53) $ (14.82)
========== ==========
Pro forma basic and diluted(1) .............................. $ (4.09)
==========
Weighted average shares:
Basic and diluted ............................................ 1,755,536 2,226,225
========== ==========
Pro forma basic and diluted(1)................................ 7,702,441
==========
As of December 31,
------------------
1998 1999
---- ----
(in thousands)
BALANCE SHEET DATA
Cash and cash equivalents ..................... $ 1,481 $ 7,813
Working capital (deficit) ..................... (199) 9,163
Total assets .................................. 1,746 18,062
Total stockholders' equity (deficit).......... (99) 12,047
- ----------------------------
(1) Pro-forma basic and diluted net loss per share is computed using the
weighted average number of common shares outstanding, including the pro-forma
effects of the conversion of the Company's Series A, Series B and Series C
convertible preferred stock into shares of the Company's common stock on a
one-to-one basis effective upon the closing of the Company's initial public
offering as if such conversion occurred on January 1, 1999 or at the date of
original issuance, if later, as well as the impact of the Company's one-for-two
reverse stock split in December 1999.
20
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a leading online retailer of new college textbooks and we provide
marketing services to other businesses interested in reaching the nation's 15
million college students. We were incorporated in December 1997 and began
offering books for sale on our Web site on August 10, 1998. For the period from
inception through August 9,1998, our primary activities consisted of:
- developing our business model;
- establishing, negotiating and consummating a relationship with our
supplier, Baker & Taylor;
- initial planning and development of our Web site;
- developing our information systems infrastructure;
- developing our marketing plans; and
- establishing finance and administrative functions.
Since the launch of our Web site, we have continued these activities and
have also focused on increasing sales, expanding our product and service
offerings, improving the efficiency of our order and fulfillment process,
recruiting and training employees, developing our booklist operations, enhancing
finance and administrative functions, and increasing customer service
operations, and the depth of our management team to help implement our growth
strategy.
We began to generate sales once we launched our Web site in August 1998, at
which time we posted the booklists for five schools. For the Spring 2000
semester, we increased the booklists we posted to over 240,000 courses at over
400 different targeted colleges and universities and we launched partnership
programs with 25 different partner institutions.
To date, our revenues have consisted primarily of sales of new textbooks.
Net sales consist of sales of books and charges to customers for outbound
shipping and are net of allowances for returns, promotional discounts and
coupons. Revenues from sales of textbooks are recognized at the time products
are shipped to customers. We have also generated revenues through the sale of
general interest books, banner advertisements and marketing service agreements,
as well as co-marketing programs, pursuant to which we have arrangements to sell
textbooks through other Web sites. Revenues from the sales of Internet
advertisements are recognized net of commissions paid. Revenues from our
marketing programs are recognized over the period in which the services are
delivered, provided that no significant performance obligations remain and the
collection of the related receivable is probable. During the fourth quarter of
fiscal 1999, we began generating revenues from co-marketing programs for which
we used our student representative network to market to students on behalf of
other businesses.
We have incurred substantial losses and negative cash flows from operations
in every fiscal period since our inception. For the year ended December 31,
1998, we incurred a loss from operations of approximately $2.7 million and
negative cash flows from operations of $1.2 million. For the year ended December
31, 1999, we incurred a loss from operations of approximately $31.9 million and
negative cash flows from operations of $29.4 million. As of December 31, 1998
and December 31, 1999, we had accumulated deficits of approximately $2.7 million
and $34.2 million, respectively. We expect operating losses and negative cash
flows to continue for the foreseeable future. We anticipate our net losses will
increase significantly from current levels because we expect to incur additional
costs and expenses related to brand development, marketing and other promotional
activities, continued expansion of our booklist operations, continued
development of our Web site and information technology infrastructure, expansion
of our product offerings and development of relationships with other businesses.
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We granted options to purchase 179,490 shares for the period ended
December 31, 1998 and options to purchase 2.1 million shares for the year ended
December 31, 1999 that have been deemed to be compensatory. As a result, we
recorded deferred compensation of $354,000 during the year ended December 31,
1998 and $5.1 million during year ended December 31, 1999. Additionally,
effective August 1, 1999, we sold 207,077 shares of our common stock at a price
of $0.30 per share to each of our founders, Mr. Kuhn and Mr. Levy. The shares
vest at a rate of 40% upon the completion of one year of service and the
remaining 60% vest at the end of the second year. Mr. Levy's shares accelerated
upon his separation which was effective March 15, 2000. Also, effective August
24, 1999, Mr. Kuhn was granted an option to purchase 138,052 shares of our
common stock at an exercise price of approximately $0.30 per share. The option
vests in equal monthly installments over each of the next 48 months assuming Mr.
Kuhn remains employed by us. Further, on December 17, 1999, we granted to Mr.
Kuhn an option to purchase 2% of the Company's fully diluted common stock at an
exercise price of $10 per share. We have deemed that the fair value of the
underlying stock for both the sale of common stock and option grants is in
excess of the related sales or exercise price. As a result, we recorded deferred
compensation of $3.5 million and $1.1 million during August 1999 and December
1999, respectively, for these transactions, resulting in total deferred
compensation for the year ended December 31, 1999 of $9.7 million. Amortization
of deferred compensation was $2.6 million for the year ended December 31, 1999
and is included in non-cash compensation in the accompanying consolidated
statements of operations as a component of the marketing and sales, product
development and general and administrative line items, as appropriate. Non-cash
compensation is being charged to operations over the vesting period of the
underlying shares and options.
The deferred compensation is being amortized as follows:
(in thousands)
--------------
Year ended December 31, 1998 ............. $ 146
Year ended December 31, 1999 ............. 2,578
Year ending December 31, 2000 ............ 4,139
Year ending December 31, 2001 ............ 1,975
Year ending December 31, 2002 ............ 888
Year ending December 31, 2003 ............ 339
-------
$10,065
=======
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The following table sets forth the results of our operations for the years
ended December 31, 1998 and 1999:
Years Ended December 31,
------------------------------------------------------
1998 1999
--------- ----------
(in thousands)
Net sales:
Product ...................................... $ 122 $ 9,885
Shipping...................................... 10 674
---------- ----------
Total net sales.............................. 132 10,559
---------- ----------
Operating expenses:
Cost of product -- related party.............. 115 9,119
Cost of shipping -- related party ............ 10 909
Equity transactions -- related party.......... 798 169
Marketing and sales:
Non-cash compensation....................... $ 53 $ 787
Other marketing and sales.................... 536 589 20,021 20,808
----- -------
Product development:
Non-cash compensation........................ 69 205
Other product development.................... 627 696 4,505 4,710
----- -------
General and administrative:
Non-cash compensation........................ 24 1,586
Other general and administrative ............ 593 617 5,117 6,703
----- ---------- ------- ----------
Total operating expenses ................... 2,825 42,418
---------- ----------
Loss from operations .......................... (2,693) (31,859)
Interest income, net .......................... 4 351
---------- ----------
Net loss ...................................... (2,689) (31,508)
---------- ----------
Preferred stock dividends...................... -- 1,487
...................................... ---------- ----------
Net loss applicable to common stockholders .... $ (2,689) $ (32,995)
========== ==========
Our fiscal year runs from January 1 through December 31. We did not execute
any transactions from December 16, 1997 (inception) through December 31, 1997.
We commenced offering books for sale on our Web site in August 1998, and,
accordingly, the calendar year ended December 31, 1998 only includes a period of
five months during which we generated net sales.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Net Sales
Net sales increased to $10.6 million for the year ended December 31, 1999
from $0.1 million for year ended December 31, 1998, as a result of the
additional selling season we experienced in January/February of 1999, the
significant growth in orders primarily from our expanding customer base as well
as the commencement of our partnership program.
Operating Expenses
Cost of Product -- Related Party (Baker & Taylor). Cost of product --
related party consists of the cost of products sold to customers. Cost of
product -- related party increased to $9.1 million for the year ended December
31, 1999 from $0.1 million for year ended December 31, 1998. This increase was
primarily attributable to our increased sales volume. We expect that cost of
product -- related party will continue to increase as we expand our customer
base and partnership program.
Cost of Shipping -- Related Party (Baker & Taylor). Cost of shipping --
related party consists of outbound shipping. Cost of shipping increased to $0.9
million for the year ended December 31, 1999 from approximately $10,000 for year
ended December 31, 1998. This increase was primarily attributable to our
increased sales volume. Also for the year ended December 31, 1999, cost of
shipping -- related party exceeded shipping revenue by $0.2 million or 34.9%. As
part of our business strategy, we charge a flat rate for shipping, which is less
than our actual costs. We believe that this strategy is responsive to the
competitive nature of our business and is positively perceived by our customer
base. We expect that cost of shipping -- related party will continue to exceed
shipping revenue and will increase as we expand our customer base.
Effective October 1, 1999 we amended the documents governing our
relationship with Baker & Taylor. The amendment provides for assignment of
separate values to the separate services provided by Baker & Taylor: supply of
books, shipping and other services, including Web site content and customer
database management. Such assignment is based on the relative fair value of each
element as determined by Baker & Taylor. Effective with the amendment of our
agreement with Baker & Taylor on October 1, 1999, we have included in "cost of
product--related party" in our statement of operations the cost of purchased
books from Baker & Taylor, we included in "shipping--related party" the cost
of shipping charges from Baker & Taylor and we included in "marketing and
sales--related party" the cost of other services charged from Baker & Taylor.
On a prospective basis, these agreements will serve to reduce Cost of
Product--Related Party (Baker & Taylor) as a percentage of revenue and increase
Marketing and Sales--Related Party (Baker & Taylor) as a percentage of revenue.
Equity Transactions--Related Party (Baker & Taylor). Equity
transactions--related party consists of the fair value of warrants and the
amortization of the excess of the fair value over the cost of common stock
issued to Baker & Taylor. During 1998, we issued a warrant to purchase 107,143
shares of our common stock at an exercise price of $2.33 per share in July; a
warrant to purchase up to 50,000 shares of our common stock at an exercise price
of $0.20 per share in October; and a warrant to purchase up to 53,571 shares of
our common stock at an exercise price of $2.33 per share in December. Additional
warrants to purchase up to 5,950 and 62,500 shares of our common stock at an
exercise price of $2.33 and $0.22 per share, respectively, were issued to Baker
& Taylor in 1999. We estimated the fair value of the warrants on the date of
grant using an established option pricing model (see note 3 to the accompanying
consolidated financial statements). On July 10, 1998, we sold 535,714 shares of
our common stock to Baker & Taylor at par value. We subsequently determined that
the fair value of the common stock was in excess of the exercise price and sales
price. Fair value per share was derived by reference to the preferred stock
value since inception -- see note 3 to the accompanying consolidated financial
statements. We expensed the excess of the fair value of the common stock over
its cost, which was approximately $643,000, in July 1998. In connection with all
of the Baker & Taylor equity transactions, we recorded an aggregate expense of
$169,000 for the year ended December, 31 1999, a decrease from the $798,000 we
recorded for such transactions for the year ended December 31, 1998.
Marketing and Sales. Marketing and sales expense consists primarily of
advertising and promotional expenditures and payroll and related expenses for
personnel engaged in marketing, including the expenses associated with the
continued development of our nationwide network of student representatives.
Marketing and sales expense increased to $20.8 million for the year ended
December 31, 1999 from $0.6 million for year ended December 31, 1998.
Advertising expense increased to $11.4 million for the year ended December 31,
1999 from $0.4 million for year ended December 31, 1998. This increase was
primarily attributable to the expansion of our online and offline advertising,
increased personnel and related expenses and the continued expansion of our
network of student representatives and our partnership program. We expect that
marketing and sales expense will continue to increase in absolute dollars as
23
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we expand our network of student representatives and incur additional
advertising and promotional expenses to build our sales base. Marketing and
sales expense will also increase as a result of the amendment of our agreements
with Baker & Taylor, which will result in the classification of services such as
Web site content and customer database management as marketing and sales
expense.
Product Development. Product development expense consists of payroll and
related expenses for development and systems personnel and consultants. Product
development expense increased to $4.7 million for the year ended December 31,
1999 from $0.7 million for year ended December 31, 1998. This increase was
primarily attributable to increased staffing and other costs related to feature
and functionality enhancements to our Web site. We expect that product
development expenses will continue to increase as we add additional features and
functionality to our Web site.
General and Administrative. General and administrative expense consists of
payroll and related expenses for executive and administrative personnel,
facilities expenses, professional services expenses, travel and other general
corporate expenses. General and administrative expense increased to $6.7 million
for the year ended December 31, 1999 from $0.6 million for year ended December
31, 1998. This increase was primarily attributable to the hiring of additional
personnel and increased professional services expenses. We expect that general
and administrative expenses will increase as we continue to build our
back-office infrastructure.
Interest Income, net
Interest income, net consists of interest income on our cash and cash
equivalents and investments, and interest expense attributable to our
convertible notes payable. Interest income, net was $0.4 million for the year
ended December 31, 1999 compared to less than $0.1 million for the year ended
December 31, 1998. This increase was primarily attributable to interest income
on higher average cash and cash equivalent and short term investment balances
during the year ended December 31, 1999.
Income Taxes
As of December 31, 1998 and December 31, 1999, we had net operating loss
carryforwards for federal income tax purposes of $1.7 million and $29.9 million,
respectively, which expire beginning in 2018. We have provided a full valuation
allowance on the resulting deferred tax asset because of uncertainty regarding
its realizability. Changes in the ownership of our common stock, as defined in
the Internal Revenue Code of 1986, as amended, may restrict the utilization of
such carryforwards. See note 10 to our consolidated financial statements.
SEASONALITY
We have experienced significant seasonality in our results of operations.
Due to the college calendar and the seasonal nature of the textbook industry,
our peak selling periods are currently August/September and January/February,
when college students return to school and new semesters begin. Part of our
strategy includes offering additional products and services through our Web
site. While these products and services may not have the same seasonal selling
periods as textbook sales, purchases of these products and services may occur
primarily with customer purchases of textbooks. In addition, the net sales
generated from these products and services may be significantly less than those
generated from our sales of textbooks. As a result, we may continue to
experience fluctuations in quarterly operating results.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through private
sales of our convertible preferred stock. On August 6, 1998 and December 3,
1998, we issued an aggregate of 2,071,420 shares of Series A preferred stock at
a purchase price of $0.70 per share, resulting in gross proceeds of
approximately $1.5 million. On February 25, 1999, we issued 6,933,806 shares of
Series B preferred stock at a purchase price of $1.44 per share, resulting in
gross proceeds of approximately $10.0 million. On August 27, 1999 and September
21, 1999, we issued an aggregate of 8,928,571 shares of Series C preferred stock
at a purchase price of $3.36 per share, resulting in gross proceeds of
approximately $30.0 million. Upon the closing of our intial public offering,
shares of our Series A, B and C preferred stock were converted into 8,966,879
shares of our common stock.
In April 1999, we entered into an agreement with Campus Pipeline, Inc.
under which a warrant to purchase 25,000 shares of our common stock with an
exercise price of $6.00 per share was issued and will be exercisable upon the
achievement of contractual revenues of $30.0 million on or before December 31,
2000, with an additional warrant for 50,000 shares with an exercise price of
$6.00 per share which will be exercisable if contractual revenues equal or
exceed $80.0 million on or before July 31, 2001. Since the exercisability of
these warrants is based on the achievement of uncertain future revenue targets,
we have not recorded any expense for these warrants. These warrants could result
in a significant change to operating results in the future.
In December 1999, we granted AOL a warrant to purchase 493,246 shares of
our common stock, which does not include the additional warrant to purchase
1,125 shares which we granted to AOL when we entered into definitive agreements
with Imperial Bank and the additional warrant to purchase 34,367 shares which we
granted to AOL when we entered into the product promotion agreement with Sallie
Mae, with an exercise price of $10 per share. Of the aggregate of 528,738
shares subject to purchase under these warrants, 176,245 are immediately
exercisable and the remaining 352,493 shares will vest over the next three
years based on ICQ's performance under our interactive marketing agreement.
In February 2000, we granted Sallie Mae, Inc. warrants to purchase up to
616,863 shares of our common stock, with an exercise price of $10 per share. Of
these shares, warrants to purchase 352,493 are immediately exercisable and the
warrants to purchase the remaining 264,370 shares will vest over the next two
years based on Sallie Mae's performance under our product promotion agreement.
In February 2000, we issued 4,000,000 shares of Common Stock at an initial
public offering price of $10.00 per share. In March 2000, we sold an additional
35,000 shares pursuant to the exercise of the underwriters' over-allotment
option at $10 per share. Total net proceeds (after deducting discounts,
commissions and other expenses of the offering) were approximately $36.0
million. As of February 29, 2000, approximately $2.5 million of this amount was
used to pay all amounts outstanding under the Credit Facility with Imperial Bank
(see discussion below). The balance of approximately $33.5 million was invested
in various short-term investments and cash equivalents as of February 29, 2000.
24
25
In August 1999, we loaned $62,000 to each of our founders, Eric J. Kuhn and
Timothy J. Levy, to each purchase 207,077 shares of our common stock. The notes
bear interest at a floating rate equal to the then current Applicable Federal
Rate, which was 5.41% for October 1999, and are due August 1, 2001.
As of December 31, 1999, we had $7.8 million of cash and cash equivalents.
As of that date, our principal commitments consisted of obligations outstanding
under operating leases, accounts payable and accrued liabilities. Although we
have no material commitments for capital expenditures, we anticipate an increase
in our capital expenditures and lease commitments consistent with anticipated
growth in operations, infrastructure and personnel.
As of December 31, 1999, prepaid marketing expenses were $4.6 million
compared to $0.2 million at December 31, 1998. This increase is a result of
the expansion of our offline and online advertising. Prepaid marketing expenses
were expensed in the quarter ending March 31, 2000 in conjunction with our
January/February selling period. Also, as of December 31, 1999, we deferred
expenses of approximately $1.0 million related to our initial public offering.
These costs were offset against additional-paid-in-capital upon the completion
of our offering in February 2000. Such costs are reflected as a deferred charge
in the accompanying December 31, 1999 consolidated balance sheet.
Net cash used in operating activities was $29.4 million for the year ended
December 31, 1999, and $1.2 million the year ended December 31, 1998, consisting
primarily of net losses adjusted for changes in accounts receivable, accounts
payable and accrued expenses.
Net cash used in investing activities was $2.7 million for the year ended
December 31, 1999, and $0.1 million the year ended December 31, 1998, consisting
primarily of purchases of computer equipment, fixtures and furniture, as well as
the purchase of a six month certificate of deposit of $0.5 million in 1999 and
an investment in United States government debt securities and related proceeds
for the year ended December 31, 1998.
Net cash provided by financing activities was $38.5 million for the year
ended December 31, 1999 and $2.8 million the year ended December 31, 1998. Net
cash provided by financing activities during the year ended December 31, 1999
consisted primarily of net proceeds of $38.4 million from the issuance of
preferred stock.
On January 19, 2000 we entered into a revolving credit facility with
Imperial Bank in an aggregate amount of $7.5 million with a sublimit of $3.0
million for purchases of property, equipment and software and $750,000 for
letters of credit. The maturity date for working capital advances is
December 31, 2000 and the maturity date for property, equipment and software
advances is October 18, 2002. Interest on outstanding balances accrues at
Imperial's prime rate (8.5% at December 31, 1999) plus 1.0% until the closing of
our initial public offering, and afterwards at Imperial's prime rate. All
amounts outstanding, which could be up to $7.5 million, would be collateralized
by a pledge of all of our assets. Under the terms of the credit facility, as
amended, we must maintain a tangible net worth of $15 million and we must
maintain a ratio of our current assets to our current liabilities of 1.5 to 1.
We also issued a warrant to Imperial to purchase 37,500 shares of our common
stock at an exercise price of $10.00 per share. We borrowed $2.5 million under
the revolving credit facility during February 2000 and repaid such borrowings
with a portion of the proceeds of our initial public offering on February 22,
2000.
We expect that operating losses and negative cash flows will continue for
the foreseeable future and anticipate that losses will increase significantly
from current levels because of additional costs and expenses related to brand
development, marketing and other promotional activities, continued expansion of
booklist operations, continued development of our Web site and information
technology infrastructure expansion of product offerings and development of
relationships with other businesses. We could reduce some of these costs if
working capital decreased significantly. Our failure to generate sufficient
revenues, raise additional capital or, if necessary, reduce discretionary
spending could harm our results of operations and financial condition.
We currently anticipate that the net proceeds of our initial public
offering, together with our available funds including amounts available under
the revolving credit facility, will be sufficient to meet our anticipated needs
for working capital and capital expenditures for the next 12 months. We may
need to raise additional funds prior to the expiration of such period if, for
example, we pursue new business, technology or intellectual property
acquisitions or experience net losses that exceed our current expectations. Any
required additional financing may be unavailable on terms favorable to us, or at
all.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Substantially all of our cash equivalents are at fixed interest rates, and,
therefore, the fair value of these instruments is affected by changes in market
interest rates. However, as of December 31, 1999, all of our cash equivalents
mature within three months. As of December 31, 1999, we believe the reported
amounts of cash equivalents and short-term investments to be reasonable
approximations of their fair values. As a result, we believe that the market
risk arising from our holdings of financial instruments is minimal.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
VarsityBooks.com Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and cash flows
present fairly, in all material respects, the financial position of
VarsityBooks.com Inc. and its subsidiaries at December 31, 1999 and December 31,
1998, and the results of their operations and their cash flows for the years
ended December 31, 1999 and December 31, 1998 in conformity with accounting
principles generally accepted in the United States. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
February 28, 2000, except as to Note 11, which is as of March 28, 2000.
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VARSITYBOOKS.COM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998 AND 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1998 1999
-------- --------
Net sales:
Product.......................................... $ 122 $ 9,885
Shipping ........................................ 10 674
---------- ----------
Total net sales ................................ 132 10,559
---------- ----------
Operating expenses:
Cost of product -- related party ................ 115 9,119
Cost of shipping -- related party ............... 10 909
Equity transactions -- related party ............ 798 169
Marketing and sales:
Non-cash compensation .......................... $ 53 $ 787
Other marketing and sales
(including $81 with related
party at December 31, 1999) ................... 536 589 20,021 20,808
----- -------
Product development:
Non-cash compensation .......................... 69 205
Other product development ...................... 627 696 4,505 4,710
----- -------
General and administrative:
Non-cash compensation .......................... 24 1,586
Other general and
administrative ................................ 593 617 5,117 6,703
----- ---------- ------- ----------
Total operating expenses........................ 2,825 42,418
---------- ----------
Loss from operations.............................. (2,693) (31,859)
---------- ----------
Interest income, net:
Interest income.................................. 16 418
Interest expense ................................ (12) (67)
---------- ----------
Interest income, net .......................... 4 351
---------- ----------
Net loss.......................................... (2,689) (31,508)
Preferred stock dividends ........................ -- 1,487
---------- ----------
Net loss applicable to common
stockholders .................................... $ (2,689) $ (32,995)
========== ==========
Net loss per share (basic and
diluted):
Net loss ........................................ $ (1.53) $ (14.15)
Preferred stock dividends........................ -- (.67)
---------- ----------
Net loss applicable to common
stockholders.................................... $ (1.53) $ (14.82)
========== ==========
Pro forma (unaudited)............................ $ (4.09)
==========
Weighted average shares:
Basic and diluted .............................. 1,755,536 2,226,225
========== ==========
Pro forma basic and diluted (unaudited) ........ 7,702,441
==========
See accompanying notes to consolidated financial statements.
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VARSITYBOOKS.COM INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
December 31,
----------------------------------
1998 1999
----------------------------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 1,481 $ 7,813
Short-term investments....................................................... -- 480
Accounts receivable, net of allowance for doubtful
accounts of $-0- at December 31, 1998 and $100 at December 31, 1999 ........ 1 626
Prepaid marketing ........................................................... 164 4,625
Deferred charge.............................................................. -- 1,024
Other ....................................................................... -- 517
-------- --------
Total current assets........................................................ 1,646 15,085
Fixed assets, net............................................................. 100 2,040
Other assets ............................................................... -- 937
-------- --------
Total assets................................................................. $ 1,746 $ 18,062
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable (including $28 and $0 with related
party at December 31, 1998 and 1999,
respectively) ............................................................... $ 656 $ 1,482
Accrued marketing expenses ................................................... -- 1,511
Other accrued expenses and other current liabilities ......................... 17 1,610
Taxes payable................................................................. 8 607
Accrued employee compensation and benefits ................................... 16 712
Convertible notes payable (including $421 and $0 with related
party at December 31, 1998 and 1999, respectively)........................... 1,148 --
-------- --------
Total current liabilities ................................................... 1,845 5,922
Long-term liabilities.......................................................... -- 93
-------- --------
Total liabilities ........................................................... 1,845 6,015
-------- --------
Commitments and contingencies
Stockholders' equity:
Series A convertible preferred stock: $.0001 par value,
2,071,420 shares authorized, issued and outstanding
(liquidation preference of $1,450 at December 31, 1998
and December 31, 1999) ..................................................... -- --
Series B convertible preferred stock: $.0001 par value,
6,933,806 shares authorized, issued and outstanding at
December 31, 1999 (liquidation preference of $10,658
at December 31, 1999) ...................................................... -- 1
Series C convertible preferred stock: $.0001 par value,
9,755,633 shares authorized; 8,928,571 shares issued
and outstanding at December 31, 1999 (liquidation
preference of $30,815 at December 31, 1999) ................................ -- 1
Common stock, $.0001 par value, 9,100,000 and 27,932,927
shares authorized, 2,035,714 and 2,643,277 shares
issued and outstanding at December 31, 1998 and
1999, respectively.......................................................... -- --
Additional paid-in capital .................................................. 2,798 53,707
Notes receivable from stockholders .......................................... -- (124)
Deferred compensation........................................................ (208) (7,341)
Accumulated deficit.......................................................... (2,689) (34,197)
-------- --------
Total stockholders' (deficit) equity........................................ (99) 12,047
-------- --------
Total liabilities and stockholders' equity.................................. $ 1,746 $ 18,062
======== ========
See accompanying notes to consolidated financial statements.
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29
VARSITYBOOKS.COM INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
YEARS ENDED DECEMBER 31, 1998 AND 1999
(IN THOUSANDS, EXCEPT SHARE DATA)
Series A Series B Series C
Convertible Convertible Convertible
Preferred Stock Preferred Stock Preferred Stock Common Stock
---------------- --------------- --------------- -------------
Shares Amount Shares Amount Shares Amount Shares Amount
-------- --------- --------- -------- -------- -------- --------- --------
Balance at December 31, 1997 .......... $-- $-- $-- $--
Issuance of common stock .............. 2,035,714 --
Issuance of series A convertible
preferred stock ...................... 2,071,420 --
Issuance of warrants:
Related party.........................
Convertible debt ($79 from issuance
to related party)....................
Deferred compensation..................
Net loss...............................
---------- ----- ---------- ----- ---------- ---- ---------- ----
Balance at December 31, 1998 .......... 2,071,420 -- -- -- 2,035,714 --
Issuance of common stock .............. 193,409 --
Issuance of series B convertible
preferred stock ...................... 5,996,306 1
Conversion of convertible notes to
series B preferred stock.............. 937,500
Issuance of series C convertible
preferred stock ...................... 8,928,571 1
Issuance of warrants:
Related party.........................
AOL warrants..........................
Convertible debt......................
Deferred compensation..................
Issuance of common stock in exchange for
loans to stockholders.................. 414,154 --
Net loss................................
---------- ----- ---------- ----- ---------- ---- ---------- ----
Balance at December 31, 1999 ........... 2,071,420 $ -- 6,933,806 $ 1 8,928,571 $ 1 2,643,277 $ -
========== ===== ========== ===== ========== ==== ========== ====
Additional Notes
-Paid-in Receivable from Deferred Accumulated
Capital Stockholders Compensation Deficit Total
------------ ----------------- -------------- ------------- --------
Balance at December 31, 1997 .......... $-- $-- $-- $-- $--
Issuance of common stock .............. 642 642
Issuance of series A convertible
preferred stock ...................... 1,433 1,433
Issuance of warrants:
Related party ........................ 155 155
Convertible debt ($79 from issuance
to related party).................... 214 214
Deferred compensation.................. 354 (208) 146
Net loss .............................. (2,689) (2,689)
-------- ------ ------ -------- --------
Balance at December 31, 1998........... 2,798 -- (208) (2,689) (99)
Issuance of common stock............... 59 59
Issuance of series B convertible
preferred stock....................... 8,552 8,553
Conversion of convertible notes to
series B preferred stock.............. 1,160 1,160
Issuance of series C convertible
preferred stock ...................... 29,895 29,896
Issuance of warrants:
Related party ........................ 169 169
AOL warrants ......................... 1,208 1,208
Convertible debt...................... 31 31
Deferred compensation.................. 9,711 (7,133) 2,578
Issuance of common stock in exchange for
loans to stockholders................ 124 (124) --
Net loss .............................. (31,508) (31,508)
-------- ------- --------- ---------- ---------
Balance at December 31, 1999 .......... $ 53,707 $(124) $ (7,341) $ (34,197) $ 12,047
======== ======= ========= ========== =========
See accompanying notes to consolidated financial statements.
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30
VARSITYBOOKS.COM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 AND 1999
(IN THOUSANDS)
1998 1999
---------- -----------
Operating activities:
Net loss ...................................................... $(2,689) $(31,508)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization .............................. 6 313
Bad debt expense............................................ -- 100
Non-cash compensation ...................................... 146 2,578
Amortization of discount on convertible notes
payable .................................................. 12 12
Equity transactions with related party and
interest expense related to warrants issued .............. 798 200
Marketing expense related to warrants issued................ -- 15
Changes in operating assets and liabilities:
Accounts receivable, net.................................. (1) (725)
Prepaid marketing......................................... (164) (4,461)
Deferred charges.......................................... -- (1,024)
Other current assets....................................... -- (128)
Accounts payable.......................................... 656 826
Accrued marketing expenses................................ -- 1,511
Other accrued expenses and other current
liabilities ............................................. 17 1,593
Taxes payable ............................................ 8 599
Accrued employee compensation and benefits................ 16 696
Other non-current liabilities .............................. -- 93
Other non-current assets.................................. -- (131)
--------- ---------
Net cash used in operating activities.................. (1,195) (29,441)
--------- ---------
Investing activities:
Additions to fixed assets...................................... (106) (2,253)
Purchase of investment securities.............................. (697) --
Increase in short-term investments, net ....................... -- (480)
Proceeds from sale of investment securities.................... 698 --
--------- ---------
Net cash used in investing activities.................. (105) (2,733)
--------- ---------
Financing activities:
Proceeds from issuance of convertible notes
payable .................................................. 1,348 --
Proceeds from issuance of preferred stock .................. 1,433 38,447
Proceeds from issuance of common stock...................... -- 59
--------- ---------
Net cash provided by financing activities.............. 2,781 38,506
--------- ---------
Net increase in cash and cash equivalents........................ 1,481 6,332
Cash and cash equivalents at beginning of period ................ -- 1,481
--------- ---------
Cash and cash equivalents at end of period ...................... $ 1,481 $ 7,813
========= =========
Supplemental disclosure of cashflow information:
Cash paid for income taxes and interest .................. $ -- $ --
========= =========
Supplemental schedule of noncash investing and
financing activities:
Conversion of convertible notes payable to
Series B preferred stock................................ $ -- $ 1,160
========= =========
Issuance of common stock for note
receivable.............................................. $ -- $ 124
========= =========
Deferred charge from issuance of warrants................. $ -- $ 1,208
========= =========
See accompanying notes to consolidated financial statements.
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31
VARSITYBOOKS.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
VarsityBooks.com Inc. (the "Company"), an Internet retailer of college
textbooks and provider of marketing services for businesses interested in
reaching the college market, was incorporated on December 16, 1997 and launched
its Web site in August 1998, at which time the Company began generating
revenues. In August 1999, the Company established two wholly-owned subsidiaries,
CollegeImpact.com Inc. and CollegeOps.com LLC, to assist in the overall
management of its marketing and retailing activities, respectively. The Company
did not execute any transactions from December 16, 1997 (inception) through
December 31, 1997 and had no assets or liabilities as of December 31, 1997.
As discused more fully in Note 11, during Febuaruy 2000, the Company
completed an initial public offering. Net proceeds to the Company from the
initial public offering totaled $36.0 million. Effective upon the closing of the
offering, all shares of the Company's preferred stock converted into 8,966,879
shares of the Company's common stock.
Liquidity
The Company has incurred substantial losses and negative cash flows from
operations in every fiscal period since inception. For the year ended December
31, 1999, the Company incurred a loss from operations of approximately $31.9
million and negative cash flows from operations of $29.4 million. As of December
31, 1999, the Company had an accumulated deficit of approximately $34.2
million. Management expects operating losses and negative cash flows to
continue for the foreseeable future and anticipates that losses will increase
significantly from current levels because of additional costs and expenses
related to brand development, marketing and other promotional activities,
continued expansion of booklist operations, continued development of the
Company's Web site and information technology infrastructure, expansion of
product offerings and development of relationships with other businesses.
Certain of these costs could be reduced if working capital decreased
significantly. Failure to generate sufficient revenues, raise additional capital
or reduce certain discretionary spending could have a material adverse effect on
the Company's results of operations and financial condition.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Fair Value Information
The carrying amounts of current assets and current liabilities approximate
fair value because of the short maturity of these items.
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Cash Equivalents and Concentrations of Credit Risk
The Company considers all highly liquid instruments with an original
maturity of three months or less to be cash equivalents. Cash equivalents
consist of funds held in money market accounts.
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of its holdings of cash and
cash equivalents, including high-quality money market instruments, short-term
investments and accounts receivable. The Company maintains its cash and cash
equivalents in bank accounts which, at times, may exceed federally insured
limits. The Company has not experienced any losses on such accounts. Accounts
receivable consists primarily of amounts due from credit card processors. The
Company monitors its accounts receivable balances to assess any collectibility
issues. The Company recorded an allowance for potentially uncollectible
receivables of $100,000 at December 31, 1999. The allowance for potentially
uncollectible receivables is included as a reduction of accounts receivable in
the accompanying consolidated balance sheet. The Company has not experienced
significant losses related to its receivables in the past.
Short-term Investments
Short-term investments consist of a certificate of deposit with a maturity
date in excess of three months. At December 31, 1999, the market value of the
certificate of deposit approximated its cost.
Deferred Charge
A deferred charge of approximately $1.0 million for expenses incurred
related to the Company's initial public offering was recorded at December 31,
1999. These costs were offset against additional-paid-in capital upon the
completion of the Company's initial public offering in February 2000 (see Note
11).
Reliance on Single Supplier
The Company relies on a single supplier as its current sole provider of
textbooks, fulfillment and shipping services (see note 3). While the Company
believes it could obtain these services from other qualified suppliers on
similar terms and conditions, a disruption in the supply of these services by
the current supplier could materially harm the business. The controlling
shareholder of this supplier was a 19% owner of the Company's common stock at
December 31, 1999 (See Notes 3 and 7).
Substantially all of the Company's computer and communications hardware and
software systems are located at a single facility that is owned, maintained and
serviced by a third party. As of December 31, 1999, the Company's future
commitment to this third party was approximately $52,000 through July 2000 and
$3,500 per month thereafter. Any damage, failure or delay that causes
interruptions in the Company's systems operations could materially harm the
Company's business.
Fixed Assets
Fixed assets are stated at cost less accumulated depreciation and
amortization. Fixed assets are depreciated on a straight-line basis over the
estimated useful lives of the assets as follows:
Computer equipment......... 3 years
Software................... 18 months
Furniture and fixtures..... 5 years
Long-Lived Assets
In accordance with Financial Accounting Standards Board ("FASB") Statement
of Financial Accounting Standards ("SFAS") No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, the
carrying value of intangible assets and other long-lived assets is reviewed on a
regular basis for the existence of facts or circumstances that may suggest
impairment. The Company recognizes an impairment when the sum of the expected
undiscounted future cash flows is less than the carrying amount of the asset.
Impairment losses, if any, are measured as the excess of the carrying amount of
the asset over its estimated fair value.
Revenue Recognition
The Company recognizes revenue from textbook sales, including sales under
the Company's partnership program, net of any discounts and coupons, when the
textbooks are shipped to customers. The Company takes title to the textbooks
sold upon transfer to the shipper and assumes the risks and rewards of
ownership including the risk of loss for collection. The Company does not
function as an agent or broker for its supplier (See Note 3). Outbound shipping
charges are included in net sales. The Company provides allowances for sales
returns, promotional discounts and coupons based on historical experience in the
period of the sale. To date, the Company's revenues have consisted primarily of
sales of new textbooks. The Company has also generated revenues through the sale
of general
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33
interest books, banner advertisements and marketing service agreements. Revenues
from the sale of Internet advertisements are recognized as the related service
is provided. Amounts received in advance are deferred. Revenues from the
Company's marketing programs are recognized as the services are delivered,
provided that the terms of the arrangement are fixed and determinable, no
significant performance obligations remain and the collection of the related
receivable is probable.
Marketing and Sales
The Company recognizes advertising expenses in accordance with Statement of
Position 93-7 "Reporting on Advertising Costs." As such, the Company expenses
the cost of communication advertising as incurred. Advertising expense was
approximately $368,500 and $11.4 million for the years ended December 31, 1998
and 1999, respectively.
Revenue share payments to partnership program schools are accrued as the
related revenue is earned. Such amounts are included as a component of marketing
and sales expense in the accompanying consolidated statements of operations. The
Company recognized an expense of approximately $50,900 for payments earned by
partnership program schools for the year ended December 31, 1999.
Product Development
Product development expenses consist principally of payroll and related
expenses for systems personnel and consultants. To date, all product development
costs have been expensed as incurred in 1999 due to the short useful life of the
web site improvements.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and related
interpretations, in accounting for its employee stock options and complies with
the disclosure requirements of SFAS No. 123, Accounting for Stock-Based
Compensation. APB No. 25 provides that the compensation expense relative to the
Company's employee stock options is measured based on the intrinsic value of the
stock option. SFAS No. 123 requires companies that continue to follow APB No. 25
to provide a pro forma disclosure of the impact of applying the fair value
method of SFAS No. 123.
Income Taxes
The Company accounts for income taxes by utilizing the liability method.
Under this method, deferred income taxes are recognized for the tax consequences
in future years of differences between the tax bases of assets and liabilities
and their financial reporting amounts, based on enacted tax laws and statutory
tax rates applicable to the periods in which the differences are expected to
affect the taxable income. Valuation allowances are established when necessary
to reduce net deferred tax assets to the amount expected to be realized.
Pro forma Net Loss Per Share (unaudited)
Pro forma basic and diluted net loss per share for the year ended December
31, 1999 is computed using the weighted average number of common shares
outstanding, including the pro forma effects of the conversion of the Company's
Series A, Series B and Series C convertible preferred stock into shares of the
Company's common stock on a one-to-one basis effective upon the closing of the
Company's initial public offering as if such conversion occurred on January 1,
1999 or at the date of original issuance, if later, as well as the impact of the
Company's one-for-two reverse stock split in December 1999. Pro forma diluted
net loss per share is computed using only the pro forma weighted average number
of common shares as the effect of the Company's convertible notes payable,
options and warrants are anti-dilutive.
Segment Reporting
The Company operates in one principal business segment across domestic and
international markets. International sales are not material. Substantially all
of the Company's operating results and all of its identifiable assets are in the
United States.
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Comprehensive Income
The Company complies with the provisions of SFAS No. 130 "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting
comprehensive income and its components in financial statements. Comprehensive
income, as defined, includes all changes in equity (net assets) during a period
from non-owner sources. During the periods presented, the Company has not had
any significant transactions that are required to be reported in comprehensive
income.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income. SFAS No. 133 is effective for the Company's fiscal year
ending December 31, 2001. The Company does not expect that the adoption of SFAS
No. 133 will have a material impact on its consolidated financial statements.
The SEC issued Staff Accounting Bulletin 101 (SAB 101) in December 1999.
SAB 101 provides guidance on the recognition and disclosure of revenue in
financial statements. Provided the registrant's former policy was not an
improper application of Generally Accepted Accounting Principles ("GAAP"),
registrants may adopt a change in accounting principle to comply with the SAB no
later than the second quarter of the fiscal year beginning after December 31,
1999. The Company believes that its current revenue recognition policies are in
accordance with GAAP. The Company is still in the process of assessing whether
any accounting policies would need to be changed to be in compliance with SAB
101.
3. TRANSACTIONS WITH BAKER & TAYLOR
On July 10, 1998, the Company entered into an Equity Investment and
Operating Agreement, and other related agreements, with Baker & Taylor, Inc.
("Baker & Taylor"), the Company's current sole supplier of textbooks,
fulfillment and shipping services and a supplier of promotional, customer
service and data base management services. The principal stockholder of Baker &
Taylor is a stockholder of the Company. In July 1998, in consideration for Baker
& Taylor's fulfillment and drop-ship services and assistance in developing the
Company's product and customer base, the Company sold Baker & Taylor 535,714
shares of the Company's common stock at its par value of $.0001 and granted a
warrant to purchase an additional 107,143 shares of the Company's common stock
at a weighted average exercise price of $2.33 per share. The Company expensed
the excess of the fair value of the common stock over its cost, which was
$643,000 in July 1998. The Company also expensed the estimated fair value of the
warrant on the date of grant using an established option pricing model since the
value of the warrants was insignificant. Also in accordance with this agreement,
an executive of Baker & Taylor was elected to the Company's board of directors.
In connection with an amendment to the agreement, in October 1998, the
Company issued Baker & Taylor a warrant to purchase 50,000 shares of the
Company's common stock at a weighted average exercise price of $0.20 per share.
The Company expensed the estimated fair value of the warrant on the date of the
grant using an established option pricing model since the value of the warrants
was insignificant.
In December 1998, the Company issued Baker & Taylor a warrant to purchase
53,571 shares of the Company's common stock at an exercise price of $2.33 per
share in conjunction with a bridge loan note from Baker & Taylor in the amount
of $500,000. Approximately $79,300 of the proceeds from the bridge loan note was
allocated to the purchase price of the warrants based on the relative fair
values of the note and warrant (see note 5). In February 1999, the Company
issued Baker & Taylor a warrant to purchase 5,950 shares of the Company's common
stock at an exercise price of $2.33 per share in conjunction with the December
1998 bridge loan. The estimated fair value of the warrant on the date of grant
of approximately $11,700 is recorded as interest expense in the accompanying
consolidated statement of operations for the nine months ended September 30,
1999 (see note 7). The bridge loan note was converted into 173,611 shares of the
Company's series B preferred shares in February 1999 (see note 7).
In February 1999, the Company issued Baker & Taylor a warrant to purchase
62,500 shares of its common stock at an exercise price of $0.22 per share. The
Company recorded expense over the remaining initial contractual term of the
agreement for the estimated
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35
fair value of the warrant on the date of grant using an established option
pricing model.
In connection with the above transactions, the Company recorded an expense
of $798,000 and $169,000 for the years ended December 31, 1998 and 1999,
respectively. Such amounts are classified as equity transactions-related party
in the accompanying consolidated statement of operations. The fair value of each
warrant is estimated on the date of grant using the Black-Scholes option pricing
model with the following weighted average assumptions: dividend yield of 0.0%;
expected volatility of 74.0%; risk-free interest rate of 6.0%; and expected term
of 3 to 5 years.
In August 1999, Baker & Taylor transferred its ownership interest in the
Company to B&T ENTERPRISES, L.L.C., a limited liability company.
Effective October 1, 1999, the Company entered into a new Operating
Agreement with Baker & Taylor and amended the other agreements governing the
Company's operating relationship with Baker & Taylor. Subject to certain
exceptions related to obligations for existing customers, Baker & Taylor has
agreed for a period of 18 months not to provide direct-to-customer fulfillment
services for any online textbook retailer serving students at colleges and
universities, distance learning programs and high schools located in the United
States that require students to purchase their textbooks . In return, the
Company has agreed to use Baker & Taylor as its principal supplier. The
exclusivity is automatically extended each semester to remain at 18 months as
long as the Company and Baker & Taylor agree on the amount of inventory Baker &
Taylor needs to acquire for the upcoming semester. The agreement provides that
Baker & Taylor would provide its services initially for three years, subject to
automatic annual extensions after the initial period. The amendment provides for
assignment of separate values to the separate services provided by Baker &
Taylor: supply of books, shipping and other services, including webpage content
and customer database management.
4. FIXED ASSETS
Fixed assets, at cost, consist of the following at December 31, 1998 and
1999:
1998 1999
---------- ----------
(IN THOUSANDS)
Computer equipment ........... $ 101 $ 2,073
Software ..................... 3 261
Furniture and fixtures ....... 2 25
------- -------
106 2,359
Less: accumulated depreciation (6) (319)
------- -------
Fixed assets, net ............ $ 100 $ 2,040
======= =======
Depreciation and amortization expense was approximately $6,000 and
$ 313,000 for the years ended December 31, 1998 and 1999, respectively.
5. CONVERTIBLE NOTES PAYABLE
On December 8, 1998, the Company issued unsecured convertible notes due
June 8, 2000 totaling $1.35 million and warrants to purchase 144,642 shares of
the Company's common stock under the terms of a Note and Warrant Purchase
Agreement. Of these amounts, $500,000 of the convertible notes and 53,571
warrants were issued to a related party -- see note 3. Approximately $214,100 of
the proceeds from the notes was allocated to the purchase price of the warrants
based on the relative fair values of the notes and the warrants. The warrants
have an exercise price of approximately $2.33 per share, are exercisable at any
time after issuance and expire on December 9, 2003 (see note 7). Debt discount
of approximately $214,000 was recorded as a result of the transaction. Total
convertible debt was $1.15 million, including $12,000 as a result of the
amortization of discount, at December 31, 1998.
Both the Company and the holders of the notes had the right to convert the
notes plus accrued interest thereon, at the rate of 8% per annum, into Series B
preferred stock upon the consummation of a new round of preferred stock
financing equal to or greater than $3.0 million, at a price no greater than
$2.865 per share. In February 1999, the notes (total of $1.16 million) were
converted into 937,500 shares of Series B preferred stock in conjunction with
the Company's Series B preferred stock financing (see note 7) at the same price
as the Series B preferred stock of $1.44 per share.
6. COMMITMENTS AND CONTINGENCIES
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Leases
The Company leases office space in Washington, D.C. under a noncancelable
operating lease. The lease includes a provision for annual rent escalation of
2.0% and requires the Company to pay for a portion of executory costs such as
taxes and insurance. The lease expires February 28, 2003. The Company also
leases certain office furniture. Future minimum lease payments excluding
executory costs, are as follows:
YEAR ENDING DECEMBER 31, AMOUNT
--------------------------------- -----------------
(IN THOUSANDS)
2000............................ $ 1,102
2001............................ 1,204
2002............................ 1,225
2003............................ 241
-------
$ 3,772
-------
Rent expense under operating leases was approximately $22,000 and $ 368,000
for the years ended December 31, 1998 and 1999, respectively. Rent payments in
1998 were made to a related party.
Legal Proceedings
On October 29, 1999, the Company was sued by the National Association of
College Stores, or N.A.C.S., in the United States District Court for the
District of Columbia. In their complaint, N.A.C.S. alleged that the Company uses
false and misleading advertisements in its efforts to sell textbooks.
Specifically, the complaint alleges that the Company falsely advertises
discounts of 40% on textbooks on its Web site. The complaint also alleges that
there is no suggested retail price for textbooks from which to calculate
discounts. N.A.C.S. claims that, in making the alleged false and misleading
statements, the Company is implying that N.A.C.S. member stores overcharge
students for their textbooks. The complaint requests that the Company be
prevented from claiming in any advertising or promotional material, packaging or
the like, or representing in any way, that it offers discounts or percentages
off of textbooks unless the Company clearly and prominently identifies the true
basis for the claimed discount, the source of the comparative price it uses to
determine the discounts it offers and the true percentage of textbooks offered
at the stated discounted price. In addition, N.A.C.S. seeks to have the Company
retract all prior claims through prominent statements on its Web site. The
complaint does not seek monetary damages, other than attorneys' fees.
The Company believes these claims to be completely without merit. The
Company's Web site and its advertising truthfully state that it offers college
textbooks at up to 40% off suggested price. The Company also believes that the
industry data it uses to determine the suggested price from which it calculates
discounts is appropriate. The Company has filed a motion to dismiss these claims
and is awaiting a ruling on its motion.
Management does not believe this lawsuit, even if adversely decided, will
have a material effect on the results of operations or financial condition of
the Company.
The Company is a party to various other legal proceedings and claims
incidental to their business. Management does not believe that these matters
will have a material adverse effect on the results of operations or financial
condition of the Company.
Other
In conjunction with the Company's interactive marketing agreement with
AOL's ICQ, Inc.(see Note 7), the Company has agreed to pay ICQ an aggregate of
$9.0 million over the three years of the agreement.
7. STOCKHOLDERS' EQUITY
Authorized Capital
At December 31, 1999, the Company was authorized to issue 18,760,859 shares
of preferred stock, $.0001 par value per share, and 27,932,927 shares of common
stock, $.0001 par value per share. The Company has designated 2,071,420 shares
of the authorized
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37
preferred stock as Series A preferred stock, 6,933,806 shares as Series B
preferred stock and 9,755,633 shares as Series C preferred stock.
On December 9, 1999, the board of directors declared a one-for-two reverse
stock split. On December 10, 1999, the shareholders of the Company approved the
one-for-two reverse stock split. The share and per share information contained
in these financial statements has been retroactively adjusted for the impact of
the stock split.
Voting Rights
Holders of preferred stock are entitled to vote together with holders of
common stock. The number of votes granted to preferred stockholders is equal to
the number of full shares of common stock into which each share of preferred
stock could be converted on the record date of the vote. Special voting rights
are provided to preferred stockholders for certain actions, as long as a minimum
number of preferred shares remain outstanding, such as increasing the size of
the board of directors.
Series A Preferred Stock
On August 6, 1998 and December 3, 1998, the Company issued an aggregate of
2,071,420 shares of Series A preferred stock at a purchase price of $0.70 per
share, resulting in gross proceeds of approximately $1.5 million. Holders of
Series A preferred stock are entitled to dividends when and if declared by the
board of directors at a rate of $0.056 per annum, per share. The right to such
dividend is not cumulative. The Company may not declare or pay any distribution
by a dividend or otherwise until the holders of preferred stock first receive a
distribution equal to the cumulative dividend due for each outstanding share of
preferred stock.
In the event of a liquidation, dissolution or winding up of the Company, (a
"Liquidation Event") the holders of Series A preferred stock are entitled to a
liquidation preference of $0.70 per share plus any declared and unpaid
dividends. After payment has been made to the holders of the Series A preferred
stock, any remaining assets would be divided pro rata among the holders of
common, Series A preferred, Series B preferred, and Series C preferred stock
based on the common stock into which they would have the right to acquire upon
conversion. The maximum amount allocable to the holders of Series A preferred
stock is $1.40 per share. Thereafter, all remaining assets or property shall be
distributed to the common shareholders.
Series A preferred stock is convertible into common stock of the Company by
dividing the conversion value per share ($1.40) at the time of conversion by the
conversion price, as adjusted.
Each share of Series A preferred stock is automatically converted into
shares of common stock upon the earlier of (i) the affirmative vote or written
consent of the holders of more than 66 2/3% of the outstanding shares of the
preferred stock or (ii) immediately in the event of an initial public offering
in which the aggregate gross proceeds to the Company are at least $7.5 million
after deduction of underwriting discounts and commissions and offering expenses.
The sale of common stock or common stock equivalents is subject to a right
of first refusal by certain investors.
Series B Preferred Stock
In February 1999, the Company issued 6,933,806 shares of Series B preferred
stock at a purchase price of $1.44 per share, resulting in gross proceeds of
approximately $10.0 million. Holders of Series B preferred stock are entitled to
cumulative dividends at a rate of $0.115 per annum, per share, adjusted for any
combinations, consolidations or stock dividends payable if and when declared by
the board of directors. Dividends accrue from the issue date irrespective of
whether the board of directors declares a dividend. Cumulative unpaid dividends
are $ 673,000 at December 31, 1999.
In the event of a Liquidation Event, the holders of Series B preferred
stock are entitled to a liquidation preference of $1.44 per share plus
cumulative unpaid dividends. After payment has been made to the holders of the
Series A preferred stock of the Series A liquidation amount, to the holders of
the Series B preferred stock of the Series B liquidation amount, and to the
holders of Series C preferred stock of the Series C liquidation amount, any
assets remaining would be divided pro rata among the holders of common, Series A
preferred, Series B preferred and Series C preferred stock based on the common
stock into which they have the right to acquire upon conversion.
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The maximum amount payable to the Series B Preferred Shareholders is (i)
$2.88 per share on or prior to the second anniversary of issuance; (ii) $4.32
per share after the second, but before the third anniversary; and (iii) $5.76
per share after the third anniversary. Thereafter, all remaining assets or
property shall be distributed to the common shareholders.
Notwithstanding the above, in the event of a Liquidation Event each holder
of Series B preferred shares may elect to convert its shares of Series B
preferred shares into common stock.
Series B preferred stock is convertible into common stock of the Company by
dividing the conversion value per share ($2.88) at the time of conversion by the
conversion price, as adjusted. Any accrued and unpaid dividends are forfeited at
the time of conversion.
Each share of preferred stock is automatically converted into shares of
common stock without notice on the closing date of a qualifying public offering.
A qualifying public offering is defined as the first underwritten public
offering by the Company of authorized, but unissued, shares of common stock that
is led by a nationally recognized underwriter pursuant to which the gross
proceeds to the Company are at least $20.0 million, the per share price of
common stock sold in such offering is not less than $5.00 per share, and the
pre-offering valuation of the Company is not less than $72.0 million.
In connection with the issuance of Series B preferred stock, the Company is
required to meet various covenants including board of directors approval of
actions such as issuances of long-term debt in excess of $100,000, the sale or
other disposition of all or substantially all of the Company's property or
business, and capital expenditures in excess of $100,000. The Company was in
compliance with all such covenants at December 31, 1999.
Series C Preferred Stock
In August and September 1999, the Company issued an aggregate of 8,928,571
shares of Series C preferred stock at a purchase price of $3.36 per share,
resulting in gross proceeds of approximately $30.0 million. Holders of Series C
preferred stock are entitled to cumulative dividends at a rate of $0.2688 per
annum, per share, adjusted for any combinations, consolidations or stock
dividends, payable if and when declared by the board of directors. Dividends
accrue from the issue date irrespective of whether the board of directors
declares a dividend. Cumulative unpaid dividends are $814,000 at December 31,
1999.
In the event of a Liquidation Event, the holders of Series C preferred
stock are entitled to a liquidation preference of $3.36 per share plus any
cumulative unpaid dividends. After payment has been made to the holders of the
Series A preferred stock of the Series A liquidation amount, to the holders of
the Series B preferred stock of the Series B liquidation amount and to the
holders of Series C preferred stock of the Series C liquidation amount, any
assets remaining would be divided pro rata among the holders of common, Series A
preferred, Series B preferred and Series C preferred stock based on the common
stock into which they have the right to acquire upon conversion. The maximum
amount payable to the Series C preferred shareholders is (i) $6.72 per share on
or prior to the second anniversary of issuance; (ii) $10.08 per share after the
second, but before the third anniversary; and (iii) $13.44 per share after the
third anniversary. Thereafter, all remaining assets or property shall be
distributed to the common shareholders.
Notwithstanding the above, in the event of a Liquidation Event, each holder
of Series C preferred shares may elect to convert its shares of Series C
preferred shares into common stock.
Series C preferred stock is convertible into common stock of the Company by
dividing the conversion value per share ($6.72) at the time of conversion by the
conversion price, as adjusted. Any accrued and unpaid dividends are forfeited at
the time of conversion.
Each share of preferred stock is automatically converted into shares of
common stock without notice on the closing date of a qualifying public offering.
A qualifying public offering is defined as the first underwritten public
offering by the Company of authorized, but unissued, shares of common stock that
is led by a nationally recognized underwriter pursuant to which the gross
proceeds to the Company are at least $25.0 million, the per share price of
common stock sold in such offering is not less than $11.94 per share, and the
pre-money valuation of the Company is not less than $160.0 million if the
offering is completed by August 31, 2000 and $180.0 million if completed anytime
thereafter.
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In connection with the issuance of Series C preferred stock, the Company is
required to meet various covenants including board of director approval of
actions such as issuances of long-term debt in excess of $100,000, the sale or
other disposition of all or substantially all of the Company's property or
business, and capital expenditures in excess of $100,000. The Company was in
compliance with all such covenants at December 31, 1999.
Warrants
On December 8, 1998, in connection with the issuance of $1,350,000 of
convertible promissory notes, the Company issued warrants to purchase 144,642
shares of the Company's common stock. Additional warrants to purchase 16,065
shares were issued to the holders of the notes in February 1999. The estimated
fair value of the additional warrants on the date of grant of approximately
$32,000 is recorded as interest expense in the accompanying consolidated
statement of operations for the year ended December 31, 1999 (see notes 3 and
5).
In April 1999, the Company entered into an agreement with a third party
under which a warrant to purchase 25,000 shares with an exercise price of $6.00
per share of the Company's common stock will be issued upon the achievement of
contractual revenues of $30.0, million on or before December 31, 2000, with an
additional warrant for 50,000 shares with an exercise price of $6.00 per share
which will be exercisable if contractual revenues equal or exceed $80.0, million
on or before July 31, 2001. Since the exercisability of these warrants is based
on the achievement of uncertain future revenue targets, the Company has not
recorded any expense for these warrants. These warrants could result in a
significant charge to operating results in the future.
During 1998, the Company issued warrants to Baker & Taylor, its supplier of
textbooks, to purchase up to 107,143 and 50,000 shares of common stock at
exercise prices of $2.33 and $0.20 per share, respectively. An additional
warrant to purchase up to 62,500 shares of common stock at an exercise price of
$0.22 per share was issued to Baker & Taylor in 1999. (See note 3 for a
discussion of transactions with Baker & Taylor).
On December 22, 1999, the Company entered into an interactive marketing
agreement with ICQ, Inc., a subsidiary of America Online, Inc. or AOL. Pursuant
to the agreement, the Company will be the exclusive college-targeted commerce
partner on the ICQ instant messaging service as well as its Web site,
www.icq.com. In addition, other than ICQ itself, the Company will be the
exclusive targeted advertiser and marketer of the ICQ service and ICQ.com on
U.S. college campuses. The exclusive period of the Company's relationship
expires on December 31, 2000. During the term of the Company's exclusive
relationship with ICQ, ICQ may not enter into an agreement with another
college-targeted commerce partner but may accept noncommerce-related
college-targeted content from our specified competitors.
Pursuant to the interactive marketing agreement, the Company has agreed to
pay ICQ an aggregate of $9.0 million in installments over the next three years.
In addition, the Company has granted AOL warrants to purchase 528,738 shares of
common stock, which represented 3% of the Company's aggregate common stock
outstanding and reserved for issuance immediately prior to its initial public
offering, at a price of $10 per share. Warrants to purchase 176,245 shares are
currently vested with the remaining shares vesting over the next three years
depending on the performance of ICQ under the interactive marketing agreement
with ICQ. The Company believes that ICQ will be able to meet the criteria needed
to allow AOL to exercise the warrants. As a result, the Company will record an
expense for the warrants from the date of issuance to the vesting date based
upon the current fair market value of the warrants as required under EITF 96-18.
Initially, the Company recorded a deferred charge equal to $1.2 million, which
was the fair value of the vested portion of the warrant issued in December on
the date of issuance. The deferred charge is being amortized on a straight-line
basis over the three-year life of the agreement. Expense of approximately
$15,400 was recorded and is reflected as a component of marketing and sales
expense in the accompanying consolidated statement of operations for the year
ended Decmeber 31, 1999.
As of December 31, 1998 and 1999, no warrants had been exercised. Warrants
to purchase 301,786 and 948,596 shares of the Company's common stock were
outstanding at December 31, 1998 and 1999, respectively. The Company reserved
shares of its common stock to issue upon conversion as follows: 1,035,706 for
Series A preferred stock and 3,466,897 Series B preferred stock, 4,464,276 for
Series C preferred stock, and 455,350 for outstanding warrants.
8. STOCK-BASED COMPENSATION
On October 2, 1998, the Company adopted the 1998 Stock Plan, under which
incentive stock options, non-qualified stock options
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or stock rights, or any combination thereof may be granted to the Company's
employees. The board of directors, or a Committee appointed by the board,
administers the Plan and determines the individuals to whom options will be
granted, the number of options granted, the exercise price and vesting schedule.
Options are exercisable at prices established at the date of grant and have a
term of ten years. Each optionee has a vested interest in 25% of the option
shares upon the completion of one year of service. The remaining balance vests
in equal successive monthly installments of 1/36 upon the completion of each of
the next 36 months of service. Vested options held at the date of termination
may be exercised within three months. The board of directors may terminate the
Plan at anytime.
Stock option activity was as follows:
WEIGHTED
NUMBER OF AVERAGE
STOCK EXERCISE EXERCISE
OPTIONS PRICE PRICE
----------- ------------ -----------
(IN THOUSANDS)
Outstanding, December 31, 1997 -- -- --
Granted ...................... 179 $ 0.20--$0.30 $ 0.21
Exercised .................... -- -- --
Cancelled .................... -- -- --
-----
Outstanding, December 31, 1998 179 -- $ 0.21
Granted....................... 2,112 $ 0.20--$10.00 0.73
Exercised..................... (124) $ 0.20--$ 6.04 0.31
Cancelled..................... (315) $ 0.20--$10.00 1.17
-----
Outstanding, December 31, 1999 1,852 -- 0.64
=====
The Company has reserved an additional 2,024,035 shares of its common
stock for future option grants. There are 4.0 million shares authorized under
the Company's Stock Option Plan.
The following table summarizes information about options at December 31,
1999.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------- -------------------------------------
RANGE OF WEIGHTED AVG.
EXERCISE NUMBER REMAINING WEIGHTED AVG. NUMBER WEIGHTED AVG.
PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE OUTSTANDING EXERCISE PRICE
------------- -------------------- --------------------- ----------------- -------------------- ---------------
(in thousands) (years) (in thousands)
$.20 to $.30 804 9.35 $ 0.29 137 $ 0.28
$6.04 171 9.71 $ 6.04 12 $ 6.04
$8.00 113 9.80 $ 8.00 - $ 8.00
$10.00 764 9.92 $ 10.00 - $ 10.00
---------- -------
1,852 9.65 $ 5.30 149 $ 0.76
========== =======
Options granted during the year ended December 31, 1998 and 1999, excluding
those granted to the Company's Chief Executive Officer as discussed below,
resulted in deferred compensation of $353,737 and $ 5.1 million, respectively.
The amounts recorded represent the difference between the exercise price and the
deemed fair value (the fair value per share was derived by reference to the
preferred stock values since inception with ratable increases between preferred
stock issuance dates) of the underlying common stock on the date of grant.
Amortization of deferred compensation for these options was $146,023 and
$1,689,261 for the years ended December 31, 1998, and 1999, respectively, and is
included in the accompanying consolidated statements of operations.
Effective August 1, 1999, the Company sold 207,077 shares of its common
stock to its Chief Executive Officer in exchange for a $62,123 promissory note
and 207,077 shares of its common stock to its Executive Vice President,
Development in exchange for a $62,123 promissory note. The notes bear interest
at the Applicable Federal Rate (5.43% for August 1999) and are due August 1,
2001. The shares vest at a rate of 40% upon the completion of one year of
service with the remaining 60% vesting at the end of the second year. Under the
terms of the agreement, none of the shares vest if either is terminated for
cause or voluntarily resigns. The shares, however, fully vest prior to the
completion of two years of service if (i) either is terminated without cause or
(ii) upon certain conditions if a change of control occurs. Mr. Levy's shares
accelerated upon his separation which was effective March 15, 2000. Effective
August 24, 1999, the Company's Chief Executive Officer was granted an option to
purchase 138,052 shares of the Company's common stock at an exercise price of
$0.30 per share. This option vests in equal monthly installments over each of
the next 48 months of service. Also, on December 17, 1999, the Company granted
to its Chief Executive Officer an option to purchase 2% of the Company's fully
diluted common stock at an exercise price of $10 per share. The Company has
established that the fair value of the underlying stock for both the sale of
common stock and grant of options is in excess of the exercise price. As a
result, the Company recorded deferred compensation of $3.5 million and 1.1
million during August 1999 and December 1999, respectively. Amortization of
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deferred compensation was $888,528 for the year ended December 31, 1999 and is
included in non-cash compensation in the accompanying consolidated statement of
operations. Non-cash compensation is being charged to operations over the
vesting period of the underlying shares and options.
SFAS No. 123, Accounting for Stock-Based Compensation, encourages adoption
of a fair value-based method for valuing the cost of stock-based compensation.
However, it allows companies to continue to use the intrinsic value method for
options granted to employees and disclose pro forma net loss and loss per share.
Had compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS No. 123, the Company's net loss and loss per
share would have been as follows:
YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
----------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net loss as reported..................................... $ (2,689) $ (31,508)
Pro forma net loss....................................... (2,697) (32,185)
Net loss per share as reported, basic and diluted........ (1.53) (14.15)
Pro forma net loss per share, basic and diluted.......... (1.54) (14.46)
The weighted-average fair value of options granted during the years ended
December 31, 1998 and 1999 was approximately $1.96 and $6.17, respectively,
based on the Black-Scholes option pricing model.
The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during the year ended December 31, 1998: Dividend
yield of 0.0%; expected volatility of 74.0%; risk-free interest rate of 6.0%;
and expected term of 2 to 5 years. The following assumptions were used for
grants during the year ended December 31, 1999: Dividend yield of 0.0%; expected
volatility of 74.0%; risk-free interest rate of 6.0 to 6.4%; and expected term
of 2 to 5 years.
As of December 31, 1998 and 1999, the weighted average remaining
contractual life of the options was 9.8 and 9.6 years, respectively.
In November 1999, effective upon completion of the initial public offering
of the Company's common stock, the Company adopted an Employee Stock Purchase
Plan. The plan is designed to allow employees to purchase shares of common
stock, at quarterly intervals, through periodic payroll deductions. A total of
500,000 shares of common stock are available for issuance under the plan. The
board may at any time amend, modify or terminate the plan. The plan will
terminate no later than November 19, 2009.
9. EARNINGS (LOSS) PER SHARE
Financial Accounting Standards Board Statement No. 128, "Earnings per
Share" ("SFAS No. 128") promulgates accounting standards for the computation and
manner of presentation of the Company's earnings per share data. Under SFAS No.
128 the Company is required to present basic and diluted earnings per share.
Basic earnings per share is computed by dividing net loss applicable to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects dilution that would occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that shared in the
earnings of the Company. The reconciliation of the basic and diluted earnings
per share computations for the year ended December 31, 1998 and 1999, is as
follows:
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1998 1999
---------------------------------------- --------------------------------------
PER SHARE PER SHARE
NET LOSS SHARES AMOUNT NET LOSS SHARES AMOUNT
---------- ---------- ------------ ----------- --------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
Net loss........................... $(2,689) $(31,508)
Less: preferred stock dividends.... -- 1,487
-------- ---------
Basic EPS
Net loss available to common
stockholders..................... (2,689) 1,755,536 $(1.53) (32,995) 2,226,225 $(14.82)
Effect of Dilutive Securities
Convertible debt................. -- -- -- -- -- --
Convertible preferred stock...... -- -- -- -- -- --
Stock option plans and
Warrants........................ -- -- -- -- -- --
Dilutive EPS
Net loss available to common
stockholders and assumed -------- ---------- -------- --------- ---------- --------
conversions...................... $(2,689) 1,755,536 $(1.53) $(32,995) 2,226,225 $(14.82)
======== ========== ======== ========= ========== ========
The Company's convertible debt, which is exchangeable into shares of the
Company's common stock, was outstanding during calendar 1998 and for
approximately two months during the year ended December 31, 1999, but was not
included in the computation of diluted earnings per share because the effect
would have been anti-dilutive. Options and warrants to purchase 179,490 and
301,786 shares, respectively, of common stock were outstanding during 1998 but
were not included in the computation of diluted earnings per share because the
effect would have been anti-dilutive. Options and warrants to purchase 1.9
million and 948,596 shares, respectively, of common stock were outstanding
during the year ended December 31, 1999 but were not included in the computation
of diluted earnings per share because the effect would have been anti-dilutive.
The Company's Series A preferred stock, which is convertible into 1,035,706
shares of the Company's common stock, was outstanding during calendar 1998 and
1999, but was not included in the computation of diluted earnings per share
because the effect would have been anti-dilutive. The Company's Series B and
Series C preferred stock, which are convertible into 3,466,897 and 4,464,276
shares, respectively, of common stock were outstanding during 1999 but were not
included in the computation of diluted earnings per share because the effect
would have been anti-dilutive.
10. INCOME TAXES
The Company did not provide any current or deferred federal or state tax
provision or benefit for any of the periods presented because it has experienced
operating losses since inception. The Company has provided a full valuation
allowance on the deferred tax asset, consisting primarily of net operating loss
carryforwards, because of uncertainty regarding its realizability.
At December 31, 1998 and 1999, the Company had net operating loss
carryforwards of approximately $1.7 million and $29.9 million, respectively,
related to federal and state jurisdictions. These net operating loss
carryforwards will begin to expire at various times beginning 2018. For federal
and state tax purposes, a portion of the Company's net operating loss may be
subject to certain limitations on annual utilization in case of changes in
ownership, as defined by federal and state tax laws.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows at December 31
1998 and 1999:
1998 1999
------------- ----------
(IN THOUSANDS)
Deferred tax assets:
Net operating loss carryforwards/other carryovers $ 753 $ 12,075
Financing and start-up costs .................... 257 231
Accrued expenses ................................ -- 537
------- --------
Total deferred tax assets ............... 1,010 12,843
Valuation allowance ............................... (985) (12,494)
------- --------
Net deferred tax assets ........................... 25 349
------- --------
Deferred tax liabilities:
Depreciation and amortization ................... (25) (80)
Deferred advertising ............................ -- (269)
------- --------
Total net deferred tax assets ........... $ -- $ --
======= ========
11. SUBSEQUENT EVENTS
On January 19, 2000 the Company executed a revolving line of credit
agreement with Imperial Bank to provide it with a revolving credit facility in
an aggregate amount of $7.5 million with sublimits of $3.0 million for purchases
of property, equipment and software and $750,000 for letters of credit. The
maturity date for advances for working capital is December 31, 2000 and for
property, equipment and software advances, the maturity date is December 31,
2002. Interest on outstanding balances
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accrues at Imperial's prime rate (8.5% at December 31, 1999) plus 1% until the
closing of the Company's initial public offering, and afterwards at Imperial's
prime rate. All amounts outstanding, which could be up to $7.5 million, are
collateralized by a pledge of all of the Company's assets. Under the terms of
the credit facility, as amended, the Company must maintain a tangible net worth
of $15.0 million and the Company must maintain a ratio of its current assets to
its current liabilities of 1.5 to 1. The Company also issued warrants to
Imperial to purchase 37,500 shares of its common stock at an exercise price of
$10 per share. The Company borrowed $2.5 million under the revolving credit
facility during February 2000 and repaid such borrowings with a portion of the
net proceeds of its initial public offering on February 22, 2000.
On February 3, 2000, the Company entered into a marketing services
agreement and a product promotion agreement with Sallie Mae, Inc. Pursuant to
the marketing services agreement, Sallie Mae will pay the Company $2.0 million
over a two year period. In exchange, the Company will develop and execute a
marketing plan for Sallie Mae to reach the college market.
In addition, the Company, pursuant to the product promotion agreement, will
pay Sallie Mae referral fees based on a percentage of any revenue generated by
Sallie Mae customers during the term of the arrangement. Sallie Mae will promote
the Company's products to Sallie Mae customers. Sallie Mae will also actively
promote the Company's partnership program to the schools to which it sells and
promotes Sallie Mae products. In addition, the Company will be the exclusive
textbook retailer on the Sallie Mae Web site. In exchange, the Company will
grant Sallie Mae a warrant to purchase up to 616,863 shares of common stock,
which represents 3.5% of its aggregate common stock outstanding and reserved for
issuance immediately prior to the completion of the Company's initial public
offering, at a price equal to the initial public offering price of $10 per
share. Of these shares, 352,493 vested on February 3, 2000 and the remaining
264,370 shares will vest over the two year term of the agreement depending on
the number of customer transactions and partnership school referrals Sallie Mae
delivers during that period. The Company believes that Sallie Mae will be able
to meet the criteria needed to allow it to exercise the performance based
warrants. As a result, the Company began to record an expense for the
warrants from the date of issuance. Initially, the Company recorded a deferred
charge during the quarter ended March 31, 2000 of approximately $2.6 million,
which was the fair value of the vested portion of the warrant on the date of
grant. The fair value of the warrant was estimated using the Black-Scholes
option pricing model with the following assumptions: dividend yield of 0.0%;
volatility of 74%; risk free interest rate of 6.0%; and expected term of 7
years. The deferred charge will be amortized on a straight-line basis over the
two-year life of the agreement.
On January 31, 2000 the Company granted to employees options to purchase
479,150 shares of its common stock at an exercise price of $10 per share.
On February 15, 2000, the Company completed its initial public offering,
which involved the sale of 4,075,000 shares of common stock (4,000,000 shares
were sold by the Company and 75,000 shares were sold by selling shareholders)
at $10.00 per share. On March 13, 2000, the Company sold an additional 35,000
shares pursuant to the exercise of the underwriters over-allotment option at
$10.00 per share. Total proceeds to the Company, after deducting underwriting
commissions and discounts, were $36.0 million.
The employment of the Company's co-founder and Executive Vice-President of
Development ended on March 15, 2000. Under the terms of his separation, all of
the shares he held which were subject to re-purchase vested immediately and the
Company paid him $150,000 in accordance with existing contractual arrangements.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The information required by this section is incorporated by reference to
Item 11(i) of the Company's Registration Statement on Form S-1 (File No.
333-89049).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Consolidated Financial Statements. The following consolidated financial
statements of registrant and its subsidiaries and report of independent
auditors are included in Item 8 of this Form 10-K:
(a) Report of Independent Accountants
(b) Consolidated Statements of Operations for the Years
Ended December 31, 1998 and 1999
(c) Consolidated Balance Sheets as of December 31, 1998
and 1999
(d) Consolidated Statements of Stockholders' (Deficit)
Equity for the Years Ended December 31, 1998 and 1999
(e) Consolidated Statements of Cash Flows for the Years
Ended December 31, 1998 and 1999
(f) Notes to Consolidated Financial Statements
2. All schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
either have been included in the Consolidated Financial
Statements or are not required under the related instructions, or
are inapplicable and therefore have been omitted.
3. Exhibits.
The Exhibits listed in the Exhibit Index immediately preceding such
Exhibits are filed as part of this Annual Report on Form 10-K, and
such Exhibit Index is incorporated herein by reference.
(B) REPORTS ON FORM 8-K.
A Current Report on Form 8-K was filed with the Securities and Exchange
Commission on March 6, 2000 to report, pursuant to Item 5, the issuance
of a press release on February 28, 2000 announcing its results for the
fourth quarter and year ended December 31, 1999.
(C) EXHIBITS.
The Company hereby files as part of this Form 10-K the exhibits listed on the
Exhibit Index referenced in Item 14(a)(3) above. Exhibits can be inspected and
copied at the public reference facilities maintained by the Commission, 450
Fifth Street, N.W., Washington, D.C., 20549 and at the Commission's regional
offices located at Seven World Trade Center, 13th Floor, New York, New York
10048, and at the Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. Copies of such material can also be obtained from the Public
Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. In addition the Company is required to file
electronic versions of these documents with the Commission through the
Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system.
The Commission maintains a World Wide Web site at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission. The common
stock of the Company is traded on the Nasdaq National Market. Reports and other
information concerning the Company may be inspected at the National Association
of Securities Dealers, Inc. 1735 K Street, N.W., Washington, D.C. 20006.
(D) FINANCIAL STATEMENT SCHEDULES.
The Company hereby files as part of this Form 10-K the consolidated financial
statement schedule listed in Item 14(a)(2) above, which is attached hereto.
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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
WASHINGTON, DISTRICT OF COLUMBIA, ON THE 30TH DAY OF MARCH, 2000.
VarsityBooks.com Inc.
By: /s/ Eric J. Kuhn
--- ------------------
Eric J. Kuhn
Chief Executive Officer and President
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of VarsityBooks.com Inc., hereby
severally constitute and appoint Eric J. Kuhn, our true and lawful attorney,
with full power to him, to sign for us in our names in the capacities indicated
below, amendments to this report, and generally to do all things in our names
and on our behalf in such capacities to enable VarsityBooks.com Inc. to comply
with the provisions of the Securities Exchange Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons in the capacities and on the dates
indicated.
Signature Title Date
/s/ Eric J. Kuhn Chairman of the Board of Directors, March 30, 2000
- ---------------- Chief Executive Officer and President
Eric J. Kuhn (Principal Executive Officer)
/s/ Timothy J. Levy Director March 30, 2000
- -------------------
Timothy J. Levy
/s/Richard Hozik Senior Vice President and Chief Financial March 30, 2000
- ---------------- Officer (Principal Financial and Accounting
Richard Hozik Officer)
/s/ Jonathan N. Grayer Director March 30, 2000
- ----------------------
Jonathan N. Grayer
/s/ Allen L. Morgan Director March 30, 2000
- -------------------
Allen L. Morgan
/s/ Andrew Oleszczuk Director March 30, 2000
- --------------------
Andrew Oleszczuk
/s/ Gene Riechers Director March 30, 2000
- -----------------
Gene Riechers
/s/ James S. Ulsamer Director March 30, 2000
- --------------------
James S. Ulsamer
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
3.1(1) Amended and Restated Certificate of Incorporation of the
Company, as amended.
3.2(1) Amended and Restated By-laws of the Company.
4.1(1) Specimen Certificate of the Company's common stock.
4.2(1) Registration Rights Agreement with Campus Pipeline dated as of April 27, 1999.
10.1(1) Form of Indemnification Agreement entered into between the Company
and its directors and executive officers.
10.2(1) 1998 Stock Option Plan.
10.3(1) Amended and Restated Operating Agreement by and between Baker & Taylor, Inc.
and VarsityBooks.com Inc. dated as of October 1, 1999.
10.4(1) Amended and Restated Database License Agreement by and between Baker & Taylor, Inc.
and VarsityBooks.com Inc. dated as of October 1, 1999.
10.5(1) Amended and Restated Drop Ship Agreement by and between Baker & Taylor, Inc. and
VarsityBooks.com Inc. dated as of October 1, 1999
10.6(1) Promotional and Customer Service Agreement by and between Baker & Taylor, Inc.
and VarsityBooks.com Inc. dated as of October 1, 1999.
10.7(1) Agreement for Eric J. Kuhn.
10.8(1) Agreement for Timothy J. Levy.
10.9(1) Sublease by and between Student Loan Marketing Association and VarsityBooks.com Inc.
dated as of January 19, 1999.
10.10(1) Sublease by and between AT&T Corp. and VarsityBooks.com Inc. dated as of
September 7, 1999.
10.11(1) Employee Stock Purchase Plan.
10.12(1) Interactive Marketing Agreement by and between AOL's ICQ, Inc. and the Registrant dated
as of December 22, 1999.
10.13(1) Credit Agreement by and between VarsityBooks.com Inc and Imperial Bank, dated as of
January 19, 2000
10.14(1) Marketing Services Agreement by and between VarsityBooks.com Inc. and Sallie Mae, Inc.
dated as of February 3, 2000.
10.15(1) Product Promotion Agreement by and between VarsityBooks.com Inc. and Sallie Mae, Inc.
dated as of February 3, 2000.
11.1 Computation of Earnings Per Common Share.
16.1(1) Letter from KPMG LLP in accordance with Item 304(a) of Regulation S-K.
21.1(1) List of Subsidiaries of the Company.
23.1 Consent of PricewaterhouseCoopers LLP.
24 Power of Attorney (included on Signature Page to this report).
27 Financial Data Schedule.
99.1 Recent Sales of Unregistered Securities
99.2 Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
(1) Incorporated herein by reference to the exhibits to the Company's
Registration Statement on Form S-1 (File No. 33-89049).
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