Continued 4
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to realize economies of scale. Accordingly, the Company intends to continue to invest heavily in marketing and promotion, product development and technology, and operating infrastructure development. The Company also offers attractive pricing programs, which have resulted in relatively low product gross margins. As a result, achieving profitability given planned investment levels depends on the Company's ability to generate and sustain substantially increased revenue levels. In addition, amounts associated with the Company's recent acquisitions, including amortization of goodwill and other purchased intangibles and ongoing operating expenses of those companies, as well as interest expense related to the Senior Discount Notes (as defined below) will further affect the Company's operating results. As a result of the foregoing factors, the Company believes that it will continue to incur substantial consolidated operating losses for the foreseeable future and that the rate at which such losses will be incurred may increase significantly from current levels. Although the Company has experienced significant revenue growth in recent periods, such growth rates are not sustainable and will decrease in the future. In view of the rapidly evolving nature of the Company's business and its limited operating history, the Company believes that period-to-period comparisons of its operating results, including the Company's gross profit and operating expenses as a percentage of net sales, are not necessarily meaningful and should not be relied upon as an indication of future performance.
As a result of the Company's limited operating history and the emerging nature of the markets in which it competes, the Company is unable to accurately forecast its revenues. The Company's current and future expense levels are based largely on its investment plans and estimates of future revenues and are to a large extent fixed. Sales and operating results generally depend on the volume of, timing of and ability to fulfill orders received, which are difficult to forecast. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall in revenues in relation to the Company's planned expenditures would have an immediate adverse effect on the Company's business, prospects, financial condition and results of operations. Further, as a strategic response to changes in the competitive environment, the Company may from time to time make certain pricing, purchasing, service, marketing or acquisition decisions that could have a material adverse effect on its business, prospects, financial condition and results of operations. For example, the Company has recently announced acquisitions that will result in the Company's incurring significant charges, including amortization of goodwill and other purchased intangibles and ongoing operating expenses of the acquired companies.
The Company expects to experience significant fluctuations in its future quarterly operating results due to a variety of factors, many of which are outside the Company's control. Factors that may adversely affect the Company's quarterly operating results include, among others, (i) the Company's ability to retain existing customers, attract new customers at a steady rate and maintain customer satisfaction, (ii) the Company's ability to acquire product, to maintain appropriate inventory levels and to manage fulfillment operations, (iii) the Company's ability to maintain gross margins in its existing business and in future product lines and markets, (iv) the development, announcement or introduction of new sites, services and products by the Company and its competitors, (v) price competition or higher wholesale prices in the industry, (vi) the level of use of the Internet and online services and increasing consumer acceptance of the Internet and other online services for the purchase of products such as those offered by the Company, (vii) the Company's ability to upgrade and develop its systems and infrastructure, (viii) the Company's ability to attract new personnel in a timely and effective manner, (ix) the level of traffic on the Company's Web site, (x) the Company's ability to manage effectively its development of new business segments and markets, (xi) the Company's ability to successfully manage the integration of operations and technology of acquisitions and other business combinations, (xii) technical difficulties, system downtime or Internet brownouts, (xiii) the amount and timing of operating costs and capital expenditures relating to expansion of the Company's business, operations and infrastructure, (xiv) the number of popular books, music selections and other products introduced during the period, (xv) the level of merchandise returns experienced by the Company, (xvi) governmental regulation and taxation policies, (xvii) disruptions in service by common carriers due to strikes or otherwise, and (xviii) general economic conditions and economic conditions specific to the Internet, online commerce and the book and music industries.
The Company expects that it will experience seasonality in its business, reflecting a combination of seasonal fluctuations in Internet usage and traditional retail seasonality patterns. Internet usage and the rate of Internet growth may be expected to decline during the summer. Further, sales in the traditional retail book and music industries are generally significantly higher in the fourth calendar quarter of each year.
Due to the foregoing factors, in one or more future quarters the Company's operating results may fall below the expectations of securities analysts or investors. In such event, the trading price of the common stock would likely be materially adversely affected.
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RECENT EVENTS
In April 1998, the Company acquired three Internet companies: Bookpages Limited ("Bookpages"), Telebook, Inc. ("Telebook") and Internet Movie Database Limited ("IMDB"). Bookpages and Telebook are online booksellers. Bookpages has operations in the United Kingdom and Telebook has operations primarily in Germany through a wholly-owned subsidiary. IMDB operates a comprehensive authoritative source of information on movies and entertainment programs on the Internet. Each of the acquisitions was accounted for under the purchase method of accounting. The aggregate purchase price of the three acquisitions, plus related charges, was approximately $55 million. The consideration for the acquisitions was comprised of common stock and cash. The Company issued an aggregate of approximately 1.1 million shares of common stock to effect the transactions. The Company will amortize the goodwill resulting from the acquisitions over two years.
In August 1998, the Company acquired 100 percent of the outstanding capital stock of Junglee Corp. ("Junglee"). Junglee is a leading provider of advanced Web-based virtual database technology that can help shoppers find and discover products on the Internet. The Company issued approximately 1.6 million shares of common stock and assumed all outstanding options and warrants in connection with the acquisition of Junglee. The Junglee acquisition was accounted for under the purchase method of accounting, with substantially all of the approximately $180 million purchase price allocated to goodwill and other purchased intangibles. The goodwill and substantially all other purchased intangible assets is being amortized on a straight-line basis over lives averaging approximately three years.
In August 1998, the Company acquired 100 percent of the outstanding capital stock of Sage Enterprises, Inc. ("PlanetAll"). PlanetAll, based in Boston, Massachusetts, provides a Web-based address book, calendar and reminder service. The Company issued approximately 800,000 shares of common stock and assumed all outstanding options in connection with the acquisition of PlanetAll. The PlanetAll acquisition was accounted for as a pooling of interests and, as a result, the Company's condensed consolidated financial statements have been restated for all periods presented.
These entities are currently incurring operating losses. The Company intends to increase spending in product development, marketing and sales, and general and administrative activities for the acquired companies, and expects that such expenses, combined with amortization of goodwill and other purchased intangibles, will significantly exceed revenues generated by these entities for the foreseeable future.
In October 1998, the Company formally entered the European market with the launch of new stores in Germany and the United Kingdom. Amazon.de and Amazon.co.uk replaced sites once operated by Telebook in Germany and Bookpages in the United Kingdom.
PRO FORMA RESULTS OF OPERATIONS
Pro forma information regarding the Company's results excluding merger and acquisition related costs is as follows:
Quarter Nine Months
Ended Ended
September 30, September 30,
1998 1998
------------- -------------
Pro forma loss from operations ................................... $ (20,994) $ (43,966)
Pro forma net loss ............................................... $ (24,659) $ (52,194)
Pro forma basic and diluted loss per share ....................... $ (0.49) $ (1.07)
Shares used in computation of basic and diluted loss per share ... 50,234 48,700
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RESULTS OF OPERATIONS
Net Sales
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------- ----------------------------------------------
1998 1997 % Change 1998 1997 % Change
------------ ------------ ------------ ------------ ------------ ------------
(in thousands) (in thousands)
Net sales .................... $ 153,698 $ 37,877 306% $ 357,103 $ 81,747 337%
Net sales are composed of the selling price of books, music and other merchandise sold by the Company, net of returns, as well as outbound shipping and handling charges. Growth in net sales reflects a significant increase in units sold due to the growth of the Company's customer base and repeat purchases from the Company's existing customers and, to a smaller extent, increased sales of music. Music sales totaled $14.4 million for the quarter ended September 30, 1998. This increase was partially offset by a decrease in prices effected in June 1997. International sales represented 20% and 26% of net sales for the quarters ended September 30, 1998 and 1997, respectively, and 21% and 27% of net sales for the nine months ended September 30, 1998 and 1997, respectively.
Gross Profit
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------- ----------------------------------------------
1998 1997 % Change 1998 1997 % Change
------------ ------------ ------------ ------------ ------------ ------------
(in thousands) (in thousands)
Gross profit............... $ 34,875 $ 7,170 386% $ 80,424 $ 15,905 406%
Gross margin............... 22.7% 18.9% 22.5% 19.5%
Gross profit consists of sales less the cost of sales, which consists of the cost of merchandise sold to customers, and outbound and inbound shipping costs. Gross profit increased in absolute dollars, reflecting the Company's increased sales volume. Gross margin increased as a result of improvements in product costs through improved supply chain management, including increased direct purchasing from publishers, as well as higher overall shipping margins, which together more than offset the impact of lower prices and lower music margins.
The Company believes that offering its customers attractive prices is an essential component of its business strategy. Accordingly, the Company offers everyday discounts of up to 40% on hundreds of thousands of titles and certain "special value" editions discounted up to 85%. The Company may in the future expand or increase the discounts it offers to its customers and may otherwise alter its pricing structure and policies.
The Company over time intends to expand its operations by promoting new or complementary products or sales formats and by expanding the breadth and depth of its product and service offerings. Gross margins attributable to new business areas may be lower than those associated with the Company's existing business activities. In particular, in June 1998 the Company launched its new music store and has announced plans to launch a video store. Music and video gross margins are lower than book gross margin. To the extent music or video becomes a larger portion of the Company's product mix, it is expected to have a proportionate impact on overall product gross margin.
Marketing and Sales
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------- ----------------------------------------------
1998 1997 % Change 1998 1997 % Change
------------ ------------ ------------ ------------ ------------ ------------
(in thousands) (in thousands)
Marketing and sales........ $ 37,517 $ 11,516 226% $ 84,522 $ 23,596 258%
Percentage of net sales.... 24.4% 30.4% 23.7% 28.9%
Marketing and sales expenses consist primarily of advertising, public relations and promotional expenditures, as well as payroll and related expenses for personnel engaged in marketing, selling and fulfillment activities. All fulfillment costs not included in cost of sales, including the cost of operating and staffing distribution centers and customer service, are included in marketing and sales. Marketing and sales expenses increased primarily due to increases in the Company's advertising and
Page 12
promotional expenditures, increased payroll and related costs associated with fulfilling customer demand and increased credit card fees resulting from higher sales, as well as increased marketing and sales activities associated with the entry into music sales, the launch of new stores in Germany and the United Kingdom and the acquired entities. Such expenses decreased as a percentage of net sales due to the significant increase in net sales. The Company intends to continue to pursue its aggressive branding and marketing campaign and expects its costs of fulfillment to increase based primarily on anticipated sales growth. In addition, the Company intends to increase investments in marketing, promotion and fulfillment activities related to its product and international expansion, as well as in marketing and sales activities of Junglee and PlanetAll. As a result of the foregoing, the Company expects marketing and sales expenses to increase significantly in absolute dollars.
Product Development
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------- ----------------------------------------------
1998 1997 % Change 1998 1997 % Change
------------ ------------ ------------ ------------ ------------ ------------
(in thousands) (in thousands)
Product development........ $ 13,374 $ 3,998 235% $ 29,526 $ 8,650 241%
Percentage of net sales.... 8.7% 10.6% 8.3% 10.6%
Product development expenses consist principally of payroll and related expenses for development, editorial, systems and telecommunications operations personnel and consultants, as well as systems and telecommunications infrastructure, and costs of acquired content partially attributable to the recent entry into music sales. The increases in product development expenses were primarily attributable to increased staffing and associated costs related to enhancing the features, content and functionality of the Company's Web site and transaction-processing systems, as well as increased investment in systems and telecommunications infrastructure. Such increases included investments associated with the entry into music sales, the launch of new stores in Germany and the United Kingdom and operating expenses associated with the acquired entities. Product development expenses decreased as a percentage of net sales due to the significant increase in net sales. To date, all product development costs have been expensed as incurred. The Company believes that continued investment in product development is critical to attaining its strategic objectives. In addition to ongoing investments in its Web store and infrastructure, the Company intends to increase investments in product and international expansion, as well as product development activities of Junglee and PlanetAll. As a result, the Company expects product development expenses to increase significantly in absolute dollars.
General and Administrative
Quarter Ended September 30, Nine Months Ended September 30,
----------------------------------------------- ----------------------------------------------
1998 1997 % Change 1998 1997 % Change
------------ ------------ ------------ ------------ ------------ ------------
(in thousands) (in thousands)
General and administrative.. $ 4,978 $ 1,972 152% $ 10,342 $ 4,930 110%
Percentage of net sales..... 3.2% 5.2% 2.9% 6.0%
General and administrative expenses consist of payroll and related expenses for executive, accounting and administrative personnel, recruiting, professional fees and other general corporate expenses. The increase in general and administrative expenses was primarily a result of increased salaries and related expenses associated with the hiring of additional personnel, expenses associated with acquired entities, and legal and other professional fees related to the Company's growth, international expansion and expanded activities. Such expenses decreased as a percentage of net sales due to the significant increase in net sales. The Company expects general and administrative expenses to increase in absolute dollars as the Company expands its staff and incurs additional costs related to the growth of its business, including investments associated with product and international expansion and the operations of Junglee and PlanetAll.
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