-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ply6onBwy4aEx4wOZhX+ypL36lWjTQR0+rOS6rQ7mZK9ivB4kG+6wxLVpGZMwjYE 79gjpQWShLLRIoual8gtVw== 0001032210-00-000425.txt : 20000310 0001032210-00-000425.hdr.sgml : 20000310 ACCESSION NUMBER: 0001032210-00-000425 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 5 FILED AS OF DATE: 20000309 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOMEGROCER COM INC CENTRAL INDEX KEY: 0001100408 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 911883408 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-93015 FILM NUMBER: 564009 BUSINESS ADDRESS: STREET 1: 10230 NE POINTS DRIVE CITY: KIRKLAND STATE: WA ZIP: 98033-7879 BUSINESS PHONE: 4252017500 MAIL ADDRESS: STREET 1: 10230 NE POINTS DRIVE CITY: KIRKLAND STATE: WA ZIP: 98033-7879 S-1/A 1 AMENDMENT NO. 6 TO FORM S-1 As filed with the Securities and Exchange Commission on March 9, 2000 Registration No. 333-93015 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- Amendment No. 6 To FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- HOMEGROCER.COM, INC. (Exact Name of Registrant as Specified in Its Charter) --------------- Washington 5411 91-1863408 (State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or Organization) Classification Code Number) Identification Number)
10230 N.E. Points Drive Kirkland, Washington 98033 (425) 201-7500 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) --------------- Mary Alice Taylor HomeGrocer.com, Inc. Chief Executive Officer 10230 N.E. Points Drive Kirkland, Washington 98033 (425) 201-7500 (Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service) --------------- COPIES TO: William W. Ericson, Esq. Daniel G. Kelly, Jr., Esq. Sonya F. Erickson, Esq. DAVIS POLK & WARDWELL VENTURE LAW GROUP 1600 El Camino Real A Professional Corporation Menlo Park, CA 94025 4750 Carillon Point Kirkland, WA 98033
--------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement. --------------- If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] _______________ If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] _______________ If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Explanatory Note This registration statement contains two separate prospectuses. The first prospectus relates to a public offering in the United States and Canada of an aggregate of 17,600,000 shares of common stock. The second prospectus relates to a concurrent offering outside the United States and Canada of an aggregate of 4,400,000 shares of common stock. The prospectuses for each of the U.S. offering and the international offering will be identical with the exception of an alternate front cover page for the international offering. This alternate page appears in this registration statement immediately following the complete prospectus for the U.S. offering. ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We may + +not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell these securities and we are not soliciting offers to buy these + +securities in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ PROSPECTUS (Subject to Completion) Issued March 9, 2000 22,000,000 Shares [LOGO OF HOMEGROCER.COM] Common Stock ------------ HomeGrocer.com, Inc. is offering 22,000,000 shares of common stock. This is our initial public offering and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $10 and $12 per share. ------------ Our common stock has been approved for quotation on the Nasdaq National Market under the symbol "HOMG." ------------ Investing in our common stock involves risks, including the risk that our executive officers, directors and major shareholders will own approximately 65% of our outstanding common shares. See "Risk Factors" beginning on page 6. ------------ PRICE $ A SHARE ------------
Underwriting Price to Discounts and Proceeds to Public Commissions HomeGrocer.com -------- ------------- -------------- Per Share................................ $ $ $ Total.................................... $ $ $
The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. HomeGrocer.com has granted the underwriters the right to purchase up to an additional 3,300,000 shares to cover over-allotments. Morgan Stanley & Co. Incorporated expects to deliver the shares of common stock to purchasers on , 2000. ------------ MORGAN STANLEY DEAN WITTER DONALDSON, LUFKIN & JENRETTE CHASE H&Q BANC OF AMERICA SECURITIES LLC J.C. BRADFORD & CO. , 2000 Gatefold The gatefold includes five photographs of the following: 1. A woman and child sitting at a computer with the caption "Convenient online shopping;" 2. HomeGrocer.com employees performing tasks in a customer fulfillment center with the caption "Efficient order fulfillment system;" 3. A HomeGrocer.com truck driving through a neighborhood with the caption "Custom designed tri-temperature trucks for product freshness;" 4. A screen shot of HomeGrocer.com's web site with the caption "Easy to navigate web site;" and 5. A HomeGrocer.com delivery person bringing bags of groceries to a customer's kitchen counter with the caption "Friendly, professional drivers bring the groceries right to the kitchen." TABLE OF CONTENTS
Page ---- Prospectus Summary.................. 3 Risk Factors........................ 6 Special Note Regarding Forward- Looking Statements................. 19 Use of Proceeds..................... 19 Dividend Policy..................... 19 Capitalization...................... 20 Dilution............................ 21 Selected Financial Data............. 22 Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 23 Business............................ 29 Management.......................... 42 Related Party Transactions.......... 57 Principal Stockholders.............. 60 Description of Capital Stock........ 62 Shares Eligible for Future Sale..... 66 Material U.S. Federal Tax Considerations for Non-U.S. Holders............................ 68 Underwriters........................ 70 Legal Matters....................... 73 Experts............................. 73 Additional Information Available to You................................ 73 Index to Financial Statements....... F-1
You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of our common stock only in those jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our common stock. For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus. Until , 2000, 25 days after commencement of the offering, all dealers effecting transactions in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. PROSPECTUS SUMMARY You should read the following summary together with the more detailed information regarding HomeGrocer.com and our financial statements and the related notes appearing elsewhere in this prospectus. HomeGrocer.com Our Business HomeGrocer.com is a retailer of grocery and other consumer products on the Internet. Using our state-of-the-art distribution system, we offer next-day home delivery of high quality products at prices comparable to local supermarkets. Our product selection currently includes fresh fruit, vegetables, dairy products, baked goods, meat, fish and a wide assortment of non-perishable items and household products. We also offer health and beauty products, wine and beer, fresh flowers, pet products, home office supplies, postage stamps, seasonal items and top-selling books, video games and movies. Since January 1, 1999, we have made deliveries to over 55,000 different households. We have rapidly expanded since our initial launch of service in June 1998 and currently serve customers in three markets: Seattle, Washington; Portland, Oregon; and Orange County/Los Angeles, California. We expect to begin service in eight to ten additional metropolitan areas in the next twelve months. Our History of Losses We incurred net losses of $7.9 million for the fiscal year ended January 2, 1999 and $84.0 million for the fiscal year ended January 1, 2000. Because of the start-up expenses at the numerous customer fulfillment centers that we intend to open over the next few years, we expect to incur substantial losses and negative operating cash flow for the foreseeable future. As of January 1, 2000, we had an accumulated deficit of $93.3 million. Our Market Opportunity We believe a significant market opportunity exists for an online store that can offer consumers an Internet shopping experience for grocery and other consumer products. Most consumers dislike the traditional grocery shopping experience. Online grocery shopping has the opportunity to eliminate many of the burdens of the traditional grocery shopping experience. Forrester Research estimates that online grocery shopping in the United States will grow from a $513 million market in 1999 to a $16.8 billion market by 2004 and that online sales of health and beauty products, another market that we address, will grow from $509 million in 1999 to $10.3 billion in 2004. Our Strategy Our goal is to be our customers' preferred regular supplier of a wide range of consumer products. Our web site is designed to reduce average shopping time by creating an easy to use, interactive and customized format for each customer. Our professional buyers purchase high quality products available from premium specialty suppliers and local sources, in addition to national suppliers. Our delivery staff is selected and trained to deliver friendly, efficient and reliable customer service. We believe that our success in reliably delivering quality groceries into the home provides us with a strong platform to expand into other product and service areas. Amazon.com, our largest shareholder, has agreed to introduce our service to its customers residing in our service areas under our advertising agreement with them. In addition, we recently entered into a five-year agreement with America Online under which our grocery shopping services will be prominently featured on the web sites of AOL and its affiliated networks. We are obligated to pay AOL a total of approximately $60 million over the next five years. 3 Our History We were incorporated in British Columbia, Canada in January 1997, reincorporated in Delaware in September 1997 and reincorporated in Washington in March 2000. After this offering, our officers, directors and their affiliates will control approximately 65% of our outstanding common stock and could prevent or delay beneficial corporate actions. Our principal executive offices are located at 10230 N.E. Points Drive, Kirkland, Washington 98033, and our telephone number is (425) 201-7500. Information contained in our web site at www.homegrocer.com does not constitute part of this prospectus. THE OFFERING Common stock offered....................... 22,000,000 shares Common stock to be outstanding after the offering.................................. 124,812,274 shares Use of proceeds............................ Finance the first phase of a national expansion, including the establishment of new customer fulfillment centers, and other general corporate purposes Proposed Nasdaq National Market symbol..... HOMG
The number of shares of our common stock to be outstanding immediately after the offering is based on the number of shares outstanding at January 1, 2000. This number does not take into account 5,886,342 shares of common stock issuable upon exercise of outstanding stock options at a weighted average exercise price of $1.69 per share, 2,749,248 shares of common stock issuable upon exercise of warrants at a weighted average exercise price of $1.00 per share and 14,287,122 shares of common stock available for grant under our existing stock option plans at January 1, 2000. "HomeGrocer," "HomeGrocer.com," "Peach Party," "here comes the grocery store" and the HomeGrocer.com corporate logo are trademarks of HomeGrocer.com. All other brand names or trademarks appearing in this prospectus are the property of their respective holders. Unless otherwise indicated, all information contained in this prospectus: . assumes no exercise of the underwriters' over-allotment option; . reflects the 2-for-1 stock split of the common stock effected in November 1999; and . gives effect to the conversion of all outstanding shares of preferred stock into 73,206,738 shares of common stock effective upon the closing of this offering. 4 SUMMARY FINANCIAL DATA The following table contains summary financial data for HomeGrocer.com. You should read this information along with our financial statements and related notes included elsewhere in this prospectus.
51 Weeks From 52 Weeks 52 Weeks January 15, 1997 Ended Ended (Inception) to January 2, January 1, January 3, 1998 1999 2000 ---------------- ---------- ---------- (in thousands, except share and per share amounts) Statement of Operations Data: Net sales............................ $ -- $ 1,094 $ 21,648 Cost of sales........................ -- 1,018 19,515 ---------- ---------- ---------- Gross profit....................... -- 76 2,133 Selling, general, and administrative expenses, excluding stock-based compensation........................ 1,064 7,455 59,208 Stock-based compensation expense..... 230 412 28,158 ---------- ---------- ---------- Loss from operations............... (1,294) (7,791) (85,233) Other income/(expense), net.......... (61) (118) 1,240 ---------- ---------- ---------- Net loss........................... $ (1,355) $ (7,909) $ (83,993) ========== ========== ========== Basic and diluted net loss per share............................... $ (0.14) $ (0.72) $ (5.56) ========== ========== ========== Pro forma basic and diluted net loss per share (1)....................... $ (1.28) ========== Weighted average shares outstanding used to compute basic and diluted net loss per share.................. 10,034,721 11,044,174 15,102,698 ========== ========== ========== Weighted average shares outstanding used to compute pro forma basic and diluted net loss per share (1)...... 65,382,807 ==========
The actual column in the following table sets forth HomeGrocer.com's summary balance sheet data as of January 1, 2000. The pro forma as adjusted column reflects the conversion of all outstanding shares of preferred stock into 73,206,738 shares of common stock and the sale of 22,000,000 shares of our common stock in this offering at an assumed initial public offering price of $11.00 per share and the application of our estimated net proceeds.
At January 1, 2000 -------------------- Pro Forma Actual As Adjusted -------- ----------- (in thousands) Balance Sheet Data: Cash and cash equivalents and marketable securities....... $ 77,568 $301,320 Working capital........................................... 66,593 290,656 Total assets.............................................. 146,929 370,094 Long-term obligations, less current portion............... 17,790 17,790 Total shareholders' equity................................ 112,147 335,807
- -------- (1) See note 1 of notes to financial statements for an explanation of the determination of the number of weighted average shares used to compute pro forma net loss per share amounts. 5 RISK FACTORS This offering and an investment in our common stock involves a high degree of risk. You should carefully consider the following risks before making an investment decision. The trading price of our common stock could decline if any of these risks materializes, and investors could lose all or part of their investment. You also should refer to the other information appearing elsewhere in this prospectus, including our financial statements and the related notes. We anticipate significant increases in our operating expenses and continuing losses for the foreseeable future. We incurred net losses of $7.9 million, or 723% of our revenues, for the fiscal year ended January 2, 1999 and $84.0 million, or 388% of our revenues, for the fiscal year ended January 1, 2000. We intend to open one or more customer fulfillment centers in each of eight to ten new markets within the next twelve months. Because all of our customer fulfillment centers have lost money over their first several quarters of operation and none are yet profitable, we anticipate that our net losses for the fiscal year ended December 30, 2000 will be significantly greater than in prior years. As of January 1, 2000, we had an accumulated deficit of $93.3 million. Although we cannot be certain of the size of the capital commitment we will make and the operating expenses we will incur, we expect the expansion will include: . approximately $4 to $7 million to equip each new customer fulfillment center in additional geographic markets; . approximately $5 to $8 million for brand development, marketing and other promotional activities in each new geographic market; and . continued investment in our computer network, web site, warehouse management and order fulfillment systems and delivery and corporate infrastructure. We anticipate using the proceeds of this offering, our revenues from operations and funds from future debt and equity offerings to finance these expenses. We expect to continue to experience substantial operating losses on a quarterly and annual basis for the foreseeable future. At current numbers of customers and orders, the geographic density of customers and productivity of employees, we are not profitable and cannot predict when or if we will be profitable. We are an early stage company operating in the e-commerce market, which makes it difficult for investors to evaluate our business and prospects. Prior to June 1998, we were focused on developing our web site and constructing and equipping our first customer fulfillment center serving the Seattle, Washington area. We did not begin commercial operations in the Seattle area until June 1998, the Portland, Oregon area until May 1999, and the Orange County, California area until September 1999. Our limited operating history makes it difficult to evaluate our financial results and future plans. You must consider our business and prospects in light of the risks and difficulties we encounter as an early stage company in the new and rapidly evolving market of e-commerce. Our failure to address such risks and difficulties could hurt our business. If a sufficient number of grocery shoppers do not accept our online shopping service, we may never become profitable. We have not operated profitably to date and cannot predict when or if we will achieve profitability overall or in any single customer fulfillment center. If we do not achieve and maintain customer volumes and sufficient density of our deliveries in our market areas at a reasonable cost, we will not be able to increase our revenues or achieve profitability. The market for e- commerce is new and rapidly evolving. It is uncertain whether e-commerce will achieve and sustain high levels of demand and market acceptance, particularly in the home 6 delivery industry. Our success will depend to a substantial extent on the willingness of consumers to increase their use of online services as a means of buying groceries and other products and services. We may not be able to convert a large number of consumers from traditional shopping methods to online shopping for groceries and other consumer products. Even if we are successful in attracting online customers, we expect that it may take several years to achieve a sufficient base of customers in a given market. Specific factors that could prevent widespread customer acceptance include: . prolonged delivery time compared to the immediate receipt of products at a traditional store; . perceptions that online delivery services are premium services and therefore may be more expensive than traditional grocery stores; . customers' desire to see and touch products, particularly fresh produce, prior to purchase; . product selection that is less varied than customers desire; . perceived or actual lack of security or privacy of online transactions; and . difficulties in making accurate and timely deliveries to customers. Moreover, the growth of our business will depend on the growth of the number of consumers who have access to personal computers or other systems that can access the Internet. If e-commerce, especially in the grocery industry, does not achieve high levels of demand and market acceptance, we may never become profitable. Our customer fulfillment center and delivery service model may not be readily or cost-effectively replicable in additional geographic markets; as a result, we may fail to expand our business effectively. A critical part of our business strategy is to expand our business by opening customer fulfillment centers in additional geographic markets at a rapid pace. Our expansion strategy is dependent upon our ability to replicate our customer fulfillment center and delivery service model in a timely and cost-effective manner. Our strategy of using proprietary technology that can be implemented in pre-existing warehouses to quickly open customer fulfillment centers may not be as effective as we anticipate. In addition, our existing customer fulfillment centers have been limited to locations on the west coast, and we may fail to recognize specific issues associated with expansion beyond the west coast. Because our three principal customer fulfillment centers have been operational for less than six months, we have not yet demonstrated whether our customer fulfillment centers and delivery service model are in fact readily and cost-effectively replicable for long-term use or across additional markets. If we fail to launch our service in new markets in a timely and cost effective manner or if the market fails to accept our new services, we may not generate the revenue we expect, and we could incur substantial additional operating costs. We may be unable to upgrade our existing technology in a cost-effective and efficient manner to accommodate the increased volumes of Internet traffic and transactions that may arise from our expansion, which could hurt our business. The launch of the HomeGrocer.com service in additional metropolitan locations may require us to expand and upgrade our technology, including our integrated set of software tools and business processes for delivery management, web site production, customer service and order fulfillment. Our existing technology may not be able to accommodate increased volumes of traffic and transactions that may arise in the future from our expansion into other metropolitan locations. To the extent that customer traffic grows substantially, we will need to expand the capacity of our web site and transaction processing systems to accommodate a larger number of customers. If we are unable to upgrade our technology, we may suffer from unanticipated system disruptions, slower response times, degradation in levels of customer service, impaired quality and speed of order fulfillment or delays in reporting accurate financial information. We may not accurately predict the rate or timing of increases in the use of our web site to allow us to effectively upgrade or expand our transaction 7 processing systems. Upgrading our current technology could result in material expenses. If we fail to cost-effectively and efficiently upgrade and expand our current technology, our business will suffer. Expansion of our service in additional geographic markets may place a greater than expected strain on our personnel and systems and jeopardize future scheduled expansion. The strain placed on our employees, management and systems by simultaneous launches of the HomeGrocer.com service in multiple metropolitan locations may jeopardize future scheduled launches or the quality of our service in a particular location. The lack of sufficient resources to operate in multiple locations could cause our quality of service or number of customers to decline. If we fail to adequately predict and maintain the personnel and systems necessary to successfully manage multiple customer fulfillment centers, we may be forced to delay our expansion and our business will suffer. We may incur unexpected costs or face substantial delays in finding adequate facilities for our customer fulfillment centers, which could hurt our business. Much of our expansion is dependent on our ability to locate and lease suitable sites for additional customer fulfillment centers. We may be unable to find adequate facilities to lease that meet our timing, location and cost expectations. Even if we are able to locate an adequate facility, we may face additional delays and costs in negotiating and reviewing the lease agreement, examining the site for compliance with governmental regulations, such as zoning and environmental compliance, and procuring the necessary permits for our operation. If we incur significant unexpected costs or face substantial delays in finding adequate facilities for our customer fulfillment centers, we may never achieve profitability. We have limited experience in managing geographically diverse operations, which may inhibit our growth. Although we have expanded geographically, we have limited experience operating or managing customer fulfillment centers in multiple regions. To date, our existing customer fulfillment centers have been limited to locations on the west coast of the United States, and we may fail to address different shopping patterns or regional tastes in our service or product offering when we expand beyond the west coast. If we fail to adequately adjust our business plans to account for differences in regional preferences, we may not attract the customers we need and our business would suffer. Accordingly, the success of our current and planned expansion into new geographic regions will depend upon a number of factors, including: . our ability to integrate the operations of new customer fulfillment centers into our existing operations; . our ability to address regional differences between our customer fulfillment centers; . our ability to coordinate and manage distribution operations in multiple, geographically distant locations; and . our ability to establish and maintain adequate management and information systems and financial controls. Our failure to successfully address these factors could inhibit our growth. If we encounter operational difficulties, our business could suffer erosion of customer trust and loss of income. Our business relies on complex systems to manage the process from the receipt of orders to the delivery of goods to our customers. The satisfactory performance, reliability and availability of our web site and transaction processing systems are critical to our reputation and our ability to attract and retain customers and maintain adequate customer service levels. Our web site has experienced numerous outages since inception. Prior to December 1, 1999, outage and impact data was not collected systematically; however, system outages of over three hours occurred at least 8 three times in the first eleven months of 1999. From December 1, 1999 to January 22, 2000, there were 13 web site outages that totaled 515 minutes. The longest of these systems outages was 2 hours and 12 minutes. In addition to outages, we occasionally experience periods of slow site response times. We have, from time to time, also experienced operational "bugs" in our systems and technologies that have resulted in order errors, such as missing items and delays in deliveries. Operational bugs may arise from one or more factors including mechanical equipment failures, computer server or system failures, network outages, software bugs, power failures and human error. We may not be able to correct every problem in a timely manner. We expect bugs to continue to occur from time to time and our operations may experience significant inefficiencies or failures. If we are unable to meet customer demand or service expectations as a result of operational issues, we may be unable to develop customer relationships that result in repeat orders, which would hurt our business. Our communications hardware is located at a third party hosting provider and natural disasters and any other unanticipated problems faced by our hosting provider may reduce our capacity or damage our systems. Our communications hardware and other computer hardware operations are located at a web site hosting provider in Seattle, Washington. The hardware for our warehouse management and inventory system is maintained in our corporate data center in Kirkland, Washington. Fires, floods, earthquakes, power losses, telecommunications failures, break-ins and similar events could damage these systems or cause them to fail completely. In addition, our hosting provider is responsible for the allocation of our system capacity and any unanticipated problems with the telecommunications network providers with whom it contracts or with the systems by which it allocates capacity among its customers could reduce our system capacity. As of January 1, 2000, we use less than ten percent of our system capacity and our maximum system use for any five-minute period has been 30% of our system capacity. We estimate we currently have sufficient system capacity to process over 4,000 orders per day, and with the addition of off-the-shelf hardware could process approximately 24,000 orders per day. Natural disasters and any other unanticipated problems faced by our hosting provider could adversely impact the customer shopping experience and, consequently, our business. We will need substantial additional capital to fund our operations and planned expansion, and we cannot be sure that additional financing will be available. We require substantial amounts of working capital to fund our business. In addition, the opening of new customer fulfillment centers and the continued development of our order fulfillment and delivery systems require significant amounts of capital. For example, we anticipate that we will require approximately $4 to $7 million to equip each new customer fulfillment center and approximately $5 to $8 million for brand development, marketing and other promotional activities in each new geographic market. In addition, we will need substantial additional capital to fund growth beyond the initial phase of our expansion into eight to ten new markets or if we encounter unexpected costs in the initial phase of our expansion, such as higher than anticipated real estate, technology or customer acquisition costs. Since our inception, we have experienced negative cash flow from operations and expect to experience significant negative cash flow from operations for the foreseeable future. In the past, we have funded our operating losses and capital expenditures through proceeds from equity offerings, debt financing and equipment leases. We expect to require substantial additional capital to fund our expansion program and operating expenses beyond those raised in this offering. Our future capital needs will be highly dependent on the number and actual cost of additional customer fulfillment centers we open, the timing of openings and the success of our facilities once they are launched. We cannot be certain that additional financing will be available to us on favorable terms when required, or at all. If we are unable to obtain sufficient additional capital when needed, we could be forced to alter our business strategy, delay or abandon some of our expansion plans or sell assets. Any of these events would have a material adverse effect on our business, financial condition and our ability to reduce losses or generate profits. In addition, if we raise additional funds through the issuance of equity, debt or other securities, those securities may have rights, preferences or privileges senior or equal to those of the rights of our common stock and our stockholders may experience dilution. 9 Our limited operating history makes it difficult for us to forecast our future financial results. As a result of our limited operating history, it is difficult to accurately forecast our total revenue, revenue per customer fulfillment center, gross and operating margins, real estate and labor costs, average order size, number of orders per day and other financial and operating data. We have a limited amount of meaningful historical financial data upon which to base planned operating expenses. Sales and operating results are difficult to forecast because they generally depend on the growth of our customer base and the volume of the orders we receive, as well as the mix of products sold. As a result, we may be unable to make accurate financial forecasts and adjust our spending in a timely manner to compensate for any unexpected revenue shortfall. This inability to accurately forecast our results could cause our net losses in a given quarter to be greater than expected and could cause a decline in the trading price of our common stock. Our quarter-to-quarter operating results are expected to be volatile and difficult to predict. We expect our quarterly operating results to fluctuate significantly in the future based on a variety of factors including: . the timing of our expansion plans as we build out and begin to operate new customer fulfillment centers in additional geographic markets; . changes in pricing policies or our product and service offerings; . our ability to manage our distribution and delivery operations to handle significant increases in the number of customers and orders or to overcome system or technology difficulties associated with these increases; and . competitive factors. Due to these factors, we expect our operating results to be volatile and difficult to predict. As a result, quarter-to-quarter comparisons of our operating results may not be good indicators of our future performance. In addition, it is possible that in the future quarterly operating results could be below the expectations of investors of HomeGrocer.com. In that event, the price of our common stock could decline substantially. Our quarter-to-quarter operating results are expected to fluctuate based upon seasonal purchasing patterns, and are therefore difficult to predict. Our quarter-to-quarter operating results are expected to fluctuate based upon seasonal purchasing patterns of our customers and the mix of groceries and other products sold by us. For instance, we expect a reduction in sales in the summer months, which is a popular vacation season in most markets, and higher sales during the weeks preceding Thanksgiving. Because of our short operating history and limited geographical experience, we may not accurately predict the seasonal purchasing patterns of our customers and may experience unexpected difficulties in matching inventory to demand by customers. Our business will suffer if we fail to manage our growth properly. We have expanded our operations rapidly since our inception. We continue to increase the scope of our operations and have increased our headcount substantially. Our total number of employees grew from approximately 100 on January 1, 1999 to approximately 1,060 on January 1, 2000. Based on our current expansion plans, we expect to hire between 4,000 and 5,000 additional employees in the next year. This growth has placed, and our anticipated growth in future operations will continue to place, a significant strain on our management systems and resources. Our ability to successfully offer our service and implement our business plan in a rapidly evolving market requires an effective planning and management process. We expect that we will need to continue to improve our financial and managerial controls, reporting systems and procedures, and will need to continue to expand, train and manage our work force nationwide. Competition for highly skilled and customer service oriented employees is intense. We may fail to attract, assimilate or retain qualified 10 personnel to fulfill our current or future needs. Our planned rapid growth places a significant demand on management and financial and operational resources. In order to grow and achieve financial success, we must: . retain existing personnel; . hire, train, manage and retain additional qualified personnel; and . effectively manage multiple relationships with our customers, suppliers and other third parties. Our failure to do so would harm our business, decrease our revenue and hinder us from being able to achieve profitability. If we fail to generate sufficient levels of repeat orders and market penetration, our revenues could be significantly lower than expected. In the online retail industry, customer attrition rates, or the rates at which subscribers cancel a service, are generally high. Although we do not charge a subscription fee for our service, we do depend upon customers to continue to order from us after their initial order is placed. We compete to retain customers once they have used our service. We currently track our repeat customers and the data we have gathered shows that since January 1, 1999, approximately 64% of our orders have been from repeat customers. A critical part of our business strategy depends on hiring, training and retaining customer friendly delivery persons to interact directly with the customer on a regular basis and promote customer loyalty. In addition, we must ensure that our customer service agents who answer telephone and email inquiries offer prompt attention and helpful information in response to our customers' concerns. If we fail to provide high quality customer care and experience significant decreases in repeat customer orders as a percentage of orders delivered, or if we are unable to establish sufficient customer loyalty needed for market penetration, our business could be hurt. Retention of customers is also dependent on operational execution. If orders are incomplete or not delivered on time, customer retention rates could decline, causing revenue and profitability to decline as well. We face intense competition from traditional grocery retailers and anticipate increased competition from online grocery retailers in our existing and future markets. The grocery retailing market is extremely competitive. Local, regional, and national food chains, independent food stores and markets, as well as online grocery retailers comprise our principal competition, although we also face substantial competition from convenience stores, liquor retailers, membership warehouse clubs, specialty retailers, supercenters and drugstores. Many of our existing and potential competitors, particularly traditional grocers and retailers, have existed for a longer period of time, have greater financial resources and have more established relationships with leading manufacturers, suppliers and advertisers than we do. In November 1999, a traditional grocery chain, Albertson's, introduced an Internet based service in the Seattle area and Webvan, an online grocery retailer, recently announced it will introduce its online grocery service in the Seattle area sometime in 2000. We expect our competition will intensify as more traditional and online grocery retailers offer competitive services, both in Seattle and other markets. The number and nature of competitors and the amount of competition we will experience will vary by market area. We expect to compete with traditional grocery stores in every market, including Albertson's, Safeway, Quality Food Centers and Kroger, and other online grocers in most markets, including companies such as Webvan, Peapod, HomeRuns, ShopLink.com and Streamline.com. The principal competitive factors that affect our business are product selection, product quality, customer service, price and convenience. For traditional grocers, convenience is largely a function of location and hours of operation. For online grocers, it is primarily determined by ease of use of the web site and availability of delivery times. If we fail to effectively compete in any of these areas, we may lose existing and potential customers and face decreased demand for our products and services, which would hurt our business. 11 If our efforts to build strong brand identity and customer loyalty are not successful, our business will suffer. We believe that customers may direct future grocery purchases to those online and traditional grocers for whose brands they feel loyalty and personal affinity. If we do not increase spending substantially to create and maintain brand loyalty, we may not attract and retain consumers and respond to competitive pressures. We believe the cost of our advertising campaigns could increase substantially in the future. The costs required to successfully establish our brand may exceed the benefits associated with creating our brand identity and loyalty. If we fail to establish and maintain brand identity and brand loyalty, we may not attract the customers we need in order to be profitable. Customer loyalty will also depend on our success in consistently providing a high quality shopping experience for purchasing groceries and other products. If consumers do not perceive our service offerings to be of high quality, or if we introduce new services that are not favorably received by consumers, the value of the HomeGrocer.com brand could be harmed. Any loss of value of our brand could decrease the attractiveness of HomeGrocer.com to consumers, which could harm our reputation, reduce our sales and cause us to lose customers. We do not have long term contracts with our suppliers and could face disruptions in our supply of products. We purchase products from a network of suppliers, wholesalers, brokers and distributors. We do not have long term or exclusive contracts with these suppliers. The loss of any of our suppliers could cause disruptions in our supply of products and harm our business. We purchase a number of top brands and high volume items directly from manufacturers and may increase our use of direct suppliers as our product volumes increase with additional customer fulfillment centers. We also utilize premium specialty suppliers and local sources for gourmet foods, traditional and organic produce, bakery items, fish and meats and floral products. From time to time, we may experience difficulty in obtaining sufficient product allocations from a key vendor. In addition, our key vendors may establish their own online retailing efforts, which may impact our ability to obtain sufficient product allocations from these vendors. Many of our key vendors also supply products to the retail grocery industry and our online competitors. If we are unable to obtain sufficient quantities of products in a timely fashion from our key vendors to meet customer demand, our business would suffer. At each of our customer fulfillment centers, a significant percentage of our current product offering is sourced through a single supplier and the loss of that supplier could cause disruptions in our supply and harm our business. We are dependent on single suppliers for a significant percentage of our products. Approximately 47% of our current product offering in the Seattle and Portland markets is sourced through a single wholesaler, SuperValu. For our three new customer fulfillment centers in Orange County, Certified Grocers is our principal supplier and supplies approximately 50% of our current product offering in that market. SuperValu does not operate in Southern California and Certified Grocers does not operate in Seattle or Portland. We have no contractual relationship with either SuperValu or Certified Grocers that requires either of them to continue to supply our needs in the future. The loss of either of these two suppliers could cause disruptions in our supply and harm our business. The loss of the services of one or more of our key personnel would seriously harm our business. The loss of the services of one or more of our key personnel, including Mary Alice Taylor, our chairman and chief executive officer, and J. Terrence Drayton, our president, could seriously harm our business. We depend on the continued services and performance of our senior management and other key personnel. In addition, Mr. Drayton and Ken Deering, our vice president of Storefront, are Canadian citizens who hold visas to work in the United States. If the Immigration and Naturalization Service were to deny a renewal of either of these visas and we were to lose the services of either of these officers, our business could suffer. 12 We may not be able to hire and retain qualified employees necessary to support our business, which would threaten our future growth. Our future success depends upon attracting and retaining the continued service of our executive officers, delivery persons, and other key software development, merchandising, marketing and support personnel. Our relationships with all of our employees are at will. Additionally, there are low levels of unemployment in the Seattle, Portland, and Orange County/Los Angeles areas, as well as in many of the regions in which we plan to operate. These low levels of unemployment have led to upward pressure on wage rates, which can make it more difficult and costly for us to attract and retain qualified employees. The failure to attract and retain qualified employees, could adversely affect our business. Several key members of our management team have only recently joined us and if they are not successfully integrated into our business or fail to work together as a management team, our business will suffer. Several key members of our management team have joined us since September 1, 1999, including Mary Alice Taylor, our chairman and chief executive officer, Daniel R. Lee, our senior vice president and chief financial officer, Rex L. Carter, our senior vice president of systems development & technology, Corwin J. Karaffa, our senior vice president of operations, David A. Pace, our senior vice president of people capability, and Kristin H. Stred, our senior vice president, general counsel and secretary. If we do not effectively integrate these executives and key personnel into our business, or if they do not work together with existing personnel as a management team to enable us to implement our business strategy, our business will suffer. We may not be able to obtain required licenses or permits for the sale of alcohol in a cost-effective manner or at all, which would hurt our sales and profitability. For the fiscal year ended January 1, 2000, sales of alcohol accounted for approximately 4% of our sales. We will be required to obtain state, and in some cases county and municipal, licenses and permits for the sale and delivery of alcohol in new markets. Some jurisdictions do not allow companies such as ours to sell alcohol. We cannot assure you that we will be able to obtain any or all required permits or licenses in a timely manner, or at all. We may be forced to incur substantial costs and experience significant delays in obtaining these permits or licenses. In addition, the U.S. Congress is considering enacting legislation, which would restrict the interstate sale of alcoholic beverages over the Internet. Changes to existing laws or our inability to obtain required permits or licenses could prevent us from selling alcohol in one or more of our geographic markets or in a portion of those markets. In those locations where we cannot obtain alcohol permits or licenses, we will be unable to sell these items and will lose an opportunity to increase revenue. We are required to verify the age of purchasers of our alcohol and tobacco products and the failure to do so may have a negative impact on our reputation and make us vulnerable to liability claims. We are required to verify the age of purchasers of our alcohol and tobacco products. If our delivery personnel fail to request the proper identification or if false identification cards are presented by the purchaser, we could face substantial penalties and legal liability for sales of alcohol and tobacco products to underage persons. Any inquiry or investigation from a regulatory authority could have a negative impact on our reputation and any liability claims could require us to spend significant time and money in litigation. We may incur significant costs or experience product availability delays in complying with regulations applicable to the sale of food products, which may hurt our business. As of the date of this prospectus, we are not regulated by the U.S. Department of Agriculture, or USDA. Whether the handling of food items in our customer fulfillment centers, such as meat and fish, will subject us to USDA regulation in the future will depend on several factors, including whether we sell food products on a wholesale basis or whether we obtain food products from non-USDA inspected facilities. In the future the USDA may require costly changes to our food handling operations. We are also required to comply with local health regulations concerning the preparation and packaging of any prepared food items, such as deli salads that 13 we prepare on site. Applicable federal, state or local regulations may cause us to incur substantial compliance costs or delay the availability of items at one or more of our customer fulfillment centers. In addition, any inquiry or investigation from a food regulatory authority could have a negative impact on our reputation. The occurrence of any of these events could delay or impair our expansion plans and could cause us to lose customers. We depend on only five customer fulfillment centers to fulfill customer orders; the loss or interruption of operations of any of these centers could significantly harm our business. We currently operate five customer fulfillment centers. Of the five, one customer fulfillment center is located in the Seattle, Washington area, one customer fulfillment center is located in the Portland, Oregon area, and three customer fulfillment centers are located in the Orange County/Los Angeles, California area. Our business could be hurt if any external factors affect our current customer fulfillment centers in any of these areas. Such factors may include: . prolonged power or equipment failures; . traffic congestion; . prolonged gasoline shortages; . disruptions in the transportation infrastructure including bridges, tunnels and roads; . refrigeration failures; or . fires, floods, earthquakes, adverse weather conditions or other disasters. Since each of our current customer fulfillment centers is located in an earthquake-prone area, we are particularly susceptible to the risk of damage to, or total destruction of, these customer fulfillment centers and the surrounding transportation infrastructure. We may not be adequately insured to cover the total amount of any losses caused by any of the above events. In addition, we are not insured against any business interruptions caused by earthquakes or to major transportation infrastructure disruptions or other events that do not occur on our premises. We could face liability based on the actions of our drivers. We use our own professional drivers to deliver products from our customer fulfillment centers to our customers as well as to transport non-perishable goods between customer fulfillment center. We may face potential liability related to the actions of our delivery drivers while on duty. For example, one of our drivers was involved in a motor vehicle accident that recently resulted in a lawsuit being filed against us for compensatory damages. This proceeding is currently pending. If negligent, illegal or unprofessional conduct of our drivers were to occur, it could harm our reputation and our business. Our reputation and business will be harmed if our online security measures fail. Our relationships with our customers may be adversely affected if the security measures that we use to protect their personal information, such as credit card numbers, are ineffective. We rely on security and authentication technology to perform real-time credit card authorizations. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect a customer's personal information. Furthermore, our computer servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any breaches. We cannot assure you that we can prevent all security breaches, and any failure to do so could hurt our reputation and business. We may need to make costly changes in how we conduct our business if government regulation of the Internet and e-commerce increases. The adoption or modification of laws or regulations relating to the Internet, e-commerce and large-scale retail store operations could adversely affect the manner in which we currently conduct our business. In 14 addition, the growth and development of the market for e-commerce may lead to more stringent consumer protection laws, which may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. The U.S. government recently enacted Internet laws regarding privacy, copyrights, taxation and the transmission of sexually explicit material. The law of the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses or alter our business model. We may face product claims that create liability and adverse publicity. Grocery and other related products can contain contaminants due to inherent defects in the products or improper storage or handling. If any of the products that we sell causes harm to any of our customers, we could be vulnerable to product liability lawsuits. If we are found liable under a product liability claim, or even if we successfully defend ourselves against this type of a claim, we could be forced to spend a substantial amount of money in litigation expenses, our reputation could suffer and customers may substantially reduce their orders or stop ordering from us. If the protection of our patents, trademarks and proprietary rights is inadequate, our business may be seriously harmed. We regard patents, copyrights, service marks, trademarks, trade secrets and similar intellectual property as important to our success. We rely on patent, trademark and copyright law, trade secret protection and confidentiality or license agreements with our employees, customers, partners and others to protect our proprietary rights; however, the steps we take to protect our proprietary rights may be inadequate and legal means afford only limited protection. For example, our confidentiality and license agreements may be unenforceable in some jurisdictions and, as a result, offer no protection of our proprietary rights. In addition, traditional legal protections may not be applicable in the Internet context. Because our business and technology have developed rapidly since our incorporation, the ownership of proprietary rights in our technology may be subject to uncertainty. Our failure to protect our proprietary rights could materially harm our business and competitive position. We currently have no patents. On January 10, 2000, we filed three provisional patent applications with the U.S. Patent and Trademark Office. From time to time, we may decide to file additional patent applications relating to aspects of our proprietary technology. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot assure you that any of our pending provisional patent applications will be approved, that any issued patents will protect our intellectual property or that any issued patents will not be challenged by third parties. Intellectual property claims against us can be costly and could result in the loss of significant rights. Intellectual property rights are becoming increasingly important to us and other e-commerce retailers. Many companies are devoting significant resources to developing patents that could affect many aspects of our business. Other parties may assert infringement or unfair competition claims against us that could relate to any aspect of our technologies, business processes or other intellectual property. We cannot predict whether third parties will assert claims of infringement against us, the subject matter of any of these claims, or whether these assertions or prosecutions will harm our business. If we are forced to defend ourselves against any of these claims, whether they are with or without merit or are determined in our favor, then we may face costly litigation, diversion of technical and management attention, an inability to use our current web site technology or product shipment delays. As a result of a dispute, we may have to develop non-infringing technology or enter into royalty or licensing agreements. These royalty or licensing agreements, if required, may be 15 unavailable on terms acceptable to us, or at all. If there is a successful claim of infringement against us and we are unable to develop non-infringing technology or license the infringed or similar technology on a timely basis, our business and competitive position may be hurt. We may not be able to protect our domain names against all infringers, which could decrease the value of our brand name and proprietary rights. We currently own the Internet domain name "homegrocer.com," as well as various other related names. Domain names generally are regulated by Internet regulatory bodies. The regulation of domain names in the United States and in foreign countries is subject to change. Regulatory bodies could establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. The relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we could be unable to prevent third parties from acquiring domain names that infringe or otherwise decrease the value of our brand name, trademarks and other proprietary rights. We may be liable for the Internet content that we publish. As a publisher of online content, we face potential liability based on the nature and content of materials that we publish or distribute. If we face liability, then our reputation and our business may suffer. After this offering, our officers and directors and some existing stockholders will control approximately 65% of our outstanding common stock and could prevent or delay beneficial corporate actions. After this offering, our executive officers and directors and their immediate family members and affiliated venture capital funds beneficially will own or control approximately 65% of our outstanding common stock. Individually, after this offering, Amazon.com will beneficially own approximately 22% of our outstanding common stock. As a result, these stockholders are able to exercise significant control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could delay or prevent another entity from acquiring or merging with us. See "Principal Stockholders." Provisions of our charter documents and state law could discourage our acquisition by a third party. Specific provisions of our articles of incorporation and bylaws, and Delaware and Washington law could make it more difficult for a third party to acquire HomeGrocer.com, even if doing so would be beneficial to our shareholders. Our proposed Washington articles of incorporation and bylaws provide for the establishment of a classified board of directors, the elimination of the ability of shareholders to call special meetings and of cumulative voting for directors, and procedures for advance notification of shareholder proposals. The presence of a classified board and the elimination of cumulative voting may make it more difficult for an acquirer to replace our board of directors. Further, the elimination of cumulative voting substantially reduces the ability of minority shareholders to obtain representation on the board of directors. Upon completion of this offering, our board of directors will have the authority to issue up to 10,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including the voting rights, of those shares without any further vote or action by our shareholders. The issuance of preferred stock could have the effect of delaying, deferring or preventing a change of control of HomeGrocer.com and may adversely affect the market price of our common stock. Washington law imposes restrictions on some transactions between a corporation and significant shareholders. Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target corporation," with some exceptions, from engaging in particular significant business transactions with an "acquiring person," which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target cooperation, for a period of five years after the acquisition, unless the transaction or 16 acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the acquisition. Prohibited transactions include, among other things: . a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from the acquiring person; . termination of 5% or more of the employees of the target corporation as a result of the acquiring person's acquisition of 10% or more of the shares; or . allowing the acquiring person to receive any disproportionate benefit as a shareholder. A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a change in control of HomeGrocer.com. The foregoing provisions of our charter documents and state law could have the effect of making it more difficult or more expensive for a third party to acquire, or could discourage a third party from attempting to acquire, control of HomeGrocer.com. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock. For a more complete discussion of these provisions, see "Description of Capital Stock." We may be required to repurchase shares of our common stock issued upon the exercise of stock options and options to purchase our common stock that may have been issued in violation of state securities laws. We recently discovered that our 1997 Stock Incentive Compensation Plan did not include special provisions that are required under the state securities laws of California. Therefore, some of our employees, directors and consultants who are California residents have been granted options of HomeGrocer.com that may have been issued in violation of state securities laws. Some of these option recipients have exercised their options. To remedy this situation and comply with California law, HomeGrocer.com expects to offer to repurchase shares and options to purchase shares of our common stock. Based upon stock option issuances and exercises prior to January 10, 2000, when we amended our option plan to comply with California securities laws, we expect to offer to repurchase up to a maximum of 782,000 shares of our common stock issued upon the exercise of stock options and options to purchase 1,013,350 shares of our common stock. The 782,000 shares of common stock have a weighted average purchase price of $0.44 per share. The options to purchase 1,013,350 shares of our common stock have a weighted average exercise price of $2.47 per share. Upon approval by the California Department of Corporations, HomeGrocer.com will distribute a repurchase offer memorandum to holders of these shares and options, and the offer will remain open for a period of 30 days from the date of receipt. If the offer is accepted by all affected securityholders, we may be required to pay up to a maximum of approximately $905,500 to repurchase these shares and options. Future sales of our common stock may cause our stock price to decline. If our stockholders sell substantial amounts of our common stock in the public market following this offering, the market price of our common stock could decline. Based on shares outstanding as of January 1, 17 2000, upon completion of this offering we will have outstanding 124,812,274 shares of common stock, assuming no exercise of the underwriters' over- allotment option. Of these shares, almost all of the 22,000,000 shares of our common stock sold in this offering will be freely tradable, without restriction, in the public market. We have agreed not to sell any shares of common stock for period of 180 days after this offering without the consent of Morgan Stanley & Co. Incorporated. We have no agreement with Morgan Stanley for a waiver of this restriction. However, Morgan Stanley may, in its discretion, release us from the agreement. In some cases underwriters have agreed to waive lock-up restrictions when a company's stock has performed well and market conditions are favorable, in order to allow a follow-on offering of common stock. Any decision by Morgan Stanley to waive the lock-up restrictions would depend on a number of factors including market conditions, the performance of our common stock in the market and our financial condition at that time. If Morgan Stanley were to waive the lock-up restrictions prior to the expiration of the 180 day period, and we were to sell additional shares of common stock to the public, the market price of our common stock could decline. Each of our officers, directors and most of our stockholders have entered into lock-up agreements generally providing that they will not sell, otherwise dispose of or transfer any of our common stock or other securities for the period of 180 days after this offering without the consent of Morgan Stanley. However, Morgan Stanley has agreed that if the reported last sale price of the common stock on the Nasdaq National Market is at least twice the initial public offering price per share for 20 of the 30 trading days ending on the last trading day preceding the 90th day after the date of this prospectus, 25% of the shares of our common stock that are held by our employees who are not officers or directors of HomeGrocer.com, or a total of approximately 418,492 shares, subject to this 180-day restriction will be released from the restriction. In addition, approximately 8,635,590 shares under outstanding options and warrants and approximately 14,287,122 shares available for grant under our existing stock option plans as of January 1, 2000 will become eligible for sale in the public market once permitted by provisions of various vesting agreements, lock-up agreements and Rules 144 and 701 under the Securities Act, as applicable. See "Shares Eligible for Future Sale." 18 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements that may be affected by a number of risks and uncertainties, many of which are beyond our control. Some of these forward-looking statements are attributable to third parties and relate to their statements regarding the growth of the e-commerce market and the number of Internet users. All statements, other than statements of historical facts included in this prospectus, regarding our strategy, future operations, financial position, estimated revenues or losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this prospectus, the words "will," "believe," "anticipate," "intend," "estimate," "expect," "project" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. All forward-looking statements speak only as of the date of this prospectus. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward- looking statements we make in this prospectus are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved. We disclose some of the important factors that could cause our actual results to differ materially from our expectations under "Risk Factors" and elsewhere in this prospectus. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. USE OF PROCEEDS Our net proceeds from the sale of the shares of common stock in this offering are estimated to be $223.7 million after deducting the underwriting discounts and commissions and estimated offering expenses. If the underwriters' over-allotment option is exercised in full, we estimate that our net proceeds will be approximately $257.4 million. The principal purpose of this offering is to fund the first phase of our expansion into eight to ten new markets, including approximately $4 to $7 million to equip each new customer fulfillment center and approximately $5 to $8 million for promotional expenses in each market. The secondary purposes of this offering are to increase our working capital, create a public market for our common stock, facilitate our future access to the public capital markets and increase our visibility in the marketplace. We expect to use the net proceeds of the offering for expansion and general corporate purposes. Pending such uses, we intend to invest the net proceeds from the offering in interest- bearing, investment grade securities. We also intend to use a portion of the net proceeds to pay our current obligations to America Online and Amazon.com, LLC pursuant to advertising agreements. We are obligated to pay approximately $15 million to AOL and $5 million to Amazon.com over the next 12 months. DIVIDEND POLICY We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and reinvest any future earnings in the growth of our business and do not anticipate paying any cash dividends in the foreseeable future. 19 CAPITALIZATION The actual column in the following table sets forth HomeGrocer.com's capitalization as of January 1, 2000. The pro forma column reflects the conversion of all outstanding shares of preferred stock into 73,206,738 shares of common stock. The pro forma as adjusted column in the following table gives effect to: . The anticipated filing of an amendment to our articles of incorporation to provide for authorized capital stock of 1,000,000,000 shares of common stock and 10,000,000 shares of undesignated preferred stock; . The conversion of all outstanding shares of preferred stock into shares of common stock upon the closing of this offering; and . The receipt of the net proceeds from the sale by HomeGrocer.com of the shares of common stock at the assumed initial public offering price of $11.00 per share, after deducting underwriting discounts and commissions and estimated offering expenses.
January 1, 2000 -------------------------------- Pro Forma Actual Pro Forma As Adjusted -------- --------- ----------- (in thousands except share and per share amounts) Cash, cash equivalents and marketable securities.................................... $ 77,568 $ 77,568 $301,320 ======== ======== ======== Current portion of long-term obligations....... $ 4,061 $ 4,061 $ 4,061 ======== ======== ======== Long-term obligations, less current portion.... 17,790 17,790 17,790 -------- -------- -------- Shareholders' equity: Convertible preferred stock, $0.001 par value; authorized: 78,357,142 shares actual and pro forma, 10,000,000 shares pro forma as adjusted; issued and outstanding: 73,206,738 shares actual, none pro forma and pro forma as adjusted....................... 73 -- -- Common stock, $0.001 par value; authorized: 130,000,000 shares actual and pro forma, 1,000,000,000 shares pro forma as adjusted; issued and outstanding: 29,605,536 shares actual, 102,812,274 shares pro forma and 124,812,274 pro forma as adjusted........... 30 103 125 Additional paid-in capital................... 250,151 250,151 473,789 Notes receivable from officers for common stock....................................... (3,231) (3,231) (3,231) Deferred stock-based compensation............ (41,619) (41,619) (41,619) Accumulated deficit.......................... (93,257) (93,257) (93,257) -------- -------- -------- Total shareholders' equity................. 112,147 112,147 335,807 -------- -------- -------- Total capitalization..................... $129,937 $129,937 $353,597 ======== ======== ========
The common stock to be outstanding after this offering is based on shares outstanding as of January 1, 2000 and excludes: . options outstanding to purchase a total of 5,886,342 shares of common stock at a weighted average exercise price of $1.69 per share and an additional 14,287,122 shares of common stock available for grant under our existing stock option plans; and . warrants outstanding to purchase a total of 2,749,248 shares of common stock with a weighted average exercise price of $1.00 per share (of which warrants to purchase 2,015,666 shares were subsequently exercised). 20 DILUTION Our pro forma net tangible book value as of January 1, 2000 was $112.1 million or approximately $1.09 per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock outstanding, after giving effect to the conversion of all shares of outstanding preferred stock into 73,206,738 shares of common stock upon the closing of this offering. Pro forma net tangible book value per share excludes options and warrants outstanding as of January 1, 2000. Dilution in pro forma net tangible book value per share represents the difference between the amount per share paid by purchasers of shares of common stock in the offering made hereby and the net tangible book value per share of common stock immediately after the completion of this offering. After giving effect to the sale of the shares of common stock offered by us at the assumed initial public offering price of $11.00 per share and after deducting the underwriting discount and estimated offering expenses, the net tangible book value of HomeGrocer.com at January 1, 2000 would have been $335.8 million or approximately $2.69 per share. This represents an immediate increase in net tangible book value of $1.60 per share to existing stockholders as of January 1, 2000 and an immediate dilution of $8.31 per share to new investors of common stock in this offering. The following table illustrates this per share dilution: Assumed initial public offering price per share .................. $11.00 Pro forma net tangible book value before the offering........... $1.09 Increase attributable to new investors.......................... 1.60 ----- Pro forma net tangible book value after the offering.............. 2.69 ------ Dilution per share to new investors............................... $ 8.31 ======
The following table summarizes, as of January 1, 2000, the differences between the existing stockholders and new investors with respect to the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid.
Shares Purchased Total Consideration ------------------- -------------------- Average Price Number Percent Amount Percent Per Share ----------- ------- ------------ ------- ------------- Existing stockholders... 102,812,274 82.4% $186,196,000 43.5% $ 1.81 New investors........... 22,000,000 17.6 242,000,000 56.5 11.00 ----------- ----- ------------ ----- Totals................ 124,812,274 100.0% $428,196,000 100.0% =========== ===== ============ =====
The number of shares held by new public investors will be 22,000,000 or approximately 17.6% (25,300,000 shares, or approximately 19.7% if the underwriters' over-allotment option is exercised in full) of the total number of shares of common stock outstanding after this offering. See "Principal Stockholders" for a more detailed description of our stockholders prior to this offering. The tables above assume no exercise of stock options and warrants outstanding at January 1, 2000. As of January 1, 2000, there were: . options outstanding to purchase a total of 5,886,342 shares of common stock at a weighted average exercise price of $1.69 per share and an additional 14,287,122 shares of common stock available for grant under our existing stock option plans. . warrants outstanding to purchase a total of 2,749,248 shares of common stock with a weighted average exercise price of $1.00 per share (of which warrants to purchase 2,015,666 shares were subsequently exercised); and To the extent outstanding options and warrants are exercised, there will be further dilution to new investors. 21 SELECTED FINANCIAL DATA The selected financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements of HomeGrocer.com and the related notes included elsewhere in this prospectus. The selected statement of operations data set forth below for the period from January 15, 1997 (inception) to January 3, 1998 and for the fiscal years ended January 2, 1999, and January 1, 2000, and the selected balance sheet data as of January 3, 1998, January 2, 1999 and January 1, 2000 have been derived from the audited financial statements of HomeGrocer.com included elsewhere in this prospectus, which have been audited by Ernst & Young LLP, Independent Auditors. The selected balance sheet data as of January 3, 1998 has been derived from the audited financial statements of HomeGrocer.com not included in this prospectus, which has been audited by Ernst & Young LLP, Independent Auditors. The historical results are not necessarily indicative of results to be expected for any future period.
51 Weeks From January 15, 1997 52 Weeks Ended (Inception) to January 2, 52 Weeks Ended January 3, 1998 1999 January 1, 2000 ---------------- -------------- --------------- (in thousands, except share and per share amounts) Statement of Operations Data: Net sales...................... $ -- $ 1,094 $ 21,648 Cost of sales.................. -- 1,018 19,515 ----------- ----------- ----------- Gross profit................. -- 76 2,133 Selling, general, and administrative expenses, excluding stock-based compensation.................. 1,064 7,455 59,208 Stock-based compensation expense....................... 230 412 28,158 ----------- ----------- ----------- Loss from operations......... (1,294) (7,791) (85,233) Other income/(expense), net.... (61) (118) 1,240 ----------- ----------- ----------- Net loss..................... $ (1,355) $ (7,909) $ (83,993) =========== =========== =========== Basic and diluted net loss per share......................... $ (0.14) $ (0.72) $ (5.56) =========== =========== =========== Pro forma basic and diluted net loss per share (1)............ $ (1.28) =========== Weighted average shares outstanding used to compute basic and diluted net loss per share......................... 10,034,721 11,044,174 15,102,698 =========== =========== =========== Weighted average shares outstanding used to compute pro forma basic and diluted net loss per share (1)........ 65,382,807 ===========
As of ------------------------------------------------ January 3, 1998 January 2, 1999 January 1, 2000 --------------- --------------- --------------- (in thousands) Balance Sheet Data: Cash and cash equivalents and marketable securities....... $ 313 $1,084 $ 77,568 Working capital (deficit).... (1,296) 373 66,593 Total assets................. 997 3,558 146,929 Long-term obligations, less current portion............. -- 880 17,790 Total shareholders' equity (deficit).................... (643) 1,387 112,147
- -------- (1) See note 1 of notes to financial statements for an explanation of the determination of the number of weighted average shares used to compute pro forma net loss per share amounts. 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This prospectus contains statements of a forward-looking nature relating to future events or the future financial performance of HomeGrocer.com. Prospective investors are cautioned that such statements involve risks and uncertainties, and that actual events or results may differ materially. In evaluating such statements, prospective investors should specifically consider the various factors identified in this prospectus, including the matters set forth under the caption "Risk Factors," which could cause actual results to differ materially from those indicated by such forward-looking statements. Overview HomeGrocer.com is a retailer of grocery and other consumer products on the Internet. We operate our own state-of-the-art distribution system providing next-day home delivery of a wide range of products, including high quality food items, at prices competitive with local supermarket prices. Our goals are to expand nationally and to be our customers' preferred regular provider of household consumer products. We designed a standardized model for our customer fulfillment centers that we believe can be easily replicated in future locations. However, the ease of replication is highly dependent on the availability of suitable real estate in each new market. We believe that our core grocery business provides us with a strong platform to expand into other product and service areas. We commercially launched our Storefront at www.homegrocer.com and began delivering groceries to the Seattle market from our Bellevue, Washington customer fulfillment center in June 1998. We have rapidly expanded since our initial launch of service and currently serve customers in two additional markets: Portland, Oregon since May 1999 and Orange County/Los Angeles, California since September 1999. We relocated our Bellevue customer fulfillment center to a significantly larger and more automated facility in Renton, Washington on October 31, 1999, and opened second and third customer fulfillment centers in the Orange County/Los Angeles, California market in November 1999 and January 2000. We expect to begin service in eight to ten additional metropolitan areas, including Dallas, Texas; Southern Connecticut and nearby suburbs of New York City; San Diego, California; Atlanta, Georgia; Washington, D.C.; Chicago, Illinois; and the Bay Area, California in the next 12 months. We also expect to open additional customer fulfillment centers in the Orange County/Los Angeles area during 2000. Since our inception, we have devoted significant resources to the following activities: . developing our business plan; . designing, implementing and enhancing our Storefront; . recruiting and training a team of experienced employees; . designing and integrating business with technology; . designing, equipping and operating our customer fulfillment centers; . establishing relationships with our vendors; . promoting the HomeGrocer.com brand; and . raising capital. We have incurred net losses of $93.3 million from inception to January 1, 2000. We believe that we will continue to incur net losses for the foreseeable future and that the amount of these losses will increase significantly from current levels. Many of our first-time customers cite word-of-mouth and the visibility of our distinctive trucks in their neighborhoods as the foremost factors attracting them to our Storefront. Hence, sales in new markets increase gradually as word-of-mouth spreads and more people see our trucks. We have operated in the Seattle market for 20 months, and while revenues have grown steadily over this period, our Seattle operations are not yet cash flow positive. We believe that our operations in subsequent 23 markets will achieve positive operating cash flow faster than our Seattle operations, in part because of the knowledge obtained in the Seattle market. We also anticipate that increased customer acceptance of the Internet and the national growth in online grocery shopping will enable our revenues to grow at a more rapid pace in new markets. Many of the markets where we intend to begin operations in the next few years also have larger populations than the Seattle metropolitan area. As we expand our operations into new markets over the next several years, our business will consist of a mix of mature and new customer fulfillment centers. Our growth plans over the next several years are aggressive and will likely result in substantially greater losses from a large number of new facilities than the earnings anticipated from a smaller number of mature facilities. As such, we anticipate reporting substantial net losses over the next few years, with the magnitude of such losses being related to the speed, scope and success of our expansion plans. We estimate that our cash on hand and the estimated proceeds of this offering are sufficient to establish more than ten to 12 new customer fulfillment centers in new and existing markets. This takes into consideration the costs of leasehold improvements in each customer fulfillment center, the anticipated negative cash flows from each customer fulfillment center in its initial several quarters of operation and corporate overhead. We anticipate opening numerous additional customer fulfillment centers in each of the next several years. These expansion plans will require significantly more capital than the proceeds of this offering. If capital is not available at some future date at a reasonable cost, we may decide to reduce the number of new customer fulfillment centers that are developed by us in future years. We believe that a reduction in the speed or scope of our expansion could result in our achieving profitability at an earlier date than would otherwise be possible. However, the level of such profitability might ultimately be less than what might be achieved if capital is available and we are able to execute our entire expansion strategy. We have a limited operating history on which to base an evaluation of our business and prospects. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets like e- commerce. See "Risk Factors" for a more complete description of the many risks we face. Results of Operations In view of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of our operating results, including our 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. We report on a fiscal year basis that ends on the Saturday nearest December 31. Our financial results are summarized below.
Fiscal Fiscal Fiscal 1997 1998 1999 ------- ------- -------- (in thousands) Statement of Operations Data: Net sales......................................... $ -- $ 1,094 $ 21,648 Cost of sales..................................... -- 1,018 19,515 ------- ------- -------- Gross profit.................................... -- 76 2,133 Selling, general, and administrative expenses, excluding stock-based compensation............... 1,064 7,455 59,208 Stock-based compensation expense.................. 230 412 28,158 ------- ------- -------- Loss from operations............................ (1,294) (7,791) (85,233) Interest expense.................................. (61) (172) (384) Interest income................................... -- 54 2,232 Other expense..................................... -- -- (608) ------- ------- -------- Net loss........................................ $(1,355) $(7,909) $(83,993) ======= ======= ========
24 Fiscal 1998 vs. Fiscal 1999 Net Sales. Our sales, net of returns and promotional discounts, increased from $1.1 million in fiscal 1998 to $21.6 million in fiscal 1999. This increase in net sales resulted from the increase in the number of markets served, a full period of service in the Seattle market, an increase in the average number of orders per day and an increase in the average size in fiscal 1998 orders. The average order size in the Seattle market was $100 in fiscal 1999, compared to $93 for deliveries in fiscal 1998 since we launched our storefront in June 1998. The average number of orders delivered per day in the Seattle market was 241, 365, 426 and 625 in the first, second, third and fourth quarters of 1999, respectively, compared to 36 and 108 in the third and fourth quarters of 1998. Gross Profit. Our cost of sales consists of the cost of merchandise sold to customers, including inbound freight costs and free products. Gross profit increased from $76,000 in the 52 weeks ended January 2, 1999 to $2.1 million in the same period of the current year. The increase in gross profit was primarily due to increased sales volumes. As a percentage of net sales, gross profit increased from 6.9% in fiscal 1998 to 9.9% in fiscal 1999. We currently anticipate the gross profit percentage to be approximately 15% in the first year of operation for each customer fulfillment center. The total gross profit achieved each year will be dependent on the mix of new and mature centers. During the thirty-nine weeks ended October 2, 1999, our gross profit percentage was 18.1%. In the fourth quarter of 1999, temporary factors related primarily to the opening of three new fulfillment centers in the September through December timeframe resulted in a fourth quarter gross profit percentage of 1.5%. Our sales in the fourth quarter exceeded our combined sales of the prior three quarters, so the low gross profit percentage in the quarter had a disproportionate impact on the gross profit percentage for the year. Selling, General and Administrative. Our selling, general and administrative expenses include costs related to fulfillment and occupancy, delivery of products, customer service, advertising and promotional expenditures, information technology and administration, and corporate overhead. Selling, general and administrative expenses increased from $7.5 million in fiscal 1998 to $59.2 million in fiscal 1999. This increase was primarily due to increased payroll and other costs associated with operating four customer fulfillment centers during fiscal 1999 as compared to one customer fulfillment center that operated during only part of the prior year period. Payroll and other costs associated with operating our customer fulfillment centers, including delivery of products and customer service increased from approximately $1.4 million in fiscal 1998 to approximately $22.2 million in fiscal 1999. Advertising and promotional expenses increased from $1.0 million in fiscal 1998 to $7.7 million in fiscal 1999. Corporate overhead, including information technology and administration, increased from approximately $5.1 million in fiscal 1998 to approximately $29.3 million in fiscal 1999. Selling, general and administrative expenses are expected to continue to increase in absolute dollars as we continue to execute our expansion plans, aggressively market the HomeGrocer.com brand and continue enhancing and expanding our information systems. Stock-Based Compensation Expense. Stock-based compensation expense consists primarily of the amortization of deferred stock compensation resulting from the grant of stock options or sale of restricted stock at exercise or sale prices subsequently deemed to be less than the fair value of the common stock on the grant or sale date. We recorded total deferred stock-based compensation of $67.7 million for fiscal 1999 in connection with stock options granted and restricted stock issued during the period. This cost is being amortized to expense over the vesting periods of the applicable agreements, resulting in amortization of deferred stock-based compensation totaling $26.1 million for fiscal 1999. Additionally, $2.0 million of stock-based compensation expense was recorded in connection with stock options granted to outside consultants. The $41.6 million of deferred stock-based compensation for stock options and restricted stock issued through January 1, 2000 is expected to be amortized in the amounts of $23.9 million for fiscal year 2000, $11.6 million for fiscal year 2001, $5.1 million for fiscal year 2002 and $1.0 million for fiscal year 2003. Such amortization amounts assume that all vesting periods are completed by all employees; to the extent that unvested options are forfeited by an employee, previously recorded amortization related to the unvested options will be credited to stock-based compensation expense. 25 Interest Income. Interest income of $2.2 million in fiscal 1999 resulted from the investment of cash, cash equivalents and marketable securities. Such funds were provided primarily from our sale of equity. Interest Expense. Interest expense increased from $172,000 in fiscal 1998 to $384,000 in fiscal 1999 as a result of borrowing arrangements we entered into primarily to finance purchases of fixed assets and fund operations and expansion. Other Expense. Other expense of $608,000 in fiscal 1999 resulted primarily from the write-off of certain machinery and equipment due to the relocation of our Bellevue, Washington customer fulfillment center to Renton, Washington. Income Taxes. There was no provision or benefit for income taxes for any period since inception due to our operating losses. As of January 1, 2000, we had approximately $66.0 million of net operating loss carryforwards for federal income tax purposes, which expire beginning in 2017. In 1999, due to the issuance and sale of Series C preferred stock, we incurred an ownership change pursuant to applicable regulations under the Internal Revenue Code of 1986, as amended. Therefore, our use of $11.5 million of losses incurred through the date of these ownership changes will be limited to approximately $1.0 million per year during the carryforward period. Our anticipated initial public offering is not expected to cause an additional ownership change. We have provided a full valuation allowance on the deferred tax asset, consisting primarily of net operating loss carryforwards, because we believe there is substantial uncertainty as to our ability to use such tax loss carryforwards. Fiscal 1997 vs. Fiscal 1998 Fiscal 1997 was a 51-week year that commenced at inception on January 15, 1997 and ended on January 3, 1998 and fiscal 1998 was a 52-week year that ended on January 2, 1999. Net Sales. We commercially launched our storefront and began delivering to customers in the Seattle market in June 1998. We did not have any net sales in fiscal 1997. We had net sales of $1.1 million in fiscal 1998. Gross Profit. We did not have any gross profit in fiscal 1997. The fiscal 1998 gross profit of $76,000 is reflective of low sales volume and competitive pricing, as well as various types of promotional discounts and incentives offered to increase HomeGrocer.com brand awareness and loyalty. Selling, General and Administrative. Selling, general and administrative expenses increased from $1.1 million in fiscal 1997 to $7.5 million in fiscal 1998 primarily as a result of costs associated with launching our storefront and commencing delivery operations in June 1998. In fiscal 1998, we increased headcount in all functional areas, increased advertising and promotional expenditures and began leasing our first customer fulfillment center, delivery vehicles and corporate headquarters. Payroll and other costs associated with operating our first customer fulfillment center increased from $62,000 in fiscal 1997 to $1.4 million in fiscal 1998. Advertising and promotional expenses increased from $82,000 in fiscal 1997 to $1.0 million in fiscal 1998. Corporate overhead, including information technology and administration, increased from approximately $920,000 in fiscal 1997 to $5.1 million in fiscal 1998. Stock-Based Compensation Expense. Stock-based compensation expense related to stock options granted to outside consultants in exchange for services rendered increased by $182,000 from $230,000 in fiscal 1997 to $412,000 in fiscal 1998. Interest Income. We did not have any interest income in fiscal 1997. Interest income increased to $54,000 in fiscal 1998 as our average cash and cash equivalents balance increased. Funds for investment were provided primarily from the sale of equity. Interest Expense. Interest expense increased by $111,000 from $61,000 in fiscal 1997 to $172,000 in fiscal 1998 as a result of borrowing arrangements we entered into primarily to finance purchases of fixed assets and fund operating activities. 26 Liquidity and Capital Resources Since inception, we have financed our operations primarily through sales of preferred stock with net cash proceeds of $168.4 million through January 1, 2000. Net cash used in operating activities was $7.5 million and $45.7 million for fiscal 1998 and fiscal 1999, respectively. Net cash used in operating activities for each of these periods consisted primarily of our net losses, offset in part by non-cash charges and increases in accounts payable and other current liabilities. Net cash used in investing activities was $1.3 million and $81.5 million for fiscal 1998 and fiscal 1999, respectively. Net cash used in investing activities for both periods consisted of purchases of fixed assets and, for fiscal 1999, also consisted of purchases of marketable securities and an increase in deposits and restricted cash balances. The restricted cash balances were a result of deposits required to support letters of credit. Net cash provided by financing activities was $9.6 million and $165.9 million for fiscal 1998 and fiscal 1999, respectively. Net cash provided by financing activities consisted primarily of proceeds from sales of equity. As of January 1, 2000, we had $77.6 million of cash and cash equivalents and marketable securities. As of that date, our principal commitments consisted of minimum lease payments due under operating leases totaling approximately $92.2 million over 15 years, and agreements to purchase additional delivery vehicles in fiscal 2000 totaling approximately $35.6 million. On February 15, 2000, we entered into a marketing agreement with America Online with a commitment of approximately $60 million over four and a half years. We anticipate a substantial increase in our capital expenditures and lease commitments as we construct customer fulfillment centers and begin operations in new markets. We currently expect that the net proceeds of this offering, together with our available funds, will be sufficient to meet our anticipated needs for working capital and capital expenditures for the next 12 months. We have adequate cash available to fund our operations for the next 12 months without the proceeds from this offering, although it would require us to decrease corporate overhead and reduce or delay our current expansion plans. Our capital needs and the pace of our expansion plans are highly interdependent. We anticipate that, before the end of 2001, we will need to raise additional funds through the issuance of equity, debt or other securities or we will have to reduce our expansion plans. Such securities may have rights, preferences or privileges senior or equal to those of the rights of our common stock and our shareholders may experience dilution. We cannot be certain that additional financing will be available to us on acceptable terms when required, or at all. New Accounting Pronouncements In March 1998, the Accounting Standards Executive Committee issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires all costs related to the development of internal use software other than those incurred during the application development stage to be expensed as incurred. Costs incurred during the application development stage are required to be capitalized and amortized over the estimated useful life of the software. We adopted SOP 98-1 on January 3, 1999 and there was no significant impact on our financial position or operating results upon adoption. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities. SOP 98-5 requires costs of start-up activities and organization costs be expensed as incurred. We adopted SOP 98-5 on January 3, 1999 and there was no significant impact on our financial position or operating results upon adoption. In December 1999, the SEC staff released Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. SAB No. 101 did not impact the way we currently recognize revenue. 27 In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. 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. We do not expect that the adoption of SFAS No. 133 will have a material impact on our financial statements because we do not currently hold any derivative instruments. In January 2000, the Emerging Issues Task Force ("EITF") reached a consensus on EITF Statement No. 99-17 "Accounting For Barter Transactions" involving a nonmonetary exchange of advertising. This EITF consensus does not impact our results of operations as we do not have any advertising barter transactions. Year 2000 Issues The impact of the Year 2000 on our technology systems to date has been insignificant. The total cost associated with our Year 2000 remediation effort has not been material and is not expected to be material in future periods. On and after January 1, 2000, our customers were able to access our web site and we were subsequently able to assemble and deliver their orders. Quantitative and Qualitative Disclosure About Market Risk We maintain a short-term investment portfolio consisting of commercial paper with maturities of four months or less. Such securities are subject to interest rate risk and will rise and fall in value if market interest rates change. The extent of this risk is not quantifiable or predictable due to the variability of future interest rates. Our restricted cash is invested in certificates of deposit. There is inherent risk in these instruments as they mature and are immediately renewed at current market rates. The extent of this risk is not quantifiable or predictable due to the variability of future interest rates. We believe that the market risk arising from our holdings of financial instruments is not material. The following table provides information about our investment portfolio, restricted cash, capital lease obligations and long-term debt as of January 1, 2000, principal cash flows and related weighted average interest rates by expected maturity dates.
Year of Maturity ----------------------------------------------- Total After Carrying 2000 2001 2002 2003 2004 2004 Value ------- ------ ------ ------ ------ ------ -------- (dollars in thousands) Cash and cash equivalents............ $39,806 -- -- -- -- -- $39,806 Average interest rate.. 5.8% -- -- -- -- -- 5.8% Marketable securities... $37,762 -- -- $37,762 Average interest rate.. 5.9% -- -- -- -- -- 5.9% Restricted cash- certificates of deposit................ $ 7,932 -- -- -- -- -- $ 7,932 Average interest rate.. 5.9% -- -- -- -- -- 5.9% Capital lease obligations............ $ 3,081 $3,463 $3,440 $2,828 $1,628 $5,682 $20,122 Average fixed interest.............. 9.1% 9.2% 8.5% 8.2% 7.6% 7.6% 8.4% Long-term debt.......... $ 980 $ 535 $ 214 -- -- -- 1,729 Average fixed interest.............. 9.5% 9.5% 9.5% -- -- -- 9.5%
Cash and cash equivalents and marketable securities consist primarily of instruments with fixed rates of interest. Fair value approximates carrying value for the above financing instruments. 28 BUSINESS Overview HomeGrocer.com is a retailer of grocery and other consumer products on the Internet. We operate our own state-of-the-art distribution system providing next-day home delivery of a wide range of products, including high quality food items, at prices competitive with local supermarket prices. Our goals are to expand nationally and to be our customers' preferred regular provider of household consumer products. We have rapidly expanded since our initial launch of service in June 1998, and currently serve customers in three markets: Seattle, Washington; Portland, Oregon; and Orange County/Los Angeles, California. We expect to begin service in eight to ten additional metropolitan areas, including Dallas, Texas; Southern Connecticut, which will also serve some suburbs of New York City; San Diego, California; Atlanta, Georgia; Washington, D.C.; Chicago, Illinois; and the Bay Area, California in the next 12 months. In some of these markets, we may open more than one customer fulfillment center. We designed a standardized model for our customer fulfillment centers that we believe can be easily replicated in future locations. However, the ease of replication is highly dependent on the availability of suitable real estate in each new market. Our web site, www.homegrocer.com, features an extensive product selection, including fresh fruit, vegetables, dairy products, baked goods, meat and fish and a wide assortment of non-perishable items and household products. We also offer health and beauty products, wine and beer, fresh flowers, pet products, home office supplies, postage stamps, seasonal items and top-selling books, video games and movies. Our professional buyers purchase high quality products available from premium specialty suppliers and local sources, in addition to national suppliers. We believe that our emphasis on high-quality customer service has created significant brand awareness and loyalty for the HomeGrocer.com shopping experience. Since January 1, 1999, we have made deliveries to over 55,000 different households. Since January 1, 1999, approximately 64% of our orders have been from repeat customers and approximately 36,000 customers have placed an order at least two times. For the fiscal year ended January 1, 2000, our customers' average order size was approximately $99. We believe that our core grocery business provides us with a strong platform to expand into other product and service areas. Our management team has extensive technology, grocery and merchandising experience, as well as experience in developing national distribution and delivery systems. Amazon.com, our largest shareholder, will introduce our service to its customers residing in our service areas under our agreement with them. 29 Industry Growth of the Internet and E-Commerce The Internet has emerged as a mass market communications medium, enabling millions of users to obtain and share information, interact with each other and conduct business electronically. The increasing affordability of personal computers and Internet access, coupled with increasing speed, convenience and improvements in content, have led to rapid growth in Internet usage. Market research firm International Data Corporation estimates that the number of individuals in the United States using the Internet will increase from approximately 62.8 million at the end of 1998 to approximately 177.0 million at the end of 2003, representing a compound annual growth rate of over 23%. The chart below illustrates the historical and anticipated growth in the number of households with personal computers and Internet subscriptions. [The chart has two bars for each year from 1997 until 2002. The first bar is labeled "Total Households with PCs at End of Year" and the second bar is labeled "Total Households with Online Subscriptions at End of Year." There are labels on the right side of the chart indicating that the compounded annual growth rate is 27% for the first bar and 5% for the second bar. Below the chart is a caption that reads: "Source: International Data Corporation"] The Internet has also emerged as a significant channel for the electronic transaction of business or e-commerce. According to IDC, over the next five years the number of individuals in the United States making purchases online will increase at a compound annual growth rate of approximately 28% from 21.1 million in 1998 to 72.1 million in 2003. Forrester Research, another market research firm, has estimated that this growing group of consumers, with each individual making increasing amounts of online purchases, will cause total U.S. Internet retail commerce to grow from approximately $20.2 billion in 1999 to approximately $184.5 billion in 2004, representing a compound annual growth rate of over 55%. Traditional Grocery Retailing The grocery market is one of the largest retail segments of the U.S. economy. Retail supermarket sales were approximately $449 billion in 1998, according to the Food Marketing Institute. In addition, sales of over-the- counter medication and non-medication health and beauty products were approximately $57 billion in 1998 according to the National Association of Chain Drug Stores. Both markets are localized and fragmented. The retail industry has principally evolved into very large stores offering a wide variety of items. Typical large grocery stores, for example, offer from 15,000 to as many as 40,000 items, including many different sized packages of the same products. We estimate, based on the historical shopping patterns of our customers, that the typical household regularly purchases less than 200 different grocery items. Hence, on a typical shopping trip to a traditional store, the consumer must sort through thousands of items to locate the dozens of items to be purchased. Most traditional retailers compound this burden by positioning staple products in inconvenient locations within the store to induce impulse purchases while the consumer seeks the items on his or her shopping list. For example, milk is typically found at the back of a traditional store while the checkout counter is surrounded by candies, toys and magazines. This system is time-consuming and tiring for the consumer. 30 According to Andersen Consulting, the average customer at a traditional grocery store spent approximately 47 minutes per shopping trip in 1998, not including travel time. Traditional retail shoppers are also burdened with carrying shopping bags and bulky items to their cars and then again into their homes. Grocery shopping is inconvenient for many consumers and a particularly difficult experience for elderly persons, disabled individuals or parents with small children. According to a study conducted by the Food Marketing Department of Philadelphia's St. Joseph's University, two-thirds of U.S. consumers dislike the grocery shopping experience. Yet, according to A.C. Nielsen, the average U.S. household shops for groceries more than 100 times per year, spending, according to FMI, more than $4,500 per year. Based on the above data, the average U.S. household spends over 125 hours per year on a necessary task that most consumers dislike. The traditional grocery store format also creates numerous difficulties for the retailer. Grocery chains typically have distribution centers near each major city and multiple stores, each with a large parking lot, on expensive real estate throughout the metropolitan area. Large inventories must be maintained within each store in order to provide the consumer with the expected visual appearance. The size of such inventories can result in spoilage or less fresh product being sold to the consumer. Often, the ambient temperature and lighting that is preferred by the customer in such stores is not the ideal environment for the products themselves, particularly for meats, dairy products and produce. Additionally, fruits and vegetables, in particular are regularly handled by numerous employees and customers, resulting in significant product damage. Finally, each store must have a sufficient number of checkout and food service counters. The needs for staffing these areas can vary widely during the year, the week and the operating day. 31 Online Grocery Retailing Opportunity The evolution of the Internet and other computer technologies has created opportunities to provide a much more convenient shopping experience at prices similar to those available in traditional stores. Forrester Research estimates that online grocery spending in the United States will grow at a compound annual growth rate of 101% over the next five years, from $513 million in 1999 to $16.8 billion by 2004. Despite its size in absolute terms, this spending is expected to represent less than 5% of the total U.S. market for grocery products in 2004. Forrester Research also estimates that online sales of health and beauty products, another market that HomeGrocer.com addresses, will grow from $509 million in 1999 to $10.3 billion in 2004. Even at that level, online sales will represent only a small part of the total U.S. market for health and beauty products in 2004. Given the growing use of the Internet, online grocery retailers have the opportunity to expand rapidly into a void in a large marketplace. The chart below shows the total sizes of various retail segments in which products are offered by HomeGrocer.com. Currently, we offer only best-selling books and videos and we may not be able to sell alcoholic beverages in every market. [Bar chart entitled "Total U.S. Retail Market Segments" The chart contains eight bars that are labeled from left to right as follows: "Groceries(1)"; "Home Meal Replacements(2); "Over the Counter Medications/Health and Beauty Aids(3)"; "Wine/Beer/Spirits(4)"; "Books(5)"; "Pet Food/Pet Supplies(6)"; "Videocassettes(7)"; "Cut Flowers and Cut Greens(8)." Below the chart is a caption that reads: "Source: (1) Food Marketing Institute; (2) AC Nielsen; (3) IMS Health, National Association of Chain Drug Stores, A.C. Nielsen; (4) Adams Business Media; (5) American Association of Publishers; (6) Pet Industry Joint Advisory Council; (7) Paul Kagan Associates; (8) U.S. Department of Agriculture."] We believe online grocery retailing permits operators to offer a better shopping experience while having reduced capital and operating expenses compared to traditional retail stores. For example, our search, personal shopping list and checkout functions can greatly expedite the process of selecting and purchasing a customer's groceries. Meanwhile, online operators can also avoid many of the significant real estate, personnel and inventory costs of operating multiple stores in a particular area. 32 The HomeGrocer.com Shopping Experience We provide a compelling value proposition for our customers by providing high quality products at competitive prices in a convenient manner. The HomeGrocer.com shopping experience provides: Convenience. Our service makes it easy for consumers to restock their households. Our Internet ordering process, available 24 hours each day, seven days each week, allows our customers to shop whenever they want from their homes, offices or any location with Internet access. Customers then select a convenient time when they can be home to accept delivery. By offering a convenient alternative to a traditional store, we transform an unpleasant task into a fast, enjoyable shopping experience. High Quality Products. We focus on earning our customers' trust by delivering high quality products, especially perishable items such as meat, breads, fruits and vegetables. Before we enter a geographic market, we identify and establish relationships with high quality suppliers. We equip both our trucks and our customer fulfillment centers with ambient, refrigerated and frozen zones to ensure product freshness at the customer's door. Our personal shoppers, proprietary technology and distribution process ensure that our products are inspected for quality, handled fewer times than at least one of our online competitors, and stored in proper temperature settings, leading to improved product quality and reduced spoilage. For example, we designed our distribution process to handle our produce six times or less prior to delivery. In comparison, produce is handled an average of eight times before the customer receives it from one of our online competitors. In traditional grocery stores, customers may handle the produce countless times prior to its purchase. Competitive Prices. Our prices are competitive with local supermarket prices. We do not charge any membership fees or delivery fees for first-time orders or for subsequent orders over $75. Our efficient supply chain and proprietary technology allow us to provide free home delivery, while charging competitive prices for our products. Complete Product Offering. We offer a broad range of consumer products and strive to satisfy all of our customers' household needs. This includes offering a significant number of specialty products, such as premium pet supplies that generally are not available at traditional grocery stores, and products that reflect local market tastes. We have relationships with local suppliers in each of our markets. High Quality Customer Service. We seek to provide the best customer service at every opportunity. Our toll-free help line is staffed seven days each week from 8 a.m. to 11 p.m., and we strive to answer customer emails within four hours. Those customers who have shopped with us at least five times shop an average of approximately twice every four weeks. Each shopping experience concludes with a HomeGrocer.com delivery person interacting face-to-face with our customer, typically in our customer's kitchen. Our delivery staff is selected and trained to deliver friendly, efficient and reliable customer service. From January through December 1999, our on-time delivery rate was greater than 97%. Highly Interactive and Personalized Storefront. Our web site, which we call our Storefront, is designed to provide our customers with a convenient shopping experience. Our personalization features can reduce the average shopping time for a repeat shopper to as little as 10-15 minutes. Our Storefront enables a customer to quickly and easily reorder products from an automatically generated list, called the "My HomeGrocer List", or to create customized lists such as a weekly shopping list or diet-based list of favorite products. Customers can also order all of the ingredients for featured recipes with a single click. Accurate and Timely Fulfillment. Our technologies fully integrate our Storefront, warehouse management, inventory, billing and routing systems. Throughout the process, our proprietary software maintains a perpetual inventory of the items on the shelves of each customer fulfillment center, the precise location within the customer fulfillment center of each item, the items in each customer's tote and the location of each tote. This system ensures the accuracy and timeliness of delivery of each customer's order. 33 Growth Strategy HomeGrocer.com intends to establish itself as the leading provider of friendly, reliable home delivery of groceries. Our goal is to establish a long- term relationship with our customers and earn their trust to deliver other high quality products to their homes. Key elements of our growth strategy include: Accelerate National Expansion. We believe that a significant opportunity exists to expand our service into metropolitan areas across the United States. We currently offer service in Seattle, Washington; Portland, Oregon; and Orange County/Los Angeles, California. We intend to initiate delivery service in approximately eight to ten additional U.S. markets over the next 12 months including Dallas, Texas; Southern Connecticut, which will also serve some suburbs of New York City; San Diego, California; Atlanta, Georgia; Washington, D.C.; Chicago, Illinois; and the Bay Area, California. Although we had previously projected opening up to 20 customer fulfillment centers in the year 2000, we have revised this estimate based on our review of available real estate as well as our capital and human resources. In some markets, we anticipate that multiple customer fulfillment centers will be required to adequately serve demand. In those markets, we may open with a single "hub" customer fulfillment center servicing the entire metropolitan area. As demand grows, we may add additional customer fulfillment centers in those markets. Capitalize on Easily Replicated Model. By converting existing warehouse space or warehouses already under construction, we are able to establish operations in new markets more efficiently. We designed a standardized model for our customer fulfillment centers that we believe can be easily replicated in future locations. However, the ease of replication is highly dependent on the availability of suitable real estate in each new market. We can use an existing customer fulfillment center to begin to serve nearby areas and generate revenues, while we establish a new customer fulfillment center for that area. Our warehouse management system has been designed to be flexible to allow different product and warehouse configurations and to enable us to add new customer fulfillment centers on an aggressive rollout schedule. By opening three new facilities in three months during the fall of 1999, we have proven our ability to expand quickly and to operate in multiple locations. Extend Our Brand to Expand Market Share. We have positioned HomeGrocer.com as a leading brand for quality products and convenient, friendly and reliable delivery service. Through our television and radio advertising campaigns, community promotional activities, media relationships and the visibility of our logo on our trucks, we build and reinforce consumer recognition of our brand. We believe that becoming a reliable supplier of quality groceries to the home is a platform for us to expand our offerings into numerous other consumer products and services. Since inception, we have expanded our product offerings to include pet supplies, fresh flowers, health and beauty products, wine, postage stamps and top-selling books, video games and movies. We intend to continue to expand our product and service offerings in an effort to become an essential shopping resource for the home. Such additional products may include cookware and housewares, photo finishing and prepared meals. Maximize Delivery Density in Each Market. By providing excellent and reliable service and through direct marketing programs, we intend to build the density of our customer base in each market. This density is important in increasing the efficiency of the distribution network and creating a competitive advantage over our traditional and online competitors. Realize Economies of Scale and Purchasing Power. We have invested heavily in our Storefront and other technologies and have assembled a corporate team to plan and execute our national expansion. We expect that overhead expenses will not grow as rapidly as our revenue in future periods. Furthermore, as we grow, we intend to take advantage of our increased purchasing power to receive better pricing from our suppliers, to purchase more frequently directly from manufacturers rather than wholesalers and to expand our private label offerings, which have higher profit margins. HomeGrocer.com Operations There are three key operational aspects to HomeGrocer.com: our Storefront, our customer fulfillment centers and our delivery service with its integrated technology and distinctive trucks with the "Peach" logo. Our commitment to technology and our focus on satisfying our customers permeate our operations. 34 The HomeGrocer.com Storefront Our Storefront is a user-friendly, informative and personalized web site that enables users to quickly and easily navigate and purchase from a wide selection of items. Some of the key features of our Storefront are evident in the illustrations and description below: The "What's New" page is the home page for repeat shoppers. [Screen shot of HomeGrocer's "What's New" web site page.] The main shopping page currently features the major categories on the left, the items in a selected category in the center and a perpetual shopping basket on the right. [Screen shot of HomeGrocer's main shopping web site page] . The main shopping page allows access to all of the approximately 9,000 to 12,000 items, including different sized packages of the same products, in stock at the appropriate customer fulfillment center for the customer's zip code, using an intuitively organized list of categories. . The customer has an opportunity to see all products in a particular category before making a selection, similar to scanning the shelves of a traditional store. 35 . We provide high-quality pictures of products photographed in our in- house digital studio. . The "My HomeGrocer List" feature automatically lists items that the customer has purchased previously. Thus, after one or two shopping visits, the customer no longer has to sort through the entire available selection to find his or her most frequently purchased items. . The "What's New" section provides customers and suppliers with a merchandising format to highlight products and product categories. . The "Lists" function allows the customer to establish a standard weekly or monthly shopping list, making it easy for the customer to re-supply his or her kitchen with the household's standard items. . The "Search" feature allows the customer to quickly search the entire database for specific items. This supplants the process of physically searching through the aisles of a traditional store. . Throughout the shopping experience, the customer's screen contains a continuously updated list of the items in the customer's virtual shopping cart and the total cost of the order. . The "Recipes" function provides menu planning suggestions and allows the customer to order all of the ingredients for a recipe with a single click. . The customer's shopping cart is maintained at all times on our servers. If a customer's connection is interrupted or his or her personal computer is turned off, the shopping cart in progress is still intact for future ordering. This also allows the customer to use our site as a perpetual shopping list to accumulate items until he or she is ready to schedule a delivery. . The customer, either before or after shopping, can reserve a specific delivery window, which may be on the next day or at any time within the next two weeks. We currently use 90 minute delivery windows and, in fiscal year 1999 had on-time delivery rates of greater than 97%. . We currently offer delivery windows from 1:30 p.m. to 9:30 p.m. Monday through Friday, 9:30 a.m. to 4:00 p.m. on Saturday, and 1:30 p.m. to 8:00 p.m. on Sunday. . The customer can modify his or her order until 11:00 p.m. on the day prior to the scheduled delivery. Customer Fulfillment Centers We operate large customer fulfillment centers that are organized for efficient assembling of orders. Perishable items, such as meats, dairy products, produce and frozen foods, are kept in rooms with temperatures appropriate for each product. We locate our customer fulfillment centers in non-retail districts where real estate is considerably less expensive than the locations of most supermarkets. Given the size of our facilities and because there is no need to have surplus product for customer displays, our customer fulfillment centers can operate with less inventory relative to sales than traditional supermarkets and have higher inventory turnover. Our customer fulfillment centers also have fewer limitations on shelf space and are designed to serve a larger customer base than traditional supermarkets; therefore, we believe we can eventually offer a significantly larger selection of products than most traditional grocery stores. We currently operate customer fulfillment centers of approximately 100,000 square feet each in Renton, Washington, and Irvine, Fullerton and Azusa, California. We also operate a smaller customer fulfillment center of approximately 20,000 square feet in Tualatin, Oregon that, together with our Renton facility, serves customers in the Portland metropolitan area. Identical software systems are implemented at each customer fulfillment center, allowing for efficient central management and enabling the continued easy replication of our customer fulfillment center model across multiple locations. When operating near designed capacity, assuming a single shift, each full-sized customer fulfillment center, together with its related delivery infrastructure, should employ approximately 300 individuals. Our current facilities were originally designed to process 2,500 orders per day in a single shift operation based on numerous assumptions. The number of orders that can be delivered each day is sometimes constrained by the number of delivery vehicles and employees. To date, the most orders processed in one day by any of our 36 customer fulfillment centers is approximately 1,530. We have therefore not yet proven that our facilities are capable of assembling or delivering 2,500 orders per day. During the fourth quarter of 1999, our Seattle customer fulfillment center, which also fulfills the non-perishable portion of orders for the Portland market, averaged 941 orders per day. Our Irvine, California facility, which began operations on September 9, 1999 averaged 260 orders per day during the fourth quarter of 1999. Our Fullerton, California facility opened on November 17, 1999 and averaged 129 orders per day over its 42 days of operation in the fourth quarter of 1999. Our Technology and Delivery Systems We have invested heavily in proprietary and third party technologies that fully integrate our Storefront and our warehouse management, inventory and delivery routing systems. This integrated technology handles the complex logistics of thousands of available items, three temperature zones, multiple truck routes and numerous delivery windows. The core of this technology is our proprietary software that enables reliable and efficient transaction processing through Internet and application servers. This technology enables our Internet and application servers to scale up to large volumes of transactions at multiple locations. We designed our system to use technology to enhance the efficiency of personal shoppers assembling the customer orders in the warehouse. Personal shoppers wear wrist-mounted display devices that provide instructions from the system and direct the shopper, using the most efficient sequence, to the location of the specific customer items. A finger-mounted bar-code scanner confirms that the proper item was selected and has been placed into the correct customer's tote. We have successfully deployed this technology in all of our customer fulfillment centers in multiple markets. We have designed the process to establish new distribution operations quickly and efficiently and to increase volume without compromising product quality or order accuracy. We also employ a routing and scheduling system that manages the delivery of orders. Trucks deliver orders to assigned neighborhoods. Each route has timeslots that are 90 minute time windows in which orders are scheduled to be delivered. This system spreads the truck loads in an orderly manner. Once a delivery is scheduled, a route-planning feature of the system determines the most efficient route to deliver goods to the customer's home. Each aspect of this process is tightly integrated and enables us to provide high quality and timely service to our customers. Our drivers are our ambassadors of customer care. Selected and trained to be courteous and efficient, the drivers, if requested, carry the products directly into the customer's kitchen. Each driver is authorized to replace items or credit the customer's bill if the customer is not 100% satisfied. Drivers are forbidden to solicit or accept tips. Whenever possible, we schedule our drivers to visit the same neighborhoods on a regular schedule, thereby providing the drivers an opportunity to establish relationships with our regular customers. We believe the direct personal interaction between our employees and our customers, which is rare in the Internet industry, fosters the development of long-term relationships with our customers. Customer Care Ongoing customer support is important to our ability to establish and maintain long-term relationships with our customers. We seek frequent meaningful communication with our customers to enable us to continually improve our service. For example, a customer service representative calls each customer after the delivery of the first order to ensure his or her satisfaction. We also offer numerous automated help options on the Storefront and a rapid email response service. Our team of customer support and service personnel handle general customer inquiries, answer customer questions about the ordering process, and investigate the status of orders, deliveries and payments. Our customer service representatives are available through our toll free telephone number seven days each week from 8 a.m. to 11 p.m. Advertising Agreements HomeGrocer.com pursues advertising agreements to increase its access to online customers, build brand recognition and expand its online presence. To date, we have entered into the following advertising agreements: 37 Amazon.com. We have entered into a $10 million advertising agreement with Amazon.com that calls for Amazon.com to introduce our service to its customers residing in our service areas. We believe that the benefits of our relationship with Amazon.com include their introduction of our web site to their customers and the beneficial aspects of our being associated with one of the premier e- commerce companies. Amazon.com is our largest shareholder and David Risher, Amazon.com's Senior Vice President and General Manager, U.S. Retail, is a member of our board of directors. America Online. We have entered into a five year agreement with America Online, an Internet online service provider with over 21 million members, establishing HomeGrocer.com as AOL's primary and preferred provider of online grocer services on AOL and its affiliated networks. Our agreement provides for exclusivity in the online grocery sector on a limited number of AOL channels and expires in February 2005. In addition, AOL has agreed to promote and advertise HomeGrocer.com in online areas controlled by AOL and to deliver a minimum number of annual page views to the online areas promoting HomeGrocer.com. Over the five year term of the agreement, we are obligated to make payments totaling up to $60 million to AOL. Of this amount we paid $6 million in February 2000 and will pay $4 million quarterly in the year 2000 beginning in June and $3 million quarterly beginning March 2001 for the remaining term of the agreement. In addition we will pay a referral fee for each new customer above specified thresholds referred by AOL to us. AOL can reduce or eliminate the limited exclusivity at various times after twenty-four months in the event AOL has delivered specified numbers of impressions to HomeGrocer.com, in which case our payment obligations would be reduced. Marketing and Promotion Our marketing and promotion programs are designed to strengthen the HomeGrocer.com brand name, encourage trials of our service in our target markets, build strong customer loyalty, maximize repeat purchases and increase our average order size. We intend to build our brand name and customer loyalty through our 100% customer satisfaction guarantee, public relations programs, advertising campaigns, promotional activities and the visibility of our branded trucks and uniformed delivery employees in customer neighborhoods. Amazon.com, our largest shareholder, will introduce our service to its customers residing in our service areas under our agreement with them. We have recently begun television advertising to build consumer awareness for HomeGrocer.com. In addition, we utilize extensive radio advertising and direct mail programs to attract first-time shoppers. To encourage a second shopping experience and to demonstrate the high quality of our fresh produce, we provide a free bag of produce with every first-time order. The second shopping experience also allows a customer to experience the "My HomeGrocer List" feature, which is designed to make online shopping faster and more convenient with every subsequent purchase. We also conduct corporate and "Peach Party" marketing programs. Through our corporate programs, we offer employees of some Fortune 500 and other large corporations special incentives and discounts to encourage their use of our service. The "Peach Party" marketing programs involve a customer hosting a party for acquaintances and neighbors. We provide sample food and refreshments and a trained representative demonstrates the use of our Storefront. In the future, we expect to be able to provide, using collaborative filtering technology, increasingly targeted and customized services based on customer purchasing, preference and behavioral data generated through our Storefront. We believe that personalization of our services will significantly increase the value of our shopping experience for our customers. Supply Relationships We source products from a network of food, houseware and health and beauty aid manufacturers, wholesalers, brokers and distributors. We currently rely on rapid fulfillment from national and regional 38 distributors for a substantial portion of our products. In the Seattle and Portland markets, approximately 47% of our current product offerings are sourced through a single wholesaler, SuperValu. For our three new customer fulfillment centers in Orange County/Los Angeles, California, we are using Certified Grocers, who supplies approximately 50% of our current product offering in that market. We have no contractual relationship with either SuperValu or Certified Grocers that requires them to continue to supply our needs in the future. We purchase a number of top brands and high volume items directly from manufacturers and may increase our use of this direct purchasing as our product volumes increase with additional customer fulfillment centers. We also utilize premium specialty suppliers or local sources for gourmet foods, traditional and organic produce, bakery items, fish and meats and floral products. As of January 1, 2000, we were purchasing products from over 150 distributors and manufacturers. Competition We are the first major online grocery retailer to operate in the Seattle, Portland and Orange County/Los Angeles markets. However, the grocery retailing market is extremely competitive. Local, regional, and national grocery stores, independent food stores and supermarkets, as well as online grocery retailers, comprise our principal competition, although we also face substantial competition from convenience stores, liquor retailers, membership warehouse clubs, specialty retailers, supercenters, and drugstore chains. Many of our existing and potential competitors, primarily traditional grocers and retailers including Albertson's, Walmart, Safeway, Quality Food Centers and Kroger, are larger and have substantially greater resources than we do. We expect online competition from other online and traditional grocers and retailers to intensify in the future. Currently, our potential competitors include between five and ten online grocery retailers such as Webvan, Peapod, NetGrocer, HomeRuns, ShopLink.com and Streamline.com and an expanding number of traditional retailers entering the market. For example, in November 1999, Albertson's introduced an Internet based service in the Seattle area, and Webvan recently announced it will introduce its online grocery service in the Seattle area sometime in 2000. The number and nature of competitors and the amount of competition we will experience will vary over time and by market area. The principal competitive factors that affect our business are convenience, quality of products and service, breadth of product selection, price and customer loyalty to traditional and online grocery retailers. We believe that we compare favorably to other online grocery retailers with respect to each of these factors. However, many traditional grocery retailers may have substantially greater levels of customer loyalty and serve many more locations than we currently do. Consumers are often familiar with the layout of a specific traditional store and may be resistant to learning other layouts or shopping techniques. If we fail to effectively compete in any one of these areas, we may lose existing and potential customers. This could materially harm our business. Government Regulation In addition to regulations applicable to businesses generally or directly applicable to e-commerce, we are subject to a variety of regulations concerning the handling, sale and delivery of food, alcohol and tobacco products. Currently, we are not subject to regulation by the U.S. Department of Agriculture, or USDA. Whether the handling of food items in our distribution facility, such as meat and fish, will subject us to USDA regulation in the future will depend on several factors, including whether we sell food products on a wholesale basis or whether we obtain food products from non-USDA inspected facilities. Although we have designed our food handling operations to comply with USDA regulations, in the future the USDA may require changes to our food handling operations. We are also required to comply with local health regulations concerning the preparation and packaging of any prepared food items, such as deli salads that we prepare on site. Any applicable federal, state or local regulations may cause us to incur substantial compliance costs or delay the availability of a number of items at one or more of our customer fulfillment centers. In addition, any inquiry or investigation from a food regulatory authority could have a negative impact on our reputation. Any of these events could delay or impair our business and expansion plans and could cause us to lose customers. We will be required to obtain state, and in some cases county and municipal, licenses and permits for the sale of alcohol in each location in which we deliver. We cannot assure you that we will be able to obtain any 39 required permits or licenses in a timely manner, or at all. We may be forced to incur substantial costs and experience significant delays in obtaining these permits or licenses. In addition, the U.S. Congress is considering enacting legislation that would restrict the interstate sale of alcoholic beverages over the Internet. Changes to existing laws or our inability to obtain required permits or licenses could prevent us from selling alcohol or tobacco products in one or more of our geographic markets or a portion of those markets where a market extends over two or more licensing jurisdictions. In those locations where we cannot obtain alcohol permits or licenses, we will be unable to sell these items, which could hurt our business. In addition, it is possible that a number of laws and regulations may be adopted with respect to the Internet and e-commerce that could adversely affect the manner in which we currently conduct our business. In addition, the growth and development of the market for e-commerce may lead to more stringent consumer protection laws which may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. The U.S. government recently enacted Internet laws regarding privacy, copyrights, taxation and the transmission of sexually explicit material. The law of the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses or alter our business model. We are not certain how our business may be affected by the application of existing laws governing issues such as property ownership, copyrights, encryption and other intellectual property issues, taxation, libel and export or import matters. The vast majority of these laws were adopted prior to the wide use of the Internet. As a result, they do not contemplate or address the unique issues of the Internet and related technologies. Changes in laws intended to address these issues could create uncertainty in the Internet marketplace. This uncertainty could reduce demand for our services or increase the cost of doing business as a result of litigation costs or increased service delivery costs. Intellectual Property We regard patents, copyrights, service marks, trademarks, trade secrets and similar intellectual property as important to our success. We rely on patent, trademark and copyright law, trade secret protection and confidentiality or license agreements with our employees, customers, partners and others to protect our proprietary rights; however, the steps we take to protect our proprietary rights may be inadequate. We have a registered trademark in the United States for "HomeGrocer," and have filed trademark registration applications for the marks "HomeGrocer.com," "Peach Party," the HomeGrocer.com logo in the United States and abroad. We have also filed a trademark application for our slogan "here comes the grocery store" in the United States. On January 10, 2000, we filed three provisional patent applications with the U.S. Patent and Trademark Office. From time to time, we may file additional patent applications directed to aspects of our proprietary technology. We currently have no patents protecting our technology. We cannot assure you that any of our pending patent applications will be approved, that any issued patents will protect our intellectual property or that any issued patents or trademark registrations will not be challenged by third parties. Employees As of January 1, 2000, we had 1,064 employees, consisting of 128 employed in the information technology area, 72 in operations and administration, 38 in merchandising, 23 in marketing and 803 at our customer fulfillment centers and performing related delivery services. We expect to hire additional personnel as we expand operations and staff additional customer fulfillment centers. We expect to hire between 4,000 and 5,000 additional employees in the next year. Although some companies that operate in the trucking, warehouse and grocery industries are subject to collective bargaining agreements, we are not currently represented by a labor union. We have not experienced any work stoppages and consider our employee relations to be good. 40 Development of Our Business We believe that due to our current cash position, which includes the proceeds from the sale of our preferred stock in September, October and November of 1999, and our flexibility with respect to the number and timing of additional customer fulfillment centers we open, the net proceeds of this offering, together with our available funds, will be sufficient to meet our anticipated needs for working capital and capital expenditures through the next 12 months. Our future capital needs will be highly dependent on the pace of our expansion plans while conversely our expansion plans may be affected by the availability and cost of capital. During the next few years, we expect a substantial increase in our capital expenditures and lease commitments as we equip customer fulfillment centers and begin operations in new markets. Our expansion will result in a material increase in our number of employees as we staff our new customer fulfillment centers and add personnel engaged in systems development and technology, operations, marketing and merchandising. Legal Proceedings From time to time, we may be involved in litigation relating to claims arising out of our ordinary course of business. On January 7, 2000, a personal injury action was filed against us in the Superior Court of California for Orange County. The plaintiffs are seeking compensatory damages in the amount of approximately $3.2 million plus loss of earnings and future earning capacity resulting from a motor vehicle accident involving one of our delivery trucks. We believe our insurance policies will cover us for any damages awarded to plaintiffs. On February 28, 2000, CNA Industrial Engineering, Inc. filed suit against HomeGrocer.com in Superior Court of Washington for King County to collect $473,357 which it claims it is owed for consulting, design and installation services. We dispute the amount claimed and intend to vigorously defend the lawsuit. Facilities Our corporate offices are located in Kirkland, Washington where we lease approximately 81,000 square feet. We lease approximately 72,000 square feet of that space under a lease that expires in 2004, with an option to renew for two additional five-year terms. We sublease from another tenant the remaining approximately 9,000 square feet of space under a sublease that expires in 2008, with no option to renew. Of this 81,000 square feet, we currently occupy approximately 64,000 square feet and sublease approximately 17,000 square feet to another tenant under a sublease that expires in August 31, 2000. We anticipate we will require additional office space in the future to accommodate our growth. We lease approximately 320,000 square feet for our Renton, Washington customer fulfillment center under a lease that expires in 2007, with an option to renew for an additional five years. We currently sublease approximately 200,000 square feet of this space to third parties. We also lease an aggregate of approximately 1,677,000 square feet for our current and future customer fulfillment centers in the Portland, Oregon; Southern California; Dallas, Texas; San Diego, California; Stamford, Connecticut; Atlanta, Georgia; Washington, D.C.; Chicago, Illinois; and the Bay Area, California markets under leases that expire from 2009 to 2015. We are evaluating sites and negotiating leases for customer fulfillment centers in additional markets. Although we expect those sites to be available, we cannot assure you that suitable sites will be available on commercially reasonable terms. We do not own any real estate and we expect, wherever possible, to lease customer fulfillment centers in the additional markets we enter. Environmental Matters We are subject to various environmental laws and regulations governing the maintenance of our vehicles, the operation of real property, and the generation, storage, use, emission, discharge, transportation and disposal of oil or other hazardous materials, and the health and safety of our employees. These laws may impose liability even if we did not know of, or were not responsible for, the contamination or other damage. Based on current information, however, we are aware of no liabilities under environmental laws which would be expected to have a material adverse effect on our business, results of operations or financial condition. 41 MANAGEMENT Executive Officers and Directors The names and ages of the executive officers and directors of HomeGrocer.com as of January 1, 2000 are as follows:
Name Age Position(s) ---- --- ----------- Mary Alice Taylor........... 49 Chief Executive Officer and Chairman of the Board J. Terrence Drayton......... 39 President and Director Daniel R. Lee............... 43 Senior Vice President and Chief Financial Officer Mary B. Anderson............ 44 Vice President of Finance Rex L. Carter............... 47 Senior Vice President of Systems Development & Technology Ken Deering................. 40 Vice President of Storefront Robert G. Duffy............. 39 Chief Information Officer Corwin J. Karaffa........... 45 Senior Vice President of Operations Jonathan W. Landers......... 47 Senior Vice President of Marketing and Sales Daniel J. Murphy............ 53 Vice President of Merchandising David A. Pace............... 40 Senior Vice President of People Capability Kristin H. Stred............ 40 Senior Vice President, General Counsel and Secretary Tom A. Alberg(1)............ 59 Director Charles K. Barbo............ 58 Director James L. Barksdale(2)....... 56 Director Mark P. Gorenberg(1)........ 44 Director Jonathan D. Lazarus(2)...... 48 Director Douglas Mackenzie(2)........ 40 Director David Risher(1)............. 34 Director Philip S. Schlein........... 65 Director
- -------- (1) Member of the Audit Committee (2) Member of the Compensation Committee Mary Alice Taylor has served as chairman and chief executive officer of HomeGrocer.com since September 1999. Prior to joining HomeGrocer.com, Ms. Taylor served as corporate executive vice president of Global Operations and Technology for Citigroup, a financial services organization, from January 1997 to September 1999 where she was responsible for standardizing and centralizing worldwide operations and leading quality and cost-effectiveness efforts. From June 1980 until January 1997, Ms. Taylor held various positions with Federal Express, an overnight courier service, serving most recently as senior vice president of Ground Operations where she was responsible for all aspects of pickup and delivery operations in North America. Prior to her positions at Citigroup and Federal Express, from 1977 to 1980 she was the financial planning manager of U.S. Operations with Northern Telecom, Inc., a telecommunications company, From 1973 to 1977 Ms. Taylor was the controller at Cook Investment Properties, a division of Cook Industries and from 1971 to 1973, Ms. Taylor served as senior accountant, oil and gas explorations with Shell Oil. Ms. Taylor also serves as a director on the boards of Autodesk, a supplier of PC design software, and Dell Computer. Previously she served on the boards of The Perrigo Company, a manufacturer of store brand items, and Allstate Insurance Company. Ms. Taylor holds a B.A. in finance from Mississippi State University and is a Certified Public Accountant. J. Terrence Drayton co-founded HomeGrocer.com and has served as its president since the incorporation of its predecessor in January 1997. Mr. Drayton also served as chief executive officer of HomeGrocer.com from January 1997 until September 1999. From February 1996 through January 1997, Mr. Drayton was the President of Terran Ventures, Inc., a venture capital and consulting company, where he focused on activities leading to the formation of HomeGrocer.com's predecessor company. Prior to co-founding HomeGrocer.com, Mr. Drayton was involved for more than ten years as co-founder and senior manager of two of the leading 42 bottled water companies in Canada. From November 1991 to January 1996, Mr. Drayton was the president of the home and office division of Aquaterra, a Canadian bottled water company producing the brand names Crystal Springs and Labrador. From September 1989 through September 1991 Mr. Drayton served as chairman and chief executive officer of Telepost Communications, a publicly traded Canadian film and video post-production company. From March 1986 to May 1989 Mr. Drayton was the co-founder, executive vice president and co-chief executive officer for Laurentian Spring Valley Water. He holds a B.Comm. from the University of Calgary and an M.B.A. from York University. Daniel R. Lee joined HomeGrocer.com as chief financial officer in November 1999 and was also appointed senior vice president in December 1999. From February 1992 to September 1999, Mr. Lee served as chief financial officer, treasurer and senior vice president of finance and development for Mirage Resorts, a publicly traded company (NYSE:MIR) that develops and operates large- scale resort hotels. From February 1990 to February 1992, he was a director of equity research for CS First Boston, an investment bank. From July 1980 to February 1990, he held various positions with the investment bank Drexel Burnham Lambert, most recently as a managing director. Mr. Lee holds a B.S. and an M.B.A., both from Cornell University, and he is a Chartered Financial Analyst. Mary B. Anderson joined HomeGrocer.com as a full-time consultant in February 1999 and has served as vice president of finance since August 1999. Prior to joining HomeGrocer.com, Ms. Anderson was executive vice president and chief financial officer of CyberSafe, an enterprise network security software company, from June 1997 to November 1998. From June 1995 to June 1997, Ms. Anderson served as chief financial officer and vice president of business operations at AT&T Wireless Services, Wireless Data Division; a telecommunications company, (formerly McCaw Cellular Communications). From April 1991 to June 1995, Ms. Anderson served as vice president of finance for McCaw Cellular Communications and LIN Broadcasting, each a telecommunications company. From June 1979 to April 1991 she served in various capacities at Seafirst Bank, most recently as senior vice president. Ms. Anderson holds a B.S. in Management from Purdue University and an M.B.A. from the University of Washington. She is also a Washington State Certified Public Accountant. Rex L. Carter has served as vice president of systems development and technology of HomeGrocer.com since November 1999 and was also appointed senior vice president in December 1999. Prior to joining HomeGrocer.com, from February 1993 to November 1999, Mr. Carter was with the Carlson Companies, an owner and operator of hotels, restaurants and travel agencies, most recently serving as senior vice president and chief information officer. From May 1991 to February 1993, Mr. Carter was a senior manager with EDS (Electronic Data Systems), an information technology consulting firm. From September 1978 to May 1991, Mr. Carter held a variety of officer positions, including vice president of telecommunications and technology centers, for the subsidiary companies of Texas Air Corporation, now known as Continental Airlines. From 1974 to 1978, Mr. Carter held the positions of consultant and senior consultant with Booz, Allen & Hamilton, management consultants. Mr. Carter holds a B.S. in engineering from Purdue University. He also attended Xavier (Ohio) Graduate School of Business and is a registered Professional Engineer with the State of Ohio. Ken Deering co-founded HomeGrocer.com. Since inception, he has held several positions with HomeGrocer.com and its predecessor, including marketing manager from August 1996 to October 1997, vice president of business development from October 1997 to May 1999 and vice president of storefront from May 1999 to the present. Prior to his involvement with HomeGrocer.com, Mr. Deering was an independent management consultant through his firm, Heldeer Ventures, from August 1994 to August 1996. From January 1992 to July 1994, Mr. Deering held the positions of general manager and then vice president of sales and marketing for Offshore Systems, a developer of electronic marine positioning systems. Over the prior 12 years, Mr. Deering held various marketing and operations positions, including six years at Glenayre Technologies, a developer of software for wireless personal communication systems. Mr. Deering has a sales and marketing management diploma from the University of British Columbia. Robert G. Duffy joined HomeGrocer.com in June 1998 as its chief technology officer and since September 1998 has served as its chief information officer. From January 1998 to May 1998, Mr. Duffy was a 43 management consultant at Analytical Software, a technology consulting firm, where he led the technology initiatives that launched HomeGrocer.com. From March 1993 to December 1997, Mr. Duffy was a management consultant and one of the founders of the systems integration practice of BEST Consulting where he provided management and technology consulting services to various Fortune 100 companies. From October 1985 to February 1993, he worked for Andersen Consulting, a management consulting company, and co-founded Andersen's Workstation Technology Group where he managed the development of a high volume perishables warehouse management system. From May 1983 to September 1985, he was a software engineer with NASA's Johnson Space Center. Mr. Duffy has a B.S. in applied mathematics/operations research from the University of Tulsa's College of Engineering. Corwin J. Karaffa has served as vice president of operations of HomeGrocer.com since September 1999 and was appointed senior vice president in December 1999. Before joining HomeGrocer.com, from January 1995 to August 1999, Mr. Karaffa was the vice president of distribution of Certified Grocers of California, a retailer-owned grocery cooperative serving 2,700 retail stores. From March 1985 to January 1995, Mr. Karaffa held various management positions with Procter & Gamble, a manufacturer of household consumer products, most recently as manager of distribution development. From June 1977 to March 1985, Mr. Karaffa was a U.S. Naval aviator. Mr. Karaffa has a B.S. in political science from the United States Naval Academy in Annapolis, Maryland. Jonathan W. Landers has served as vice president of marketing and sales for HomeGrocer.com since November 1998 and was appointed senior vice president in December 1999. Prior to joining HomeGrocer.com, Mr. Landers was the vice president of marketing for Norm Thompson Outfitters, Inc., a consumer specialty retailer of high quality merchandise, in Hillsboro, Oregon from May 1997 to November 1998. From April 1992 to April 1997, Mr. Landers was vice president of corporate marketing and new business development for the National Geographic Society in Washington D.C. From October 1991 to March 1992, he was interim vice president of corporate marketing for Russell Athletic, a clothing manufacturer, in Alexander City, Alabama. From February 1989 to December 1991, Mr. Landers was the president and chief executive officer of Neuhaus (U.S.A.), a Belgian chocolate retailer, in Port Washington, New York and from August 1983 to January 1989, Mr. Landers held various positions within Sara Lee subsidiaries including Hanes, a manufacturer of cotton goods, and Coach Leatherware, a specialty retailer of leather goods. Mr. Landers holds a B.A. in government from Bowdoin College and an M.B.A. from Columbia University. Daniel J. Murphy has served as vice president of merchandising for HomeGrocer.com since May 1999. Prior to joining HomeGrocer.com, from October 1998 to May 1999, Mr. Murphy was vice president of U.S.A., Retail Client Services for Inter-Act Systems, a provider of electronic coupon technology to manufacturers and retailers. Prior to that, from October 1997 to October 1998, Mr. Murphy was vice president of sales and merchandising for Super Fresh Food Markets. From July 1989 to October 1997, he was vice president of sales and merchandising for Shop Rite Supermarkets, a subsidiary of Wakefern Food Corporation. From May 1985 to July 1989, Mr. Murphy was the director of merchandising for Wakefern Food Corporation, a member-owned food cooperative, and from September 1979 to May 1985, he was the director of chain store sales for The Coca-Cola Bottling Co. of New York. He holds a B.A. in business administration and a B.S. in secondary education from John F. Kennedy College. David A. Pace joined HomeGrocer.com in September 1999 as vice president of people capability, with primary responsibility for human resources, and was appointed senior vice president in December 1999. Prior to joining HomeGrocer.com, from October 1997 to September 1999, Mr. Pace was with Tricon Restaurants International, a restaurant management company, most recently as senior vice president of human resources. Prior to his position with Tricon, from June 1981 to October 1997, Mr. Pace was with PepsiCo, a beverage and restaurant company, throughout the United States, Africa, Middle East and Europe, most recently as senior vice president, Human Resources for PepsiCo Restaurants International. Mr. Pace holds a B.S. in industrial and labor relations from Cornell University. Kristin H. Stred joined HomeGrocer.com as vice president and general counsel in September 1999 and was appointed senior vice president in December 1999. Prior to joining HomeGrocer.com, from July 1992 to 44 September 1999, Ms. Stred held various positions with Shurgard Storage Centers, a developer of self-storage properties, and its predecessor companies, where she was most recently senior vice president and general counsel. From October 1991 to July 1992, she was an attorney with Boeing and from July 1987 to September 1991, Ms. Stred was assistant general counsel at King Broadcasting, a regional broadcasting company. From June 1984 to July 1987, she practiced law at Garvey, Schubert & Barer, a Seattle based law firm. Ms. Stred holds a B.A. in history and a J.D., both from Harvard University. Tom A. Alberg has served as a director of HomeGrocer.com since June 1998 as Madrona Investment Group's designee under a voting agreement that will expire upon effectiveness of this offering. He has been a principal of Madrona Investment Group, a venture investment firm focused on capital investments in early stage technology companies, since January 1996 and a managing director of Madrona Venture Fund, a venture capital fund, since October 1999. Prior to that time, Mr. Alberg was the President and a director of LIN Broadcasting, a cellular telephone company, from April 1991 to October 1995, and an Executive Vice President of AT&T Wireless Services, formerly McCaw Cellular Communications, from July 1990 to October 1995. Prior to July 1990, Mr. Alberg was chairman of the executive committee and a partner in the law firm of Perkins Coie in Seattle. Mr. Alberg is also a director of Active Voice, a provider of unified messaging and computer telephony software, Advanced Digital Information, a hardware and software based data storage solutions company, Amazon.com, an Internet retailer of books and other consumer products, Emeritus, an assisted living community company, Teledesic, a telecommunications network provider, and Visio Corporation, a diagramming software provider. Mr. Alberg received his B.A. from Harvard University and his J.D. from Columbia University. Charles K. Barbo has served as a director of HomeGrocer.com since October 1997. In 1972, Mr. Barbo co-founded the predecessor of Shurgard Storage Centers, a developer of self-storage properties, and served most recently as president and chairman of the board until March 1995 when he became chairman and chief executive officer of Shurgard Storage Centers. Mr. Barbo is a graduate of the Owner/President Management Program of Harvard Business School and has a B.A. in history from the University of Washington. James L. Barksdale has served as a director of HomeGrocer.com since April 1999 as The Barksdale Group's designee under a voting agreement that will expire upon effectiveness of this offering. Mr. Barksdale has been managing partner of The Barksdale Group, an investment and advisory group, since May 1999. He was president and chief executive officer of Netscape Communications from January 1995 until March 1999, when Netscape was acquired by America Online. From January 1992 to December 1994, Mr. Barksdale served as president and chief operating officer of AT&T Wireless Services, Wireless Data Division (formerly McCaw Cellular Communications), and from September 1994 to December 1994 also served as the chief executive officer. Prior to that, from April 1983 to January 1992, he served as executive vice president and chief operating officer of Federal Express, an overnight courier service, and from 1979 to 1983 he served as the chief information officer. Mr. Barksdale is also a director of 3Com, a provider of information access products and network systems; Liberate Technologies, a provider of software delivering Internet content to television sets; Federal Express, Robert Mondavi, a winery; Respond.com, an online shopping service; Sun Microsystems, a provider of Internet hardware, software and services; and America Online, a provider of Internet services. Mr. Barksdale holds a B.A. in business from the University of Mississippi. Mark P. Gorenberg has served as a director of HomeGrocer.com since March 1999 as Hummer Winblad Venture Partners' designee under a voting agreement that will expire upon effectiveness of this offering. Since July 1993, Mr. Gorenberg has been a general partner of Hummer Winblad Venture Partners, an investment partnership, and, from July 1990 to June 1993, Mr. Gorenberg was an associate of Hummer Winblad Venture Partners. Prior to joining Hummer Winblad Venture Partners, Mr. Gorenberg was a senior software manager in Advanced Product Development at Sun Microsystems. Mr. Gorenberg is also a director of AdForce, a provider of online advertisement management services, and seven private companies. Mr. Gorenberg received a B.S. in electrical engineering from the Massachusetts Institute of Technology, an M.S. in electrical engineering from the University of Minnesota and an M.S. in engineering management from Stanford University. 45 Jonathan D. Lazarus has served as a director of HomeGrocer.com since September 1998. Since retiring from Microsoft in September 1996, Mr. Lazarus has spent most of his time working with small companies who are exploring the commercial entrepreneurial opportunities of the Internet and personal computing. From July 1988 to September 1996, Mr. Lazarus worked at Microsoft, where he served most recently as vice president, strategic relations. Mr. Lazarus currently serves on the boards of directors of Ziff-Davis, a technology media and marketing company; DataChannel, a XML-based enterprise information portal provider; and Vision Solutions, a developer of information management software. Mr. Lazarus holds a B.S. in communications from Temple University. Douglas Mackenzie has served as a director of HomeGrocer.com since September 1998 as Kleiner Perkins Caufield & Byers's designee under a voting agreement that will expire upon effectiveness of this offering. Mr. Mackenzie has been a partner with Kleiner Perkins Caufield & Byers, a venture capital firm, since 1992. Currently, Mr. Mackenzie also serves on the boards of directors of Visio Corporation, a diagramming software provider; Marimba, a provider of Internet management software; Pivotal Corporation, a developer of e-commerce solutions; and E.piphany, a provider of real-time analytical applications. Mr. Mackenzie holds an A.B. in economics and an M.S. in industrial engineering, both from Stanford University, and an M.B.A. from Harvard Business School. David Risher has served as a director of HomeGrocer.com since April 1999 as Amazon.com's designee under a voting agreement that will expire upon effectiveness of this offering. From February 1997 to the present, Mr. Risher has held several positions at Amazon.com., an Internet retailer of books and other consumer products, where he is presently the senior vice president of product development. From July 1991 to February 1997, Mr. Risher held a variety of marketing and project management positions at Microsoft, most recently as founder and product unit manager for MS Investor, Microsoft's web site for personal investment. Mr. Risher received his B.A. in comparative literature from Princeton University and an M.B.A. from Harvard Business School. Philip S. Schlein has served as a director of HomeGrocer.com from October 1997 to December 1997 and from April 1998 through the present. Mr. Schlein has been a general partner, and subsequently a venture partner, of U.S. Venture Partners, a venture capital firm, since April 1985. Mr. Schlein held various executive positions with Macy's, a retail department store, from 1957 to 1973 and was president and chief executive officer of Macy's California division from 1974 to 1985. Additionally, Mr. Schlein currently serves as a director of bebe stores, a women's specialty clothing retailer; Ross Stores, a discount department store; Xoom.com, a direct e-commerce retailer; Burnham Pacific, a real estate investment trust; and Quick Response Services, a provider of business-to-business e-commerce services. Mr. Schlein holds a B.S. in economics from the University of Pennsylvania. Board Composition Our bylaws currently authorize ten directors and we have ten directors on our board. Each director is elected for a period of one year at the annual meeting of stockholders and serves until the next annual meeting or until a successor is duly elected and qualified. Our executive officers serve at the discretion of our board of directors. There are no family relationships among any of our directors or executive officers. Our board of directors will be divided into three classes effective upon an amendment to our articles of incorporation which will occur upon the closing of the offering. The Class I directors, James L. Barksdale, Mark P. Gorenberg, and Philip S. Schlein, will serve an initial term until the 2000 annual meeting of stockholders, the Class II directors, Charles K. Barbo, J. Terrence Drayton, Jonathan D. Lazarus and Douglas Mackenzie, will serve an initial term until the 2001 annual meeting of stockholders, and the Class III directors, Tom A. Alberg, David Risher and Mary Alice Taylor, will serve an initial term until the 2002 annual meeting of stockholders. Each class will be elected for a three-year term following its initial term. 46 Board Compensation We reimburse directors for reasonable out-of-pocket expenses incurred in attending meetings of the board of directors. Directors are also eligible to participate in our 1997 stock incentive compensation plan and our 1999 stock incentive plan, and beginning as of the effective date of this offering, they will be eligible to participate in our 1999 Directors' Stock Option Plan and in our 1999 Employee Stock Purchase Plan. All of our 1999 plans are subject to stockholder approval, which we expect to receive prior to the closing of this offering. See "Stock Plans." Pursuant to our 1997 stock incentive compensation plan, in April 1998, Mr. Barbo was granted an option to purchase 500,000 shares of common stock and an additional option to purchase 200,000 shares of common stock, each with an exercise price of $0.25 per share; in April 1998, Mr. Schlein was granted an option to purchase 200,000 shares of common stock at an exercise price of $0.25 per share; in June 1998, Mr. Alberg was granted an option to purchase 200,000 shares of common stock at an exercise price of $0.25 per share; in November 1998, Mr. Lazarus was granted an option to purchase 200,000 shares of common stock at an exercise price of $0.25 per share; and in April 1999, Mr. Barksdale was granted an option to purchase 200,000 shares of common stock at an exercise price of $0.45 per share. Each of these options is fully vested and exercisable at this time. Board Committees In April 1998, the board established an audit committee and a compensation committee. The audit committee reviews our annual audit, meets with independent auditors and oversees the effectiveness of financial management practices. The audit committee currently consists of Tom A. Alberg, Mark P. Gorenberg and David Risher. The compensation committee recommends compensation for senior management to the board and administers our stock plans. The compensation committee currently consists of James L. Barksdale, Jonathan D. Lazarus and Douglas Mackenzie. Compensation Committee Interlocks and Insider Participation No interlocking relationship exists between our board of directors or compensation committee and the board of directors or compensation committee of any other company, nor has any interlocking relationship existed in the past. 47 Executive Compensation The following table provides summary information concerning the compensation received for services rendered to HomeGrocer.com during the fiscal years ended January 2, 1999 and January 1, 2000 by our chief executive officer and each of the other most highly compensated executive officers whose aggregate compensation during fiscal years 1998 and 1999 exceeded $100,000. Throughout this prospectus, we refer to the following officers as our named executive officers. Summary Compensation Table
Long-Term Compensation Annual Compensation Awards -------------------------------------------- ------------ Securities Name and Principal Fiscal Other Annual Underlying Positions Year Salary ($) Bonus ($) Compensation ($) Options (#) - ------------------ ------ ---------- --------- ---------------- ------------ Mary Alice Taylor(1).... 1999 $63,846 $ -- $29,316 4,500,000 Chief Executive Officer and Chairman of the Board J. Terrence Drayton(2).. 1999 172,446 -- 8,740 1,650,000 President, Director and 1998 81,411 -- -- -- Former Chief Executive Officer Ken Deering............. 1999 131,388 41,137 4,596 200,000 Vice President of 1998 Storefront 99,539 43,468 -- 520,000 Robert G. Duffy......... 1999 124,788 38,438 92 100,000 Chief Information 1998 Officer 69,231 9,885 -- 200,000 Jonathan W. Landers..... 1999 182,150 56,209 8,517 100,000 Senior Vice President 1998 of Marketing and Sales 20,192 -- -- 200,000
- -------- (1) Mary Alice Taylor has served as chief executive officer of HomeGrocer.com since September 2, 1999. (2) Mr. Drayton served as chief executive officer of HomeGrocer.com from January 1997 to September 1999. 48 Option Grants The following table provides summary information regarding stock options granted to the named executive officers during the fiscal year ended January 1, 2000. The options were granted pursuant to our 1997 stock incentive compensation plan and 6,150,000 options were granted to two officers outside the plan. In accordance with the rules of the Securities and Exchange Commission, also shown below is the potential realizable value over the term of the option, the period from the grant date to the expiration date, giving effect to an assumed initial public offering price of $11.00 per share and based on assumed rate of stock appreciation of 5% and 10%, compounded annually. These rates are mandated by the Securities and Exchange Commission and do not represent our estimate of our future common stock price. Actual gains, if any, on stock option exercises will depend on the future performance of our common stock. In the fiscal year ended January 1, 2000, we granted options to acquire up to an aggregate of 16,960,400 shares of common stock to employees, consultants and directors, all at exercise prices equal to the deemed fair market value of our common stock on the date of grant as determined in good faith by our board of directors. Option Grants in the Fiscal Year Ended January 1, 2000
Individual Grants Potential Realizable ----------------------------------------------- Value At Assumed Number Of Percent Of Annual Rates of Stock Securities Total Options Price Appreciation Underlying Granted To Exercise Or For Option Term Options Employees In Base Price Expiration ------------------------ Name Granted(#) Fiscal Year ($/Share) Date 5% 10% - ---- ---------- ------------- ----------- ---------- ----------- ------------ Mary Alice Taylor(1).... 4,500,000 26.5% $0.45 9/9/09 $75,596,474 $117,862,774 J. Terrence Drayton(2).. 1,650,000 9.7 0.45 9/9/09 27,718,707 43,216,351 Ken Deering(3).......... 200,000 1.2 0.45 6/11/09 3,319,487 5,115,668 Robert G. Duffy(4)...... 100,000 0.6 0.45 6/11/09 1,659,744 2,557,834 Jonathan W. Landers(5).. 100,000 0.6 0.45 6/11/09 1,659,744 2,557,834
- -------- (1) Ms. Taylor's option was granted outside of the 1997 stock incentive compensation plan and she exercised this option in full on September 9, 1999. Ms. Taylor has granted us a right of repurchase on these shares. This right lapses as to one-fourth of the shares on September 2, 2000, and thereafter on the second day of every month at a rate of one forty-eighth of the total number of shares until all the shares are released from the repurchase option. (2) Mr. Drayton's option was granted outside of the 1997 stock incentive compensation plan and he exercised this option in full on September 9, 1999. Mr. Drayton has granted us a right of repurchase on these shares. This right lapses as to one-fourth of the shares on June 11, 2000, and thereafter on the eleventh day of every month at a rate of one forty- eighth of the total number of shares until all the shares are released from the repurchase option. (3) Mr. Deering exercised this option as to 100,000 shares on September 22, 1999 and 50,000 shares on December 13, 1999 and has granted us a right of repurchase to these shares as required under the 1997 stock incentive compensation plan. (4) Mr. Duffy exercised this option as to 50,000 shares on November 10, 1999 and has granted us a right of repurchase to these shares as required under the 1997 stock incentive compensation plan. (5) Mr. Landers exercised this option in full on December 13, 1999 and has granted us a right of repurchase to these shares as required under the 1997 stock incentive compensation plan. 49 Option Exercises and Holdings The following table provides summary information concerning the shares of common stock represented by outstanding stock options held by each of the named executive officers as of January 1, 2000. Aggregated Option Exercises in Fiscal 1999 and Fiscal Year-End Option Values
Number of Securities Value of Unexercised Shares Underlying Unexercised In-the-Money Options at Acquired Options at January 1, 2000 January 1, 2000(2) On Option -------------------------------- ------------------------- Name Exercise Value Realized(1) Exercisable Unexercisable Exercisable Unexercisable - ---- --------- ---------------- -------------- -------------- ----------- ------------- Mary Alice Taylor....... 4,500,000 $ -- -- -- $ -- -- J. Terrence Drayton..... 1,650,000 -- -- -- -- -- Ken Deering............. 670,000 225,700 50,000 -- 527,500 -- Robert G. Duffy......... 250,000 -- 50,000 -- 527,500 -- Jonathan W. Landers..... 300,000 655,000 -- -- -- --
- -------- (1) Equal to the deemed fair market value of the purchased shares on option exercise date as determined in good faith by our board of directors, less the exercise price paid for such shares. (2) Value is determined by subtracting the exercise price from the proposed initial public offering price of $11 for the common stock, and multiplying by the number of shares underlying the options. Employment Agreements We have entered into employment agreements with five of our executive officers: Mary Alice Taylor. In September 1999, we entered into an employment agreement with Mary Alice Taylor, our chairman and chief executive officer. Under the agreement, we agreed to pay Ms. Taylor an annual base salary of $200,000 and a quarterly bonus to be determined by the compensation committee. In connection with this employment agreement we also granted Ms. Taylor an option to purchase 4,500,000 shares of our common stock. On September 9, 1999 Ms. Taylor purchased 1,500,000 shares of our common stock at a purchase price of $0.45 per share for an aggregate purchase price of $675,000 and exercised options to purchase 4,500,000 shares of common stock at an exercise price of $0.45 per share for an aggregate purchase price of $2,025,000. We also loaned Ms. Taylor a total of $2,241,000 pursuant to two full recourse promissory notes, each with an annual interest rate of 5.98%. Ms. Taylor used this loan and cash to purchase the 1,500,000 shares and to exercise the 4,500,000 options. All principal and accrued interest under the loan remains outstanding and is due and payable on September 9, 2004. As of January 1, 2000, the outstanding balance of Ms. Taylor's loan was approximately $2,283,000. As of January 1, 2000, HomeGrocer.com had a right to repurchase 4,500,000 shares of unvested common stock held by Ms. Taylor. This right lapses with respect to one-fourth ( 1/4th) of the unvested shares on September 2, 2000, and thereafter on the second day of every month at a rate of one forty-eighth ( 1/48th) of the total number of shares, until all of the shares are released from the repurchase option, subject to Ms. Taylor's continued service with HomeGrocer.com. If Ms. Taylor dies or becomes permanently disabled, the repurchase right will lapse to the extent of the greater of 50% of the shares still subject to the repurchase right or the number of shares that would have vested had Ms. Taylor continued in the employment of HomeGrocer.com for an additional 12 months. If Ms. Taylor's employment is terminated without cause or she resigns for good reason, the lesser of 750,000 shares or all of the shares still subject to the repurchase right shall be released from the repurchase right and we will pay Ms. Taylor's salary for two years after the date of her termination or resignation. If HomeGrocer.com merges into or is acquired by another entity and Ms. Taylor is not offered a similar position with similar responsibilities by the surviving entity, the greater of 3,000,000 shares or the number of shares that would have been released from the repurchase right if Ms. Taylor had continued her employment for another two years, will be released from the repurchase right. Under the terms of the agreement, we also granted Ms. Taylor piggyback registration rights for her shares of common stock. HomeGrocer.com will also pay relocation-related expenses incurred by Ms. Taylor. 50 J. Terrence Drayton. In June 1999, we entered into an employment agreement with J. Terrence Drayton, our president. Under the employment agreement, we agreed to pay Mr. Drayton a base salary of $200,000 per year and a quarterly bonus to be determined by the compensation committee. In connection with this employment agreement, we also granted Mr. Drayton an option to purchase 1,650,000 shares of our common stock. On September 9, 1999 Mr. Drayton purchased 550,000 shares of HomeGrocer.com common stock at a price of $0.45 per share for an aggregate purchase price of $247,500 and exercised options to purchase 1,650,000 shares of common stock at an exercise price of $0.45 per share for an aggregate purchase price of $742,500. We also loaned Mr. Drayton $990,000 pursuant to two full recourse promissory notes, each with an annual interest rate of 5.98%. Mr. Drayton used this loan to purchase the 550,000 shares and to exercise the 1,650,000 options. All principal and accrued interest under the loan remains outstanding and is due and payable on September 9, 2004. As of January 1, 2000, the outstanding balance of Mr. Drayton's loan was approximately $1,008,000. As of January 1, 2000, HomeGrocer.com had a right to repurchase 1,650,000 shares of unvested common stock held by Mr. Drayton. This right will lapse with respect to one-fourth ( 1/4th) of the total number of shares as of June 11, 2000, and thereafter on the eleventh day of every month at a rate of one forty- eighth ( 1/48th) of the total number of shares, until all of the shares are released from the repurchase option, subject to Mr. Drayton's continued service with HomeGrocer.com. If Mr. Drayton dies or becomes permanently disabled, the repurchase right will lapse to the extent of the greater of 50% of the shares still subject to the repurchase right or the number of shares that would have vested had Mr. Drayton continued in the employment of HomeGrocer.com for 12 months. Under the agreement, if Mr. Drayton's employment is terminated without cause or he resigns for good reason, the lesser of 270,000 shares or all of the shares still subject to the repurchase right shall be released from the repurchase right and we will pay Mr. Drayton's salary for two years after the date of his termination or resignation. If HomeGrocer.com merges into or is acquired by another entity and Mr. Drayton is not offered a similar position with similar responsibilities by the surviving entity, the greater of 1,100,000 shares or the number of shares that would have been released from the repurchase right if Mr. Drayton had continued his employment for another two years will be released from the repurchase right. Under the terms of the agreement, we also granted Mr. Drayton piggyback registration rights for his shares of common stock. Daniel R. Lee. In November 1999, we entered into an employment agreement with Daniel R. Lee, our senior vice president and chief financial officer. Under the agreement, we agreed to pay Mr. Lee a base salary of $180,000 per year and a quarterly bonus to be determined by the compensation committee. The bonus is guaranteed to be at least $50,000 for 2000. We granted Mr. Lee an option to purchase 1,200,000 shares of our common stock at an exercise price of $2.50 per share. Mr. Lee exercised such options on December 13, 1999 for an aggregate purchase price of $3,000,000. As of January 1, 2000, HomeGrocer.com had a right to repurchase the 1,200,000 shares held by Mr. Lee. Such right lapses with respect to one-fourth of the shares on November 3, 2000 and as to 25,000 additional shares on the third day of every month thereafter at the rate of 25,000 shares per month. If Mr. Lee's employment is terminated by HomeGrocer.com during the first year, HomeGrocer.com's repurchase right shall lapse in accordance with the pro-rated number of months that he was employed with HomeGrocer.com. HomeGrocer.com will also pay relocation-related expenses incurred by Mr. Lee. David A. Pace. In August 1999, we entered into an employment agreement with David A. Pace, our senior vice president of people capability. Under the agreement, we agreed to pay Mr. Pace a base salary of $175,000 per year and a quarterly bonus guaranteed to be $50,000 for 1999. If Mr. Pace's employment is terminated by HomeGrocer.com during the first year, Mr. Pace is entitled to receive continuation of his salary for 12 months beyond the date of his termination. Rex L. Carter. In November 1999, we entered into an employment agreement with Rex L. Carter, our senior vice president of systems development and technology. Under the agreement, we agreed to pay Mr. Carter a base salary of $175,000 per year and an annual bonus of $50,000 based on the achievement of mutually agreed upon objectives for the calendar year. In addition, Mr. Carter is entitled to receive 51 reimbursement of reasonable expenses incurred by him and his family relating to his move to the Seattle, Washington region from Minnesota. Stock Plans 1999 Stock Incentive Plan. The 1999 stock incentive plan was adopted by the board of directors in December 1999. We will be submitting it for approval by the stockholders prior to the closing of this offering. We have reserved a total of 12,500,000 shares plus an annual increase on the first day of each of the next five HomeGrocer.com fiscal years beginning in 2001 equal to the lesser of 2,500,000 shares or 2.5% of the outstanding shares of common stock on the last day of the preceding fiscal year for issuance under the 1999 stock incentive plan. HomeGrocer.com has not issued any options or other stock awards under the 1999 stock incentive plan to date. The 1999 stock incentive plan provides for the grant of incentive stock options to employees and directors who are employees, and the grant of nonstatutory stock options and awards of restricted stock, stock appreciation rights and stock units to employees, non-employee directors and consultants. The compensation committee currently administers the 1999 stock incentive plan. The administrator of the 1999 stock incentive plan will determine number, vesting schedule, and exercise price for options, or conditions for awards of restricted stock, stock appreciation rights and stock units granted under the 1999 stock incentive plan, provided, however, an individual employee may not receive aggregate option grants and other stock awards for more than 2,500,000 shares in any fiscal year, and the exercise price of incentive stock options must be at least equal to the fair market value of the common stock on the date of grant or, in the case of a 10% shareholder, at least equal to 110% of the fair market value of the common stock on the date of grant. Payment of the exercise price or purchase price may be made in cash or other consideration as determined by the administrator. In the event a participant is terminated from service for HomeGrocer.com in circumstances that may constitute cause, the participant's right to exercise any award is suspended until the administrator determines whether cause existed, and if so, the participant's rights with respect to the award are forfeited. In the event of a sale of all or substantially all of the assets of HomeGrocer.com, or the merger or consolidation of HomeGrocer.com with or into another corporation, the administrator may take any one or more of the following actions, in its discretion: . Provide that outstanding awards, or types of outstanding awards, shall be assumed or equivalent awards be substituted by the successor corporation; . Provide notice to award recipients that all awards, or types of awards, to the extent then exercisable or to be exercisable as a result of the transaction, must be exercised on or before a specified date after which the awards terminate; . Terminate each award, or types of awards, in exchange for a payment equal to the excess of the fair market value of the shares underlying the award that are vested and exercisable immediately prior to the closing of the transaction over the exercise price with respect to such shares; . Facilitate the exercise of awards that become exercisable as a result of the transaction by adopting procedures providing for the exercise of unvested awards contingent on the consummation of the transaction; or . Provide that repurchase rights with respect to stock purchased upon exercise of an option or a stock purchase right be assigned to the successor corporation, or if not so assigned, lapse in full upon the consummation of the transaction. The board of directors may amend or terminate the 1999 stock incentive plan provided that no action that impairs the rights of any holder of an outstanding option may be taken without the holder's consent. In addition, we will obtain requisite stockholder approval for any action requiring stockholder approval under applicable law. The 1999 stock incentive plan will terminate in December 2009 unless the board of directors terminates it earlier. 52 1997 Stock Incentive Compensation Plan. The 1997 plan was adopted by the board of directors and approved by the stockholders on October 7, 1997. It provides for the grant of incentive stock options to employees and the grant of nonstatutory stock options and stock awards to employees, non-employee directors and consultants. A total of 15,924,334 shares of common stock has been reserved for issuance under the 1997 plan as of the date of this offering. As of January 1, 2000, options to purchase 8,250,870 shares of common stock had been exercised, options to purchase a total of 5,886,342 shares at a weighted average exercise price of $1.69 were outstanding and 1,787,122 shares remained available for future grants. The plan has no fixed expiration date; provided, however, that no incentive stock options may be granted more than ten years after the plan's adoption (on October 7, 1997). Accordingly, after October 7, 2007, no incentive stock options may be granted under the 1997 plan. Some of our employees, directors and consultants reside in California and received options under our 1997 plan. Some of these recipients have exercised their options. We recently discovered that under the laws of California, our 1997 plan did not include special provisions that are required under the laws of that state. To remedy this situation and comply with California law, HomeGrocer.com expects to offer to repurchase shares and options to purchase shares of our common stock. Based upon stock option issuances and exercises prior to January 10, 2000, when we amended our option plan to comply with California securities laws, we expect to offer to repurchase up to a maximum of 782,000 shares of our common stock issued upon the exercise of stock options and options to purchase 1,013,350 shares of our common stock. The 782,000 shares of common stock have a weighted average purchase price of $0.44 per share. The options to purchase 1,013,350 shares of our common stock have a weighted average exercise price of $2.47 per share. Upon approval by the California Department of Corporations, HomeGrocer.com will distribute a repurchase offer memorandum to holders of these shares and options, and the offer will remain open for a period of 30 days from the date of receipt. If the offer is accepted by all affected securityholders, we may be required to pay up to a maximum of approximately $905,500 to repurchase these shares and options. We do not plan to use the proceeds from this offering to repurchase the shares and options subject to the rescission offer. The 1997 plan is currently administered by the compensation committee of the board of directors. The terms of options and stock awards granted under the 1997 Plan are determined by the administrator, including the number of shares underlying options, exercise price, term and exercisability. The term of options shall be 10 years from date of grant unless otherwise established by the administrator, and options generally vest at the rate of 25% of the total number of shares subject to options 12 months after the date of grant and 1/48th of the total number of shares subject to options each month thereafter. The exercise price of incentive stock options must be at least equal to the fair market value of the common stock on the date of grant or, in the case of a 10% shareholder, at least equal to 110% of the fair market value of the common stock on the date of grant. Payment of the exercise price or purchase price may be made in cash or other consideration as determined by the administrator. The 1997 plan does not impose an annual limitation on the number of shares subject to options that may be issued to any individual employee. In addition, upon a sale of all or substantially all of the HomeGrocer.com assets, or a merger or consolidation of HomeGrocer.com with or into another corporation, all options outstanding under the 1997 plan will be assumed or equivalent options substituted by the successor corporation, unless the successor corporation does not agree to this assumption or substitution, in which case the options shall automatically accelerate so that each option shall, immediately prior to the closing of the transaction, become 100% vested and exercisable. Any options that are assumed or replaced in the sale, merger or consolidation that do not otherwise accelerate, shall be accelerated in the event that the option holder's employment or services are terminated within two years following the transaction unless the option holder is terminated for cause or leaves voluntarily without good reason. Also, the acceleration of options shall not occur if it would make unavailable "pooling of interest" accounting treatment for the sale, merger or consolidation. 1999 Directors' Stock Option Plan. The 1999 directors' plan was adopted by our board of directors in December 1999 and will become effective upon the closing of this offering. We will be submitting it for approval by the stockholders prior to the closing of this offering. A total of 500,000 shares of common stock 53 has been reserved for issuance under the directors' plan. The directors' plan provides for the grant of nonstatutory stock options to non-employee directors of HomeGrocer.com. The directors' plan is designed to work automatically without administration; however, to the extent administration is necessary, it will be performed by the board of directors. To the extent that conflicts of interest arise, it is expected that conflicts will be addressed by having any interested director abstain from both deliberations and voting regarding matters in which the director has a personal interest. Unless terminated earlier, the directors' plan will terminate in December 2009. The directors' plan provides that each person who becomes a non-employee director of HomeGrocer.com will be granted a nonstatutory stock option to purchase 20,000 shares of common stock on the date on which he or she first becomes a non-employee director of HomeGrocer.com, which option will vest and become exercisable in installments of 25% of the total number of shares subject to the option on the first, second, third and fourth anniversaries of the date of grant. Thereafter, on the date of our annual stockholders' meeting each year following the year of the initial grant, each non-employee director of HomeGrocer.com will be granted an additional option to purchase 5,000 shares of common stock if, on that date, he or she has served on our board of directors for at least six months, which option shall be fully vested and exercisable on the date of grant. Such annual grants become exercisable in full on the fourth anniversary of the date of grant. No option granted under the directors' plan is transferable by the option holder other than by will or the laws of descent or distribution or under a domestic relations order, and each option is exercisable, during the lifetime of the option holder, only by that option holder. The exercise price of all stock options granted under the directors' plan shall be equal to the fair market value of a share of HomeGrocer.com common stock on the date of grant of the option. Options granted under the directors' plan have a term of ten years. However, unvested options will terminate when the optionee ceases to serve as a director and vested options will terminate if they are not exercised within 12 months after the director's death or disability or within 90 days after the director ceases to serve as a director for any other reason. In the event of a sale of all or substantially all of the assets of HomeGrocer.com, or the merger or consolidation of HomeGrocer.com with or into another corporation in which HomeGrocer.com is not the surviving corporation or in which the ownership of more than 50% of the total combined voting power of HomeGrocer.com outstanding securities changes hands, or if during any two consecutive two-year periods persons who constitute the board at the beginning of such period (or who were appointed by a majority of the board in place at the beginning of such period) cease to constitute at least 50% of the board, each option outstanding under the directors' plan will be assumed or equivalent options substituted by our acquirer, unless our acquirer does not agree to such assumption or substitution, in which case the options will terminate upon consummation of the transaction to the extent not previously exercised. In connection with any acquisition, each director holding options under the directors' plan will have the right to exercise his or her options immediately before the consummation of the merger as to all shares underlying the options, including shares which would not have been vested and exercisable but for the acquisition. Our board of directors may amend or terminate the directors' plan as long as such action does not adversely affect any outstanding option and we obtain stockholder approval for any amendment to the extent required by law. 1999 Employee Stock Purchase Plan. Our 1999 Employee Stock Purchase Plan, or the 1999 purchase plan, provides our employees with an opportunity to purchase our common stock through accumulated payroll deductions. This plan will become effective upon the closing of this offering. A total of 3,000,000 shares of common stock have been reserved for issuance under the 1999 purchase plan, plus an annual increase on the first day of each of our next five fiscal years from 2001 through 2005 equal to the lesser of: . 500,000 shares; . 0.5% of our outstanding common stock on the last day of the immediately preceding fiscal year; or . any lesser amount determined by the board. The 1999 purchase plan will be administered by the board of directors or by a committee appointed by the board. The 1999 purchase plan permits eligible employees to purchase common stock through payroll 54 deductions up to a maximum of $25,000 of fair market value of such stock in each calendar year or up to a maximum of 2,500 shares for each purchase period, whichever is lesser. Employees are eligible to participate if they are employed by us or any majority-owned subsidiary for at least an average of 20 hours per week and customarily more than five months in any calendar year. However, an employee cannot participate in the plan at any time his or her participation in the plan would cause his or her outstanding options plus ownership of stock to equal 5% or more of the total voting power or value of all classes of our stock. The 1999 purchase plan provides that unless the board of directors or its committee determines otherwise, the plan will operate by a series of overlapping offering periods of approximately 12 months' duration, with new offering periods (other than the first offering period) commencing on the first trading day on or after January 1 and July 1 of each year. Each offering period will generally consist of two consecutive purchase periods of six months' duration, at the end of which the amount in participants' accounts will be used to make an automatic purchase of shares to be held in a plan account on their behalf. The board has determined that the first offering period will commence upon the effective date of this offering and end on December 31, 2000 with a single corresponding purchase period, and that, notwithstanding the flexibility in the plan that allows twelve month periods, beginning January 1, 2001, the offering period shall be of six months' duration with a coinciding six month purchase period. The price at which common stock will be purchased under the 1999 purchase plan is equal to 85% of the fair market value of the common stock on the first day of the offering period or on the last day of the applicable purchase period, whichever is lower. The initial purchase period will commence on the date of this prospectus and end on the last trading day on or before June 30, 2000, with a subsequent purchase period commencing on the first trading day on or after July 1 and ending on the last day of the offering period in December 2000. Employees may end their participation in an offering period at any time, and participation automatically ends on termination of employment, with accrued funds as of the date of termination being returned to the employee. In the event we are acquired or we sell substantially all of our assets, each outstanding option to purchase shares under the 1999 purchase plan will be assumed or an equivalent option substituted by our acquirer. If our acquirer does not agree to assume or substitute for the option, any offering period then in progress will be shortened and a new purchase date occurring prior to the closing of the transaction will be set. Generally, our board may change or terminate offering, holding and purchase periods, including extending new offering periods to up to 27 months' duration, and may amend, modify or terminate the 1999 purchase plan at any time as long as such action does not adversely affect any outstanding rights to purchase stock under the 1999 purchase plan. However, the board may amend or terminate the 1999 purchase plan or an offering period even if it would adversely affect outstanding options in order to avoid our incurring adverse accounting charges. The employee may be required to hold the stock for a minimum period established at the board of directors' or its committee's discretion within the applicable laws, after purchase. Unless terminated earlier by the board, the 1999 purchase plan will terminate twenty years after the closing of the offering. The 1999 purchase plan is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended. 401(k) Plan We maintain the HomeGrocer.com 401(k) Plan for eligible employees. In order to be a participant in the 401(k) plan, an employee must have attained age 21 and have worked for HomeGrocer.com for three months. Eligible employees may join the plan at the beginning of each quarter. A participant may contribute up to the lesser of 20% of his or her total annual compensation to the 401(k) plan on a pre-tax basis, or a statutorily prescribed pre-tax annual limit. The annual limit for 1999 is $10,000. Each participant is fully vested in his or her deferred salary contributions. Participant contributions are held and invested by the 401(k) plan's trustee. Currently, we match participant contributions dollar for dollar up to 5% of their compensation if the participant has performed at least 1,000 hours of service during the year. Matching contributions vest 33% after two years of service, 66% after three years of service, and 100% after four years of service. HomeGrocer.com currently pays the administrative costs for the plan. The 401(k) plan is intended to qualify under Section 401 of 55 the Internal Revenue Code, so that contributions by us or our employees to the 401(k) plan, and income earned on the 401(k) plan contributions, are not taxable to employees until withdrawn from the 401(k) plan, and so that our contributions will be deductible by us when made. Limitation of Liability and Indemnification Matters Our articles of incorporation which we expect to be in force on the date of this prospectus, limit the liability of directors to the fullest extent permitted by the Washington Business Corporation Act as it currently exists or as it may be amended in the future. Consequently, subject to the Washington Business Corporation Act, no director shall be personally liable to HomeGrocer.com or its shareholders for monetary damages resulting from his or her conduct as a director of HomeGrocer.com, except liability for: . acts or omissions involving intentional misconduct or knowing violations of law; . unlawful distributions; or . transactions from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. Our articles of incorporation also provide that we shall indemnify any individual made a party to a proceeding because that individual is or was a director of HomeGrocer.com and shall advance or reimburse reasonable expenses incurred by such individual in advance of the final disposition of the proceeding to the full extent permitted by applicable law. Any repeal of or modification to our articles of incorporation may not adversely affect any right of a director of HomeGrocer.com who is or was a director at the time of such repeal or modification. To the extent the provisions of our articles of incorporation provide for indemnification of directors for liabilities arising under the Securities Act of 1933, those provisions are, in the opinion of the Securities and Exchange Commission, against public policy as expressed in the Securities Act and they are therefore unenforceable. Our bylaws provide that we shall indemnify our directors and officers and may indemnify our employees and agents to the full extent permitted by law. In addition, we have entered into separate indemnification agreements with our directors and executive officers that could require us, among other things, to indemnify them against liabilities that arise because of their status or service as directors or executive officers and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. Finally, we intend to purchase and maintain a liability insurance policy pursuant to which our directors and officers may be indemnified against liability they may incur for serving in their capacities as directors and officers of HomeGrocer.com. We believe that the limitation of liability provision in our articles of incorporation, the indemnification provisions in our bylaws, the indemnification agreements and the liability insurance policy will facilitate our ability to continue to attract and retain qualified individuals to serve as directors and officers of HomeGrocer.com. 56 RELATED PARTY TRANSACTIONS From our inception through January 1, 2000, we have issued and sold shares of our capital stock as follows: . 29,605,536 shares of common stock at a weighted average price of $0.53 per share of cash and other consideration, . 8,000,000 shares of Series A preferred stock at a price of $0.50 per share in February, April, June and July 1998, . 16,857,142 shares of Series B preferred stock at a price of $0.35 per share in September 1998, . 29,942,050 shares of Series C preferred stock at a price of $1.75 per share in April and May 1999, . 18,407,546 shares of Series D preferred stock at a price of $5.80 per share in September through November 1999, . warrants to purchase 1,800,000 shares of common stock at a price of $0.375 per share, . warrants to purchase 1,269,786 shares of common stock at a price of $0.50 per share, . warrants to purchase 153,600 shares of Series C preferred stock at a price of $0.78125 per share, and . warrants to purchase 275,862 shares of Series D preferred stock at a price of $5.80 per share. The following table summarizes the shares of capital stock purchased by executive officers, directors and five-percent shareholders of HomeGrocer.com, and persons and entities associated with them, in the private placement transactions described above. Shares held by affiliated persons and entities have been added together for the purposes of this chart.
Outstanding Warrants Series A Series B Series C Series D to Purchase Common Preferred Preferred Preferred Preferred Common Investor Stock Stock Stock Stock Stock Stock - -------- --------- --------- --------- ---------- --------- ----------- Mary Alice Taylor (1)... 6,000,000 -- -- -- 17,240 -- J. Terrence Drayton (2).................... 6,150,000 -- -- 2,758 -- 100,000 Amazon.com, Inc. (3).... -- -- -- 24,285,716 3,448,274 -- Hummer Winblad Venture Partners (3)........... 700,000 800,000 8,285,714 484,732 3,448,274 -- Kleiner Perkins Caufield & Byers (4)............ 1,300,000 200,000 8,285,714 484,732 3,448,274 200,000 The Barksdale Group, L.L.C. (5)............. 200,000 -- -- 2,857,142 2,586,206 -- Charles Barbo (6)....... 1,000,000 700,000 -- 38,618 229,490 -- Madrona Investment Group, LLC (7)......... 200,000 500,000 -- 27,586 862,068 300,000 Ken Deering (8)......... 1,170,000 -- -- -- -- -- Lazarus Family Investments LLC (9).... 200,000 200,000 285,714 26,798 170,756 -- Philip S. Schlein....... 200,000 50,000 -- 2,758 20,000 --
- -------- (1) Includes shares held by Mary Alice Taylor, Mary Alice Taylor 1999 5-Year GRAT, Taylor Family 1999 Trust, Emery DeWitt Wooten 1999 5-Year GRAT and GMME Partnership, L.P. Ms. Taylor is our chief executive officer and a director of HomeGrocer.com. 4,500,000 of Ms. Taylor's shares are subject to a repurchase right in favor of HomeGrocer.com pursuant to an agreement between Ms. Taylor and HomeGrocer.com. (2) Includes shares held by J. Terrence Drayton, Terran Ventures, Inc. and Investment King. Mr. Drayton is our president and a director of HomeGrocer.com. 1,650,000 of Mr. Drayton's shares are subject to a repurchase right in favor of HomeGrocer.com pursuant to an agreement between Mr. Drayton and HomeGrocer.com. Includes warrants to purchase 100,000 shares of common stock held by Terran Ventures, Inc. 57 (3) Includes shares held by Hummer Winblad Venture Partners III, L.P., Hummer Winblad Venture Partners IV, L.P. and Hummer Winblad Technology Fund III, L.P., together a 13% shareholder of HomeGrocer.com. (4) Includes shares held by Kleiner Perkins Caufield & Byers VIII, L.P., KPCB VIII Founders Fund, L.P. and KPCB Information Sciences Zaibatsu Fund II, L.P., together a 13% shareholder of HomeGrocer.com. Includes warrants to purchase 200,000 shares of common stock held by Kleiner Perkins Funds- related entities. (5) Includes shares held by The Barksdale Group, L.L.C., Peter L.S. Currie (a principal and officer of The Barksdale Group, LLC), James L. Barksdale, Pickwick Group, L.P. and Barksdale Investments, L.L.C., together a 5.5% shareholder of HomeGrocer.com The other Barksdale-related entities disclaim beneficial ownership of 190,572 shares of Series C preferred stock and 344,740 shares of Series D preferred stock held by Mr. Currie. (6) Includes shares held by C&LB Family Limited Partnership, Charles Barbo, a director of HomeGrocer.com, Charles K. and Linda K. Barbo, Anne Barbo, Julie Anne Barbo Trust dated 12/10/91 and Sarah Barbo Staiger. (7) Includes warrants to purchase 300,000 shares of common stock held by Madrona Investment Group, LLC, 862,068 shares held by Madrona Holdings I, L.L.C. for the benefit of Madrona Venture Fund I-A, L.P., Madrona Venture Fund I-B, L.P. and Madrona Managing Director Fund, LLC, together a 1.5% shareholder of HomeGrocer.com. (8) Does not include an option to purchase 50,000 shares of common stock held by Mr. Deering, our vice president of Storefront. (9) Includes shares held by Lazarus Family Investments LLC, Lazarus Family Investments III, LLC and Lazarus Family Investments II, LLC. Jonathan Lazarus, a director of HomeGrocer.com, is a principal in each of these funds. HomeGrocer.com has had discussions with Fitpro Pty Ltd., an Australian company and a shareholder of HomeGrocer.com, concerning the possibility of developing a joint venture to introduce the HomeGrocer.com business to South East Asia, including Australia, New Zealand and Singapore. In the absence of an agreement on mutually satisfactory terms to form such a joint venture, Fitpro Pty Ltd. may have certain rights of first refusal regarding the HomeGrocer.com service in South East Asia. HomeGrocer.com has no current plans to expand to the South East Asian market in the foreseeable future. In September 1999, we made loans to Mary Alice Taylor, our chief executive officer, and Mr. Drayton in connection with their exercises of stock options and purchases of our common stock. We loaned Ms. Taylor a total of $2,241,000 and Mr. Drayton a total of $990,000, each pursuant to two full recourse promissory notes, all with an annual interest rate of 5.98%. All principal and accrued interest under the loans remain outstanding and are due and payable on September 9, 2004. As of January 1, 2000, the outstanding balance of Ms. Taylor's loan was approximately $2,283,000 and the outstanding balance of Mr. Drayton's loan was approximately $1,008,000. In September 1999, we entered into an agreement with Ms. Taylor pursuant to which she purchased an aggregate of 6,000,000 shares of our common stock outside of our 1997 stock incentive compensation plan for an aggregate purchase price of $2,700,000. As part of such agreement, Ms. Taylor has granted to us a right of repurchase with respect to 4,500,000 shares of our common stock. Our repurchase right lapses over a period of four years. In June 1999, we entered into an agreement with Mr. Drayton pursuant to which he purchased an aggregate of 2,200,000 shares of our common stock outside of our 1997 stock incentive compensation plan for an aggregate purchase price of $990,000. As part of such agreement, Mr. Drayton has granted to us a right of repurchase with respect to 1,650,000 shares of our common stock. Our repurchase right lapses over a period of four years. 58 In November 1999, we entered into an agreement with Amazon.com, LLC under which we have agreed to pay Amazon an aggregate of $10 million over the next two years to deliver advertising mailings up to two million of their customers residing in our service areas. Amazon.com, LLC is a wholly owned subsidiary of Amazon.com, Inc., a 27% shareholder. Two of our board members, Tom Alberg and David Risher, are Amazon.com affiliates: Mr. Alberg is a member of Amazon.com's board of directors and Mr. Risher is Amazon.com's senior vice president of product development. We believe the terms of our agreement with Amazon.com are as favorable as we could have obtained from an unaffiliated third party. Amazon.com, Inc. also has special shareholder rights pursuant to an agreement with Homegrocer.com: . If we receive an offer to purchase capital stock representing more than 20% of our capital stock or all or substantially all of our assets, we must give notice of the terms of the offer to Amazon.com, and Amazon.com then has seven days to determine whether to accept the terms. If Amazon.com does not accept the terms, we are free to complete such a transaction with a third party on no more favorable terms for a period of 60 days. After this 60 day period, we must again give Amazon notice of any such offer. This right expires four years after the closing of this offering. . Amazon.com had the right to purchase its pro rata portion of the shares issued in this offering to maintain its percentage ownership of HomeGrocer.com. Amazon.com has waived this right. . Amazon.com may not acquire more than 35% of our capital stock unless Amazon.com first negotiates with us to purchase all of our capital stock. This restriction will terminate on the closing of this offering. Julie Barbo, daughter of HomeGrocer.com director Charles K. Barbo, has served as a business and legal consultant to HomeGrocer.com and was our assistant secretary until December 1999. 59 PRINCIPAL STOCKHOLDERS The following table sets forth information regarding the beneficial ownership of our common stock as of January 1, 2000 and as adjusted to reflect the sale of the common stock offered by HomeGrocer.com under this prospectus by: . each of HomeGrocer.com directors and named executive officers; . all directors and executive officers as a group; and . each person who is known to own beneficially more than 5% of our common stock. Except as otherwise noted, the address of each person listed in the table is c/o HomeGrocer.com, 10230 N.E. Points Drive, Kirkland, Washington 98033. The table includes all shares of common stock issuable within 60 days of January 1, 2000 upon the exercise of options and other rights beneficially owned by the indicated stockholders on that date. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes voting and investment power with respect to shares. To the knowledge of HomeGrocer.com, except under applicable community property laws or as otherwise indicated, the persons named in the table have sole voting and sole investment control with respect to all shares beneficially owned. Assuming the conversion of all outstanding shares of preferred stock, the applicable percentage of ownership for each stockholder is based on 102,812,274 shares of common stock outstanding as of January 1, 2000, together with applicable options for that stockholder. The number of shares underlying options and warrants listed below includes only those shares underlying options and warrants immediately exercisable or exercisable within 60 days of January 1, 2000. Shares of common stock issuable upon exercise of options and other rights beneficially owned were deemed outstanding for the purpose of computing the percentage ownership of the person holding these options and other rights, but are not deemed outstanding for computing the percentage ownership of any other person.
Percentage of Common Stock Number of Shares Outstanding (1) Shares Underlying ----------------- Name and Address of Beneficial Beneficially Options & Before After Owner Owned Warrants Offering Offering - ------------------------------ ------------ ---------- -------- -------- Amazon.com, Inc. (2)............... 27,733,990 -- 26.98% 22.22% 1200 12th Avenue S., Suite 1200 Seattle, WA 98144 Kleiner Perkins Caufield & Byers (3)............................... 13,718,720 200,000 13.51 11.13 2750 Sand Hill Road Menlo Park, CA 94025 Hummer Winblad Venture Partners (4)............................... 13,718,720 -- 13.34 10.99 2 South Park, 2nd Floor San Francisco, CA 94107 J. Terrence Drayton (5)............ 6,152,758 100,000 6.08 5.01 Mary Alice Taylor (6).............. 6,017,240 -- 5.85 4.82 The Barksdale Group, L.L.C. (7).... 5,643,348 -- 5.49 4.52 2730 Sand Hill Road, Suite 100 Menlo Park, CA 94043 Charles K. Barbo (8)............... 1,968,108 -- 1.91 1.58 1155 Valley Street, Suite 400 Seattle, WA 98109 Madrona Investment Group, LLC (9).. 1,589,654 300,000 1.83 1.51 1000 Second Avenue, Suite 3700 Seattle, WA 98104 Ken Deering........................ 1,170,000 50,000 1.19 * Jonathan D. Lazarus (10)........... 883,268 -- * * One Mercer Plaza 2835 82nd Avenue S.E., Suite 310 Mercer Island, WA 98040 Jonathan W. Landers................ 300,000 -- * * Philip S. Schlein.................. 272,758 -- * * 2180 Sand Hill Road, Suite 300 Menlo Park, CA 94025 Robert G. Duffy.................... 250,000 50,000 * * All directors and executive officers as a group (20 persons) (11)..................... 81,697,564 1,551,000 79.77 65.88
- -------- * Less than 1% of the outstanding shares of common stock. 60 (1) Assumes no exercise of the underwriters' over-allotment option. (2) David Risher, a director of HomeGrocer.com and a vice president of Amazon.com, Inc., disclaims beneficial ownership of the shares held by Amazon.com. (3) Includes shares held by Hummer Winblad Venture Partners III, L.P., Hummer Winblad Venture Partners IV, L.P. and Hummer Winblad Technology Fund III, L.P. Mark Gorenberg, a director of HomeGrocer.com, is a principal in Hummer Winblad Venture Partners. Mr. Gorenberg disclaims beneficial ownership of the shares held by these entities except to the extent of his pecuniary interest in those shares. (4) Includes shares held by Kleiner Perkins Caufield & Byers VIII, L.P., KPCB VIII Founders Fund, L.P. and KPCB Information Sciences Zaibatsu Fund II, L.P. Douglas Mackenzie, a director of HomeGrocer.com, and a general partner of the Kleiner Perkins funds, disclaims beneficial ownership of shares held by these entities except to the extent of his pecuniary interest therein; also includes 200,000 shares issuable upon exercise of warrants held by affiliates of Kleiner Perkins Caufield & Byers VIII, L.P. (5) Includes shares held by J. Terrence Drayton, Terran Ventures, Inc. and Investment King. As of January 1, 2000, 1,650,000 of Mr. Drayton's shares are subject to a repurchase right in favor of HomeGrocer.com pursuant to an agreement between Mr. Drayton and HomeGrocer.com; also includes 100,000 shares issuable upon exercise of warrants held by Terran Ventures, Inc. (6) Includes shares held by Mary Alice Taylor, Mary Alice Taylor 1999 5-Year GRAT, Taylor Family 1999 Trust, Emery DeWitt Wooten 1999 5-Year GRAT and GMME Partnership, L.P. Ms. Taylor, chief executive officer and chairman of the board of directors of HomeGrocer.com, disclaims beneficial ownership of the shares held by the Taylor Family 1999 Trust. As of January 1, 2000, 4,500,000 of Ms. Taylor's shares are subject to a repurchase right in favor of HomeGrocer.com pursuant to an agreement between Ms. Taylor and HomeGrocer.com. (7) Includes shares held by The Barksdale Group, L.L.C., Peter LS Currie (a principal and officer of The Barksdale Group, LLC), James L. Barksdale, Pickwick Group, L.P. and Barksdale Investments, L.L.C. The other Barksdale-related entities disclaim beneficial ownership of 190,572 shares of Series C preferred stock and 344,740 shares of Series D preferred stock held by Mr. Currie. (8) Includes shares held by C&LB Family Limited Partnership, Charles K. Barbo, Charles K. and Linda K. Barbo, Anne Barbo, Julie Anne Barbo Trust dated 12/10/91 and Sarah Barbo Staiger. Charles K. Barbo, a director of HomeGrocer.com, disclaims beneficial ownership of the shares held by Anne Barbo, the Julie Anne Barbo Trust dated 12/10/91 and Sarah Barbo Staiger. (9) Includes 300,000 shares issuable upon exercise of warrants held by Madrona Investment Group, LLC and 862,068 shares held by Madrona Holdings I, L.L.C. for the benefit of Madrona Venture Fund I-A, L.P., Madrona Venture Fund I-B, L.P. and Madrona Managing Director Fund, L.L.C. Mr. Alberg, a director of HomeGrocer.com and a principal of Madrona Investment Group, LLC and the Madrona funds, disclaims beneficial ownership of the shares held by Madrona Investment Group, LLC and the Madrona funds except to the extent of his pecuniary interest therein. (10) Includes shares held by Lazarus Family Investments LLC, Lazarus Family Investments III, LLC and Lazarus Family Investments II, LLC. Jonathan Lazarus, a director of HomeGrocer.com, is a principal in each of these funds. (11) Includes all shares described above and an additional 3,130,000 shares held by other executive officers, of which 2,279,000 shares were outstanding as of January 1, 2000 and 851,000 shares were subject to options exercisable within 60 days of January 1, 2000. 61 DESCRIPTION OF CAPITAL STOCK Upon the completion of this offering, HomeGrocer.com will be authorized to issue 1,000,000,000 shares of common stock, no par value per share, and 10,000,000 shares of undesignated preferred stock, no par value per share. All currently outstanding shares of preferred stock will be converted into common stock upon the closing of this offering. Common Stock As of January 1, 2000, there were 102,812,274 shares of common stock outstanding that were held of record by 348 stockholders after giving effect to the conversion of all outstanding shares of our preferred stock into common stock. After giving effect to this offering and the conversion of our currently outstanding preferred stock into common stock upon the closing of this offering, there will be 124,812,274 shares of common stock outstanding, assuming no exercise of the underwriter's over-allotment option. The holders of common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders. Subject to preferences that may be applicable to any preferred stock that may be outstanding after the completion of this offering, holders of common stock are entitled to receive ratably such dividends as may be declared by the board of directors out of funds legally available for that purpose. In the event of liquidation, dissolution or winding up of HomeGrocer.com, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to the prior distribution rights of any preferred stock that may be outstanding after the completion of this offering. The common stock has no preemptive or conversion rights or other subscription rights. The outstanding shares of common stock are, and the shares of common stock to be issued upon completion of this offering will be, fully paid and non-assessable. Preferred Stock Upon the closing of the offering, all outstanding shares of preferred stock will be converted into 73,206,738 shares of common stock and automatically retired. Thereafter, the board of directors will have the authority, without further action by the stockholders, to issue up to 10,000,000 shares of preferred stock, no par value, in one or more series. The board of directors will also have the authority to designate the rights, preferences, privileges and restrictions of each such series, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series. The issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of HomeGrocer.com without further action by the stockholders. The issuance of preferred stock with voting and conversion rights may also adversely affect the voting power of the holders of common stock. In some circumstances, an issuance of preferred stock could have the effect of decreasing the market price of the common stock. HomeGrocer.com currently has no plans to issue any shares of preferred stock. Warrants As of January 1, 2000, there were warrants outstanding to purchase an aggregate of 2,749,248 shares of common stock, at a weighted average exercise price of $1.00 per share. Warrants to purchase 2,015,666 shares of common stock were exercised in January and February 2000. Warrants to purchase the remaining 733,582 shares of common stock will expire between July 20, 2005 and September 15, 2009. Generally, each warrant contains provisions for the adjustment of the exercise price and the aggregate number of shares issuable upon the exercise of the warrant under some circumstances, including stock dividends, stock splits, reorganizations, reclassifications or consolidations. Registration Rights The holders of 84,481,738 shares of common stock (assuming the conversion of all outstanding preferred stock upon completion of this offering) and warrants to purchase 2,749,248 shares of common stock or their 62 transferees are entitled to rights with respect to the registration of such shares under the Securities Act. These rights are provided under the terms of various agreements between HomeGrocer.com and the holders of these securities. Subject to limitations in these agreements, the holders of at least 25% of these securities then outstanding, or a lesser amount if the offering price to the public would be an aggregate of at least $5,000,000, may require on two occasions beginning six months after the date of this prospectus that we use our best efforts to register these securities for public resale if Form S-3 is not available. If HomeGrocer.com registers any of its common stock either for its own account or for the account of other security holders, the holders of these securities are entitled to include their shares of common stock in that registration, subject to the ability of the underwriters to limit the number of shares included in the offering. The holders of these securities may also require us, not more than twice in any 12-month period, to register all or a portion of these securities on Form S-3 when the use of that form becomes available, provided, among other limitations, that the proposed aggregate selling price, net of any underwriters' discounts or commissions, is at least $1,000,000. We will be responsible for paying all registration expenses, and the holders selling their shares will be responsible for paying all selling expenses. State Anti-Takeover Law and Charter and Bylaw Provisions Provisions of state law and our articles of incorporation and bylaws could make more difficult the acquisition of HomeGrocer.com by means of a tender offer, a proxy contest or otherwise and the removal of incumbent officers and directors. These provisions, summarized below, are expected to discourage coercive takeover practices and inadequate takeover bids and to encourage persons seeking to acquire control of HomeGrocer.com to first negotiate with us. We believe that the benefits of increased protection of our potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure HomeGrocer.com outweigh the disadvantages of discouraging such proposals because, among other things, negotiation of such proposals could result in an improvement of their terms. Election and Removal of Directors. Effective upon the closing of this offering, our articles of incorporation will provide for the division of our board of directors into three classes, as nearly as equal in number as possible, with the directors in each class serving for a three-year term, and one class being elected each year by our shareholders. The initial term of the Class I directors expires at our annual meeting of shareholders to be held in 2000; the initial term of the Class II directors expires at our annual meeting of shareholders to be held in 2001; and the initial term of the Class III directors expires at our annual meeting of shareholders to be held in 2002. Thereafter, the term of each class of directors will be three years. This system of electing and removing directors generally makes it more difficult for shareholders to replace a majority of the members of our board of directors and may tend to discourage a third party from making a tender offer or otherwise attempting to gain control of HomeGrocer.com and may have the effect of maintaining the incumbency of our board of directors. Supermajority Vote to Amend Bylaw Provisions. Effective upon the completion of this offering, our bylaws will provide that (1) any amendment to the bylaws that increases or reduces the authorized number of directors shall require the affirmative approval of at least two-thirds of the directors and (2) any amendment or repeal of the bylaws relating to these provisions by the shareholders will require the affirmative approval of holders of at least two- thirds of our outstanding capital stock. This provision is principally intended to prevent a shareholder or shareholders having a majority of the common stock from making changes in the bylaws to increase the number of directors or reduce the authority of our board or directors. It also may have the effect of discouraging efforts to acquire control of the board of directors and thus make takeovers or changes in control more difficult. Shareholder Meetings. Effective upon the completion of this offering, our bylaws will provide that, except as otherwise required by law or by our articles of incorporation, special meetings of the shareholders may only be called pursuant to a resolution adopted by our chief executive officer, president, the chairman of our board of directors or a majority of the board of directors. These provisions of our articles of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a change of control. 63 Our intent in using these provisions is to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies formulated by them and to discourage transactions that may involve an actual or threatened change of control. These provisions are designed to reduce our vulnerability to an unsolicited acquisition proposal and to discourage tactics that may be used in proxy fights. However, these provisions could have the effect of discouraging others from making tender offers for our shares and, as a consequence, they could inhibit fluctuations in the market price of our shares that could result from actual or rumored takeover attempts. Such provisions could have the effect of preventing changes in our management. Requirements for Advance Notification of Shareholder Nominations and Proposals. Effective upon the completion of this offering, our bylaws will contain advance notice procedures with respect to shareholder proposals and the nomination of candidates for election as directors, other than nominations made by or at the direction of the board of directors or a committee thereof. Elimination of Shareholder Action by Written Consent. Effective upon the closing of this offering, our articles of incorporation will not permit shareholders to act by written consent. Elimination of Cumulative Voting. Effective upon the closing of this offering, our articles of incorporation and bylaws will not provide for cumulative voting in the election of directors. Undesignated Preferred Stock. Effective upon the closing of this offering, our board of directors, without shareholder approval, has the authority under our articles of incorporation to issue up to 10,000,000 shares of preferred stock with rights superior to the rights of our common stock. The authorization of undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could defer hostile takeovers or delay changes in control or management of HomeGrocer.com. Approval of Business Combinations. Upon completion of this offering, our articles of incorporation will require that business combinations (including a merger, share exchange and the sale, lease, exchange, mortgage, pledge, transfer or other disposition or encumbrance of a substantial portion of our assets other than in the usual and regular course of business) be approved by the holders of at least two-thirds of our outstanding capital stock. Washington Anti-Takeover Law. Washington law imposes restrictions on some transactions between a corporation and significant shareholders. Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target corporation", with some exceptions, from engaging in significant business transactions with an "acquiring person", which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation, for a period of five years after such acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the time of such acquisition. Such prohibited transactions include, among other things: . a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from the acquiring person; . termination of 5% or more of the employees of the target corporation as a result of the acquiring person's acquisition of 10% or more of the shares; or . allowing the acquiring person to receive any disproportionate benefit as a shareholder. After the five-year period, a "significant business transaction" may occur, as long as it complies with the "fair price" provisions of the statute. A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a change of control of HomeGrocer.com. 64 In addition to the provisions summarized above, Amazon.com's right of first refusal may also delay, defer or prevent a change of control. See "Related Party Transactions." Transfer Agent and Registrar The transfer agent and registrar for our common stock is ChaseMellon Shareholder Services LLC. The Transfer Agent's address is 520 Pike Street, Suite 1220, Seattle, WA 98101, and its telephone number is (206) 674-3030. 65 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no market for our common stock. Future sales of substantial amounts of common stock in the public market could adversely affect prevailing market prices. Furthermore, since only a limited number of shares will be available for sale shortly after this offering because of contractual and legal restrictions on resale, sales of substantial amounts of our common stock in the public market after the restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon completion of the offering, we will have 124,812,274 shares of common stock outstanding. Of these shares, 22,000,000 shares sold in the offering (plus any shares issued upon exercise of the underwriters' over-allotment option) will be freely tradable without restriction under the Securities Act, unless purchased by "affiliates" of HomeGrocer.com as that term is defined in Rule 144 under the Securities Act, which generally includes officers, directors or 10% stockholders, or unless purchased by employees of HomeGrocer.com directly from the underwriters'. The remaining 102,812,274 shares outstanding are "restricted securities" within the meaning of Rule 144 under the Securities Act. These shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144 or 701 promulgated under the Securities Act, which are summarized below. Sales of these shares in the public market, or the availability of such shares for sale, could adversely affect the market price of the common stock. Each of our officers, directors and most of our stockholders have entered into lock-up agreements generally providing that they will not sell, otherwise dispose of or transfer any of the economic consequences of ownership of our common stock or other securities during the period ending 180 days after the date of this prospectus without the prior written consent of Morgan Stanley & Co. Incorporated. See "Underwriters" for a more complete description of the lock-up agreements. As a result of these contractual restrictions, notwithstanding possible earlier eligibility for sale under the provisions of Rules 144 and 701, shares subject to lock-up agreements will not be salable from the date of this prospectus until such agreements expire or are waived by the designated underwriters' representative. Taking into account the lock-up agreements, and assuming Morgan Stanley & Co. Incorporated does not release stockholders from these agreements, the following shares will be eligible for sale in the public market at the following times: . Beginning on the effective date of this prospectus, only the 22,000,000 shares sold in the offering will be immediately available for sale in the public market. . Beginning 180 days after the effective date, approximately 8,238,870 shares will be eligible for sale pursuant to Rule 701 (assuming no exercise of options) and approximately 78,595,612 additional shares will be eligible for sale pursuant to Rule 144, of which all but approximately 17,488,010 shares are held by affiliates. . Approximately an additional 20,423,212 shares will be eligible for sale pursuant to Rule 144 at various times after September 15, 2000. Shares eligible to be sold pursuant to Rule 144 may be subject to volume restrictions as described below. In addition, if the reported last sale price of the common stock on the Nasdaq National Market is at least twice the initial public offering price per share for 20 of the 30 trading days ending on the last trading day preceding the 90th day after the date of this prospectus, 25% of the shares of our common stock that are held by our employees who are not officers or directors of HomeGrocer.com, or a total of approximately 418,492 shares, subject to the 180- day restriction described above will be released from these restrictions. The release of these shares will occur on the later to occur of: . the 90th day after the date of this prospectus if our first post- offering public release of our earnings results occurs between the eleventh trading day after the date of this prospectus and the 89th day after the date of this prospectus, or 66 . on the second trading day following the first public release of our earnings results, if we do not release our earnings results in the period set forth in the preceding clause. Morgan Stanley & Co. Incorporated may in its sole discretion choose to release any or all of these shares from such restrictions prior to the expiration of such 90 or 180-day period. In general, under Rule 144 as currently in effect, and beginning after the expiration of the lock-up agreements (180 days after the date of this prospectus) of a person (or persons whose shares are aggregated) who has beneficially owned restricted shares for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: (1) 1% of the number of shares of common stock then outstanding (which will equal approximately 1,248,123 shares immediately after the offering); or (2) the average weekly trading volume of the common stock during the four calendar weeks preceding the sale. Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about HomeGrocer.com. Under Rule 144(k), a person who is not deemed to have been an affiliate of HomeGrocer.com at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. The holders of approximately 84,481,738 shares of common stock and warrants to purchase 2,749,248 shares of common stock or their transferees are also entitled to rights with respect to registration of their shares of common stock for offer or sale to the public. If the holders, by exercising their registration rights, cause a large number of shares to be registered and sold in the public market, the sales could have a material adverse effect on the market price for our common stock. As a result of the lock-up agreements, all of our employees holding shares of common stock or stock options may not sell shares acquired upon exercise until 180 days after the date of this prospectus. Beginning 180 days after the date of this prospectus, any employee, officer or director of or consultant to HomeGrocer.com who purchased shares pursuant to a written compensatory plan or contract may be entitled to rely on the resale provisions of Rule 701. Rule 701 permits affiliates to sell their Rule 701 shares under Rule 144 without complying with the holding period requirements of Rule 144. Rule 701 further provides that non-affiliates may sell such shares in reliance on Rule 144 without having to comply with the holding period, public information, volume limitation or notice provisions of Rule 144. In addition, we intend to file registration statements under the Securities Act as promptly as possible after the effective date to register shares to be issued pursuant to our employee benefit plans. As a result, any options exercised under the Stock Plan or any other benefit plan after the effectiveness of such registration statement will also be freely tradable in the public market, except that shares held by affiliates will still be subject to the volume limitation, manner of sale, notice and public information requirements of Rule 144 unless otherwise resalable under Rule 701. As of January 1, 2000, there were outstanding options to purchase 5,886,342 shares of common stock, of which options to purchase approximately 327,352 shares were vested and exercisable. 67 MATERIAL U.S. FEDERAL TAX CONSIDERATIONS FOR NON-U.S. HOLDERS The following is a general discussion of the material U.S. federal income and estate tax consequences of the ownership and disposition of common stock by a beneficial owner that is a "Non-U.S. Holder." A "Non-U.S. Holder" is a person or entity that, for U.S. federal income tax purposes, is a non-resident alien individual, a foreign corporation, a foreign partnership, or a foreign estate or trust. This discussion is based on the Internal Revenue Code of 1986, as amended, and administrative interpretations as of the date of this prospectus, all of which are subject to change, including changes with retroactive effect. This discussion does not address all aspects of U.S. federal income and estate taxation that may be relevant to Non-U.S. Holders in light of their particular circumstances and does not address any tax consequences arising under the laws of any state, local or foreign jurisdiction. Prospective holders should consult their tax advisors with respect to the particular tax consequences to them of owning and disposing of common stock, including the consequences under the laws of any state, local or foreign jurisdiction. Dividends Although we do not anticipate paying any dividends in the foreseeable future, dividends paid to a Non-U.S. Holder of common stock generally will be subject to withholding tax at a 30% rate or a reduced rate specified by an applicable income tax treaty. For purposes of determining whether tax is to be withheld at a reduced rate under an income tax treaty, HomeGrocer.com will presume that dividends, if any, paid on or before December 31, 2000 to an address in a foreign country are paid to a resident of that country unless it has knowledge that the presumption is not warranted. In order to obtain a reduced rate of withholding for dividends paid after December 31, 2000, a Non-U.S. Holder will be required to provide an Internal Revenue Service Form W-8BEN certifying its entitlement to benefits under a treaty. In addition, in cases where dividends are paid to a Non-U.S. Holder that is a partnership or other pass-through entity, persons holding an interest in the entity may need to provide the required certification. The withholding tax does not apply to dividends paid to a Non-U.S. Holder that provides a Form 4224 or, after December 31, 2000, a Form W-8ECI, certifying that the dividends are effectively connected with the Non-U.S. Holder's conduct of a trade or business within the United States. Instead, the effectively connected dividends will be subject to regular U.S. income tax as if the Non-U.S. Holder were a U.S. resident. A non-U.S. corporation receiving effectively connected dividends may also be subject to an additional "branch profits tax" imposed at a rate of 30% (or a lower treaty rate) on an earnings amount that is net of the regular tax. Gain on Disposition of Common Stock A Non-U.S. Holder generally will not be subject to U.S. federal income tax on gain realized on a sale or other disposition of common stock unless: . the gain is effectively connected with a trade or business of the Non- U.S. Holder in the United States, . in the case of Non-U.S. Holders who are non-resident alien individuals and hold the common stock as a capital asset, the individuals are present in the United States for 183 or more days in the taxable year of the disposition, . the Non-U.S. Holder is subject to tax under the provisions of the Code regarding the taxation of U.S. expatriates, or . HomeGrocer.com is or has been a U.S. real property holding corporation at any time within the five-year period preceding the disposition or the Non-U.S. Holder's holding period, whichever period is shorter. 68 The tax relating to stock in a U.S. real property holding corporation does not apply to a Non-U.S. Holder whose holdings, actual and constructive, at all times during the applicable period, amount to 5% or less of the common stock of a U.S. real property holding corporation, provided that the common stock is regularly traded on an established securities market. Generally, a corporation is a U.S. real property holding corporation if the fair market value of its U.S. real property interests, as defined in the Code and applicable regulations, equals or exceeds 50% of the aggregate fair market value of its worldwide real property interests and its other assets used or held for use in a trade or business. HomeGrocer.com believes that it is not, and does not anticipate becoming, a U.S. real property holding corporation. Information Reporting Requirements and Backup Withholding HomeGrocer.com must report to the IRS the amount of dividends paid, the name and address of the recipient, and the amount of any tax withheld. A similar report is sent to the Non-U.S. Holder. Under tax treaties or other agreements, the IRS may make its reports available to tax authorities in the recipient's country of residence. Dividends paid on or before December 31, 2000 at an address outside the United States are not subject to backup withholding, unless the payor has knowledge that the payee is a U.S. person. However, a Non-U.S. Holder may need to certify its non-U.S. status in order to avoid backup withholding at a 31% rate on dividends paid after December 31, 2000 or dividends paid on or before that date at an address inside the United States. U.S. information reporting and backup withholding generally will not apply to a payment of proceeds of a disposition of common stock where the transaction is effected outside the United States through a non-U.S. office of a non-U.S. broker. However, a Non-U.S. Holder may need to certify its non-U.S. status in order to avoid information reporting and backup withholding at a 31% rate on disposition proceeds where the transaction is effected by or through a U.S. office of a broker. In addition, U.S. information reporting requirements may apply to the proceeds of a disposition effected by or through a non-U.S. office of a U.S. broker, or by a non-U.S. broker with specified connections to the United States. Backup withholding is not an additional tax. Rather, the tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. When withholding results in an overpayment of taxes, a refund may be obtained if the required information is furnished to the IRS. Federal Estate Tax An individual Non-U.S. Holder who is treated as the owner of, or has made lifetime transfers of, an interest in the common stock will be required to include the value of the stock in his gross estate for U.S. federal estate tax purposes, and may be subject to U.S. federal estate tax unless an applicable estate tax treaty provides otherwise. 69 UNDERWRITERS Under the terms and subject to the conditions contained in an underwriting agreement dated the date of this prospectus, the U.S. underwriters named below, for whom Morgan Stanley & Co. Incorporated, Donaldson, Lufkin & Jenrette Securities Corporation, Chase Securities Inc., Banc of America Securities LLC and J.C. Bradford & Co. are acting as U.S. representatives, and the international underwriters named below for whom Morgan Stanley & Co. International Limited, Donaldson, Lufkin & Jenrette International, Chase Securities Inc., Bank of America International Limited and J.C. Bradford & Co. are acting as international representatives, have severally agreed to purchase, and HomeGrocer.com has agreed to sell to them, severally, the number of shares indicated below:
Number of Name Shares ---- --------- U.S. Underwriters: Morgan Stanley & Co. Incorporated................................ Donaldson, Lufkin & Jenrette Securities Corporation.............. Chase Securities Inc ............................................ Banc of America Securities LLC................................... J.C. Bradford & Co. ............................................. Morgan Stanley Dean Witter Online Inc............................ DLJdirect Inc.................................................... Subtotal......................................................... ========= International Underwriters: Morgan Stanley & Co. International Limited....................... Donaldson, Lufkin & Jenrette International....................... Chase Securities Inc. ........................................... Bank of America International Limited............................ J.C. Bradford & Co. ............................................. Subtotal......................................................... Total.......................................................... =========
The U.S. underwriters and the international underwriters, and the U.S. representatives and the international representatives, are collectively referred to as the "underwriters" and the "representatives," respectively. The underwriters are offering the shares of common stock subject to their acceptance of the shares from HomeGrocer.com and subject to prior sale. The underwriting agreement provides that the obligations of the several underwriters to pay for and accept delivery of the shares of common stock offered by this prospectus are subject to the approval of legal matters by their counsel and to other conditions. The underwriters are obligated to take and pay for all of the shares of common stock offered by this prospectus if any such shares are taken. However, the underwriters are not required to take or pay for the shares covered by the underwriters' over-allotment option described below. In the agreement between U.S. and international underwriters, sales may be made between U.S. underwriters and international underwriters of any number of shares as may be mutually agreed. The per share price of any shares sold by the underwriters shall be the public offering price listed on the cover page of this prospectus, in U.S. dollars, less an amount not greater than the per share amount of the concession to dealers described below. The underwriters initially propose to offer part of the shares of common stock directly to the public at the public offering price listed on the cover page of this prospectus and part to dealers at a price that represents a concession not in excess of $ a share under the public offering price. Any underwriter may allow, and such dealers may reallow, a concession not in excess of $ a share to other underwriters or to dealers. 70 After the initial offering of the shares of common stock, the offering price and other selling terms may from time to time be varied by the representatives. HomeGrocer.com has granted to the U.S. underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of additional shares of common stock at the public offering price listed on the cover page of this prospectus, less underwriting discounts and commissions. The U.S. underwriters may exercise this option solely for the purpose of covering overallotments, if any, made in connection with the offering of the shares of common stock offered by this prospectus. To the extent the option is exercised, each U.S. underwriter will become obligated, subject to conditions, to purchase about the same percentage of the additional shares of common stock as the number listed next to the U.S. underwriter's name in the preceding table bears to the total number of shares of common stock listed next to the names of all U.S. underwriters in the preceding table. If the U.S. underwriters' option is exercised in full, the total price to the public would be $ , the total underwriters' discounts and commissions would be $ and total proceeds to HomeGrocer.com would be $ . HomeGrocer.com has advised the underwriters that the estimated expenses of the offering, in addition to the underwriting discounts and commissions, are approximately $1,400,000. The following table shows the per share and total underwriting discounts and commissions to be paid to the underwriters by HomeGrocer.com. These amounts are shown assuming both no exercise and full exercise of the underwriters' over- allotment option. The underwriting discounts and commissions will be determined by negotiations between us and the representatives. Among the factors to be considered in determining the discounts and commissions will be the size of offering, the nature of the security offered and the discounts and commissions charged in comparable transactions.
Per Share Total ------------------------- ------------------------- No Exercise Full Exercise No Exercise Full Exercise ----------- ------------- ----------- ------------- Underwriting discounts and commissions paid by HomeGrocer.com........... $ $ $ $ Other amounts considered to be underwriting compensation by the NASD..................... $ $ $ $
Morgan Stanley Dean Witter Online Inc., an affiliate of Morgan Stanley & Co. Incorporated, and DLJdirect Inc., are acting as underwriters in connection with the offering and will distribute shares of common stock over the Internet to their respective eligible account holders. The underwriters have informed HomeGrocer.com that they do not intend sales to discretionary accounts to exceed 5% of the total number of shares of common stock offered by them. We have been approved for quotation of our common stock on the Nasdaq National Market under the symbol "HOMG." Each of HomeGrocer.com and the directors, executive officers and other stockholders of HomeGrocer.com have agreed that, without the prior written consent of Morgan Stanley & Co. Incorporated on behalf of the underwriters, it will not, during the period ending 180 days after the date of this prospectus: . offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of directly or indirectly, any shares of common stock or any securities convertible into or exercisable or exchangeable for common stock; or . enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the common stock whether any transaction described above is to be settled by delivery of common stock or such other securities, in cash or otherwise. This lock-up restriction is subject in certain circumstances, for shares held by employees other than executive officers and directors, to earlier release. For a description of circumstances leading to this earlier release, please see "Shares Eligible for Future Sale." In addition, employees of HomeGrocer.com who 71 purchase reserved shares directly from the Underwriters will also be required to agree to these restrictions. The restrictions described in this paragraph do not apply to: . the sale of shares to the underwriters; . the issuance by HomeGrocer.com of shares of common stock upon the exercise of an option or a warrant or the conversion of a security outstanding on the date of this prospectus of which the underwriters have been advised in writing; . the grant by HomeGrocer.com of options to purchase shares of common stock pursuant to the 1997 Stock Incentive Compensation Plan, 1999 Stock Incentive Plan and 1999 Director's Stock Option Plan and the issuance by HomeGrocer.com of purchase rights or shares of common stock pursuant to the 1999 Employee Stock Purchase Plan, provided that the recipient of such option or share of common stock shall agree as a condition to be bound by the terms of the lock-up agreement; . transactions by any person other than HomeGrocer.com relating to shares of common stock or other securities acquired in open market transactions after the completion of the offering of the shares; or . shares of stock issued in conjunction with an acquisition. In order to facilitate the offering of the common stock, the underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock. Specifically, the underwriters may over- allot in connection with the offering, creating a short position in the common stock for their own account. In addition, to cover over-allotments or to stabilize the price of the common stock, the underwriters may bid for, and purchase, shares of common stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an underwriter or a dealer for distributing the common stock in the offering, if the syndicate repurchases previously distributed common stock in transactions to cover syndicate short positions, in stabilization transactions or otherwise. Any of these activities may stabilize or maintain the market price of the common stock above independent market levels. The underwriters are not required to engage in these activities, and may end any of these activities at any time. HomeGrocer.com and the underwriters have agreed to indemnify each other against some liabilities, including liabilities under the Securities Act. At the request of HomeGrocer.com, the underwriters have reserved for sale, at the initial offering price, up to 2.2 million shares offered hereby for our directors, officers, employees, business associates, and related persons. Employees of HomeGrocer.com who purchase these reserved shares will be subject to contractual resale restrictions for a period of 180 days beginning on the date of this prospectus. The shares of common stock available for sale to the general public will be reduced to the extent such persons purchase such reserved shares. Any reserved shares that are not so purchased will be offered by the underwriters to the general public on the same basis as the other shares offered hereby. Prior to this offering, there has been no public market for the common stock. The initial public offering price will be determined by negotiations between HomeGrocer.com and the U.S. representatives. Among the factors to be considered in determining the initial public offering price will be the future prospects of HomeGrocer.com and its industry in general, sales, earnings and other financial operating information of HomeGrocer.com in recent periods, and the price-earnings ratios, price-sales ratios, market prices of securities and financial and operating information of companies engaged in activities similar to those of HomeGrocer.com. The estimated initial public offering price range set forth on the cover page of this preliminary prospectus is subject to change as a result of market conditions and other factors. As of the date of this prospectus, Access Technology Partners, L.P. owns 689,656 shares of our Series D preferred stock. Access Technology Partners is a fund of investors that is managed by an entity associated with Chase Securities Inc., one of the representatives in this offering. Employees and entities associated with Chase Securities Inc. own an aggregate of 172,412 shares of our Series D preferred stock. 72 LEGAL MATTERS The validity of the common stock offered hereby will be passed upon for HomeGrocer.com by Venture Law Group, A Professional Corporation, Kirkland, Washington. Legal matters in connection with this offering will be passed upon for the underwriters by Davis Polk & Wardwell, Menlo Park, California. As of the date of this prospectus, directors of Venture Law Group and an investment partnership affiliated with Venture Law Group own 53,878 shares of our Series D preferred stock, which will convert into 53,878 shares of common stock upon completion of this offering. EXPERTS Ernst & Young LLP, independent auditors, have audited our financial statements at January 2, 1999 and January 1, 2000 and for the period from January 15, 1997 (inception) to January 3, 1998 and for the years ended January 2, 1999 and January 1, 2000, as set forth in their report. We have included our financial statements in the prospectus and elsewhere in the registration in reliance on Ernst & Young LLP's report, given on their authority as experts in accounting and auditing. ADDITIONAL INFORMATION AVAILABLE TO YOU We have filed with the Securities and Exchange Commission a registration statement on Form S-1 under the Securities Act with respect to the common stock offered hereby. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules. For further information with respect to HomeGrocer.com and the common stock offered hereby, we refer you to the registration statement and to the exhibits and schedules. Statements made in this prospectus concerning the contents of any document referred to herein are not necessarily complete. With respect to each such document filed as an exhibit to the registration statement, we refer you to the exhibit for a more complete description of the matter involved. The registration statement and the exhibits and schedules may be inspected without charge at the public reference facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the regional offices of the SEC located at Seven World Trade Center, 13th Floor, New York, NY 10048, and the Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of all or any part of the registration statement may be obtained from the SEC's offices upon payment of fees prescribed by the SEC. The SEC maintains a web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. The address of the site is www.sec.gov. 73 INDEX TO FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors........................... F-2 Balance Sheets.............................................................. F-3 Statements of Operations.................................................... F-4 Statements of Shareholders' Equity.......................................... F-5 Statements of Cash Flows.................................................... F-6 Notes to Financial Statements............................................... F-7
F-1 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders HomeGrocer.com, Inc. We have audited the accompanying balance sheets of HomeGrocer.com, Inc. as of January 2, 1999 and January 1, 2000, and the related statements of operations, shareholders' equity, and cash flows for the period from January 15, 1997 (inception) to January 3, 1998 and the years ended January 2, 1999 and January 1, 2000. 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 in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of HomeGrocer.com, Inc. at January 2, 1999 and January 1, 2000, and the results of its operations and its cash flows for the period from January 15, 1997 (inception) to January 3, 1998 and the years ended January 2, 1999 and January 1, 2000, in conformity with accounting principles generally accepted in the United States. Ernst & Young LLP Seattle, Washington January 18, 2000, except for Note 9, as to which the date is February 15, 2000 F-2 HOMEGROCER.COM, INC. BALANCE SHEETS (in thousands, except share and per share amounts)
Pro Forma Shareholders' Equity January 2, January 1, January 1, 1999 2000 2000 ---------- ---------- ------------- (Note 6) Assets Current assets: Cash and cash equivalents................ $ 1,084 $ 39,806 Marketable securities.................... -- 37,762 Inventories.............................. 284 2,555 Prepaid expenses and other current assets.................................. 296 3,032 ------- -------- Total current assets.................... 1,664 83,155 Fixed assets, net.......................... 1,237 52,066 Deposits and other long-term assets........ 657 3,776 Restricted cash............................ -- 7,932 ------- -------- Total assets............................ $ 3,558 $146,929 ======= ======== Liabilities & Shareholders' Equity Current liabilities: Accounts payable......................... $ 199 $ 4,396 Accrued liabilities...................... 522 4,856 Accrued compensation and related liabilities............................. 239 3,249 Current portion of capital lease obligations............................. 209 3,081 Current portion of long-term debt........ 122 980 ------- -------- Total current liabilities............... 1,291 16,562 Capital lease obligations, less current portion................................... 602 17,041 Long-term debt, less current portion....... 278 749 Other long-term liabilities................ -- 430 ------- -------- Total liabilities....................... 2,171 34,782 Commitments and contingencies Shareholders' equity: Convertible preferred stock, $0.001 par value: 78,357,142 shares authorized; Series A, 8,000,000 shares authorized, 8,000,000 issued and outstanding (none pro forma); liquidation preference of $4,000 (none pro forma);............... 8 8 Series B, 16,857,142 shares authorized, 16,857,142 issued and outstanding (none pro forma); liquidation preference of $5,900 (none pro forma);............... 17 17 Series C, 30,200,000 shares authorized, 29,942,050 issued and outstanding at January 1, 2000 (none pro forma); liquidation preference of $52,399 at January 1, 2000 (none pro forma)....... -- 30 Series D, 23,300,000 shares authorized, 18,407,546 issued and outstanding at January 1, 2000 (none pro forma); liquidation preference of $106,764 at January 1, 2000 (none pro forma)....... -- 18 Common stock, $0.001 par value: 130,000,000 shares authorized; 12,416,666 issued and outstanding at January 2, 1999 and 29,605,536 at January 1, 2000 (102,812,274 pro forma)................................. 12 30 $ 103 Additional paid-in-capital............... 10,614 250,151 250,151 Notes receivable from officers for common stock................................... -- (3,231) (3,231) Deferred stock-based compensation........ -- (41,619) (41,619) Accumulated deficit...................... (9,264) (93,257) (93,257) ------- -------- -------- Total shareholders' equity.............. 1,387 112,147 $112,147 ------- -------- ======== Total liabilities & shareholders' equity................................. $ 3,558 $146,929 ======= ========
See accompanying notes. F-3 HOMEGROCER.COM, INC. STATEMENTS OF OPERATIONS (in thousands, except share and per share amounts)
51 Weeks from 52 Weeks 52 Weeks January 15, 1997 Ended Ended (Inception) to January 2, January 1, January 3, 1998 1999 2000 ---------------- ---------- ---------- Net sales............................. $ -- $ 1,094 $ 21,648 Cost of sales......................... -- 1,018 19,515 ---------- ---------- ---------- Gross profit........................ -- 76 2,133 Selling, general and administrative expenses, excluding stock-based compensation......................... 1,064 7,455 59,208 Stock-based compensation expense...... 230 412 28,158 ---------- ---------- ---------- Loss from operations................ (1,294) (7,791) (85,233) Interest expense...................... (61) (172) (384) Interest income....................... -- 54 2,232 Other expense......................... -- -- (608) ---------- ---------- ---------- Net loss............................ $(1,355) $(7,909) $(83,993) ========== ========== ========== Basic and diluted net loss per share.. $ (0.14) $ (0.72) $ (5.56) ========== ========== ========== Pro forma basic and diluted net loss per share (unaudited)................ $ (1.28) ========== Weighted average shares outstanding used to compute basic and diluted net loss per share....................... 10,034,721 11,044,174 15,102,698 ========== ========== ========== Weighted average shares outstanding used to compute pro forma basic and diluted net loss per share (unau- dited)............................... 65,382,807 ==========
See accompanying notes. F-4 HOMEGROCER.COM, INC. STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands, except share amounts)
Convertible Preferred Stock ---------------------------------------------------------------------- Notes Series A Series B Series C Series D Common Stock Additional Receivable ---------------- ----------------- ----------------- ----------------- ------------------ Paid-in from Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Capital Officers --------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ---------- Sale of common stock........... -- $-- -- $-- -- $-- -- $-- 15,200,000 $ 15 $ 277 $ -- Issuance of common stock warrants with convertible promissory notes........... -- -- -- -- -- -- -- -- -- -- 190 -- Stock issued and stock options granted in exchange for consulting services........ -- -- -- -- -- -- -- -- 800,000 1 229 -- Net loss and comprehensive loss for the period ended January 3, 1998............ -- -- -- -- -- -- -- -- -- -- -- -- --------- ---- ---------- ---- ---------- ---- ---------- ---- ---------- ---- -------- ------- Balance at January 3, 1998............ -- -- -- -- -- -- -- -- 16,000,000 16 696 -- Repurchase of common stock.... (3,333,334) (4) 2 Issuance of common stock warrants for goods and services........ -- -- -- -- -- -- -- -- -- -- 27 -- Stock options granted in exchange for consulting services........ -- -- -- -- -- -- -- -- -- -- 191 -- Issuance of Series A preferred stock, net of offering costs of $73.... 7,500,000 8 -- -- -- -- -- -- -- -- 3,669 -- Issuance of Series A preferred stock for consulting services........ 500,000 -- -- -- -- -- -- -- -- -- 250 -- Issuance of Series B preferred stock, net of offering costs of $48.... -- -- 16,857,142 17 -- -- -- -- -- -- 5,835 -- Issuance of Series C preferred stock warrants for goods and services........ -- -- -- -- -- -- -- -- -- -- 84 -- Common stock returned in settlement with service provider........ -- -- -- -- -- -- -- -- (250,000) -- (140) -- Net loss and comprehensive loss for the year ended January 2, 1999............ -- -- -- -- -- -- -- -- -- -- -- -- --------- ---- ---------- ---- ---------- ---- ---------- ---- ---------- ---- -------- ------- Balance at January 2, 1999............ 8,000,000 8 16,857,142 17 -- -- -- -- 12,416,666 12 10,614 -- Issuance of Series C preferred stock, net of offering costs of $48.... -- -- -- -- 29,942,050 30 -- -- -- -- 52,320 -- Issuance of Series D preferred stock, net of offering costs of $291... -- -- -- -- -- -- 18,407,546 18 -- -- 106,455 -- Issuance of series D preferred stock warrants for goods and services........ -- -- -- -- -- -- -- -- -- -- 1,361 -- Stock options granted in exchange for consulting services........ -- -- -- -- -- -- -- -- -- -- 2,028 -- Exercise of common stock options......... -- -- -- -- -- -- -- -- 14,400,870 14 8,429 -- Repurchase of restricted common stock.... -- -- -- -- -- -- -- -- (12,000) 1 (5) -- Issuance of restricted common stock.... -- -- -- -- -- -- -- -- 2,050,000 2 920 -- Exercise of warrants to purchase common stock........... -- -- -- -- -- -- -- -- 750,000 1 280 -- Notes receivable from officers for common stock........... -- -- -- -- -- -- -- -- -- -- -- (3,231) Deferred stock- based compensation.... -- -- -- -- -- -- -- -- -- -- 67,749 -- Amortization of stock-based compensation.... -- -- -- -- -- -- -- -- -- -- -- -- Net loss and comprehensive loss for the year ended January 1, 2000............ -- -- -- -- -- -- -- -- -- -- -- -- --------- ---- ---------- ---- ---------- ---- ---------- ---- ---------- ---- -------- ------- Balance at January 1, 2000............ 8,000,000 $ 8 16,857,142 $ 17 29,942,050 $ 30 18,407,546 $ 18 29,605,536 $ 30 $250,151 $(3,231) ========= ==== ========== ==== ========== ==== ========== ==== ========== ==== ======== ======= Total Deferred Shareholders' Stock-based Accumulated Equity Compensation Deficit (Deficit) ------------ ----------- ------------- Sale of common stock........... $ -- $ -- $ 292 Issuance of common stock warrants with convertible promissory notes........... -- -- 190 Stock issued and stock options granted in exchange for consulting services........ -- -- 230 Net loss and comprehensive loss for the period ended January 3, 1998............ -- (1,355) (1,355) ------------ ----------- ------------- Balance at January 3, 1998............ -- (1,355) (643) Repurchase of common stock.... (2) Issuance of common stock warrants for goods and services........ -- -- 27 Stock options granted in exchange for consulting services........ -- -- 191 Issuance of Series A preferred stock, net of offering costs of $73.... -- -- 3,677 Issuance of Series A preferred stock for consulting services........ -- -- 250 Issuance of Series B preferred stock, net of offering costs of $48.... -- -- 5,852 Issuance of Series C preferred stock warrants for goods and services........ -- -- 84 Common stock returned in settlement with service provider........ -- -- (140) Net loss and comprehensive loss for the year ended January 2, 1999............ -- (7,909) (7,909) ------------ ----------- ------------- Balance at January 2, 1999............ -- (9,264) 1,387 Issuance of Series C preferred stock, net of offering costs of $48.... -- -- 52,350 Issuance of Series D preferred stock, net of offering costs of $291... -- -- 106,473 Issuance of series D preferred stock warrants for goods and services........ -- -- 1,361 Stock options granted in exchange for consulting services........ -- -- 2,028 Exercise of common stock options......... -- -- 8,443 Repurchase of restricted common stock.... -- -- (4) Issuance of restricted common stock.... -- -- 922 Exercise of warrants to purchase common stock........... -- -- 281 Notes receivable from officers for common stock........... -- -- (3,231) Deferred stock- based compensation.... (67,749) -- 0 Amortization of stock-based compensation.... 26,130 -- 26,130 Net loss and comprehensive loss for the year ended January 1, 2000............ -- (83,993) (83,993) ------------ ----------- ------------- Balance at January 1, 2000............ $ (41,619) $ (93,257) $ 112,147 ============ =========== =============
See accompanying notes. F-5 HOMEGROCER.COM, INC. STATEMENTS OF CASH FLOWS (in thousands)
51 Weeks Ended 52 Weeks 52 Weeks January 15, 1997 Ended Ended (inception) to January 2, January 1, January 3, 1998 1999 2000 ---------------- ---------- ---------- Operating Activities: Net loss................................ $(1,355) $(7,909) $(83,993) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation.......................... 7 175 2,881 Amortization.......................... 57 132 120 Stock-based compensation expense...... 230 412 28,158 Loss on disposal of fixed assets...... -- -- 628 Changes in operating assets and liabilities: Prepaid expenses and other current assets............................... (165) (265) (2,736) Inventories........................... -- (284) (2,271) Accounts payable...................... 740 49 4,197 Accrued liabilities................... -- (68) 4,334 Accrued compensation and related liabilities.......................... -- 239 3,010 ------- ------- -------- Net cash used in operating activities... (486) (7,519) (45,672) Investing Activities: Purchases of fixed assets............... (393) (737) (34,387) Purchases of marketable securities...... -- -- (37,762) Deposits and other...................... -- (571) (1,448) Restricted cash......................... -- -- (7,932) ------- ------- -------- Net cash used in investing activities... (393) (1,308) (81,529) Financing Activities: Net proceeds from sale of Series A preferred stock........................ -- 2,926 -- Net proceeds from sale of Series B preferred stock........................ -- 5,852 -- Net proceeds from sale of Series C preferred stock........................ -- -- 52,350 Net proceeds from sale of Series D preferred stock........................ -- -- 106,473 Proceeds from sale of common stock...... 292 -- 459 Repurchase of common stock.............. -- (2) (4) Proceeds from exercise of stock options................................ -- -- 5,675 Proceeds from exercise of warrants...... -- -- 281 Proceeds from convertible notes......... 900 -- -- Repayment of convertible notes.......... -- (100) -- Proceeds from notes payable............. -- 900 -- Repayment of notes payable.............. -- (500) -- Proceeds from sale leaseback............ -- 522 -- Proceeds from long-term debt............ -- -- 2,309 Repayments of long-term debt............ -- -- (980) Repayments of capital lease obligations............................ -- -- (640) ------- ------- -------- Net cash provided by financing activities............................. 1,192 9,598 165,923 ------- ------- -------- Net increase in cash and cash equivalents............................ 313 771 38,722 Cash and cash equivalents, beginning of period................................. -- 313 1,084 ------- ------- -------- Cash and cash equivalents, end of period................................. $ 313 $ 1,084 $ 39,806 ======= ======= ======== Supplemental Cash Flow Information: Cash paid during the period for interest............................... $ -- $ 35 $ 509 Noncash Financing and Investing Activities: Fixed assets acquired through capital lease.................................. -- 811 19,951 Issuance of warrants to purchase common stock in connection with convertible notes issued........................... 190 -- -- Conversion of notes to Series A preferred stock (net of convertible note origination fees)................. -- 751 -- Issuance of warrants to purchase preferred stock in connection with loan agreement.............................. -- -- 1,361 Issuance of notes receivable for officers to purchase common stock...... -- -- (3,231)
See accompanying notes. F-6 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS 1. Significant Accounting Policies Description of Business HomeGrocer.com, Inc. (the "Company") is an Internet retailer of grocery and other consumer products. The Company operates its own distribution system providing next-day delivery of products. The Company began delivering groceries to the Seattle market from its first customer fulfillment center located in Bellevue, Washington in June 1998. As of January 1, 2000, the Company was delivering groceries from four customer fulfillment centers in the following markets:
Customer Fulfillment Center Location Delivery Commencement Market Served - --------------------------- --------------------- ------------- Renton, WA (formerly Bellevue) June 1998 Seattle Tualatin, OR May 1999 Portland Irvine, CA September 1999 Orange County Fullerton, CA November 1999 Orange County/Los Angeles
The Company was incorporated on January 15, 1997 in British Columbia, Canada as GrocerNet Home Shopping, Inc. On September 29, 1997, the Company reincorporated in Delaware as HomeGrocer.com, Inc. The Company has incurred significant operating losses since its inception. To date, the Company has financed its operations primarily through the issuance of equity securities. The Company's current expansion plans as well as costs associated with increasing its customer base in its existing markets will require additional financing. The Company believes that additional financing can be obtained from existing or new investors. Fiscal Year The Company reports on a 52/53 week fiscal year basis that ends on the Saturday nearest December 31. Because the Company commenced on January 15, 1997 (inception), the fiscal year ended January 3, 1998 was a 51-week year. Fiscal years 1998 and 1999 were 52-week years that ended on January 2, 1999 and January 1, 2000, respectively. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents are carried at fair market value, which approximates cost. Marketable Securities The Company considers all investments with a maturity of more than three months but less than one year when purchased and investments to be sold within one year to be short-term and available-for-sale. The Company's marketable securities consists of commercial paper. F-7 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Concentrations of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of its holdings of cash, cash equivalents and marketable securities. Banking and investing with credit-worthy financial institutions mitigates risks associated with cash, cash equivalents and marketable securities. Fair Value of Financial Instruments Financial instruments consist of cash and cash equivalents, marketable securities, capital leases and other long-term obligations. The carrying value of all financial instruments approximates fair market value. Inventories Inventories are stated at the lower of cost (using the weighted average cost method) or market. The Company's largest vendor accounted for approximately 29% and 32% of the Company's purchases in fiscal 1998 and 1999, respectively. In addition, another vendor accounted for approximately 11% of the Company's purchases in fiscal 1999. Although products are readily available from other sources, the vendors' inability to supply product in a timely manner or on terms acceptable to the Company could adversely affect the Company's ability to meet customers' demands. 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, which range from two to fifteen years. Fixed assets purchased under capital leases are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or lease term. The Company evaluates the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is measured by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from use of the assets and their ultimate disposition. In circumstances where impairment is determined to exist, the Company writes down the impaired asset to its fair value based on the present value of estimated expected future cash flows. Restricted Cash The Company has entered into various lease agreements requiring standby letters of credit. The bank has required the Company to maintain certain balances on deposit as security for the letters of credit. These letters of credit expire at various dates ranging from July 2000 through August 2015. As of January 1, 2000, standby outstanding letters of credit totalled $7.9 million. Income Taxes The Company accounts for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are recovered. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized. Revenue Recognition The Company recognizes revenue from product sales, net of promotional discounts, when products are delivered to customers. The Company provides an allowance for sales returns, which have been insignificant, based upon historical experience. F-8 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Cost of Sales Cost of sales includes the cost of merchandise sold to customers, inbound freight costs and the cost of free product given to customers. Cost of sales also includes a provision for inventory loss resulting from shrinkage and damaged and spoiled inventory. The Company adjusts its provision based on historical experience. Selling, General and Administrative Expenses Selling, general and administrative expenses include payroll and other costs associated with operating the Company's customer fulfillment centers, delivery fleet and related expenses, advertising and promotional expenditures, information technology and corporate overhead. Advertising Costs The costs of advertising are expensed as incurred. The Company incurred advertising costs of $82,000, $1.0 million and $7.7 million for the 51 weeks ended January 3, 1998 and the 52 weeks ended January 2, 1999, and January 1, 2000, respectively. No similar costs were incurred in fiscal 1997. 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 employee stock options rather than the alternative fair value accounting allowed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). Under APB No. 25 compensation expense related 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 pro forma disclosure of the impact of applying the fair value method of SFAS No. 123. The Company recognizes compensation expense for options granted to non-employees in accordance with the provisions of SFAS No. 123 and the Emerging Issues Task Force consensus Issue 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, which require using a Black-Scholes option pricing model and remeasuring such stock options to the current fair market value until the performance date has been reached. Deferred stock-based compensation consists of amounts recorded when the exercise price of an option or the sales price of restricted stock was lower than the subsequently determined deemed fair value for financial reporting purposes. Deferred stock-based compensation is amortized over the vesting period of the underlying options. Net Loss Per Share Net loss per share is calculated using the weighted average number of common shares outstanding less the number of shares subject to repurchase. Common stock that the Company has the right to repurchase and shares associated with outstanding stock options, warrants and convertible preferred stock are not included in the calculation of diluted loss per share because they are antidilutive. Pro forma net loss per share is calculated using the weighted average number of common shares outstanding less shares subject to repurchase, including the pro forma effects of the automatic conversion of all outstanding convertible preferred stock into shares of common stock effective upon closing of the Company's initial public offering as if such conversion had occurred at the original date of issuance. F-9 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) The following table sets forth the computation of basic and diluted loss per share and pro forma basic and diluted loss per share for the periods indicated:
Fiscal Fiscal Fiscal 1997 1998 1999 ----------- ----------- ----------- (in thousands, except share and per share amounts) Numerator: Net loss.............................. $ (1,355) $ (7,909) $ (83,993) =========== =========== =========== Denominator: Weighted average common shares outstanding.......................... 15,868,041 13,833,333 18,587,559 Less: Weighted average shares subject to repurchase agreements............. (5,833,320) (2,789,159) (3,484,861) ----------- ----------- ----------- Denominator for basic and diluted calculation.......................... 10,034,721 11,044,174 15,102,698 =========== =========== =========== Weighted average effect of pro forma conversion of securities: Series A convertible preferred stock.............................. 8,000,000 Series B convertible preferred stock.............................. 16,857,142 Series C convertible preferred stock.............................. 21,381,550 Series D convertible preferred stock.............................. 4,041,417 ----------- Denominator for pro forma basic and diluted (unaudited).................. 65,382,807 =========== Net loss per share: Basic and diluted..................... $ (0.14) $ (0.72) $ (5.56) =========== =========== =========== Pro forma basic and diluted (unaudited).......................... $ (1.28) ===========
At January 3, 1998, January 2, 1999 and January 1, 2000, 3,666,653, 7,642,986, and 19,782,460, respectively, shares of common stock subject to repurchase, stock options and warrants were excluded from the computation of actual and pro forma diluted loss per share, as their impact was antidilutive. If the Company had reported net income, the calculation of earnings per share would have included the dilutive effect of these common stock equivalents using the treasury stock method. Comprehensive Income (Loss) In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, Reporting Comprehensive Income ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in financial statements. This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company adopted SFAS No. 130 on January 4, 1998. The Company has no items of other comprehensive income or loss. Segment Information In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a company's operating segments. The Company adopted SFAS No. 131 on January 4, 1998. The Company operates in one principal business segment across domestic markets. F-10 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) New Accounting Pronouncements In March 1998, the Accounting Standards Executive Committee issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use ("SOP 98-1"). SOP 98-1 requires all costs related to the development of internal use software other than those incurred during the application development stage to be expensed as incurred. Costs incurred during the application development stage are required to be capitalized and amortized over the estimated useful life of the software. The Company adopted SOP 98-1 on January 3, 1999 and there was no significant impact on the Company's financial position or operating results. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities ("SOP 98-5"). SOP 98-5 requires costs of start-up activities and organization costs be expensed as incurred. The Company adopted SOP 98-5 on January 3, 1999 and there was no significant impact on the Company's financial position or operating results. In December 1999, the Securities and Exchange Commission staff released Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB No. 101"), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. SAB No. 101 did not impact the Company's revenue recognition policy. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. 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. The Company does not expect that the adoption of SFAS No. 133 will have a material impact on its financial statements because the Company does not currently hold any derivative instruments. 2. Fixed Assets Fixed assets, at cost, consist of the following (in thousands):
January 2, January 1, 1999 2000 ---------- ---------- Computer equipment and software........................ $ 923 $17,163 Machinery and equipment................................ 110 8,000 Delivery fleet......................................... -- 12,846 Furniture and fixtures................................. 224 1,951 Leasehold improvements................................. 162 6,481 Construction in progress............................... -- 8,564 ------ ------- 1,419 55,005 Less accumulated depreciation and amortization......... (182) (2,939) ------ ------- $1,237 $52,066 ====== =======
At January 2, 1999 and January 1, 2000, fixed assets held under capital leases totaled $811,000 and $20.8 million, respectively, and accumulated amortization for these assets totaled $25,000 and $867,000, respectively. Construction in progress at January 1, 2000 consists primarily of leasehold improvements and equipment purchases related to customer fulfillment centers which were not placed in service as of January 1, 2000. The Company capitalized interest of approximately $246,000 in fiscal 1999 during the acquisition and construction of certain assets. F-11 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) 3. Debt Long-Term Debt The Company has entered into various Payment Plan Agreements with Oracle Credit Corporation. The dates of the agreements range from November 1998 through May 1999 and have payment terms ranging from seven to 12 quarters. The interest rates on the agreements range from 6.72% to 13.65%. Maturities of the amounts outstanding under the Payment Plan Agreements are as follows (in thousands):
Fiscal Year ----------- 2000................................................................. $ 980 2001................................................................. 535 2002................................................................. 214 ------ $1,729 ======
In September 1999, the Company entered into a Subordinated Loan and Security Agreement with Comdisco. Under the terms of the agreement, Comdisco agreed to loan up to $10.0 million to the Company in minimum installments of $1.0 million. Borrowings under the agreement are due and payable in 36 equal monthly payments and amounts outstanding bear interest at 11%. No amounts were outstanding under the agreement at January 1, 2000. In connection with the Subordinated Loan and Security Agreement, the Company granted Comdisco a warrant to purchase 275,862 shares of Series D preferred stock at an exercise price of $5.80 per share. The warrant is exercisable for a period of ten years from the date of issuance or five years from the date of the Company's initial public offering, whichever is earlier. The fair value of this warrant was determined to be $1.4 million and is being amortized as interest expense over 40 months which is the term of the underlying Subordinated Loan and Security Agreement. The fair value of the warrant was determined using the following assumptions: expected life of ten years; risk-free interest rate of 6.25%; no dividends during the expected term and volatility of 80%. During fiscal 1998, the Company incurred debt of $400,000 through a credit facility with Silicon Valley Bank bearing interest at prime plus 1% and requiring 36 equal payments commencing January 1999. The general assets of the Company exclusive of intellectual property secured the facility. All amounts outstanding under the credit facility at January 2, 1999 were repaid in August 1999 and the agreement was terminated. Convertible Promissory Notes In November and December 1997, the Company issued convertible promissory notes with an aggregate face amount of $900,000. The notes bear interest at 6% per annum and were convertible or redeemable upon completion of the Series A preferred stock financing. The notes also contained a provision providing for the issuance of warrants to purchase 1,800,000 shares of common stock at $0.38 per share and expire on the earlier of December 31, 2000, or an initial public offering. The fair value of these warrants was determined to be $190,000 and was amortized to interest expense during fiscal 1997 and 1998. The fair value was calculated at the time of issuance using the Black-Scholes pricing model with the following assumptions: expected life of three years; risk free interest rate of 5%; no dividends during the term and volatility of 50%. During fiscal 1999, warrants to purchase 750,000 shares were exercised and the remaining warrants to purchase 1,050,000 shares are exercisable at January 1, 2000. In February 1998, holders of the convertible notes elected to convert $800,000 of the outstanding notes into 1,600,000 shares of Series A preferred stock. The Company redeemed the remaining $100,000 outstanding convertible notes. F-12 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) 4. Leases The Company leases its corporate offices, operating facilities, certain operating equipment and its delivery fleet under noncancelable leases. The leases have lives of three to 15 years and generally contain renewal options for up to ten years. Aggregate rental expense for the 51 weeks ended January 3, 1998, 52 weeks ended January 2, 1999 and the 52 weeks ended January 1, 2000 was $50,000, $603,000 and $3.2 million, respectively. Future minimum payments under capital leases and noncancelable operating leases during the next five years for leases with a remaining life in excess of one year at January 1, 2000 were as follows (in thousands):
Capital Operating Leases Leases ------- --------- 2000....................................................... $ 4,872 $ 8,363 2001....................................................... 4,894 9,090 2002....................................................... 4,482 9,466 2003....................................................... 3,544 9,754 2004....................................................... 2,125 8,909 Thereafter................................................. 6,283 46,586 ------- ------- Total minimum payments..................................... 26,200 $92,168 ======= Less amounts representing interest......................... 6,078 ------- Present value of minimum lease payments.................... 20,122 Less current portion of capital lease obligations.......... 3,081 ------- Noncurrent capital lease obligations....................... $17,041 =======
In January 2000, leases for four additional operating facilities were executed with future minimum lease commitments totalling $36.4 million. In July and October 1998, the Company issued warrants to purchase 304,120 shares of common stock in connection with equipment lease and loan agreements. The fair value of this warrant was determined to be $27,000 and is being amortized to interest expense over the terms of the agreements. The fair value of the warrants was calculated at the time of issuance using the Black-Scholes option pricing model with the following assumptions: expected life of seven years; risk-free interest rate of 5%; no dividends during the expected term and volatility of 50%. This warrant has an exercise price of $0.50 per share and is exercisable on or before the later of seven years from the date of issuance, or three years from the closing of an initial public offering. In November 1998, the Company entered into a Master Lease Agreement with Comdisco, Inc. ("Comdisco"), under which Comdisco agreed to provide the Company lease financing, up to an aggregate purchase price of $3.0 million. In addition, during fiscal 1999, Comdisco agreed to provide an additional $5.0 million of lease financing. As of January 2, 1999 and January 1, 2000, leases executed pursuant to this loan agreement aggregated to approximately $811,000 and $8.0 million, respectively and provide for equal monthly payments over a 30, 42- or 48-month term with implicit interest rates ranging from 8% to 18%. Amounts outstanding under the lease agreement are secured by the equipment which has a net book value of $6.8 million at January 1, 2000. The Company accounts for its obligations under the Master Lease Agreement as capital leases. As part of the Master Lease Agreement, the Company granted Comdisco a warrant to purchase 153,600 shares of Series C preferred stock at an exercise price of $0.78 per share. This warrant is exercisable for a period of seven years from the date of issuance or three years from the date of the Company's initial public offering, whichever is longer. The fair value of this warrant was determined to be $84,000. The fair value of the warrants was calculated at the time of issuance using the Black-Scholes pricing model with the F-13 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) following assumptions: expected life seven years; risk-free interest rate of 5%; no dividends during the expected term and volatility of 50%. In August 1999, the Company entered into a Lease Agreement with Valley Freightliner, Inc ("VFI") and a related financing agreement with Mercedes-Benz Credit Corporation ("MBCC"). Under the terms of the Lease Agreement, the Company will lease its delivery fleet from VFI for a period of 84 months following receipt of the vehicles. The Company has no option to purchase the vehicles at any time and is obligated to pay VFI a guaranteed residual value of $12,500 per vehicle at the end of the lease term. The Company accounts for its obligations under this Lease Agreement as capital leases. The financing agreement entered into with MBCC is a revolving line of credit under which the Company may borrow up to $15.0 million for the purchase of delivery vehicles or to finance the lease of such vehicles. As of January 1, 2000, leases executed pursuant to this agreement aggregated approximately $12.7 million. Amounts available under the agreement will increase to $20.0 million if the Company raises an additional $44.0 million in equity financing. The financing agreement restricts the Company's ability to pay dividends and expires on June 30, 2000. Borrowings under the line are payable in 84 monthly installments and are secured by the delivery vehicles which have a net book value of $12.6 million at January 1, 2000. 5. Income Taxes The Company did not provide any current or deferred United States federal income tax provision or benefit for any of the periods presented because it has experienced operating losses since inception. The Company provided a full valuation allowance on the net deferred tax asset, consisting primarily of net operating loss carryforwards, because management believes there is substantial uncertainty as to its ability to use such tax loss carryforwards. As of January 1, 2000, the Company had approximately $66.0 million of net operating loss carryforwards for federal income tax purposes, which expire beginning in 2017. In 1999, due to the issuance and sale of Series C preferred stock, the Company incurred an ownership change pursuant to applicable regulations under the Internal Revenue Code of 1986, as amended. The Company's use of the $11.5 million of net operating losses incurred through the date of ownership change will be limited to approximately $1.0 million per year in order to offset future taxable income. To the extent that any single-year loss is not utilized to the full amount of the limitation, such unused loss is carried over to subsequent years until the earlier of its utilization or the expiration of the relevant carryforward period. The Company's anticipated initial public offering is not likely to cause an additional ownership change. 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 liabilities and assets are as follows (in thousands):
January 2, January 1, 1999 2000 ---------- ---------- Deferred tax assets: Net operating loss carryforwards...................... $ 2,796 $ 23,109 Stock-based compensation.............................. -- 307 Accrued liabilities and other......................... 336 370 ------- -------- Total deferred tax assets........................... 3,132 23,786 Deferred tax liabilities--depreciation and other...... 46 575 ------- -------- Net deferred tax assets............................. 3,086 23,211 Less valuation allowance............................ (3,086) (23,211) ------- -------- $ 0 $ 0 ======= ========
F-14 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Because the Company's utilization of these deferred tax assets is dependent on future profits that are not assured, a valuation allowance equal to the deferred tax assets has been provided. The valuation reserve increased $2.6 million and $20.1 million during fiscal 1998 and 1999, respectively. 6. Stockholders' Equity Stock Split In November 1999, the Company's shareholders approved a two-for-one stock split of shares, warrants and options outstanding which became effective on November 23, 1999. All share and per share amounts in the accompanying financial statements have been adjusted to reflect the stock split. Proposed Initial Public Offering of Common Stock On December 14, 1999, the Board of Directors authorized the Company to proceed with an initial public offering of its common stock. If the offering is consummated as currently expected, all of the outstanding preferred stock will automatically convert into common stock. The unaudited pro forma shareholders' equity at January 1, 2000 reflects the anticipated conversion of all outstanding shares of Series A, Series B, Series C and Series D preferred stock into 73,206,738 shares of common stock upon completion of the offering. Common Stock In fiscal 1997, the Company sold 15,200,000 shares of common stock for cash consideration of $292,000. In September 1997, the Company's founders entered into common shareholders' agreements whereby the Company had the right to repurchase 6,000,000 shares of common stock held by the founders at the original purchase price of $0.0005 per share if their employment terminated under certain circumstances. The Company's right of repurchase originally lapsed quarterly from December 31, 1997 through September 30, 2000. In addition, the Company had the option to purchase any unrestricted shares from the founders upon termination at fair market value. In December 1997, one founder left the employment of the Company. The Company exercised its repurchase right in February 1998 as to 2,000,000 shares for $1,000. In August 1998, another founder left the employment of the Company. The Company exercised its repurchase right as to 1,333,334 shares for $667. The Company did not exercise its right to purchase either of the founders' unrestricted shares. In August 1998, as a part of the Series B preferred stock financing, the lapsing schedule for the Company's remaining founder was accelerated such that his remaining shares became fully vested by January 1, 2000. The Company entered into a service agreement in April 1997 with a consultant pursuant to which the Company issued 800,000 shares of common stock ($230,000) in 1997 and 500,000 shares of Series A preferred stock ($250,000) in 1998 for services provided. In October 1998, the service agreement was terminated and the consultant returned 250,000 shares of common stock. Preferred Stock In February, April, June and July 1998, the Company issued 8,000,000 shares of Series A preferred stock. Net proceeds of $3.7 million were obtained from the conversion of $800,000 of notes for 1,600,000 shares, the sale of 5,900,000 shares at $0.50 per share and the issuance of 500,000 shares in exchange for services. In F-15 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) June 1998, the Company issued a warrant to purchase 965,666 shares of common stock to an investor as part of the Series A preferred stock financing. The exercise price of this warrant is $0.50 per share and it is exercisable through December 31, 2000, but terminates upon an initial public offering. In September 1998, 16,857,142 shares of Series B preferred stock were issued at a price of $0.35 per share, resulting in net proceeds of $5.9 million. In January and February 1999, certain preferred stock shareholders provided $2.0 million of bridge financing. In April and May 1999, 29,942,050 shares of Series C preferred stock were sold at a price of $1.75 per share, resulting in net proceeds of $52.4 million, including $1.7 million of shareholder loans obtained in 1999 that were converted into 969,464 shares of Series C preferred stock. As part of the Series C preferred stock offering, the Company granted one of the Series C investors an initial public offering purchase option, which was waived in December 1999. In September, October and November 1999, 18,407,546 shares of Series D preferred stock were sold at a price of $5.80 per share, resulting in net proceeds of $106.5 million. Subject to certain conditions, the preferred stock has mandatory conversion requirements in the event of a qualified initial public offering of the Company's common stock in which net proceeds exceed $75.0 million and a price of not less than $5.80 per share, or if a majority of the preferred stockholders, voting as a single class, elects to convert to common stock. In the event of any distribution of assets upon liquidation of the Company, holders of Series A, Series B, Series C and Series D preferred stock shall first receive a liquidation preference of $0.50 per share, $0.35 per share, $1.75 per share and $5.80 per share respectively, plus cumulative dividends, if and when declared, at an annual rate of 9%. Each share of outstanding preferred stock has voting rights equivalent to the number of common shares issuable, if converted. Stock Option Plans In October 1997, the Company adopted the 1997 Stock Incentive Compensation Plan ("1997 Plan"), under which the Company grants incentive stock options and nonqualified stock options to employees, officers and consultants. Incentive stock options are issued only to employees and are exercisable at prices that are no less than the fair market value of the stock on the date of grant. Generally, options granted under the 1997 Plan become exercisable immediately and vest over four years. Shares issued upon exercise of options that are unvested are restricted and subject to repurchase by the Company upon termination of employment or services and such restrictions lapse over the original vesting schedule. During fiscal 1999, the Company repurchased 12,000 shares of restricted common stock from employees who terminated prior to the lapsing of the repurchase restrictions at their original price of an aggregate of $4,000. At January 1, 2000, 4,996,870 shares of restricted common stock issued were subject to repurchase at a weighted average exercise price of $0.97 per share. Nonqualified stock options are granted at a price and vesting period determined by the Plan administrator. Options under the 1997 Plan generally have a term of ten years. Unless earlier terminated by the Board of Directors, the 1997 Plan expires in October 2007. On December 14, 1999, the Company's 1999 Stock Incentive Plan ("1999 Stock Plan") was adopted by the Board of Directors, subject to shareholder approval. A total of 12,500,000 shares have been reserved for issuance under the plan subject to an annual increase on the first day of each of the Company's next five fiscal years beginning in fiscal 2001 equal to the lesser of 2,500,000 shares or 2.5% of outstanding shares on the last day of the preceding fiscal year. The number of options granted, the exercise price of the option and the option vesting period will be determined by the Plan administrator, subject to certain restrictions. Unless terminated earlier by the Board of Directors, the 1999 Stock Plan will terminate in December 2009. F-16 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) On December 14, 1999, the Company's 1999 Directors' Stock Option Plan ("1999 Directors' Plan") was adopted by the Board of Directors, subject to shareholder approval and the completion of the initial public offering. A total of 500,000 shares of common stock has been reserved for issuance under the plan. The 1999 Directors' Plan provides for a nonqualified stock option grant to purchase 20,000 shares of common stock on the date on which the individual becomes a non-employee director. Thereafter, on the date of the Company's annual shareholders' meeting, each non-employee director who has served as a director of the Company for six months will be granted an additional option to purchase 5,000 shares. Options granted under the plan will vest ratably over four years and have a term of ten years. Unless terminated earlier, the 1999 Directors Plan will terminate in December 2009. A summary of activity related to the Company's 1997 plan follows:
Shares Available Weighted-Average for Future Grant Options Exercise Price ---------------- ---------- ---------------- 1997 Plan adoption................ 10,124,334 -- $ -- Granted......................... (4,509,000) 4,509,000 0.24 Canceled........................ 656,000 (656,000) 0.25 ----------- ---------- Balance, January 2, 1999.......... 6,271,334 3,853,000 0.24 1997 Plan amendment............. 5,800,000 -- -- Granted......................... (10,810,400) 10,810,400 1.39 Exercised....................... -- (8,250,870) 0.69 Canceled........................ 526,188 (526,188) 0.62 1999 Stock Plan adoption........ 12,500,000 -- -- ----------- ---------- Balance, January 1, 2000.......... 14,287,122 5,886,342 $1.69 =========== ==========
The following information is provided for options outstanding and vested at January 1, 2000:
Outstanding Vested ------------------------------------------- ------------------------ Weighted-Average Number Range of Number of Weighted-Average Remaining of Weighted-Average Exercise Prices Options Exercise Price Contractual Life Options Exercise Price --------------- --------- ---------------- ---------------- ------- ---------------- $0.00--$0.09 40,000 $0.09 8.3 40,000 $0.09 $0.10--$0.25 414,442 $0.25 8.7 178,953 $0.25 $0.26--$0.45 2,825,300 $0.45 9.6 100,000 $0.45 $0.46--$2.50 1,781,000 $2.50 9.9 8,399 $2.50 $2.51--$5.00 825,600 $5.00 10.0 -- $5.00 --------- ------- $0.00--$5.00 5,886,342 $1.69 9.7 327,352 $0.35 ========= =======
Under APB No. 25, no compensation expense is recognized when the exercise price of the Company's employee stock options equals the fair value of the underlying stock on the date of grant. Deferred stock-based compensation was recorded when the exercise price of an option or the sales price of restricted stock was lower than the subsequently determined deemed fair value for financial reporting purposes of the underlying common stock. The Company recorded aggregate deferred stock-based compensation of $67.7 million in fiscal 1999 and will amortize the deferred stock-based compensation over the vesting period of the underlying options, which is typically four years. Amortization of deferred stock-based compensation was $26.1 million in fiscal 1999. Had the Company elected to recognize compensation cost based on the fair value of the options as prescribed by SFAS 123, the pro forma net loss would have been $8.0 million or $(0.73) per share in fiscal 1998 and pro forma net loss of $80.0 million or $(5.30) per share in fiscal 1999. The fair value of each option F-17 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) grant was estimated on the date of grant using the minimum value method and the following assumptions: average expected option life of four years, risk-free interest rates from 4.1% to 6.4%, and no expected dividends. The weighted- average fair value of options granted during 1998 and 1999 was $0.04 and $3.93 per share, respectively. No options were granted during 1997. The initial impact on pro forma net loss may not be representative of compensation expense in future years, when the effect of the amortization of multiple awards will be reflected in the results of operations. A total of 1,795,350 options under the 1997 Plan have been granted to employees, directors and consultants who reside in California. Some of these optionees have exercised their options prior to January 1, 2000. The 1997 Plan did not include certain provisions required by California state securities laws. The Company plans to offer to repurchase shares that were exercised (782,000 shares) and to repurchase unexercised options (1,013,350 options). The rescission offer aggregates $344,000 for outstanding common stock and $562,000 for outstanding stock options. The Company expects to make the rescission offer March 2000 and this offer will remain open for 30 days. Due to this rescission offer, the $344,000 related to outstanding common stock should be classified in the January 1, 2000 balance sheet outside of shareholders' equity as mezzanine equity until the rescission offer expires, however this amount was included within shareholders' equity because the amount is not considered material. Stock Option Grants and Restricted Stock Sales In September 1999, two officers of the Company were granted nonqualified stock options to purchase 6,150,000 shares of the Company's common stock for $0.45 per share. The options were granted outside of the Company's 1997 Plan and vest over a period of four years. Each option agreement also provide that in the event the officer's employment is terminated for other than cause or in the event of a change in control whereby the officer is not offered a position with similar responsibilities, additional shares will vest to the officer. These shares are subject to a repurchase option which gives the Company the right to purchase such shares at a price equal to that paid by the officers. The repurchase option expires over the original vesting schedule of the underlying option and no shares were vested at January 1, 2000. In addition to the stock options, in September 1999, the Company sold 2,050,000 shares of restricted common stock to the same two officers at $0.45 per share. The shares are fully vested but are subject to a right of first refusal, whereby the Company has the right to purchase the shares for the same price and terms as offered to the officers by a third party. This right expires upon the Company's successful completion of an initial public offering. In September 1999, the Company loaned the two officers $3,231,000 to enable them to exercise the stock options granted to them and purchase the restricted shares of the Company's common stock. The promissory notes are with full recourse against the officers, bear interest at 5.98% and are payable in full on September 9, 2004. Principal amounts outstanding under the notes are reflected as a component of shareholders' equity. F-18 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Common Stock Reserved The following shares of common stock were reserved for future issuance:
January 1, 2000 ---------- Outstanding stock options....................................... 5,886,342 Stock options available for future grant........................ 14,287,122 Warrants to purchase common stock............................... 2,319,786 Conversion of convertible preferred stock: Series A....................................................... 8,000,000 Series B....................................................... 16,857,142 Series C....................................................... 29,942,050 Series D....................................................... 18,407,546 Warrant to purchase preferred stock that is convertible to common stock................................................... 429,462 ---------- Total common shares reserved for future issuance................ 96,129,450 ==========
7. Employee Benefit Plans The Company has a 401(k) Plan that is available to all employees over the age of 21 who have been with the Company three months. Eligible employees may contribute up to 20% of their annual compensation to the 401(k) Plan, subject to limitations imposed by federal income tax regulations. Each participant is fully vested in his or her deferred salary contribution. The Company matches participants' contributions to the 401(k) Plan up to 5% of the participants' compensation if the participant has performed at least 1,000 hours of service during the year. The Company's fiscal 1998 and 1999 matching contributions were $23,000 and $318,000, respectively. The Company's matching contributions vest 33% after two years of service, 66% after three years of service and 100% after four years of service. On December 14, 1999, the Company's 1999 Employee Stock Purchase Plan ("1999 ESPP") was adopted by the Board of Directors, subject to shareholder approval. If approved by the shareholders, the 1999 ESPP will become effective upon the completion of the initial public offering and completion of the initial public offering. A total of 3,000,000 shares of common stock has been reserved for issuance under the 1999 ESPP plus an annual automatic increase on the first day of each fiscal year beginning in 2001 and continuing through 2005 equal to the lesser of 500,000 shares, 0.5% of the Company's outstanding shares or the number of shares determined by the Board of Directors. Under the 1999 ESPP, eligible employees may purchase common stock at 85% of the lesser of the fair market value of the Company's common stock on the first or last day of the previous six or 12 months. Employees may end their participation in the 1999 ESPP at any time during the offering period. Unless terminated earlier, the 1999 ESPP will terminate in December 2019. 8. Commitments and Contingencies In November 1999, the Company entered into a noncancelable advertising agreement with one of its investors under which the Company will pay an aggregate sum of $10.0 million for a maximum of 2.0 million advertising mailings. The $10.0 million is due in eight quarterly installments commencing on March 31, 2000, subject to acceleration if certain milestones are achieved. As of January 1, 2000, the Company has signed agreements to acquire additional delivery vehicles with an estimated cost of $35.6 million and had construction-related commitments of approximately $6.5 million. The Company is party to routine claims and litigation incidental to its business. The Company believes the ultimate resolution of these routine matters will not have a material adverse effect on its financial position, results of operations or cash flows. F-19 HOMEGROCER.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) 9. Subsequent Event On February 15, 2000, the Company entered into a marketing agreement with America Online ("AOL"), an Internet online service provider. Under the terms of the agreement, AOL has agreed to promote the Company online and to deliver a minimum number of annual page views. Over the five year term of the agreement, the Company is obligated to make payments totaling up to $60 million to AOL and pay a referral fee for each new customer referred by AOL to the Company above specified thresholds. F-20 Back Inside Cover The back inside cover contains a heading reading "Easy to navigate web site" and three screen shots of HomeGrocer.com's web site having the following three captions: 1. "Large selection of products with personalized lists for quick shopping;" 2. "Easy-to-shop categories, product photos, nutritional information and more;" 3. "Simple and quick checkout." The HomeGrocer.com peach logo and corporate name are at the bottom of the page. [ARTWORK] [Photograph of the back of a HomeGrocer.com delivery truck displaying HomeGrocer.com's peach logo driving through a neighborhood] ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We may + +not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell these securities and we are not soliciting offers to buy these + +securities in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ PROSPECTUS (Subject to Completion) Issued March 9, 2000 22,000,000 Shares [LOGO OF HOMEGROCER.COM] Common Stock ------------ HomeGrocer.com, Inc. is offering 22,000,000 shares of common stock. This is our initial public offering and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $10 and $12 per share. ------------ Our common stock has been approved for quotation on the Nasdaq National Market under the symbol "HOMG." ------------ Investing in our common stock involves risks, including the risk that our executive officers, directors and major shareholders will own approximately 65% of our outstanding common shares. See "Risk Factors" beginning on page 6. ------------ PRICE $ A SHARE ------------
Underwriting Price to Discounts and Proceeds to Public Commissions HomeGrocer.com -------- ------------- -------------- Per Share................................ $ $ $ Total.................................... $ $ $
HomeGrocer.com has granted the underwriters the right to purchase up to an additional 3,300,000 shares to cover over-allotments. The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Morgan Stanley & Co. International Limited expects to deliver the shares of common stock to purchasers on , 2000. ------------ MORGAN STANLEY DEAN WITTER DONALDSON, LUFKIN & JENRETTE CHASE H&Q BANK OF AMERICA INTERNATIONAL LIMITED J.C. BRADFORD & CO. , 2000 PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by HomeGrocer.com in connection with the sale of common stock being registered. All amounts are estimates except the SEC registration fee and the NASD filing fee and the Nasdaq National Market listing fee.
Amount to be Paid ---------- SEC registration fee........................................... $ 80,151 NASD filing fee................................................ 30,500 Nasdaq National Market listing fee............................. 90,000 Printing and engraving expenses................................ 250,000 Legal fees and expenses........................................ 500,000 Accounting fees and expenses................................... 300,000 Blue Sky qualification fees and expenses....................... 10,000 Transfer Agent and Registrar fees.............................. 15,000 Miscellaneous fees and expenses................................ 124,349 ---------- Total...................................................... $1,400,000 ==========
Item 14. Indemnification of Directors and Officers Sections 23B.08.500 through 23B.08.600 of the Washington Business Corporation Act (the "WBCA") authorize a court to award, or a corporation's board of directors to grant, indemnification to directors and officers on terms sufficiently broad to permit indemnification under some circumstances for liabilities arising under the Securities Act of 1933, as amended (the "Securities Act"). The registrant's Bylaws (Exhibit 3.5 hereto) provide for indemnification of the registrant's directors, officers, employees and agents to the maximum extent permitted by Washington. The directors and officers of the registrant also may be indemnified against liability they may incur for serving in that capacity pursuant to a liability insurance policy maintained by the registrant for such purpose. Section 23B.08.320 of the WBCA authorizes a corporation to limit a director's liability to the corporation or its shareholders for monetary damages for acts or omissions as a director, except in circumstances involving intentional misconduct, knowing violations of law or illegal corporate loans or distributions, or any transaction from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. The registrant's Articles of Incorporation (Exhibit 3.2 hereto) contain provisions implementing, to the fullest extent permitted by Washington law, as applicable, such limitations on a director's liability to the registrant and its shareholders. The registrant will enter into indemnification agreements with its officers and directors, the form of which is attached as Exhibit 10.26 to this Registration Statement and incorporated herein by reference. The indemnification agreements provide the registrant's officers and directors with indemnification to the maximum extent permitted by the WBCA. Item 15. Recent Sales of Unregistered Securities Since HomeGrocer.com's inception through January 1, 2000, HomeGrocer.com has issued and sold the following unregistered securities: 1. From inception to January 1, 2000, HomeGrocer.com granted and issued options to purchase 15,319,400 shares of its common stock with a weighted average price of $1.05 to a number of employees, II-1 directors and consultants of HomeGrocer.com pursuant to its 1997 stock incentive compensation plan. Among those receiving options were Tom A. Alberg, Mary B. Anderson, Charles K. Barbo, James L. Barksdale, Rex L. Carter, Ken Deering, Robert Duffy, Corwin Karaffa, Jonathan Landers, Jonathan D. Lazarus, Daniel R. Lee, Daniel J. Murphy, David A. Pace, Philip S. Schlein and Kristin H. Stred. 2. From inception to January 1, 2000, HomeGrocer.com has issued an aggregate of 8,250,870 shares of its common stock to executive officers, directors and employees upon the exercise of stock options granted pursuant to the HomeGrocer.com 1997 stock incentive compensation plan with an aggregate exercise price of $5,674,568. Among those that HomeGrocer.com issued shares to were Tom A. Alberg, Mary B. Anderson, Charles K. Barbo, James L. Barksdale, Rex L. Carter, Ken Deering, Robert Duffy, Corwin Karaffa, Jonathan D. Lazarus, Jonathan Landers, Daniel R. Lee, David A. Pace, Philip S. Schlein and Kristin H. Stred. 3. On September 29, 1997, HomeGrocer.com issued an aggregate of 15,200,000 shares of its common stock to investors and J. Terrence Drayton, our president, in connection with the domestication of its Canadian predecessor into the state of Delaware for consideration of the Canadian shares. 4. On October 15, 1997 and September 1, 1998, HomeGrocer.com issued Organic Online, Inc. a total of 800,000 shares of its common stock and 500,000 shares of its Series A preferred stock for consideration of services rendered. On May 21, 1999, HomeGrocer repurchased 250,000 shares of this common stock from Organic Online, Inc. in connection with an agreement to terminate services. 5. On February 11, 1998, HomeGrocer.com granted and issued warrants with an expiration date of December 31, 2000, to purchase an aggregate of 1,800,000 shares of its common stock, at an exercise price of $0.375 per share, to the following investors in connection with a bridge loan financing: an entity affiliated with the Barbo Group, Madrona Investment Group, LLC, Geoffrey A. Boguch, an entity affiliated with Kleiner Perkins Group, Michael B. Donald, an entity affiliated with the Heffring Group, Richard J. Robbins and Bonnie B. Robbins (as Tenants in Common), Spanish Caravan Investments, LLC, Dennis M. Weibling, Arthur W. Harrigan, John Maynard and Terran Ventures, Inc., Terran Ventures is an affiliate of J. Terrence Drayton, an executive officer. 6. On June 25, 1998, HomeGrocer.com granted and issued a warrant with an expiration date of December 31, 2000, to purchase 965,666 shares of its common stock at an exercise price of $0.50 per share to Fitpro Pty. Ltd, in connection with a bridge loan financing. 7. In July 1998, HomeGrocer.com granted and issued warrants with an expiration date of July 2005 or three years from the effective date of this offering, whichever is earlier, to purchase an aggregate of 300,000 shares of its common stock at an exercise price of $0.50 per share to First Portland Corp. and Silicon Valley Bank, each in connection with a commercial loan. 8. On February 11, 1998, April 3, 1998, June 2, 1998, and July 16, 1998, HomeGrocer.com issued 8,000,000 shares of its Series A preferred stock to investors, including but not limited to Fitpro Pty Ltd., Stewart A. Konzen, entities affiliated with Hummer Winblad Group, entities affiliated with the Barbo Group, Madrona Investment Group, LLC, Organic, Inc., Richard J. Robbins and Bonnie B. Robbins (Tenants in Common), Geoffrey A. Boguch, R. Kirk Wilson, Philip S. Schlein, entities affiliated with the Sonntag Group, Lazarus Family Investments LLC, and entities associated with Kleiner Perkins Group for an aggregate cash consideration of $4,000,000. Of the 8,000,000 shares of Series A preferred stock, HomeGrocer.com issued 50,000 shares to Terran Ventures, Inc., an affiliate of our president, J. Terrence Drayton. Of the 8,000,000 shares of Series A preferred stock, HomeGrocer.com issued 100,000 shares to Director Charles Barbo. 9. On September 1, 1998, HomeGrocer.com issued 16,857,142 shares of its Series B preferred stock to investors, including to Ken Deering, entities affiliated with Hummer Winblad Group, entities affiliated with Kleiner Perkins Group and the Lazarus Family Investments LLC, for an aggregate cash consideration of approximately $5,900,000. 10. On October 19, 1998, HomeGrocer.com granted and issued a warrant with an expiration date of October 19, 2005 or three years from the effective date of this offering, whichever is earlier, to purchase II-2 4,120 shares of its common stock at an exercise price of $0.50 per share to First Portland Corp. in connection with a equipment leasing arrangement. 11. On November 9, 1998, HomeGrocer.com granted and issued a warrant, with an expiration date of November 9, 2005 or three years from the effective date of this offering, whichever is earlier, to purchase 153,600 shares of its Series C to Comdisco, Inc., with an exercise price of $0.78125 per share, in connection with a equipment leasing arrangement. 12. On March 15, 1999, HomeGrocer.com issued 300,000 shares of its common stock at an exercise price of $0.375 per share to C&LB Family Limited Partnership, an entity associated with the Barbo Group, pursuant to a common stock warrant dated February 11, 1998, for an aggregate cash consideration of $112,500. 13. On March 30, 1999, HomeGrocer.com issued 300,000 shares of its common stock at an exercise price of $0.375 per share to Geoffrey A. Boguch, pursuant to a common stock warrant dated February 11, 1998, for an aggregate cash consideration of $112,500. 14. On April 13, 1999 and May 13, 1999, HomeGrocer.com issued 29,942,050 shares of its Series C preferred stock to investors, including but not limited to J. Terrence Drayton, Madrona Investment Group, LLC, Lazarus Family Investments LLC, Philip S. Schlan, Amazon.com, Inc., entities affiliated with the Barksdale Group, Liberty HG, Inc., entities affiliated with the Hummer Winblad Group and entities affiliated with the Kleiner Perkins Group for an aggregate cash consideration of approximately $52,399,000. Of the issued 29,942,050 shares of its Series C preferred stock, HomeGrocer.com issued 5,516 shares to director Charles Barbo. 15. On September 9, 1999, HomeGrocer.com granted Mary Alice Taylor, our Chairman and Chief Executive Officer and J. Terrence Drayton, our president and a director of HomeGrocer.com, options to purchase an aggregate of 6,150,000 shares of common stock at an exercise price of $0.45 per share and the two officers exercised the options to purchase the shares on that date. The options were exercised for aggregate consideration of $2,767,500 in the form of cash and promissory notes from the officers. Additionally, on September 9, 1999, HomeGrocer.com sold the two officers an aggregate of 2,050,000 shares of common stock at an exercise price of $0.45 per share for aggregate consideration of $922,500 in the form of cash and promissory notes from the officers. 16. On September 15, 1999, HomeGrocer.com granted and issued a warrant, with an expiration date of September 15, 2006 or three years from the effective date of this offering to purchase 275,862 shares of its Series D preferred stock to Comdisco, Inc., with an exercise price $5.80 per share. 17. On October 19, 1999, HomeGrocer.com issued 100,000 shares of its common stock at an exercise price of $0.375 per share to Spanish Caravan Investments, LLC, pursuant to a common stock warrant dated February 11, 1998, for an aggregate cash consideration of $37,500. 18. On October 21, 1999, HomeGrocer.com issued 50,000 shares of its common stock at an exercise price of $0.375 per share to Arthur W. Harrigan, Jr., pursuant to a common stock warrant dated February 11, 1998, for an aggregate cash consideration of $18,750. 19. On September 30, 1999, October 13, 1999, October 29, 1999, November 12, 1999 and November 18, 1999, HomeGrocer.com issued 18,407,546 shares of its Series D preferred stock to investors, including but not limited to Philip S. Schlein, Amazon.com, Inc., an entity affiliated with the Hummer Winblad Group, entities affiliated with the Kleiner Perkins Group, entities associated with the Barksdale Group, entities associated with Hambrecht & Quist Group, Liberty HG, Inc., Madrona Investment Group, entities affiliated with Van Wagoner Group, Martha Stewart, Comdisco, Inc., and entities affiliated with the Lazarus Group for an aggregate cash consideration of approximately $106,764,000. Of the 18,407,546 shares of its Series D preferred stock, HomeGrocer.com also issued 17,200 shares to Director Charles Barbo. Additionally, chief executive officer Mary Alice Taylor was issued 17,240 shares. II-3 20. In January 2000, HomeGrocer.com issued an aggregate of 1,050,000 shares of its common stock at an exercise price of $0.375 per share upon the exercise of common stock warrants dated February 11, 1998 and April 26, 1999, for an aggregate cash consideration of $393,750, to: Madrona Investment Group, Michael B. Donald, Heffring Investment Group, Richard & Bonnie Robbins, Spanish Caravan Investments, Dennis M. Weibling, Arthur W. Harrigan, Jr., Terran Ventures, Inc., John Maynard and entities affiliated with the Kleiner Perkins Group. 21. In January and February 2000, HomeGrocer.com issued an aggregate of 965,666 shares of its common stock to Fitpro Pty. Ltd. at an exercise price of $0.50 per share upon exercise of common stock warrants dated June 25, 1998, for an aggregate cash consideration of $482,833. The issuances of the above securities were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) and Regulation D as transactions by an issuer not involving any public offering. In addition, issuances described in Items 1 and 2 were deemed exempt from registration under the Securities Act in reliance upon Rule 701 promulgated under the Securities Act. The recipients of securities in each such transaction represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and warrants issued in such transactions. All recipients had adequate access, through their relationships with HomeGrocer.com, to information about HomeGrocer.com. Item 16. Exhibits and Financial Statement Schedules (a) Exhibits
Number Description ------ ----------- 1.1** Form of Underwriting Agreement. 3.1** Restated Certificate of Incorporation of HomeGrocer.com. 3.2** Amended and Restated Articles of Incorporation of HomeGrocer.com. 3.3** Second Amended and Restated Articles of Incorporation of HomeGrocer.com (proposed). 3.4** Bylaws of HomeGrocer.com (Delaware). 3.5** Bylaws of HomeGrocer.com (Washington). 4.1** Specimen Stock Certificate. 4.2** Third Amended and Restated Investors Rights Agreement dated September 30, 1999, as amended. 4.3** Warrant Agreement to purchase Series C Preferred Stock dated November 9, 1998 issued by HomeGrocer.com in favor of Comdisco, Inc. 4.4** Warrant Agreement to purchase Series D Preferred Stock dated September 15, 1999 issued by HomeGrocer.com in favor of Comdisco, Inc. 4.5** Form of Common Stock Purchase Warrant issued by HomeGrocer.com to certain lenders. 4.6** Form of Common Stock Warrant Certificate issued by HomeGrocer.com in connection with its preferred stock financings. 5.1** Opinion of Venture Law Group regarding the legality of the common stock being registered. 10.1** Advertising Agreement dated November 18, 1999 between HomeGrocer.com and Amazon.com, LLC. 10.2** Lease Agreement dated August 16, 1999 between HomeGrocer.com and Valley Freightliner, Inc. 10.3** Revolving Line of Credit Commitment Letter dated June 11, 1999 by Mercedes-Benz Credit Corporation in favor of HomeGrocer.com, Inc. 10.4** Master Lease Agreement dated November 9, 1998 between HomeGrocer.com and Comdisco, Inc.
II-4
Number Description ------ ----------- 10.5** Addendum to Master Lease Agreement dated as of November 9, 1999 between HomeGrocer.com and Comdisco, Inc. 10.6** Subordinated Loan and Security Agreement dated September 15, 1999 between HomeGrocer.com and Comdisco, Inc. 10.7** Form of Promissory Note dated September 9, 1999 issued by Mary Alice Taylor in favor of HomeGrocer.com. 10.8** Form of Promissory Note dated September 9, 1999 issued by J. Terrence Drayton in favor of HomeGrocer.com. 10.9** Employment Agreement dated September 2, 1999 between HomeGrocer.com and Mary Alice Taylor. 10.10** Employment Agreement dated June 1, 1999 between HomeGrocer.com and J. Terrence Drayton. 10.11** Employment Agreement dated November 3, 1999 between HomeGrocer.com and Daniel R. Lee. 10.12** Employment Agreement dated August 31, 1999 between HomeGrocer.com and David A. Pace. 10.13** Facility Lease dated May 19, 1999 between HomeGrocer.com, as sublessee, and The Plaza at Yarrow Bay, LLC. 10.14** Facility Sublease dated July 22, 1999 between HomeGrocer.com, as sublessor, and AT&T Wireless Services of Washington, Inc. 10.15** Facility Sublease dated April 8, 1999 between HomeGrocer.com, as sublessee, and Delta Engineering and Manufacturing. 10.16** Facility Lease dated July 23, 1999 between HomeGrocer.com, as lessee, and Exposition Property Associates (interest transferred from The Ezralow Company, LLC). 10.17** Facility Lease dated November 4, 1996 between HomeGrocer.com, as successor in interest to the lessee, and Benaroya Capital Company, LLC. 10.18** Facility Sublease dated June 24, 1999 between HomeGrocer.com, as sublessor, and A&M Warehouses, Incorporated. 10.19** Facility Lease dated July 8, 1999 between HomeGrocer.com, as lessee, and Lincoln-RECP Fullerton OPCO, LLC. 10.20** Facility Lease dated August 10, 1999 between HomeGrocer.com, as lessee, and Realty Associates Iowa Corporation. 10.21** Facility Lease dated May 24, 1999 between HomeGrocer.com, as sublessee, and The Concourse Joint Venture. 10.22** Amendment No. 1 dated June 21, 1999 to the Facility Lease dated May 24, 1999 between HomeGrocer.com, as sublessee, and The Concourse Joint Venture. 10.23** Facility Sublease dated November 15, 1999 between HomeGrocer.com, as sublessee, and Thyssen Dover Elevator. 10.24** Facility Lease dated November 15, 1999 between HomeGrocer.com, as lessee, and Watson Partners, L.P. 10.25** Commercial Lease Agreement dated December 17, 1999 between HomeGrocer.com as Lessee, and CB Luna Industrial No. 3, Ltd. 10.26** Form of Indemnification Agreement between HomeGrocer.com and each of its Officers and Directors. 10.27** 1997 Stock Incentive Compensation Plan dated April 1997. 10.28** 1999 Stock Incentive Plan dated December 1999. 10.29** 1999 Employee Stock Purchase Plan dated December 1999.
II-5
Number Description ------ ----------- 10.30** 1999 Directors' Stock Option Plan dated December 1999. 10.31** Network Services Agreement dated December 17, 1997 between HomeGrocer.com and InterNAP Network Services Corporation. 10.32** Employment Agreement dated November 22, 1999 between HomeGrocer.com and Rex L. Carter. 10.33** Facility Lease dated January 14, 2000 between HomeGrocer.com and Reliance Hamilton Associates, LLC. 10.34** Facility Lease dated October 1, 1999 between HomeGrocer.com and Waples Corporation. 10.35** Facility Lease dated January 4, 2000 between HomeGrocer.com and The Irvine Company. 10.36** Facility Lease dated January 25, 2000 between HomeGrocer.com and Mercy Capital Center Joint Venture. 10.37** Retailer's Agreement dated December 10, 1997 between HomeGrocer.com and SuperValu. 10.38+ Interactive Marketing Agreement dated February 15, 2000 between HomeGrocer.com and America Online, Inc. 10.39** First Amendment to Lease Agreement dated February 29, 2000 between HomeGrocer.com and Mercy Capital Center Joint Venture. 10.40** Facility Lease dated February 2000 between HomeGrocer.com and MBC Springbelt, LLC. 10.41** Facility Lease dated February 23, 2000 between HomeGrocer.com and Duke-Weeks Realty Limited Partnership. 10.42 Facility Lease dated March 3, 2000 between HomeGrocer.com and Gonsalves & Santucci, Inc. 10.43 First Amendment to Lease Agreement dated November 15, 1999 between HomeGrocer.com and Lincoln-RECP Fullerton OPCO, LLC. 21.1** List of Subsidiaries. 23.1 Consent of Ernst & Young LLP. 23.2 Consent of Venture Law Group (included in Exhibit 5.1). 24.1** Power of Attorney (included in signature page to Registration Statement). 27.1** Financial Data Schedule.
- -------- ** Previously filed. + Confidential treatment has been requested for portions of the copy of the exhibit filed with the Securities and Exchange Commission. The omitted information has been filed separately with the Securities and Exchange Commission under our application for confidential treatment. (b) Financial Statement Schedules Schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. Item 17. Undertakings The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreements certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the II-6 registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer, or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-7 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this amendment to registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Kirkland, State of Washington on March 9, 2000. HomeGrocer.com, Inc. /s/ Mary Alice Taylor By: _________________________________ Mary Alice Taylor Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Amendment to Registration Statement has been signed by the following persons in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Mary Alice Taylor Chairman of the Board and March 9, 2000 ______________________________________ Chief Executive Officer Mary Alice Taylor * Chief Financial Officer March 9, 2000 ______________________________________ Daniel R. Lee * President and Director March 9, 2000 ______________________________________ J. Terrence Drayton * Director March 9, 2000 ______________________________________ Tom A. Alberg * Director March 9, 2000 ______________________________________ Charles K. Barbo * Director March 9, 2000 ______________________________________ James L. Barksdale * Director March 9, 2000 ______________________________________ Mark P. Gorenberg * Director March 9, 2000 ______________________________________ Jonathan D. Lazarus * Director March 9, 2000 ______________________________________ Douglas Mackenzie * Director March 9, 2000 ______________________________________ David Risher * Director March 9, 2000 ______________________________________ Philip S. Schlein /s/ Mary Alice Taylor March 9, 2000 *By: _________________________________ Mary Alice Taylor Attorney-in-Fact
II-8 INDEX TO EXHIBITS
Number Description ------ ----------- 1.1** Form of Underwriting Agreement. 3.1** Restated Certificate of Incorporation of HomeGrocer.com. 3.2** Amended and Restated Articles of Incorporation of HomeGrocer.com. 3.3** Second Amended and Restated Articles of Incorporation of HomeGrocer.com (proposed). 3.4** Bylaws of HomeGrocer.com (Delaware). 3.5** Bylaws of HomeGrocer.com (Washington). 4.1** Specimen Stock Certificate. 4.2** Third Amended and Restated Investors Rights Agreement dated September 30, 1999, as amended. 4.3** Warrant Agreement to purchase Series C Preferred Stock dated November 9, 1998 issued by HomeGrocer.com in favor of Comdisco, Inc. 4.4** Warrant Agreement to purchase Series D Preferred Stock dated September 15, 1999 issued by HomeGrocer.com in favor of Comdisco, Inc. 4.5** Form of Common Stock Purchase Warrant issued by HomeGrocer.com to certain lenders. 4.6** Form of Common Stock Warrant Certificate issued by HomeGrocer.com in connection with its preferred stock financings. 5.1** Opinion of Venture Law Group regarding the legality of the common stock being registered. 10.1** Advertising Agreement dated November 18, 1999 between HomeGrocer.com and Amazon.com, LLC. 10.2** Lease Agreement dated August 16, 1999 between HomeGrocer.com and Valley Freightliner, Inc. 10.3** Revolving Line of Credit Commitment Letter dated June 11, 1999 by Mercedes-Benz Credit Corporation in favor of HomeGrocer.com, Inc. 10.4** Master Lease Agreement dated November 9, 1998 between HomeGrocer.com and Comdisco, Inc. 10.5** Addendum to Master Lease Agreement dated as of November 9, 1999 between HomeGrocer.com and Comdisco, Inc. 10.6** Subordinated Loan and Security Agreement dated September 15, 1999 between HomeGrocer.com and Comdisco, Inc. 10.7** Form of Promissory Note dated September 9, 1999 issued by Mary Alice Taylor in favor of HomeGrocer.com. 10.8** Form of Promissory Note dated September 9, 1999 issued by J. Terrence Drayton in favor of HomeGrocer.com. 10.9** Employment Agreement dated September 2, 1999 between HomeGrocer.com and Mary Alice Taylor. 10.10** Employment Agreement dated June 1, 1999 between HomeGrocer.com and J. Terrence Drayton. 10.11** Employment Agreement dated November 3, 1999 between HomeGrocer.com and Daniel R. Lee. 10.12** Employment Agreement dated August 31, 1999 between HomeGrocer.com and David A. Pace. 10.13** Facility Lease dated May 19, 1999 between HomeGrocer.com, as sublessee, and The Plaza at Yarrow Bay, LLC. 10.14** Facility Sublease dated July 22, 1999 between HomeGrocer.com, as sublessor, and AT&T Wireless Services of Washington, Inc. 10.15** Facility Sublease dated April 8, 1999 between HomeGrocer.com, as sublessee, and Delta Engineering and Manufacturing. 10.16** Facility Lease dated July 23, 1999 between HomeGrocer.com, as lessee, and Exposition Property Associates (interest transferred from The Ezralow Company, LLC).
Number Description ------ ----------- 10.17** Facility Lease dated November 4, 1996 between HomeGrocer.com, as successor in interest to the lessee, and Benaroya Capital Company, LLC. 10.18** Facility Sublease dated June 24, 1999 between HomeGrocer.com, as sublessor, and A&M Warehouses, Incorporated. 10.19** Facility Lease dated July 8, 1999 between HomeGrocer.com, as lessee, and Lincoln-RECP Fullerton OPCO, LLC. 10.20** Facility Lease dated August 10, 1999 between HomeGrocer.com, as lessee, and Realty Associates Iowa Corporation. 10.21** Facility Lease dated May 24, 1999 between HomeGrocer.com, as sublessee, and The Concourse Joint Venture. 10.22** Amendment No. 1 dated June 21, 1999 to the Facility Lease dated May 24, 1999 between HomeGrocer.com, as sublessee, and The Concourse Joint Venture. 10.23** Facility Sublease dated November 15, 1999 between HomeGrocer.com, as sublessee, and Thyssen Dover Elevator. 10.24** Facility Lease dated November 15, 1999 between HomeGrocer.com, as lessee, and Watson Partners, L.P. 10.25** Commercial Lease Agreement dated December 17, 1999 between HomeGrocer.com as Lessee, and CB Luna Industrial No. 3, Ltd. 10.26** Form of Indemnification Agreement between HomeGrocer.com and each of its Officers and Directors. 10.27** 1997 Stock Incentive Compensation Plan dated April 1997. 10.28** 1999 Stock Incentive Plan dated December 1999. 10.29** 1999 Employee Stock Purchase Plan dated December 1999. 10.30** 1999 Directors' Stock Option Plan dated December 1999. 10.31** Network Services Agreement dated December 17, 1997 between HomeGrocer.com and InterNAP Network Services Corporation. 10.32** Employment Agreement dated November 22, 1999 between HomeGrocer.com and Rex L. Carter. 10.33** Facility Lease dated January 14, 2000 between HomeGrocer.com and Reliance Hamilton Associates, LLC. 10.34** Facility Lease dated October 1, 1999 between HomeGrocer.com and Waples Corporation. 10.35** Facility Lease dated January 4, 2000 between HomeGrocer.com and The Irvine Company. 10.36** Facility Lease dated January 25, 2000 between HomeGrocer.com and Mercy Capital Center Joint Venture. 10.37** Retailer's Agreement dated December 10, 1997 between HomeGrocer.com and SuperValu. 10.38+ Interactive Marketing Agreement dated February 15, 2000 between Homegrocer.com and America Online, Inc. 10.39** First Amendment to Lease Agreement dated February 29, 2000 between HomeGrocer.com and Mercy Capital Center Joint Venture. 10.40** Facility Lease dated February 2000 between HomeGrocer.com and MBC Springbelt, LLC. 10.41** Facility Lease dated February 23, 2000 between HomeGrocer.com and Duke-Weeks Realty Limited Partnership. 10.42 Facility Lease dated March 3, 2000 between HomeGrocer.com and Gonsalves & Santucci, Inc.
Number Description ------ ----------- 10.43 First Amendment to Lease Agreement dated November 15, 1999 between HomeGrocer.com and Lincoln-RECP Fullerton OPCO, LLC. 21.1** List of Subsidiaries. 23.1 Consent of Ernst & Young LLP. 23.2 Consent of Venture Law Group (included in Exhibit 5.1). 24.1** Power of Attorney (included in signature page to Registration Statement). 27.1** Financial Data Schedule.
- -------- ** Previously filed. + Confidential treatment has been requested for portions of the copy of the exhibit filed with the Securities and Exchange Commission. The omitted information has been filed separately with the Securities and Exchange Commission under our application for confidential treatment. EX-10.38 2 INTERACTIVE MARKETING AGREEMENT EXHIBIT 10.38 Confidential Treatment Requested INTERACTIVE MARKETING AGREEMENT ------------------------------- This Interactive Marketing Agreement (the "Agreement"), dated as of February 15, 2000 (the "Effective Date"), is between America Online, Inc. ("AOL"), a Delaware corporation, with offices at 22000 AOL Way, Dulles, Virginia 20166, and HomeGrocer.com, Inc. ("Marketing Partner" or "MP") a Delaware corporation, with offices at 10230 NE Points Drive, Kirkland, WA 98033-7879. AOL and MP may be referred to individually as a "Party" and collectively as the "Parties." INTRODUCTION ------------ AOL and MP each desires to enter into an interactive marketing relationship whereby AOL will promote and distribute an interactive site referred to (and further defined) herein as the Affiliated MP Site (as defined in Section 2.1). This relationship is further described below and is subject to the terms and conditions set forth in this Agreement. Defined terms used but not defined in the body of the Agreement will be as defined on Exhibit B attached hereto. --------- TERMS ----- 1. PROMOTION, DISTRIBUTION AND MARKETING. ------------------------------------- 1.1. AOL Promotion of Affiliated MP Site. ----------------------------------- 1.1.1. AOL will provide MP with the promotions (the "Promotions") described on Exhibit A attached hereto for the Affiliated MP --------- Site (as defined in Section 2.1). Subject to MP's reasonable approval, AOL will have the right to fulfill its promotional commitments with respect to any of the foregoing by providing MP comparable promotional placements in appropriate alternative areas of the AOL Network. In addition, if AOL is unable to deliver any particular Promotion, AOL will work with MP to provide MP a comparable promotional placement. AOL reserves the right to redesign or modify the organization, structure, "look and feel," navigation and other elements of the AOL Network at any time. In the event such modifications materially and adversely affect any specific Promotion, AOL will work with MP to provide MP, as its sole remedy, a comparable promotional placement. As used throughout this Agreement, the phrases "comparable promotional placements" or "comparable promotions" shall mean placements which are of comparable overall value, to be determined based on a variety of factors, including size, quality, type (e.g., integrated or banner), location (i.e., page or screen and the subject matter thereof), demographically and geographically targeted relevance, and audience reach (taking into account the targeted nature of the placement). If the parties disagree about whether any substitute promotional placements are "comparable," either party may invoke the dispute resolution procedures set forth in Section 7. 1.1.2. AOL shall use commercially reasonable efforts to enable additional advertising slots in relevant channels on the AOL Network for geo-targeted advertising to the local geographic markets in which MP provides the Exclusive Product; provided, however, that nothing herein shall require AOL to specifically create such areas. 1.1.3. As soon as available and in all events by not later than the second anniversary of the Effective Date (or such later date as the parties may agree), AOL shall provide to MP an anchor tenancy in a relevant department/commerce center of "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" AOL's Shop@AOL shopping area (or its successor). AOL shall provide MP with 90 days' written notice of an anchor tenancy becoming available. 1.1.4. Within thirty (30) days following the Effective Date, the Parties shall meet to review the Carriage Plan and devise a switching matrix pursuant to which MP shall be permitted to switch Promotions no more often than monthly for other inventory which becomes available on the AOL Network; provided, however, that all switching of Promotions shall be subject to inventory availability and AOL's reasonable approval. At the meeting the Parties shall, among other things, make good faith efforts to establish minimum levels of Impressions by Designated Exclusivity Area in order to maintain exclusivity in such Designated Exclusivity Area, and, in addition, shall revise the carriage plan to increase geo-targeted Impressions (taking into account relative value and the switching matrix) including allocation from Digital City local sales force, establish future allocation for an anchor tenancy in Shop@AOL as required under Section 1.1.3, and reallocate the overallotment of Impressions in Calendar and a possible reallocation of what may be an overallotment of Impressions in Oxygen Cable. 1.2. Impressions Commitment. During the Term, AOL shall deliver a minimum ---------------------- of [***] Impressions which link to the Co-Branded Entry Page through the Promotions in accordance with Exhibit A and the timelines set ------- - forth therein (the "Impressions Commitment"). The Impressions targets specified on Exhibit A are the minimum amount of Impressions to be --------- provided by AOL. The parties will determine annually, beginning March 1, 2001, whether the actual Impressions targets for the immediately preceding year were met, and any shortfall in Impressions at the end of any year during the Term will not be deemed a breach of the Agreement by AOL so long as AOL promptly takes commercially reasonable action to remedy the situation with comparable Impressions. If a significant shortfall continues after six (6) months, either party may invoke the dispute resolution procedures set forth in Section 7 to fashion a strategy reasonably acceptable to MP to alleviate such continuing significant shortfall. In the event there is a shortfall in Impressions as of the end of the Term (a "Final Shortfall"), AOL will, within ninety days of the end of the Term, provide MP with Impressions equal in number to the Final Shortfall (the "Final Makegood"); provided, however, that, if the Final Shortfall is equal to a number of Impressions which is more than [***] percent ([***]%) of the total Impressions to be delivered hereunder in that year, then, upon written notice delivered to AOL within five (5) days of the end of the Term, MP shall be entitled to receive in lieu of the Final Makegood, a refund of the Payment, calculated in accordance with the Pro-Rata Refund Formula. The Parties agree that in each year during the term of this Agreement [***] percent ([***]%) of the Impressions will be for the Exclusive Product and not more than [***] percent ([***]%) of the Impressions may include references to MP Products other than traditional grocery store products. 1.3. Content of Promotions. The Promotions will link only to the Co- --------------------- Branded Entry Page and will promote only the Exclusive Product and not more than [***] percent ([***]%) of the Promotions each year shall promote MP Products other than everyday grocery products and services. The specific MP Content to be contained within the Promotions described in this Agreement (the "Promo Content") will be determined by MP, subject to AOL's technical limitations, the terms of this Agreement and AOL's then-applicable policies relating to advertising and promotions (the "Ad Policies"); provided, however, that MP shall have ninety (90) days from written notice of any new Ad Policy to comply and provided, further that if MP's compliance with such new Ad Policy is not technically feasible or commercially reasonable, AOL shall either waive such new Ad Policy for MP or provide MP with an equitable remedy to alleviate the effect of such new Ad Policy. In the event that the Parties are unable to agree on an equitable remedy, the matter shall be "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 2 submitted to the Management Committee for resolution in accordance with dispute resolution procedures set forth in Section 7 of this Agreement. MP will submit in advance to AOL for its review a quarterly online marketing plan with respect to the Affiliated MP Site. The Parties will meet in person or by telephone at least monthly to review operations and performance hereunder, including a review of the Promo Content to ensure that it is designed to maximize performance. MP will periodically update the Promo Content. Except to the extent expressly described herein, the specific form, placement, duration and nature of the Promotions will be as determined by AOL in its reasonable editorial discretion (consistent with the editorial composition of the applicable screens). Either Party may invoke the dispute resolution procedures of Section 7 in the event that the requirements of this Section 1.3 materially adversely affect the rights of such Party under this Agreement. 1.4. MP Promotion of Affiliated MP Site and AOL. As set forth in fuller ------------------------------------------ detail in Exhibit C, MP will promote AOL and the availability of the --------- Affiliated MP Site through the AOL Network. MP will not implement or authorize any promotion that is substantially similar (including, without limitation, in scope, purpose, amount, prominence or regularity) to the promotion required or provided pursuant to Exhibit ------- C for any other Interactive Service on terms more favorable than - those provided herein. 2. AFFILIATED MP SITE. ------------------ 2.1. Creation of Affiliated MP Site. MP will create a customized start ------------------------------ page to which the Promotions shall link (the "Co-Branded Entry Page") (to the extent consistent with the terms hereof), including distinct versions of the Co-Branded Entry Page for each applicable property of the AOL Network as set forth below (e.g., one for linking from the AOL Service which is co-branded with the AOL brand, one for linking from the CompuServe Service which is co-branded with the CompuServe brand, etc.). Such Co-Branded Entry Page shall serve as the start page for an Interactive Site of MP which conforms to the requirements set forth herein (the "Affiliated MP Site"). MP will use commercially reasonable efforts to include certain distinct Content within each such distinct version of the Co-Branded Entry Page, tailored and targeted to the applicable audience as mutually agreed (the "Brand Specific Content"). On the Co-Branded Entry Page, MP will comply with AOL's and its affiliates' then generally applicable customization standards and design guideline templates for each property with respect to headers, footers, co-branding and URLs, by way of example as set forth on Exhibit H attached hereto. The Parties agree that the --------- Co-Branded Entry Page shall reside on a joint URL structured in a manner to provide MP with user and unique visitor credit. Internal pages within the Affiliated MP Site shall reside on a joint URL structured in a manner to provide AOL with credit for time spent on the Affiliated MP Site, which shall nonetheless be owned by MP. The Co-Branded Entry Page shall have AOL or AOL affiliate branded headers and footers. AOL shall have the right to change or modify its design guideline templates and co-branding requirements during the Terms, to conform to general changes made to the AOL Network or portions thereof. In the event that MP desires to add such tools to the Affiliated MP Site, MP will consider in good faith the integration of, and may with AOL's consent integrate, AOL's tools and technology for chat, message boards, Quick Checkout, Shopping Cart and Search, plus such other tools and technology as the Parties may further mutually agree, so long as the integration of such tools and technology is technically feasible and commercially reasonable and does not adversely affect the shopping experience. If the Parties cannot agree on any of these matters, either Party may invoke the dispute resolution procedures set forth in Section 7. "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 3 2.2. Content. MP will make available through the Affiliated MP Site the ------- comprehensive offering of Products and related Content described on Exhibit D (the "MP Products"). Except as mutually agreed in writing --------- by the Parties, the Affiliated MP Site will contain the MP Products and will not contain more than [***]% of products and services other than everyday grocery products and services. All sales of Products through the Affiliated MP Site will be conducted through a direct sales format; MP will not promote, sell, offer or otherwise distribute any products through any format other than a direct sales format (e.g., through auctions or clubs) without the prior written consent of AOL; provided, however, that MP may use a third-party for back-end fulfillment. MP will review, delete, edit, create, update and otherwise manage all Content available on or through the Affiliated MP Site in accordance with the terms of this Agreement. MP will ensure that the Affiliated MP Site does not in any respect promote or advertise, market or distribute the products, services or content of (x) any other Interactive Service, or (y) solely with respect to the Co-Branded Entry Page, any entity that is in direct competition with any third party with which AOL has an exclusive or premier relationship (provided that AOL has given written notice to MP of such third party and the exclusive or premier relationship that AOL has with such third party). MP may offer any material functionality (e.g. instant messaging, calendar, decision guides) on its Affiliated MP Site, even if such functionality is reasonably deemed to be competitive with a material functionality offered by or on behalf of AOL on the AOL Network, so long as in connection therewith there is no attribution or link to an Interactive Service, provided further that MP shall offer no functionality which requires a user to register with another Interactive Service. If the parties cannot agree on any matter described in this subsection, either party may invoke the dispute resolution procedures of Section 7. 2.3. Production Work. Except as agreed to in writing by the Parties --------------- pursuant to the "Production Work" section of the Standard Online Commerce Terms & Conditions attached hereto as Exhibit F, MP will be --------- responsible for all production work associated with the Affiliated MP Site, including all of MP's related costs and expenses. 2.4. Technology. AOL will be entitled to require reasonable changes to the ---------- Content (including, without limitation, the features or functionality) within the Affiliated MP Site to the extent such Content will, in AOL's good faith judgment, adversely affect any technological operational aspect of the AOL Network. AOL reserves the right to review and test the Affiliated MP Site from time to time to determine whether the site is compatible with AOL's then-available client and host software and the AOL Network. 2.5. Product Offering. MP will use commercially reasonable efforts to ---------------- ensure that the Affiliated MP Site includes generally all of the Products and other Content (including, without limitation, any features, offers, contests, functionality or technology) that are then made available by or on behalf of MP through the MP Interactive Site for the same geographical area; provided, however, that such inclusion will not be required where it is commercially or technically impractical (e.g., inclusion would cause either Party to incur substantial incremental costs), and not more that [***] percent ([***]%) of the Products shall be other than everyday grocery items. 2.6. Pricing and Terms. MP will ensure that: (i) the prices (and any ----------------- other required consideration) for Products in the Affiliated MP Site do not exceed the prices for the Products or substantially similar Products offered by or on behalf of MP through the MP Interactive Site for the same geographical area during the same time period; and (ii) the terms and conditions related to Products in the Affiliated MP Site are no less favorable in any respect to the terms and conditions for the Products or substantially similar Products offered by or on behalf of MP through the primary MP Interactive Site for the same geographical area during the same time period; and (iii) the prices in the aggregate for "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 4 MP's top [***] grocery Products shall be no higher than [***] percent ([***]%) above of the prices of such Products offered by any MP Competitor through any Interactive Site for sale in the same geographic area during the same time period. 2.7. Exclusive AOL Offers/Member Benefits. MP will generally promote ------------------------------------ through the Affiliated MP Site any special or promotional offers made available by or on behalf of MP through any Additional MP Channel. In addition, MP shall promote through the Affiliated MP Site on a regular and consistent basis special offers (which, from time to time, shall be exclusive to AOL Users) available to AOL Users (the "AOL Offers") equal to or better than any other special offer available to non-AOL users. MP shall, at all times, feature at least one AOL Offer for at least first time AOL Users. The AOL Offer made available by MP shall provide a substantial member benefit to AOL Users, either by virtue of a meaningful price discount, product enhancement, unique service benefit or other special feature. Specific AOL Offers that may be made available by MP include the AOL Offers listed on Exhibit D-1 attached hereto. MP will provide AOL ----------- with reasonable prior notice of AOL Offers so that AOL can market the availability of such AOL Offers in the manner AOL deems appropriate in its editorial discretion. 2.8. Operating Standards. MP will ensure that the Affiliated MP Site ------------------- complies in all material respects and at all times with the standards set forth in Exhibit E within a commercially reasonable amount of --------- time. To the extent operating site standards are not established in Exhibit E with respect to any aspect or portion of the Affiliated MP --------- Site (or the Products or other Content contained therein), MP will provide such aspect or portion of operating standards which meets or exceeds prevailing standards in the online grocery industry. In the event AOL determines that MP has failed to comply with the material technical requirements of this Section 2.8 AOL will have the right (in addition to any other remedies available to AOL hereunder), after providing MP with advance notice, to decrease the promotion it provides to MP hereunder until such time as MP corrects its non- compliance (and in such event, if such failure to comply shall last for more than five (5) days, AOL will be relieved of the proportionate amount of any promotional commitment made to MP by AOL hereunder corresponding to such decrease in promotion) and any revenue threshold(s) set forth in Section 4 will each be adjusted proportionately to correspond to such decrease in promotion during the period of non-compliance. MP may invoke the dispute resolution procedures of Section 7 in the event that it reasonably believes that the Affiliated MP Site meets the applicable standards, AOL has acted unjustly, or AOL has adversely affected MP's rights hereunder. AOL shall not be permitted to decrease the promotion for MP's failure to comply with the requirements of Section 1 of Exhibit E, if MP has invoked the dispute resolution procedures of Section 7. 2.9. Advertising Sales. In the event that MP decides to designate ----------------- advertising inventory on the Affiliated MP Site, MP will offer AOL the opportunity to present its proposal for selling such inventory. 2.10. Traffic Flow. MP will take commercially reasonable efforts to ------------ ensure that AOL traffic is either kept within the Affiliated MP Site or is channeled back into the AOL Network (with the exception of advertising links sold and implemented pursuant to the Agreement) through a "return to AOL" button at checkout, the "back" button on an Internet browser, and/or the AOL control bar. In the event that AOL points to the Co-Branded Entry Page or any other MP Interactive Site or otherwise delivers traffic to such site hereunder, MP will channel back to the AOL Network from such site, whether through a particular pointer or link, the "back" button on an Internet browser, the closing of an active window, or any other return mechanism. "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 5 3. AOL EXCLUSIVITY OBLIGATIONS During the Term, except as otherwise provided --------------------------- herein, AOL shall not promote any MP Competitor or the Exclusive Product in the Designated Exclusivity Areas. For the purposes of this Agreement, "Exclusive Product" shall mean the service of online ordering from an Online Grocer, for delivery (directly or through a third-party) or pick-up, of everyday grocery items assembled for the customer. For purposes of this Agreement, the term "Online Grocer" shall mean any entity that offers the online ordering of and whose primary business is the sale or delivery of, a comprehensive range of everyday grocery items, regardless of whether such entity offers such grocery items solely online or as ancillary to its traditional bricks-and-mortar grocery or convenience food store business; provided however, that in no event shall "Online Grocer" include any entity (i) with a [***], provided that this exception shall not except a [***] business or an [***] from the definition of "Online Grocer", (ii) who offers only a [***], or (iii) that provides predominantly a [***]. As part of the exclusivity, AOL shall not itself or through any agent use any part of the Designated Exclusivity Areas to market or promote the Exclusive Product. Notwithstanding anything to the contrary in this Section 3 (and without limiting any actions which may be taken by AOL without violation of MP's rights hereunder), no provision of this Agreement will limit AOL's ability (on or off the AOL Network) to (i) undertake activities or perform duties pursuant to existing arrangements with third parties, provided, however, that the Impressions delivered pursuant to any such arrangement with any MP Competitor or as part of the marketing of the Exclusive Product by any other Online Grocer shall reduce the number of Impressions permitted under Section 3.2.1 below (or pursuant to any agreements to which AOL becomes a party subsequent to the Effective Date as a result of Change of Control, merger, acquisition or other similar transaction), (ii) create editorial content relating to any third party marketer of the Exclusive Product (but shall not sell contextual links to any marketer of the Exclusive Product except in accordance with this Agreement) or (iii) offer information relating to marketers of the Exclusive Product on any yellow pages, white pages, classifieds or other search, directory or review services or Content or similar service. In addition, to the extent that any third party does not solely [***], AOL will not be restricted from promoting such party (on or off the AOL Network), so long as such promotions do not, [***], expressly [***] or allow a [***]. Notwithstanding any provision of this Agreement to the contrary: 3.1. The delivery services for the following types of products shall not be deemed to be "Exclusive Product" except when sold, delivered, offered or promoted by MP Competitors: (i) delivery of [***]; (ii) delivery services where the [***] is not the [***]; (iii) delivery services where the [***] is not the delivery of the [***]; (iv) delivery of [***]; or (v) delivery of [***]; and 3.2. AOL may sell promotions mentioning the Exclusive Product of any traditional bricks-and-mortar grocer or convenience food store ("Traditional Grocer Exclusive Product Promotions") so long as such Traditional Grocer Exclusive Product Promotions do not promote any MP Competitor and provided that: 3.2.1. Traditional Grocer Exclusive Product Promotions shall constitute no more than [***] Impressions in the aggregate during the Term; and (a) in the national market, in any year total Traditional Grocer Exclusive Product Promotions shall not exceed the "Permitted National Market Carve-out Amount"; for these purposes, the "Permitted National Market Carve-out Amount" shall equal [***] percent ([***]%) of the Impressions Commitment in the national market for that year; and (b) in any local markets where MP provides the Exclusive Product, Traditional Grocer Exclusive Product Promotions shall not exceed in any year the "Permitted Local Market Carve-out Amount"; for these purposes, the "Permitted Local Market Carve-out Amount" shall equal [***] percent ([***]%) of the Impressions Commitment in that local market for that year; and 3.2.2. AOL agrees to [***], in consideration of its [***] permitted under this Section 3.2. "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 6 4. PAYMENTS. -------- 4.1.1. Payment. Subject to Sections 4.1.2, 4.1.3, 4.1.4 and 6 below, ------- in consideration of AOL's obligations hereunder including without limitation the delivery of the Impressions, MP will pay AOL a payment (the "Payment") equal to Sixty Million Dollars ($60,000,000) in the aggregate as follows: 4.1.1.1. Six Million Dollars ($6,000,000) payable on the Effective Date; 4.1.1.2. Four Million Dollars ($4,000,000) on each of June 1, 2000, September 1, 2000, and December 1, 2000; and 4.1.1.3. Three Million Dollars (US $3,000,000) on each of March 1, 2001, June 1, 2001, September 1, 2001, December 1, 2001, March 1, 2002, June 1, 2002, September 1, 2002, December 1, 2002, March 1, 2003, [June 1, 2003], September 1, 2003, December 1, 2003, March 1, 2004, and June 1, 2004 4.1.2. Early Termination of Exclusivity. -------------------------------- 4.1.2.1. Twenty Fourth Month. AOL shall be entitled, on the ------------------- later of (x) March 1, 2002, or (y) the date on which a total of [***] billion Impressions have been delivered under this Agreement (the "First Exclusivity Termination Date"), to terminate its exclusivity obligations set forth in Section 3 of this Agreement solely with respect to Traditional Grocer Exclusive Product Promotions by providing MP, not later than six (6) months prior to March 1, 2002, with written notice of its election to terminate such exclusivity. In the event that AOL elects to terminate its exclusivity obligations under this Agreement in accordance with this Section 4.1.2.1, all payments due by MP pursuant to Section 4.1.1 on or after March 1, 2002, shall be reduced to [***], and the Impressions Commitment shall be increased by [***] comparable Impressions to be delivered over the remainder of the Term; provided, however, that all requirements of AOL pursuant to Section 3.2 of this Agreement shall terminate as of the First Exclusivity Termination Date. 4.1.2.2. Thirtieth Month. Notwithstanding any provision of --------------- Section 3 of this Agreement to the contrary, AOL shall be entitled as of September 1, 2002 to promote any marketer of the Exclusive Product, including without limitation any MP Competitor in any local market in which MP has neither established local- based offerings of the Exclusive Product ("Local Offerings") nor notified AOL that it intends to establish Local Offerings in such local market (a "Fifteen Month Notice"). Following receipt of a Fifteen Month Notice, AOL shall, within three months of receipt of such Fifteen Month Notice, discontinue any local promotions for marketers of the Exclusive Product (unless otherwise permitted under this Agreement, including without limitation, pursuant to Section 3.2). In the event that MP has failed, as of a date which is fifteen months after AOL's receipt of such Fifteen Month Notice (the "Fifteen Month Date"), to establish Local Offerings in the local market which is the subject of such Fifteen Month Notice, AOL shall be entitled to promote any marketer of the Exclusive Product, including without limitation, any MP Competitor, in such local "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 7 market until the later of (a) nine months from the Fifteen Month Date or (b) the date on which MP establishes Local Offerings in such local market. 4.1.2.3. Thirty Sixth Month. In addition to the rights ------------------ granted to AOL pursuant to Sections 4.1.2.1 or 4.1.2.2 above, in the event that MP is not then one of the top [***] marketers of the Exclusive Product in at least [***] of the [***] Performance Criteria, AOL shall be entitled, on the later of (x) March 1, 2003, or (y) the date on which [***] Impressions are delivered under this Agreement (the "Second Exclusivity Termination Date"), to terminate its exclusivity obligations set forth in Section 3 of this Agreement by providing MP with written notice of its election to terminate such exclusivity by not later than six (6) months prior to March 1, 2003. In the event AOL terminates its exclusivity obligations in accordance with this Section 4.1.2.3, and MP does not exercise its right to terminate the Agreement as set forth below, then all payments due by MP pursuant to Section 4.1.1 on or after March 1, 2003, shall be reduced to [***], if AOL has not exercised its exclusivity termination option granted pursuant to Section 4.1.2.1 above. In addition, in the event AOL terminates its exclusivity obligations in accordance with this Section 4.1.2.3, MP shall have the right to terminate the Agreement, and, upon MP's exercise of such right to terminate this Agreement, (x) AOL shall refund and pay to MP, within 30 days of MP's notice of termination, a refund calculated in accordance with the Pro-Rata Refund Formula; and (y) MP shall have no obligation to make any of the payments due on or after March 1, 2003, pursuant to Section 4.1.1. 4.2. Payment by MP of Bounty. During each year of the Term, MP shall pay ----------------------- AOL a bounty according to the schedule below for each new AOL Purchaser during such year:
Year 1 Goal Bounty Year 2 Goal Bounty [***] [***] [***] [***] [***] [***] [***] [***] [***] [***] Year 3 Goal Bounty Year 4 Goal Bounty [***] [***] [***] [***] [***] [***] [***] [***] [***] [***] [***] [***]
Year 5 Goal Bounty [***] [***] [***] [***] [***] [***] [***] 4.3. Late Payments; Wired Payments. All amounts owed hereunder not paid ----------------------------- when due and payable will bear interest from the date such amounts are due and payable at the prime rate as set forth in the Wall Street Journal in effect at such time. All payments required to be paid to AOL hereunder will be paid in immediately available, non-refundable U.S. funds wired to the "America Online" account, [***]. All payments required to be paid to MP hereunder will be paid in immediately available, non-refundable U.S. funds wired to the account of HomeGrocer.com at [***]. "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 8 4.4. Auditing Rights. Each Party will maintain complete, clear and --------------- accurate records of all expenses, revenues and fees in connection with the performance of this Agreement. For the sole purpose of ensuring compliance with this Agreement, each Party (or its representative) will have the right on an annual basis to have a third-party accounting firm reasonably acceptable to the Party being audited (the "Audit Party") conduct a reasonable and necessary inspection limited to the portions of the books and records of the Audit Party which are relevant to such Audit Party's performance pursuant to this Agreement. Any such audit may be conducted after twenty (20) business days' prior written notice to the other Party. The Party requesting the audit (the "Requesting Party") shall bear the expense of any audit conducted pursuant to this Section 4.4, unless such audit shows an error in the Requesting Party's favor amounting to a deficiency to the Requesting Party in excess of five percent (5%) of the actual amounts paid and/or payable to such Party hereunder, in which event the Audit Party shall bear the reasonable expenses of the audit. If any payment deficiency is discovered, during an audit or otherwise, the Party owing the deficient payment shall pay the deficient amount to the Party owed such amount within thirty (30) days after receipt of notice thereof. 4.5. Taxes. MP will collect and pay and indemnify, and hold AOL harmless ----- from, any sales, use, excise, import or export value added or similar tax or duty including any penalties and interest, as well as any costs associated with the collection or withholding thereof, including attorneys' fees, which arises out of the sale or any other transaction between MP and any other party (other than AOL) or which is based on MP's net income. Likewise, AOL will collect and pay and indemnify, and hold MP harmless from, any sales, use, excise, import or export value added or similar tax or duty including any penalties and interest, as well as any costs associated with the collection or withholding thereof, including attorneys' fees, which arises out of the sale or any other transaction between AOL and any other party (other than MP) or which is based on AOL's net income. 4.6. Reports. ------- 4.6.1. Sales Reports. MP will provide AOL in an automated manner ------------- with a monthly report in an AOL-designated format, detailing the following activity in such period (and any other information mutually agreed upon by the Parties or reasonably required for measuring activity at the Co-Branded Entry Page): summary sales information by day (date and total number of AOL Purchasers for such day, total new AOL Purchasers by day and total revenue for such day)(collectively, the "Sales Reports"). AOL will be entitled to use the Sales Reports in its own internal business operations, subject to the terms of this Agreement, but agrees to protect such information as Confidential Information. 4.6.2. Usage Reports. At least once a month, AOL shall provide MP ------------- with standard usage information related to the Promotions (e.g. a schedule of the Impressions delivered by AOL at such time) which is similar in substance and form to the reports provided by AOL to other interactive marketing partners similar to MP. MP acknowledges that such information may be Confidential Information as defined herein. 4.6.3. Fraudulent Transactions. To the extent permitted by ----------------------- applicable laws, MP will provide AOL with an prompt report of any fraudulent order, including the date, screenname or email address and amount associated with such order, promptly following MP obtaining knowledge that the order is, in fact, fraudulent. 5. [INTENTIONALLY DELETED] --------------------- 9 6. TERM; AFTER EXPIRATION OF TERM; TERMINATION. ------------------------------------------- 6.1. Term. Unless earlier terminated as set forth herein, the term of ----- this Agreement will be five years from the Effective Date (the "Term"). 6.2. After Expiration of Term. Upon the expiration of Term (as opposed to ------------------------ termination), AOL has the right to continue the link to the Affiliated MP Site for an additional one-year period upon written notice to MP, with the right to renew for two (2) additional one-year terms upon written notice to MP. MP shall pay AOL a [***] ($[***]) dollar bounty for new AOL Purchasers generated during any such extended period and shall have no other payments obligations hereunder to AOL. MP will pay all of the foregoing amounts on a quarterly basis within thirty (30) days following the end of the quarter in which the applicable bounties were generated. 6.3. [intentionally deleted]. --------------------- 6.4. Termination for Breach. Except as expressly provided elsewhere in ---------------------- this Agreement, either Party may terminate this Agreement at any time in the event of a material breach of the Agreement by the other Party which remains uncured after thirty (30) days written notice thereof to the other Party (or such shorter period as may be specified elsewhere in this Agreement); provided that if MP fails to make any payment required under Section 4.1.1, AOL will provide notice to MP of MP's failure and the cure period with respect to any scheduled payment will be twelve (12) days from the date of such notice. In the event this Agreement is terminated, any payment obligations accrued prior to termination will survive the termination of this Agreement, and, except to the extent expressly set forth to the contrary in this Agreement, the parties shall be relieved of all other payment obligations, provided, however, that nothing herein shall affect any Party's right to damages as a result of the other Party's breach. If this Agreement is terminated by MP under this provision, MP shall be entitled to a refund calculated in accordance with the Pro-Rata Refund Formula. 6.5. Termination for Bankruptcy/Insolvency. Subject to existing ------------------------------------- bankruptcy laws, either Party may terminate this Agreement immediately following written notice to the other Party if the other Party (i) ceases to do business in the normal course, (ii) becomes or is declared insolvent or bankrupt, (iii) is the subject of any proceeding related to its liquidation or insolvency (whether voluntary or involuntary) which is not dismissed within ninety (90) calendar days or (iv) makes an assignment for the benefit of creditors. 6.6. Termination on Change of Control. -------------------------------- 6.6.1. In the event of a Change of Control of MP resulting in control of MP by an Interactive Service, AOL may terminate this Agreement by providing thirty (30) days prior written notice of such intent to terminate. 6.6.2. In the event of a Change of Control of AOL resulting in control of AOL by an MP Competitor, MP may terminate this Agreement by providing thirty (30) days prior written notice of such intent to terminate. 6.7. Press Releases. Each Party will submit to the other Party, for its --------------- prior written approval, which will not be unreasonably withheld or delayed, any press release or any other public statement ("Press Release") regarding the transactions contemplated hereunder. Notwithstanding the foregoing, either Party may, if and to the extent required by law, issue Press Releases and other disclosures without the consent of the other Party so "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 10 long as the disclosing Party provides at least five (5) business days prior written notice of such disclosure. The failure by one Party to obtain the prior written approval of the other Party prior to issuing a Press Release (except as and to the extent required by law) shall be deemed a material breach of this Agreement. Because it would be difficult to precisely ascertain the extent of the injury caused to the non-breaching party, in the event of such material breach, the non-breach party may elect as its sole remedy to either (a) terminate this Agreement immediately upon notice to the other Party, or (b) as liquidated damages, elect to modify the Impression Commitment hereunder by [***] percent ([***]%) (either an increase in Impressions if AOL has materially breached the Agreement or a decrease in Impressions if MP has materially breached the Agreement). The Parties agree that the liquidated damages set forth are a reasonable approximation of the injury that would be suffered by the non-breaching Party. 7. MANAGEMENT COMMITTEE/ARBITRATION. -------------------------------- 7.1. Management Committee. The Parties will act in good faith and use -------------------- commercially reasonable efforts to promptly resolve any claim, dispute, claim, controversy or disagreement (each a "Dispute") between the Parties or any of their respective subsidiaries, affiliates, successors and assigns under or related to this Agreement or any document executed pursuant to this Agreement or any of the transactions contemplated hereby. If the Parties cannot promptly resolve any such Dispute, either party may submit the dispute to the "Management Committee" for resolution. The Management Committee shall initially consist of MP's Senior Vice President of Marketing, Jon Landers, and AOL's President of Marketing, David M. Colburn. At the parties' earliest convenience and by not later than 10 days after the request for dispute resolution, the Management Committee shall convene at a mutually acceptable location or telephonically, and shall have the exclusive right for the following ten (10) days to resolve such Dispute; provided further that the Management Committee will have the final and exclusive right to resolve Disputes arising from any provision of the Agreement which expressly or implicitly provides for the Parties to reach mutual agreement as to certain terms. If the Management Committee is unable to amicably resolve the Dispute during such ten-day period, then the Management Committee will consider in good faith the possibility of retaining a third party mediator to facilitate resolution of the Dispute. In the event the Management Committee elects not to retain a mediator within the five (5) days immediately following the dead-lock, the dispute will be subject to the resolution mechanisms described below. Neither Party will seek, nor will be entitled to seek, binding outside resolution of the Dispute unless and until the Parties have sought resolution of the Dispute by the Management Committee and have been unable amicably to resolve the Dispute as set forth in this Section 7 and then, only in compliance with the procedures set forth in this Section 7. 7.2. Arbitration. Except for Disputes relating to issues of (i) ------------ proprietary rights, including but not limited to intellectual property and confidentiality, and (ii) any provision of the Agreement which expressly or implicitly provides for the Parties to reach mutual agreement as to certain terms (which will be resolved by the Parties solely and exclusively through amicable resolution as set forth in Section 7.1), any Dispute not resolved by amicable resolution as set forth in Section 7.1 will be governed exclusively and finally by arbitration. Such arbitration will be conducted by the American Arbitration Association ("AAA") in Washington, D.C., or Seattle, Washington, and will be initiated and conducted in accordance with the Commercial Arbitration Rules ("Commercial Rules") of the AAA, including the AAA Supplementary Procedures for Large Complex Commercial Disputes ("Complex Procedures"), as such rules will be in effect on the date of delivery of a demand for arbitration ("Demand"), except to the extent that such rules are inconsistent with the provisions set forth herein. Notwithstanding the foregoing, the Parties may agree "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 11 in good faith that the Complex Procedures will not apply in order to promote the efficient arbitration of Disputes where the nature of the Dispute, including without limitation the amount in controversy, does not justify the application of such procedures. 7.3. Selection of Arbitrators. The arbitration panel will consist of ------------------------- three arbitrators. Each Party will name an arbitrator within ten (10) days after the delivery of the Demand. The two arbitrators named by the Parties may have prior relationships with the naming Party, which in a judicial setting would be considered a conflict of interest. The third arbitrator, selected by the first two, should be a neutral participant, with no prior working relationship with either Party. If the two arbitrators are unable to select a third arbitrator within ten (10) days, a third neutral arbitrator will be appointed by the AAA from the panel of commercial arbitrators of any of the AAA Large and Complex Resolution Programs. If a vacancy in the arbitration panel occurs after the hearings have commenced, the remaining arbitrator or arbitrators may not continue with the hearing and determination of the controversy, unless the Parties agree otherwise. 7.4. Governing Law. The Federal Arbitration Act, 9 U.S.C. Secs. 1-16, and -------------- not state law, will govern the arbitrability of all Disputes. The arbitrators will allow such discovery as is appropriate to the purposes of arbitration in accomplishing a fair, speedy and cost- effective resolution of the Disputes. The arbitrators will reference the Federal Rules of Civil Procedure then in effect in setting the scope and timing of discovery. The Federal Rules of Evidence will apply in toto. The arbitrators may enter a default decision against any Party who fails to participate in the arbitration proceedings. 7.5. Arbitration Awards. The arbitrators will have the authority to award ------------------- compensatory damages only. Any award by the arbitrators will be accompanied by a written opinion setting forth the findings of fact and conclusions of law relied upon in reaching the decision. The award rendered by the arbitrators will be final, binding and non- appealable, and judgment upon such award may be entered by any court of competent jurisdiction. The Parties agree that the existence, conduct and content of any arbitration will be kept confidential and no Party will disclose to any person any information about such arbitration, except as may be required by law or by any governmental authority or for financial reporting purposes in each Party's financial statements. 7.6. Fees. Each Party will pay the fees of its own attorneys, expenses of ----- witnesses and all other expenses and costs in connection with the presentation of such Party's case (collectively, "Attorneys' Fees"). The remaining costs of the arbitration, including without limitation, fees of the arbitrators, costs of records or transcripts and administrative fees (collectively, "Arbitration Costs") will be borne equally by the Parties. Notwithstanding the foregoing, the arbitrators may modify the allocation of Arbitration Costs and award Attorneys' Fees in those cases where fairness dictates a different allocation of Arbitration Costs between the Parties and an award of Attorneys' Fees to the prevailing Party as determined by the arbitrators. 7.7. Non Arbitratable Disputes. Any Dispute that is not subject to final -------------------------- resolution by the Management Committee or to arbitration under this Section 7 or by law (collectively, "Non-Arbitration Claims") will be brought in a court of competent jurisdiction in the Commonwealth of Virginia or the State of Washington. Each Party irrevocably consents to the non-exclusive jurisdiction of the courts of the Commonwealth of Virginia and the federal courts situated in the Commonwealth of Virginia, and of the courts of the State of Washington and the federal courts situated in the State of Washington, over any and all Non-Arbitration Claims and any and all actions to enforce such claims or to recover damages or other relief in connection with such claims. 12 8. NEW DELIVERY PLATFORMS; FURTHER DISCUSSIONS. In the event that AOL ------------------------------------------- launches any new delivery platform other than standard narrow-band platform, and at any time thereafter [***] percent ([***]%) or more of the AOL Users uses the new delivery platform, then MP shall have the opportunity to negotiate for promotions on the new delivery platform. 9. FURTHER ASSURANCES REGARDING LOCAL OFFERINGS. If MP has not established -------------------------------------------- local based offerings of the Exclusive Product in a local market, and AOL has identified a substantial AOL User demand for the Exclusive Product in such market, then the Parties shall work together in good faith to develop a plan to satisfy the needs of such AOL Users, which plan may include MP's partnering with a local marketer of the Exclusive Product or the establishment of a revenue sharing relationship. 10. NATIONAL OFFERING OF THE EXCLUSIVE PRODUCT. MP shall use commercially ------------------------------------------ reasonable efforts to offer the Exclusive Product on a national basis within twelve (12) months from the Effective Date. In the event that MP is unable to accomplish this objective, AOL may refer such matter to the Management Committee in accordance with Section 7, in order to agree upon a strategy to provide the Exclusive Product to AOL Users on a national basis. 11. STANDARD TERMS. The exhibits and schedules identified in and attached to -------------- this Agreement (including without limitation the Standard Online Commerce Terms & Conditions set forth on Exhibit F attached hereto and Standard ------- Legal Terms & Conditions set forth on Exhibit G attached hereto) are each --------- incorporated into this Agreement and are hereby made a part of this Agreement. In the event of a conflict between the substantive provisions set forth above in body of this Agreement (the "Substantive Agreement") and the exhibits and schedules incorporated into this Agreement, the Substantive Agreement shall control. [Signature Page Follows] "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 13 IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as of the Effective Date. AMERICA ONLINE, INC. HOMEGROCER.COM, INC. By: /s/ Terry Drayton By: /s/ Eric Keller ------------------------------- ------------------------------- Name: Terry Drayton Name: Eric Keller Title: President Title: Vice President, Business Affairs 14 EXHIBIT A Placement/Promotion ------------------- I. Attached Hereto. II. During the Term, subject to the terms and conditions hereof, MP shall have the right to use the following Keyword Search Terms: HomeGrocer. 15 EXHIBIT B Definitions ----------- The following definitions will apply to this Agreement: Additional MP Channel. Any other distribution channel (e.g., an Interactive - --------------------- Service other than AOL) through which MP makes available an offering comparable in nature to the Affiliated MP Site Advertising Sales Commission. Actual amounts paid as commission to third party - ---------------------------- agencies by either buyer or seller in connection with sale of the Advertisement. AOL Interactive Site. Any Interactive Site which is managed, maintained, owned - -------------------- or controlled by AOL or its agents. AOL Look and Feel. The elements of graphics, design, organization, - ------------------ presentation, layout, user interface, navigation and stylistic convention (including the digital implementations thereof) which are generally associated with Interactive Sites within the AOL Service or AOL.com. AOL Member. Any authorized user of the AOL Service, including any sub-accounts - ---------- using the AOL Service under an authorized master account. AOL Network. (i) The AOL Service, (ii) AOL.com, (iii) CompuServe, (iv) Digital - ----------- City, (v) Netcenter, (vi) MovieFone, and (vii) any other product or service owned, operated, distributed or authorized to be distributed by or through AOL or its affiliates worldwide (and including those properties excluded from the definitions of the AOL Service or AOL.com). AOL Purchaser. Any person or entity who enters the Affiliated MP Site from the - ------------- AOL Network including, without limitation, from any third party area therein (to the extent entry from such third party area is traceable through both Parties' commercially reasonable efforts), and generates Transaction Revenues (regardless of whether such person or entity provides an e-mail address during registration or entrance to the Affiliated MP Site which includes a domain other than an "AOL.com" domain), AOL Service. The standard narrow-band U.S. version of the America Online(R) - ----------- brand service, specifically excluding (a) AOL.com, Netcenter or any other AOL Interactive Site, (b) the international versions of an America Online service (e.g., AOL Japan), (c) the CompuServe(R) brand service and any other CompuServe products or services (d) "Driveway," "ICQ(TM)," "AOL NetFind(TM)," "AOL Instant Messenger(TM)," "Digital City," "NetMail(TM)," "Electra", "Thrive", "Real Fans", "Love@AOL", "Entertainment Asylum," "AOL Hometown," "My News" or any similar independent product, service or property which may be offered by, through or with the U.S. version of the America Online(R) brand service, (e) any programming or Content area offered by or through the U.S. version of the America Online brand service over which AOL does not exercise complete operational control (including, without limitation, Content areas controlled by other parties and member-created Content areas), (f) any yellow pages, white pages, classifieds or other search, directory or review services or Content offered by or through the U.S. version of the America Online brand service, (g) any property, feature, product or service which AOL or its affiliates may acquire subsequent to the Effective Date and (h) any other version of an America Online service which is materially different from the standard narrow-band U.S. version of the America Online brand service, by virtue of its branding, distribution, functionality, Content or services, including, without limitation, any co-branded version of the service or any version distributed through any broadband distribution platform or through any platform or device other than a desktop personal computer. 16 AOL User. Any user of the AOL Service, AOL.com, CompuServe, Digital City, - -------- Netcenter, or the AOL Network. AOL.com. AOL's primary Internet-based Interactive Site marketed under the - ------- "AOL.COM(TM)" brand, specifically excluding (a) the AOL Service, (b) Netcenter, (c) any international versions of such site, (d) "ICQ," "AOL NetFind(TM)," "AOL Instant Messenger(TM)," "NetMail(TM)," "AOL Hometown," "My News" or any similar independent product or service offered by or through such site or any other AOL Interactive Site, (e) any programming or Content area offered by or through such site over which AOL does not exercise complete operational control (including, without limitation, Content areas controlled by other parties and member-created Content areas), (f) any programming or Content area offered by or through such site which was operated, maintained or controlled by the former AOL Studios division (e.g., Electra), (g) any yellow pages, white pages, classifieds or other search, directory or review services or Content offered by or through such site or any other AOL Interactive Site, (h) any property, feature, product or service which AOL or its affiliates may acquire subsequent to the Effective Date and (i) any other version of an America Online Interactive Site which is materially different from AOL's primary Internet-based Interactive Site marketed under the "AOL.COM(TM)" brand, by virtue of its branding, distribution, functionality, Content or services, including, without limitation, any co- branded versions or any version distributed through any broadband distribution platform or through any platform or device other than a desktop personal computer. Change of Control. (a) The consummation of a reorganization, merger or - ----------------- consolidation or sale or other disposition of substantially all of the assets of a party or (b) the acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1933, as amended) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under such Act) of more than 50% of either (i) the then outstanding shares of common stock of such party; or (ii) the combined voting power of the then outstanding voting securities of such party entitled to vote generally in the election of directors. CompuServe. The standard, narrow-band U.S. version of the CompuServe brand - ---------- service, specifically excluding (a) any international versions of such service, (b) any web-based service including "compuserve.com", "cserve.com" and "cs.com", or any similar product or service offered by or through the U.S. version of the CompuServe brand service, (c) Content areas owned, maintained or controlled by CompuServe affiliates or any similar "sub-service," (d) any programming or Content area offered by or through the U.S. version of the CompuServe brand service over which CompuServe does not exercise complete or substantially complete operational control (e.g., third-party Content areas), (e) any yellow pages, white pages, classifieds or other search, directory or review services or Content and (f) any co-branded or private label branded version of the U.S. version of the CompuServe brand service, (g) any version of the U.S. version of the CompuServe brand service which offers Content, distribution, services and/or functionality materially different from the Content, distribution, services and/or functionality associated with the standard, narrow-band U.S. version of the CompuServe brand service, including, without limitation, any version of such service distributed through any platform or device other than a desktop personal computer and (h) any property, feature, product or service which CompuServe or its affiliates may acquire subsequent to the Effective Date. Confidential Information. Any information relating to or disclosed in the - ------------------------ course of the Agreement, which is or should be reasonably understood to be confidential or proprietary to the disclosing Party, including, but not limited to, the material terms of this Agreement, information about AOL Members, AOL Users, AOL Purchasers and MP customers, technical processes and formulas, source codes, product designs, sales, cost and other unpublished financial information, product and business plans, projections, and marketing data. "Confidential Information" will not include information (a) already lawfully known to or independently developed by the receiving Party, (b) disclosed in published materials, (c) generally known to the public, or (d) lawfully obtained from any third party. 17 Content. Text, images, video, audio (including, without limitation, music used - ------- in synchronism or timed relation with visual displays) and other data, Products, advertisements, promotions, URLs, links, pointers and software, including any modifications, upgrades, updates, enhancements and related documentation. Designated Exclusivity Areas. Digital City, the AOL Service AOL.com, Netscape - ---------------------------- Netcenter, MovieFone.com, Oxygen (but not Oxygen's non-online operations), Shop@AOL, and CompuServe collectively and individually, as the context shall require. Digital City. The standard, narrow-band U.S. version of Digital City's local - ------------- content offerings marketed under the Digital City(R) brand name, specifically excluding (a) the AOL Service, AOL.com, Netcenter, or any other AOL Interactive Site, (b) any international versions of such local content offerings, (c) the CompuServe(R) brand service and any other CompuServe products or services (d) "Driveway," "ICQ(TM)," "AOL NetFind(TM)," "AOL Instant Messenger(TM)," "Digital City," "NetMail(TM)," "Electra", "Thrive", "Real Fans", "Love@AOL", "Entertainment Asylum," "AOL Hometown," "My News" or any similar independent product, service or property which may be offered by, through or with the standard narrow band version of Digital City's local content offerings, (e) any programming or Content area offered by or through such local content offerings over which AOL does not exercise complete operational control (including, without limitation, Content areas controlled by other parties and member-created Content areas), (f) any yellow pages, white pages, classifieds or other search, directory or review services or Content offered by or through such local content offerings, (g) any property, feature, product or service which AOL or its affiliates may acquire subsequent to the Effective Date, (h) any other version of a Digital City local content offering which is materially different from the narrow-band U.S. version of Digital City's local content offerings marketed under the Digital City(R) brand name, by virtue of its branding, distribution, functionality, Content or services, including, without limitation, any co- branded version of the offerings or any version distributed through any broadband distribution platform or through any platform or device other than a desktop personal computer, and (i) Digital City- branded offerings in any local area where such offerings are not owned or operationally controlled by America Online, Inc. or DCI (e.g., Chicago, Orlando, South Florida, and Hampton Roads). Impression. User exposure to the applicable Promotion, as such exposure may be - ---------- reasonably determined and measured by AOL in accordance with its standard methodologies and protocols which shall be consistent with then-applicable industry standards. Interactive Service. An entity offering one or more of the following: (i) - ------------------- online or Internet connectivity services (e.g., an Internet service provider); (ii) an interactive site or service featuring a broad selection of aggregated third party interactive content (or navigation thereto) (e.g., an online service or search and directory service) and/or marketing a broad selection of products and/or services across numerous interactive commerce categories (e.g., an online mall or other leading online commerce site); and (iii) communications software capable of serving as the principal means through which a user creates, sends and receives electronic mail or real time online messages. Interactive Site. Any interactive site or area, including, by way of example and - ---------------- without limitation, (i) an MP site on the World Wide Web portion of the Internet or (ii) a channel or area delivered through a "push" product such as the Pointcast Network or interactive environment such as Microsoft's Active Desktop. Keyword Search Terms. (a) The Keyword(TM) online search terms made available - -------------------- on the AOL Service, combining AOL's Keyword(TM) online search modifier with a term or phrase specifically related to MP (and determined in accordance with the terms of this Agreement), and (b) the Go Word online search terms made available on CompuServe, combining CompuServe's Go Word online search modifier with a term or phrase specifically related to MP and determined in accordance with the terms of this Agreement). 18 Licensed Content. All Content offered through the Affiliated MP Site pursuant - ---------------- to this Agreement or otherwise provided by MP or its agents in connection herewith (e.g., offline or online promotional Content, Promotions, AOL "slideshows", etc.), including in each case, any modifications, upgrades, updates, enhancements, and related documentation. MovieFone.com. AOL's primary Internet-based Interactive Site marketed under the - ------------- "MovieFone(TM)" brand, specifically excluding (a) the AOL Service, (b) AOL.com, (c) any international versions of such site, (d) "ICQ," "AOL Netfind(TM)," "AOL Instant Messenger(TM)," "NetMail(TM)," "AOL Hometown," "My News," "Digital City(TM)," or any similar independent product or service offered by or through such site or any other AOL Interactive Site, (e) any programming or Content area offered by or through such site over which AOL does not exercise complete operational control (including, without limitation, Content areas controlled by other parties and member-created Content areas), (f) any programming or Content area offered by or through the U.S. version of the America Online(R) brand service which was operated, maintained or controlled by the former AOL Studios division (e.g., Electra), (g) any yellow pages, white pages, classifieds or other search, directory or review services or Content offered by or through such site or any other AOL Interactive Site, (h) any property, feature, product or service which AOL or its affiliates may acquire subsequent to the Effective Date and (i) any other version of an AOL or Netscape Communications Corporation Interactive Site which is materially different from AOL's primary Internet-based Interactive Site marketed under the "MovieFone(TM)" brand, by virtue of its branding, distribution, functionality, Content or services, including, without limitation, any co-branded versions and any version distributed through any broadband distribution platform or through any platform or device other than a desktop personal computer. MP Competitors. The entities listed on Exhibit B-1. - -------------- ------- MP Interactive Site. Any Interactive Site (other than the Affiliated MP Site) - ------------------- which is managed, maintained, owned or controlled by MP or its agents. Net Transaction Revenues. Transaction Revenues minus the actual cost to MP of - ------------------------ goods sold (i.e., the cost paid to MP's vendors for such goods, but not MP's costs of selling such goods). Netcenter. Netscape Communications Corporation's primary Internet-based - --------- Interactive Site marketed under the "Netscape Netcenter(TM)" brand, specifically excluding (a) the AOL Service, (b) AOL.com, (c) any international versions of such site, (d) "ICQ," "AOL Netfind(TM)," "AOL Instant Messenger(TM)," "NetMail(TM)," "AOL Hometown," "My News," "Digital City(TM)," or any similar independent product or service offered by or through such site or any other AOL Interactive Site, (e) any programming or Content area offered by or through such site over which AOL does not exercise complete operational control (including, without limitation, Content areas controlled by other parties and member-created Content areas), (f) any programming or Content area offered by or through the U.S. version of the America Online(R) brand service which was operated, maintained or controlled by the former AOL Studios division (e.g., Electra), (g) any yellow pages, white pages, classifieds or other search, directory or review services or Content offered by or through such site or any other AOL Interactive Site, (h) any property, feature, product or service which AOL or its affiliates may acquire subsequent to the Effective Date and (i) any other version of an AOL or Netscape Communications Corporation Interactive Site which is materially different from Netscape Communications Corporation's primary Internet-based Interactive Site marketed under the "Netscape Netcenter(TM)" brand, by virtue of its branding, distribution, functionality, Content or services, including, without limitation, any co-branded versions and any version distributed through any broadband distribution platform or through any platform or device other than a desktop personal computer (e.g. Custom NetCenters built specifically for third parties). Oxygen. Oxygen Media's Interactive Site customized for AOL Members, accessible - ------ through the AOL Service, specifically excluding (a) any programming or Content area offered by or through such site over 19 which AOL does not have the exclusive right to sell all online advertising inventory and (b) any other property of Oxygen Media other than its Internet based properties. Performance Criteria. [***] as measured by [***] (or its successor), [***] of - -------------------- the online business, and [***] from online business. Unless MP is in the top [***] marketers of the Exclusive Product in at least [***] of these categories, AOL shall be entitled, in accordance with and as more particularly set forth in the terms of Section 4.1.2.2 of the Agreement, to terminate the exclusivity. Product. Any product, good or service which MP (or others acting on its behalf - ------- or as distributors) offers, sells, provides, distributes or licenses to AOL Users directly or indirectly through (i) the Affiliated MP Site (including through any Interactive Site linked thereto), (ii) any MP Interactive Site (including through any Interactive Site linked thereto), (iii) any other electronic means directed at AOL Users (e.g., e-mail offers), or (iv) an "offline" means (e.g., toll-free number) for receiving orders related to specific offers within the Affiliated MP Site or any MP Interactive Site requiring purchasers to reference a specific promotional identifier or tracking code, including, without limitation, products sold through surcharged downloads (to the extent expressly permitted hereunder). Promotions. The promotions described on Exhibit A, any comparable promotions - ----------- --------- delivered by AOL in accordance with Section1.1, and any additional promotions of the Affiliated MP Site provided by AOL (including, without limitation, additional Keyword Search Terms and other navigational tools). Pro-Rata Refund Formula. The pro rata refund shall equal the difference - ----------------------- between (a) the total of the amounts which have actually been paid by MP to AOL pursuant to Section 4.1 of this Agreement as of the date of termination of the Agreement, and (b) the product of $60,000,000 multiplied by a fraction the numerator of which shall be the number of Impressions actually delivered pursuant to the Agreement up to the minimum amount required to be delivered for the applicable period, and the denominator of which shall be the total number of Impressions constituting the Impressions commitment. Transaction Revenues. Aggregate amounts paid by AOL Purchasers in connection - -------------------- with the sale, licensing, distribution or provision of any Products, including, in each case, handling, shipping, service charges, and excluding, in each case, (a) amounts collected for sales or use taxes or duties and (b) credits and chargebacks for returned or canceled goods or services, but not excluding cost of goods sold or any similar cost. "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 20 EXHIBIT B-1 MP Competitors [***] From time to time MP shall have the right to add by name other online grocery ordering and/or delivery services to such list, provided that (i) all additions shall require the approval of AOL, which approval shall not be unreasonably withheld, (ii) MP may add to such list no more than [***] once every [***] and (iii) the addition of any entity shall have no effect on pre-existing contractual obligations of AOL, so long as such contractual obligations were not a breach of AOL's obligations under this Agreement. "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 21 EXHIBIT C MP Cross-Promotion ------------------ 1. MP shall provide the following (collectively, the "AOL Promos"): (i) on the Co-Branded Entry Page, a prominent promotional banner or button (at least 90 x 30 pixels in size) appearing "above the fold" on the Co-Branded Entry Page, to promote such AOL products or services as AOL may designate (for example, the America Online(R) brand service, the CompuServe(R) brand service, the AOL.com(R) site, any of the Digital City services or the AOL Instant Messenger(TM) service); and (ii) on the home page of the primary MP Interactive Site, a prominent "Try AOL" button (at least 90 x 30 pixels in size) through which users can obtain promotional information about AOL products or services designated by AOL; and (iii) at AOL's option, MP will provide a link on the Co-Branded Entry Page that allows AOL users to order the then-current version of client software for such AOL products or services. AOL will provide the creative content to be used in the AOL Promos (including designation of links from such content to other content pages), no more frequently than once per calendar quarter. MP shall post (or update, as the case may be) the creative content supplied by AOL within the spaces for the AOL Promos within ten (10) days of its receipt of such content from AOL. Without limiting any other reporting obligations of the Parties contained herein, MP shall provide AOL with monthly written reports specifying the number of impressions to the pages containing the AOL Promos during the prior month. In the event that AOL elects to serve the AOL Promos from an ad server controlled by AOL or its agent, MP shall take all reasonable operational steps necessary to facilitate such ad serving arrangement including, without limitation, inserting HTML code designated by AOL on the pages on which the AOL Promos will appear. MP shall be permitted to participate in AOL's generally applicable affiliate program. For the AOL Promos, AOL will take commercially reasonable efforts to ensure that, if technically feasible, MP traffic is channeled back to MP and the MP Interactive Site containing such AOL Promo. 2. In addition, within each MP Interactive Site, MP shall provide prominent promotion for the keywords granted to MP hereunder. Other than for instances in which physical execution would be commercially impractical (i.e., in the case of radio or television, an advertisement of fifteen seconds or less, and, in the case of print advertisement, an advertisement less than one quarter page) or in which MP is not the party paying for such advertisements, in MP's television, radio, print and "out of home" (e.g., buses and billboards) advertisements (excluding all delivery vehicles, provided that no Interactive Service shall be promoted on such delivery vehicles) and in any publications, programs, features or other forms of media over which MP exercises primary editorial control, MP will include specific references or mentions (verbally where possible) of the availability of the Affiliated MP Site through the AOL Network, which are at least as prominent as any references that MP makes to the URL (e.g., "www.") or other navigation (but not including general branding of MP's tradename) for any MP Interactive Site. Without limiting the generality of the foregoing, MP's listing of the "URL" (e.g., "www.") for any MP Interactive Site will be accompanied by an equally prominent listing of the "keyword" term on AOL for the Affiliated MP Site. 3. At AOL's option, MP shall no more than once per quarter distribute CD-Roms containing the software necessary to operate the AOL Service through MP's grocery delivery business and shall pay MP [***] ($[***]) per CD-Rom distributed. In addition, MP may request that AOL provide CD-Roms for delivery to MP customers and potential customers. In the event AOL grants MP's request, AOL shall provide MP with all such CD-Roms free of charge. AOL shall pay MP a bounty of [***] dollars ($[***]) for each Qualified New Member obtained through such distribution. "Qualified New Member" shall mean any person over the age of 18 in the U.S. who newly registers (i.e., is not a current member and was not a member for the 2 months immediately preceding such registration) for the AOL Service during the Term using MP 's special promotion identifier and who pays the then-standard fees required for membership to the AOL Service and remains a fully paid member in good standing through at least one (1) billing cycle (60 days total, including one free month and one paid month). AOL shall deliver "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 22 all payments due under this paragraph to MP quarterly. In the event that the one dollar per CD-Rom charge is adverse to AOLs ability to participate in the distribution described in this Section 3, the Parties agree to discuss in good faith a restructuring of this arrangement. 23 EXHIBIT D Description of Products and Other Content ----------------------------------------- Products and services generally available in grocery supermarkets 24 EXHIBIT D-1 AOL Exclusive Offers -------------------- Examples include: Free delivery on next two orders $10 off on each of the next two shops that are over $75.00 25 EXHIBIT E Operations ---------- 1. General. The Affiliated MP Site (including the Products and other Content ------- contained therein) will be in the top [***] in the online grocery delivery industry, as determined by each of the following methods: (a) based on a cross- section of third-party reviewers who are recognized authorities in such industry and (b) with respect to all material quality averages or standards in such industry, including each of the following: (i) pricing of Products, (ii) scope and selection of Products, (iii) quality of Products, (iv) customer service and fulfillment associated with the marketing and sale of Products and (v) ease of use. 2. Affiliated MP Site Infrastructure. MP will be responsible for all --------------------------------- communications, hosting and connectivity costs and expenses associated with the Affiliated MP Site. MP will provide all hardware, software, telecommunications lines and other infrastructure necessary to meet traffic demands on the Affiliated MP Site from the AOL Network. MP will design and implement the network between the AOL Service and Affiliated MP Site such that (I) no single component failure will have a materially adverse impact on AOL Members seeking to reach the Affiliated MP Site from the AOL Network and (ii) no single lineunder material control by MP will run at more than 70% average utilization for a 5-minute peak in a daily period. In the event that MP elects to create a custom version of the Affiliated MP Site in order to comply with the terms of this Agreement, MP will bear responsibility for all aspects of the implementation, management and cost of such customized site. 3. Optimization; Speed. MP will use commercially reasonable efforts to ------------------- ensure that: (a) the functionality and features within the Affiliated MP Site are optimized for the client software then in use by AOL Members; and (b) the Affiliated MP Site is designed and populated in a manner that minimizes delays when AOL Members attempt to access such site. At a minimum, MP will ensure that the Affiliated MP Site's data transfers initiate within fewer than fifteen (15) seconds on average. Prior to commercial launch of any material promotions described herein, MP will permit AOL to conduct performance and load testing of the Co-Branded Site (in person or through remote communications), with such commercial launch not to commence until such time as AOL is reasonably satisfied with the results of any such testing. 4. intentionally deleted --------------------- 5. Technical Problems. MP agrees to use commercially reasonable efforts to ------------------ address material technical problems (over which MP exercises control) affecting use by AOL Members of the Affiliated MP Site (a "MP Technical Problem") promptly following notice thereof. In the event that MP is unable to promptly resolve a MP Technical Problem following notice thereof from AOL (including, without limitation, infrastructure deficiencies producing user delays), AOL will have the right to initiate the dispute resolution procedures set forth in Section 7 of the Agreement. 6. Monitoring. MP will ensure that the performance and availability of the ---------- Affiliated MP Site is monitored on a continuous basis. MP will provide AOL with contact information (including e-mail, phone, pager and fax information, as applicable, for both during and after business hours) for MP's principal business and technical representatives, for use in cases when issues or problems arise with respect to the Affiliated MP Site. 7. Telecommunications. Where applicable MP will utilize encryption methodology ------------------ to secure data communications between the Parties' data centers. The network between the Parties will be configured such that no single component failure will significantly impact AOL Users. 8. Security. MP will utilize Internet standard encryption technologies (e.g., -------- Secure Socket Layer - SSL) to provide a secure environment for conducting transactions and/or transferring private member information (e.g. credit card numbers, banking/financial information, and member address information) to and from the Affiliated MP Site. MP will facilitate periodic reviews of the Affiliated MP Site with AOL in order to evaluate the security risks of such site. MP will promptly remedy any security risks or breaches of security as may be identified by AOL's Operations Security team. 9. Technical Performance. --------------------- i. MP will design the Affiliated MP Site to support the AOL-client embedded versions of the Microsoft Internet Explorer 4.XX and 5.XX browsers (Windows and Macintosh) and the Netscape Browser 4.XX and make commercially reasonable efforts to support all other AOL browsers listed at: "http://webmaster.info.aol.com." ii. To the extent MP creates customized pages on the Affiliated MP Site for AOL Members, MP will develop and employ a methodology to detect AOL Members (e.g. examine the HTTP User-Agent field in order to identify the "AOL Member-Agents" listed at: "http://webmaster. info.aol.com)." iii. MP will periodically review the technical information made available by AOL at http://webmaster.info.aol.com. iv. MP will design its site to support HTTP 1.0 or later protocol as defined in RFC 1945 and to adhere to AOL's parameters for refreshing or preventing the caching of information in AOL's proxy system as outlined in the document provided at the following URL: http://webmaster.info.aol.com. MP is responsible for the manipulation of these parameters in web-based objects so as to allow them to be cached or not cached as outlined in RFC 1945. v. Prior to releasing material, new functionality or features through the Affiliated MP Site ("New Functionality"), MP will use commercially reasonable efforts to (i) test the New Functionality to confirm its compatibility with AOL Service client software and (ii) provide AOL with written notice of the New Functionality so that AOL can perform tests of the New Functionality to confirm its compatibility with the AOL Service client software. Should any "[***] CONFIDENTIAL TREATMENT REQUESTED. OMITTED PORTIONS FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION]" 26 new material, new functionality or features through the Affiliated MP Site be released without notification to AOL, AOL will not be responsible for any adverse member experience until such time that compatibility tests can be performed and the new material, functionality or features qualified for the AOL Service 10. AOL Internet Services MP Support. AOL will provide MP with access to the -------------------------------- standard online resources, standards and guidelines documentation, technical phone support, monitoring and after-hours assistance that AOL makes generally available to similarly situated web-based partners. AOL support will not, in any case, be involved with content creation on behalf of MP or support for any technologies, databases, software or other applications which are not supported by AOL or are related to any MP area other than the Affiliated MP Site. 27 EXHIBIT F Standard Online Commerce Terms & Conditions ------------------------------------------- 1. AOL Network Distribution. MP will not authorize or permit any third party ------------------------ to distribute or promote the Products or any MP Interactive Site through the AOL Network absent AOL's prior written approval. The Promotions and any other promotions or advertisements purchased from or provided by AOL will link only to the Affiliated MP Site, will be used by MP solely for its own benefit and will not be resold, traded, exchanged, bartered, brokered or otherwise offered to any third party. 2. Provision of Other Content. In the event that AOL notifies MP that (i) as -------------------------- reasonably determined by AOL, any Content within the Affiliated MP Site violates AOL's then-standard Terms of Service (as set forth on the America Online brand service at Keyword term "TOS"), for the AOL Service or any other AOL property through which the entry page is promoted, the terms of this Agreement or any other standard, written AOL policy or (ii) AOL reasonably objects to the inclusion of any Content within the Affiliated MP Site (other than any specific items of Content which may be expressly identified in this Agreement), then MP will take commercially reasonable steps to block access by AOL Users to such Content using MP's then-available technology. In the event that MP cannot, through its commercially reasonable efforts, block access by AOL Users to the Content in question, then MP will provide AOL prompt written notice of such fact. AOL may then, at its option, restrict access from the AOL Network to the Content in question using technology available to AOL. MP will cooperate with AOL's reasonable requests to the extent AOL elects to implement any such access restrictions. 3. Contests. MP will take all steps necessary to ensure that any contest, -------- sweepstakes or similar promotion conducted or promoted through the Affiliated MP Site (a "Contest") complies with all applicable federal, state and local laws and regulations. 4. Navigation. Subject to the prior consent of MP, which consent will not be ---------- unreasonably withheld, AOL will be entitled to establish navigational icons, links and pointers connecting the Co-Branded Entry Page (or portions thereof) with other content areas on or outside of the AOL Network, provided that MP shall have final approval, in its sole discretion, of the design. Additionally, in cases where an AOL User performs a search for MP through any search or navigational tool or mechanism that is accessible or available through the AOL Network (e.g., Promotions, Keyword Search Terms, or any other promotions or navigational tools), AOL shall have the right to direct such AOL User to the Affiliated MP Site, or any other MP Interactive Site determined by AOL in its reasonable discretion. 5. Disclaimers. Upon AOL's request, MP agrees to include within the Affiliated ----------- MP Site a product disclaimer (the specific form and substance to be mutually agreed upon by the Parties) indicating that transactions are solely between MP and AOL Users purchasing Products from MP. 6. AOL Look and Feel. MP acknowledges and agrees that AOL will own all right, ----------------- title and interest in and to the elements of graphics, design, organization, presentation, layout, user interface, navigation and stylistic convention outlined in the standards and design guideline templates (including the digital implementations thereof) which are generally associated with online areas contained within the AOL Network, subject to MP's ownership rights in any MP trademarks or creative works within the Affiliated MP Site and to any software code created by MP. 7. Management of the Affiliated MP Site. MP will manage, review, delete, edit, ------------------------------------ create, update and otherwise manage all Content available on or through the Affiliated MP Site, in a timely and professional manner and in accordance with the terms of this Agreement. MP will ensure that the Affiliated MP Site is current, accurate and well-organized at all times. MP warrants that the Products and other Licensed Content: (i) will not infringe on or violate any copyright, trademark, U.S. patent or any other third party right, including without limitation, any music performance or other music-related rights; (ii) will not violate AOL's then-applicable Terms of Service for the AOL Service and any other AOL property through which the Affiliated MP Site will be promoted or any other standard, written AOL policy; and (iii) will not violate any applicable law or regulation, including those relating to contests, sweepstakes or similar promotions. Additionally, MP represents and warrants that it owns or has a valid license to all rights to any Licensed Content used in AOL "slideshow" or other formats embodying elements such as graphics, animation and sound, free and clear of all encumbrances and without violating the rights of any other person or entity. MP also warrants that a reasonable basis exists for all Product performance or comparison claims appearing through the Affiliated MP Site. MP shall not in any manner, including, without limitation in any Promotion, the Licensed Content or the Materials state or imply that AOL recommends or endorses MP or MP's Products (e.g., no statements that MP is an "official" or "preferred" provider of products or services for AOL). AOL will have no obligations with respect to the Products available on or through the Affiliated MP Site, including, but not limited to, any duty to review or monitor any such Products 8. Duty to Inform. MP will promptly inform AOL of any claim or threatened -------------- claim related to the Affiliated MP Site which could reasonably lead to a claim, demand, or liability of or against AOL and/or its affiliates by any third party. 9. Customer Service. It is the sole responsibility of MP to provide customer ---------------- service to persons or entities purchasing Products through the MP Interactive Site, when accessed through the Affiliated MP Site and AOL Network ("Customers"). MP will bear full responsibility for all customer service, including without limitation, order processing, billing, fulfillment, shipment, collection and other customer service associated with any Products offered, sold or licensed through the Affiliated MP 28 Site, and AOL will have no obligations whatsoever with respect thereto. MP will receive all emails from Customers via a computer available to MP's customer service staff and respond to such emails in a timely manner. t. MP will receive all orders electronically and generally process all orders within one business day of receipt, provided Products ordered are not advance order items. MP will ensure that all orders of Products are received, processed, fulfilled and delivered on a timely and professional basis. MP will offer AOL Users who purchase Products through such Affiliated MP Site a money back satisfaction guarantee. MP will bear all responsibility for compliance with federal, state and local laws in the event that Products are out of stock or are no longer available at the time an order is received. MP will also comply with the requirements of any federal, state or local consumer protection or disclosure law. Payment for Products will be collected by MP directly from customers. 10. Production Work. In the event that MP requests AOL's production assistance --------------- in connection with (i) ongoing programming and maintenance related to the Affiliated MP Site, (ii) a redesign of or addition to the Affiliated MP Site (e.g., a change to an existing screen format or construction of a new custom form), (iii) production to modify work performed by a third party provider or (iv) any other type of production work, MP will work with AOL to develop a detailed production plan for the requested production assistance (the "Production Plan"). Following receipt of the final Production Plan, AOL will notify MP of (i) AOL's availability to perform the requested production work, (ii) the proposed fee or fee structure for the requested production and maintenance work and (iii) the estimated development schedule for such work. To the extent the Parties reach agreement regarding implementation of the agreed- upon Production Plan, such agreement will be reflected in a separate work order signed by the Parties. To the extent MP elects to retain a third party provider to perform any such production work, work produced by such third party provider must generally conform to AOL's standards & practices (as provided on the America Online brand service at Keyword term "styleguide"). The specific production resources which AOL allocates to any production work to be performed on behalf of MP will be as determined by AOL in its sole discretion. AOL shall bear all AOL fees and expenses with respect to any routine production, maintenance or related services which AOL reasonably determines are necessary for AOL to perform in order to support the proper functioning and integration of the Affiliated MP Site ("Routine Services"). 11. Overhead Accounts. To the extent AOL has granted MP any overhead accounts ----------------- on the AOL Service, MP will be responsible for the actions taken under or through its overhead accounts, which actions are subject to AOL's applicable Terms of Service and for any surcharges, including, without limitation, all premium charges, transaction charges, and any applicable communication surcharges incurred by any overhead Account issued to MP, but MP will not be liable for charges incurred by any overhead account relating to AOL's standard monthly usage fees and standard hourly charges, which charges AOL will bear. Upon the termination of this Agreement, all overhead accounts, related screen names and any associated usage credits or similar rights, will automatically terminate. AOL will have no liability for loss of any data or content related to the proper termination of any overhead account. 12. Navigation Tools. Any Keyword Search Terms to be directed to the Affiliated ---------------- MP Site shall be (i) made available for use by MP and (ii) limited to the combination of the Keyword search modifier combined with a registered trademark of MP (e.g. "AOL keyword: XYZ Company Name"). AOL reserves the right to revoke at any time MP's use of any Keyword Search Terms which do not incorporate registered trademarks of MP. MP acknowledges that its utilization of a Keyword Search Term will not create in it, nor will it represent it has, any right, title or interest in or to such Keyword Search Term, other than the right, title and interest MP holds in MP's registered trademark independent of the Keyword Search Term. Without limiting the generality of the foregoing, MP will not: (a) attempt to register or otherwise obtain trademark or copyright protection in the Keyword Search Term; or (b) use the Keyword Search Term, except for the purposes expressly required or permitted under this Agreement. To the extent AOL allows AOL Users to "bookmark" the URL or other locator for the Affiliated MP Site, such bookmarks will be subject to AOL's control at all times. Upon the termination of this Agreement, MP's rights to any Keyword Search Terms (subject to Section 4 of Exhibit G) will terminate. 13. Merchant Certification Program. MP will participate in any generally ------------------------------ applicable "Certified Merchant" program operated by AOL or its authorized agents or contractors. Such program may require merchant participants on an ongoing basis to meet certain reasonable, generally applicable standards relating to provision of electronic commerce through the AOL Network (including, as a minimum, use of 40-bit SSL encryption and if requested by AOL, 128-bit encryption) and may also require the payment of certain reasonable certification fees to the applicable entity operating the program. Each Certified Merchant in good standing will be entitled to place on its affiliated Interactive Site an AOL designed and approved button promoting the merchant's status as an AOL Certified Merchant. 14. Reward Programs. On the Affiliated MP Site, MP shall not offer, provide, --------------- implement or otherwise make available any promotional programs or plans that are intended to provide customers with rewards or benefits in exchange for, or on account of, their past or continued loyalty to, or patronage or purchase of, the products or services of MP or any third party (e.g., a promotional program similar to a "frequent flier" program), unless such promotional program or plan is provided to no greater degree than AOL's "AOL Rewards" program, accessible on the AOL Service at Keyword: "AOL Rewards." 15. Search Terms. To the extent this Agreement sets forth any mechanism by ------------ which the Affiliated MP Site or the MP Interactive Site that is accessed through the Affiliated MP Site will be promoted in connection with specified search terms within any AOL product or service, MP hereby represents and warrants that MP has all consents, authorizations, approvals, licenses, permits or other rights necessary for MP to use such specified search terms. 29 EXHIBIT G Standard Legal Terms & Conditions --------------------------------- 1. Promotional Materials (Other than Press Releases). Each Party will submit ------------------------------------------------- to the other Party, for its prior written approval, which will not be unreasonably withheld or delayed, any marketing, advertising, or other promotional materials, excluding Press Releases, related to the Affiliated MP Site and/or referencing the other Party and/or its trade names, trademarks, and service marks (the "Promotional Materials"); provided, however, that either Party's use of screen shots of the Affiliated MP Site for promotional purposes will not require the approval of the other Party so long as America Online(R) is clearly identified as the source of such screen shots and so long as the URL of the MP and/or the trademark of the MP is included; and provided further, however, that, following the initial public announcement of the business relationship between the Parties in accordance with the approval and other requirements contained herein, either Party's subsequent factual reference to the existence of a business relationship between the Parties in Promotional Materials, will not require the approval of the other Party. Each Party will solicit and reasonably consider the views of the other Party in designing and implementing such Promotional Materials. Once approved, the Promotional Materials may be used by a Party and its affiliates for the purpose of promoting the Affiliated MP Site and the content contained therein and reused for such purpose until such approval is withdrawn with reasonable prior notice. In the event such approval is withdrawn, existing inventories of Promotional Materials may not be depleted. 2. License. MP hereby grants AOL a revocable non-exclusive worldwide license ------- to market, license, distribute, reproduce, display, perform, transmit and promote the Licensed Content (or any portion thereof) through such areas or features of the AOL Network as AOL deems appropriate. MP acknowledges and agrees that the foregoing license permits AOL to distribute portions of the Licensed Content in synchronism or timed relation with visual displays prepared by MP or AOL (e.g., as part of an AOL "slideshow"), subject in each case to MP's approval of the display. In addition, AOL Users will have the right to access and use the Affiliated MP Site. 3. Trademark License. In designing and implementing the Materials and subject ----------------- to the other provisions contained herein, MP will be entitled to use the following trade names, trademarks, and service marks of AOL: the "America Online" brand service, "AOL" service/software and AOL's triangle logo; and AOL and its affiliates will be entitled to use the trade names, trademarks, and service marks of MP for which MP holds all rights necessary for use in connection with this Agreement (collectively, together with the AOL marks listed above, the "Marks"); provided that each Party: (i) does not create a unitary composite mark involving a Mark of the other Party without the prior written approval of such other Party; and (ii) displays symbols and notices clearly and sufficiently indicating the trademark status and ownership of the other Party's Marks in accordance with applicable trademark law and practice. 4. Ownership of Trademarks. Each Party acknowledges the ownership right of ----------------------- the other Party in the Marks of the other Party and agrees that all use of the other Party's Marks will inure to the benefit, and be on behalf, of the other Party. Each Party acknowledges that its utilization of the other Party's Marks will not create in it, nor will it represent it has, any right, title, or interest in or to such Marks other than the licenses expressly granted herein. Each Party agrees not to do anything contesting or impairing the trademark rights of the other Party. 5. Quality Standards. Each Party agrees that the nature and quality of its ----------------- products and services supplied in connection with the other Party's Marks will conform to quality standards set by the other Party. Each Party agrees to supply the other Party, upon request, with a reasonable number of samples of any Materials publicly disseminated by such Party which utilize the other Party's Marks. Each Party will comply with all applicable laws, regulations, and customs and obtain any required government approvals pertaining to use of the other Party's marks. 6. Infringement Proceedings. Each Party agrees to promptly notify the other ------------------------ Party of any unauthorized use of the other Party's Marks of which it has actual knowledge. Each Party will have the sole right and discretion to bring proceedings alleging infringement of its Marks or unfair competition related thereto; provided, however, that each Party agrees to provide the other Party with its reasonable cooperation and assistance with respect to any such infringement proceedings. 7. Representations and Warranties. Each Party represents and warrants to the ------------------------------ other Party that: (i) such Party has the full corporate right, power and authority to enter into this Agreement and to perform the acts required of it hereunder; (ii) the execution of this Agreement by such Party, and the performance by such Party of its obligations and duties hereunder, do not and will not violate any agreement to which such Party is a party or by which it is otherwise bound; (iii) when executed and delivered by such Party, this Agreement will constitute the legal, valid and binding obligation of such Party, enforceable against such Party in accordance with its terms; and (iv) such Party acknowledges that the other Party makes no representations, warranties or agreements related to the subject matter hereof that are not expressly provided for in this Agreement. MP hereby represents and warrants that it possesses all authorizations, approvals, consents, licenses, permits, certificates or other rights and permissions necessary to sell the Products. 8. Confidentiality. Each Party acknowledges that Confidential Information may --------------- be disclosed to the other Party during the course of this Agreement. Each Party agrees that it will take reasonable steps, at least substantially equivalent to the steps it takes to protect its 30 own proprietary information, during the term of this Agreement, and for a period of three years following expiration or termination of this Agreement, to prevent the duplication or disclosure of Confidential Information of the other Party, other than by or to its employees or agents who must have access to such Confidential Information to perform such Party's obligations hereunder, who will each agree to comply with this section. Notwithstanding the foregoing, either Party may issue a press release or other disclosure containing Confidential Information without the consent of the other Party, to the extent such disclosure is required by law, rule, regulation or government or court order. In such event, the disclosing Party will provide at least five (5) business days prior written notice of such proposed disclosure to the other Party. Further, in the event such disclosure is required of either Party under the laws, rules or regulations of the Securities and Exchange Commission or any other applicable governing body, such Party will (i) redact mutually agreed-upon portions of this Agreement to the fullest extent permitted under applicable laws, rules and regulations and (ii) submit a request to such governing body that such portions and other provisions of this Agreement receive confidential treatment under the laws, rules and regulations of the Securities and Exchange Commission or otherwise be held in the strictest confidence to the fullest extent permitted under the laws, rules or regulations of any other applicable governing body. 9. Limitation of Liability; Disclaimer; Indemnification. ---------------------------------------------------- 9.1 Liability. UNDER NO CIRCUMSTANCES WILL EITHER PARTY BE LIABLE TO THE --------- OTHER PARTY FOR INDIRECT, INCIDENTAL, CONSEQUENTIAL, SPECIAL OR EXEMPLARY DAMAGES (EVEN IF THAT PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES), ARISING FROM BREACH OF THE AGREEMENT, THE SALE OF PRODUCTS AND/OR SERVICES, THE USE OR INABILITY TO USE THE AOL NETWORK, THE AOL SERVICE, AOL.COM OR THE CO-BRANDED ENTRY PAGE THE AFFILIATED MP SITE OR ANY OF THE MP INTERACTIVE SITES, OR ARISING FROM ANY OTHER PROVISION OF THIS AGREEMENT, SUCH AS, BUT NOT LIMITED TO, LOSS OF REVENUE OR ANTICIPATED PROFITS OR LOST BUSINESS (COLLECTIVELY, "DISCLAIMED DAMAGES"); PROVIDED THAT EACH PARTY WILL REMAIN LIABLE TO THE OTHER PARTY TO THE EXTENT ANY DISCLAIMED DAMAGES ARE CLAIMED BY A THIRD PARTY AND ARE SUBJECT TO INDEMNIFICATION PURSUANT TO SECTION 9.3. EXCEPT AS PROVIDED IN SECTION 9.3, (I) LIABILITY ARISING UNDER THIS AGREEMENT WILL BE LIMITED TO DIRECT, OBJECTIVELY MEASURABLE DAMAGES, AND (II) THE MAXIMUM LIABILITY OF ONE PARTY TO THE OTHER PARTY FOR ANY CLAIMS ARISING IN CONNECTION WITH THIS AGREEMENT WILL NOT EXCEED THE AGGREGATE AMOUNT OF FIXED PAYMENT OBLIGATIONS OWED BY MP UNDER SECTION 4.1.1 OF THE AGREEMENT IN THE YEAR IN WHICH THE EVENT GIVING RISE TO LIABILITY OCCURS; PROVIDED THAT EACH PARTY WILL REMAIN LIABLE FOR THE AGGREGATE AMOUNT OF ANY PAYMENT OBLIGATIONS OWED TO THE OTHER PARTY PURSUANT TO THE AGREEMENT. 9.2 No Additional Warranties. EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, ------------------------ NEITHER PARTY MAKES ANY, AND EACH PARTY HEREBY SPECIFICALLY DISCLAIMS ANY REPRESENTATIONS OR WARRANTIES, EXPRESS OR IMPLIED, REGARDING THE AOL NETWORK, THE AOL SERVICE, AOL.COM, THE CO-BRANDED ENTRY PAGE OR THE AFFILIATED MP SITE OR ANY OF THE MP INTERACTIVE SITES, INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE AND IMPLIED WARRANTIES ARISING FROM COURSE OF DEALING OR COURSE OF PERFORMANCE. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, AOL SPECIFICALLY DISCLAIMS ANY WARRANTY REGARDING THE PROFITABILITY OF THE AFFILIATED MP SITE. 9.3 Indemnity. Each Party will defend, indemnify, save and hold harmless the --------- other Party and the officers, directors, agents, affiliates, distributors, franchisees and employees of the other Party from any and all third party claims, demands, liabilities, costs or expenses, including reasonable attorneys' fees ("Liabilities"), resulting from the indemnifying Party's material breach of any duty, representation, or warranty of this Agreement. 9.4 Claims. If a Party entitled to indemnification hereunder (the "Indemnified ------ Party") becomes aware of any matter it believes is indemnifiable hereunder involving any claim, action, suit, investigation, arbitration or other proceeding against the Indemnified Party by any third party (each an "Action"), the Indemnified Party will give the other Party (the "Indemnifying Party") prompt written notice of such Action. Such notice will (i) provide the basis on which indemnification is being asserted and (ii) be accompanied by copies of all relevant pleadings, demands, and other papers related to the Action and in the possession of the Indemnified Party. The Indemnifying Party will have a period of ten (10) days after delivery of such notice to respond. If the Indemnifying Party elects to defend the Action or does not respond within the requisite ten (10) day period, the Indemnifying Party will be obligated to defend the Action, at its own expense, and by counsel reasonably satisfactory to the Indemnified Party. The Indemnified Party will cooperate, at the expense of the Indemnifying Party, with the Indemnifying Party and its counsel in the defense and the Indemnified Party will have the right to participate fully, at its own expense, in the defense of such Action. If the Indemnifying Party responds within the required ten (10) day period and elects not to defend such Action, the Indemnified Party will be free, without prejudice to any of the Indemnified Party's rights hereunder, to compromise or defend (and control the defense of) such Action. In such case, the Indemnifying Party will cooperate, at its own expense, with the Indemnified Party and its counsel in the defense against such Action and the Indemnifying Party will have the right to participate fully, at its own expense, in the defense of such Action. Any compromise or settlement of an Action will require the 31 prior written consent of both Parties hereunder, such consent not to be unreasonably withheld or delayed. 10. Acknowledgment. AOL and MP each acknowledges that the provisions of this -------------- Agreement were negotiated to reflect an informed, voluntary allocation between them of all risks (both known and unknown) associated with the transactions contemplated hereunder. The limitations and disclaimers related to warranties and liability contained in this Agreement are intended to limit the circumstances and extent of liability. The provisions of this Section 10 will be enforceable independent of and severable from any other enforceable or unenforceable provision of this Agreement. 11. Solicitation of AOL Users. During the term of the Agreement and for a two ------------------------- year period thereafter, MP will not use the AOL Network (including, without limitation, the e-mail network contained therein) to solicit AOL Users on behalf of another Interactive Service. More generally, MP will not send unsolicited, commercial e-mail (i.e., "spam") or other online communications through or into AOL's products or services, absent a Prior Business Relationship. For purposes of this Agreement, a "Prior Business Relationship" will mean that the AOL User to whom commercial e-mail or other online communication is being sent has voluntarily either (i) engaged in a transaction with MP or (ii) provided information to MP through a contest, registration, or other communication, which included clear notice to the AOL User that the information provided could result in commercial e-mail or other online communication being sent to that AOL User by MP or its agents. Any commercial e-mail or other online communications to AOL Users which are otherwise permitted hereunder, will (a) include a prominent and easy means to "opt-out" of receiving any future commercial communications from MP, and (b) shall also be subject to AOL's then-standard restrictions on distribution of bulk e-mail (e.g., related to the time and manner in which such e-mail can be distributed through or into the AOL product or service in question). 12. AOL User Communications. To the extent that MP is permitted to communicate -------------------------- with AOL Users under Section 11 of this Exhibit G, in any communications to AOL Users on or off the Affiliated MP Site (including, without limitation, e-mail solicitations) that are the type of communications described in Section 11 (the "AOL User communications"), MP will not encourage AOL Users to take any action inconsistent with the scope and purpose of this Agreement, including without limitation, the following actions: (i) using an entry page other than the Affiliated MP Site for the purchase of Products, (ii) using Content other than the Licensed Content; (iii) bookmarking of Interactive Sites; or (iv) changing the default home page on the AOL browser. Additionally, with respect to such AOL User communications, in the event that MP encourages an AOL User to purchase products through such communications, MP shall ensure that (a) the AOL Network is promoted as the primary means through which the AOL User can access the Affiliated MP Site and (b) any link to the Affiliated MP Site will link to a page which indicates to the AOL User that such user is in a site which is affiliated with the AOL Network. 13. Collection and Use of User Information. Each party shall ensure that its -------------------------------------- collection, use and disclosure of information obtained from AOL Users under this Agreement ("User Information") complies with (i) all applicable laws and regulations and (ii) AOL's standard privacy policies, available on the AOL Service at the keyword term "Privacy" (or, in the case of the Affiliated MP Site, MP's standard privacy policies so long as such policies are prominently published on the site and provide adequate notice, disclosure and choice to users regarding MP's collection, use and disclosure of user information). MP will not (a) disclose User Information collected hereunder (i) to any third party in a manner that identifies AOL Users as end users of an AOL product or service, or (ii) to any Interactive Service or (b) use Member Information collected under this Agreement to market another Interactive Service. Likewise, AOL will not without in each case the prior written consent of MP (a) disclose User Information collected hereunder (i) to any third party in a manner that identifies AOL Users as end users of an MP product or service, or (ii) to any Interactive Service or (b) use Member Information collected under this Agreement to market another provider of the Exclusive Product. 14. Excuse. Neither Party will be liable for, or be considered in breach of ------ or default under this Agreement on account of, any delay or failure to perform as required by this Agreement as a result of any causes or conditions which are beyond such Party's reasonable control and which such Party is unable to overcome by the exercise of reasonable diligence. 15. Independent Contractors. The Parties to this Agreement are independent ----------------------- contractors. Neither Party is an agent, representative or employee of the other Party. Neither Party will have any right, power or authority to enter into any agreement for or on behalf of, or incur any obligation or liability of, or to otherwise bind, the other Party. This Agreement will not be interpreted or construed to create an association, agency, joint venture or partnership between the Parties or to impose any liability attributable to such a relationship upon either Party. 16. Notice. Any notice, approval, request, authorization, direction or other ------ communication under this Agreement will be given in writing and will be deemed to have been delivered and given for all purposes (i) on the delivery date if delivered by electronic mail on the AOL Network (to screenname "AOLNotice@AOL.com" in the case of AOL) or by confirmed facsimile; (ii) on the delivery date if delivered personally to the Party to whom the same is directed; (iii) one business day after deposit with a commercial overnight carrier, with written verification of receipt; or (iv) five business days after the mailing date, whether or not actually received, if sent by U.S. mail, return receipt requested, postage and charges prepaid, or any other means of rapid mail delivery for which a receipt is available. In the case of AOL, such notice will be provided to both the Senior Vice President for Business Affairs (fax no. 703- 265-1206) and the Deputy General Counsel (fax no. 703-265-1105), each at the address of AOL set forth in the first paragraph of this Agreement. In the case of MP, such notice will be provided to both the Senior Vice 32 President of Marketing, currently Jon Landers (fax no. 425-201-7887) and the General Counsel, currently Kristin Stred (fax no. 425-201-7805) each at the address for MP set forth in the first paragraph of this Agreement. 17. Launch Dates. In the event that any terms contained herein relate to or ------------ depend on the commercial launch date of the Affiliated MP Site contemplated by this Agreement (the "Launch Date"), then it is the intention of the Parties to record such Launch Date in a written instrument signed by both Parties promptly following such Launch Date; provided that, in the absence of such a written instrument, the Launch Date will be as reasonably determined by AOL based on the information available to AOL. 18. No Waiver. The failure of either Party to insist upon or enforce strict --------- performance by the other Party of any provision of this Agreement or to exercise any right under this Agreement will not be construed as a waiver or relinquishment to any extent of such Party's right to assert or rely upon any such provision or right in that or any other instance; rather, the same will be and remain in full force and effect. 19. Return of Information. Upon the expiration or termination of this --------------------- Agreement, each Party will, upon the written request of the other Party, return or destroy (at the option of the Party making the request) all confidential information, documents, manuals and other materials specified the other Party. 20. Survival. Sections 1.2, 4.4, 4.5, 6.2, and 7.7 of the body of the -------- Agreement, Sections 4 and 8 through 30 of this Exhibit, and any payment ------- obligations accrued prior to termination or expiration will survive the completion, expiration, termination or cancellation of this Agreement. 21. Entire Agreement. This Agreement sets forth the entire agreement and ---------------- supersedes any and all prior agreements of the Parties with respect to the transactions set forth herein. Neither Party will be bound by, and each Party specifically objects to, any term, condition or other provision which is different from or in addition to the provisions of this Agreement (whether or not it would materially alter this Agreement) and which is proffered by the other Party in any correspondence or other document, unless the Party to be bound thereby specifically agrees to such provision in writing. 22. Amendment. No change, amendment or modification of any provision of this --------- Agreement will be valid unless set forth in a written instrument signed by the Party subject to enforcement of such amendment, and in the case of AOL, by an executive of at least the same standing to the executive who signed the Agreement. 23. Further Assurances. Each Party will take such action (including, but not ------------------ limited to, the execution, acknowledgment and delivery of documents) as may reasonably be requested by any other Party for the implementation or continuing performance of this Agreement. 24. Assignment. Neither party may assign this Agreement or any right, ---------- interest or benefit under this Agreement without the prior written consent of the other party; provided, however, that (i) MP shall have the right to assign this Agreement to any successor to MP, whether by way of acquisition, merger, consolidation or otherwise, without the prior approval of AOL, unless such successor is an Interactive Service and (ii) AOL shall have the right to assign this Agreement to any affiliate of AOL. Subject to the foregoing, this Agreement will be fully binding upon, inure to the benefit of and be enforceable by the Parties hereto and their respective successors and assigns. 25. Construction; Severability. In the event that any provision of this -------------------------- Agreement conflicts with the law under which this Agreement is to be construed or if any such provision is held invalid by a court with jurisdiction over the Parties to this Agreement, (i) such provision will be deemed to be restated to reflect as nearly as possible the original intentions of the Parties in accordance with applicable law, and (ii) the remaining terms, provisions, covenants and restrictions of this Agreement will remain in full force and effect. 26. Remedies. Except where otherwise specified, the rights and remedies -------- granted to a Party under this Agreement are cumulative and in addition to, and not in lieu of, any other rights or remedies which the Party may possess at law or in equity; provided that, in connection with any dispute hereunder, MP will be not entitled to offset any amounts that it claims to be due and payable from AOL against amounts otherwise payable by MP to AOL. 27. Applicable Law. Except as otherwise expressly provided herein, this -------------- Agreement will be interpreted, construed and enforced in all respects in accordance with the laws of the State of New York except for its conflicts of laws principles. 28. Export Controls. Both Parties will adhere to all applicable laws, --------------- regulations and rules relating to the export of technical data and will not export or re-export any technical data, any products received from the other Party or the direct product of such technical data to any proscribed country listed in such applicable laws, regulations and rules unless properly authorized. 29. Headings. The captions and headings used in this Agreement are inserted -------- for convenience only and will not affect the meaning or interpretation of this Agreement. 30. Counterparts. This Agreement may be executed in counterparts, each of ------------ which will be deemed an original and all of which together will constitute one and the same document 33 EX-10.42 3 FACILITY LEASE W. GONSALVES & SANTUCCI, INC. EXHIBIT 10.42 STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET FORNI DRIVE--HOMEGROCER.COM 1. Basic Provisions ("Basis Provisions") 1.1 Parties: This Lease ("Lease"), dated for reference purposes only March 3, 2000, is made by and between Gonsalves & Santucci, Inc., a California corporation ("Lessor") and HomeGrocer.Com, Inc., a Delaware corporation ("Lessee"), (collectively the "Parties", or individually a "Party"). 1.2 Premises: That certain real property, including all improvements therein or to be provided by Lessor under the terms of this Lease, and commonly known as Forni Drive and described in Exhibit A attached hereto, located in the County of Contra Costa, State of California, and generally described as a to-be- constructed free standing concrete tilt-up building of approximately 100,800 square feet comprised of a combination of office and warehouse space ("Building") situated on approximately 5.59 acres (such real property and Building, the "Premises"). (See also Paragraph 2) 1.3 Term: Commencing on the Commencement Date (as defined below) and ending on the last day of the month that is one hundred twenty (120) full months after the Rent Commencement Date (as defined below) (such last date, the "Expiration Date"), which initial term is referred to herein as the "Original Term". The "Commencement Date" shall be the date that Lessor delivers the Premises to Lessee in the condition required under this Lease. The "Rent Commencement Date" shall be the date that is the earlier of (a) the date that Lessee commences the operation of business in the Premises, or (b) sixty (60) days after the Commencement Date (See also Paragraph 3) 1.4 Early Possession: [not applicable.] 1.5 Base Rent: Initially, $ 0.68 per square foot of gross space per month ("Base Rent"), payable on the first day of each month commencing on the Rent Commencement Date. If the gross square footage is determined to be 100,800 square feet, then the Base Rent will be $68,544 per month, subject to adjustment as provided in this Lease. (See also Paragraph 4). 1.6 Base Rent Paid Upon Execution: $68,544 as Base Rent for first full month after the Rent Commencement Date. If the first month of the Original Term is less than a full month, then promptly after the Rent Commencement Date, Lessee shall pay the Base Rent for such partial month, prorated as provided in Paragraph 4.2. 1.7 Security Deposit: $100,000 to be paid by Lessee to Lessor within ten (10) business days after execution of this Lease by the Parties. Concurrently therewith, Lessee is to deliver to Lessor an irrevocable standby letter of credit issued to Lessor's favor by a financial institution reasonably acceptable to Lessor, in form reasonably acceptable to Lessor, in the amount of $800,000 ("Letter of Credit"). The cash deposit and the Letter of Credit are referred to herein as the "Security Deposit". (See also Paragraphs 5 and 51) 1.8 Agreed Use: warehousing, office, retail distribution and related activities. (See also Paragraph 6) 1.9 Insuring Party. Lessor is the "Insuring Party" unless otherwise stated herein. (See also Paragraph 8) 1.10 Real Estate Brokers: (See Paragraph 15) (a) Representation: The following real estate brokers (collectively, the "Brokers") and brokerage relationships exist in this transaction: Cushman & Wakefield represents Lessor exclusively ("Lessor's Broker"); E&Y Kenneth Leventhal Real Estate Group represents Lessee exclusively ("Lessee's Broker"). (b) Payment to Brokers: Upon final approval of the conditional use permit described in Section 3.3 below, Lessor shall pay to the Brokers one-half of the fee agreed to in their separate written agreement. Provided such conditional use permit is obtained, on or before December 31, 2000, Lessor shall pay to the Brokers the remaining one-half of the fee. Lessee's Broker acknowledges its arrangement with Lessee that immediately upon receipt of its share of each commission payment from Lessor, Lessee's Broker shall pay such commission over to Lessee to defray Lessee's costs with respect to the Premises and this transaction. 1.11 Guarantor. [not applicable]. 1.12 Addenda and Exhibits. Attached hereto is Addendum A, consisting of Paragraphs 50 through 58, and Exhibits A through C, all of which constitute a part of this Lease. 1.13 Force Majeure. As used in this Lease, "Force Majeure" shall mean any delay resulting from or caused by an Act of God, fire, earthquake, flood, explosion, action of the elements, war, invasion, insurrection, riot, mob violence, sabotage, malicious mischief, inability to procure or general shortage of labor, equipment, facilities, materials, or supplies in the open market, inability to obtain or delays in obtaining necessary government approvals, licenses or permits, failure of transportation, strike, lockout, action of labor unions, changes in law, order or regulation of government authority, or any other cause (excluding financial inability) whether similar or dissimilar to the forgoing not within the reasonable control of Lessor. 1.14 Work Letter. As used in this Lease, "Work Letter" means the Work Letter attached to this Lease as Exhibit B. 2. Premises. 2.1 Letting; Premises. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. The exact square footage of the Premises shall be determined by Lessor's architect, subject to the reasonable approval of Lessee. Lessor's architect shall measure the space, and certify in writing that such measuring is based upon the standards most recently promulgated by the Building Owners and Managers Association upon completion of -2- construction. If Lessee disagrees with the rentable square footage determined by Lessor's architect, Lessor and Lessee shall mutually agree upon an independent, third party architect who shall measure the Premises based on the foregoing standards and whose decision will be final and binding upon Lessor and Lessee. The cost of such third party architect shall be shared equally by Lessor and Lessee. Lessor's leasing of the Premises to Lessee also includes the appurtenant right for Lessee to use, throughout the term all entranceways, common areas, parking areas, sidewalks, lobbies, elevators, stairwells and other common areas located on or serving the Building, Complex and Land. 2.2 Condition. Lessor shall deliver the Premises to Lessee on the Commencement Date in the condition described in the Work Letter attached hereto as Exhibit B, and so long as the required service contracts described in Paragraph 7.1 (b) below are obtained by Lessee within thirty (30) days following the Commencement Date, warrants that the electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"), loading doors, if any, and all other such elements in the Premises, other than those constructed by Lessee, shall as of that date be in good operating condition on said date and that the structural elements of the roof, bearing walls and foundation of the Building on the Premises shall be free of material defects. If a non-compliance with said warranty exists as of the Commencement Date, Lessor shall, as Lessor's sole obligation with respect to such matter, except as otherwise provided in this Lease, promptly after receipt of written notice from Lessee setting forth with reasonable specificity the nature and extent of such non-compliance, rectify same at Lessor's expense. If, after the Commencement Date, Lessee does not give Lessor written notice of any non-compliance with this warranty within: (i) as to the HVAC systems, the later of (a) six (6) months or (b) ten (10) days prior to the expiration of the warranties therefor, (ii) as to the remaining systems and other non-structural elements of the Building, the later of (a) ninety (90) days or (b) ten (10) days prior to the expiration of all warranties therefor, then correction of such non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. Lessor shall within thirty (30) days after the Commencement Date provide to Lessee copies of all written warranties for the electrical, plumbing, fire sprinkler, lighting, HVAC and loading doors, which Lessor covenants and warrants shall be on no less favorable terms than those standard in the building management industry. 2.3 Compliance. Lessor warrants that the Building and all other improvements on the Premises shall comply with all applicable laws, covenants or restrictions of record, building codes, regulations and ordinances ("Applicable Requirements") in effect on the Commencement Date, or such later date as the Building and all other improvements are completed by Lessor. Said warranty does not apply to the use to which Lessee will put the Premises or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. Lessee is responsible for determining whether or not the zoning is appropriate for Lessee's intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same at Lessor's expense. If the Applicable Requirements are hereafter changed (as opposed to being in existence at the Commencement Date, which is addressed in Paragraph 6.2(e) below) so as to require during the term of this Lease the -3- construction of an addition to or an alteration of the Building, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Building ("Capital Expenditure"), Lessor and Lessee shall allocate the cost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required (i) during the last two (2) years of the Original Term or any extensions thereof and the cost thereof exceeds six (6) months Base Rent, or (ii) during the last twelve (12) months of the Original Term or any extension thereof and the cost thereof exceeds three (3) months Base Rent, then Lessee may instead terminate this Lease unless Lessor thereafter notifies Lessee, in writing, within ten (10) business days after receipt of Lessee's termination notice that Lessor has elected to pay all the costs of such Capital Expenditures. If Lessee elects termination, Lessee's notice of termination shall specify a termination date at least ninety (90) days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure. (b) If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as by way of example, but not by way of limitation, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for such costs pursuant to the provisions of Paragraph 7.1 (c). (c) Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, or modification to the Premises then, and in that event, Lessee shall be fully responsible for the cost thereof, and Lessee shall not have any right to terminate this Lease. 2.4 Acknowledgments. Lessor agrees to deliver the Building and the Premises in the form and condition set forth in the Work Letter attached hereto as Exhibit B. 3. Term. 3.1 Term. The Commencement Date, Rent Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3. 3.2 Possession on Commencement Date. While the obligation to pay Base Rent is abated during the period from the Commencement Date until the Rent Commencement Date, all other terms of this Lease (including but not limited to the obligations to pay insurance premiums and to maintain the Premises) shall, however, be in effect during such period. Lessee's possession during such period shall not affect the Expiration Date. 3.3 Delay In Possession. Lessor agrees to use its best commercially reasonable and diligent efforts to obtain a conditional use permit for warehouse and distribution use of the -4- Premises on or before April 30, 2000. If Lessor is unable to do so, then this Lease shall terminate on or before May 15, 2000, provided however, that this Lease shall not terminate, if Lessee provides Lessor with written notice on or before May 15, 2000 of its intent to (a) keep this Lease in full force and effect, and (b) seek a conditional use permit for warehouse and distribution use. If Lessee so notifies Lessor, then (i) Lessee shall diligently seek to obtain the conditional use permit and Lessor shall fully cooperate with Lessee's efforts, and (ii) this Lease shall terminate on July 31, 2000 if the governmental agencies having jurisdiction over this site have not issued the conditional use permit for warehouse and distribution use of the Premises. If the conditional use permit is not issued on or before April 30, 2000, then all provisions of this Lease relating to the date that Lessor will provide the Premises to Lessee shall be adjusted to reflect the days of delay between April 30, 2000 and the date the conditional use permit is actually issued. Notwithstanding the foregoing, if such governmental agencies approve the conditional use permit for warehouse and distribution use, Lessee may within ten (10) days of such approval seek confirmation that Lessee's planned use of the Premises as a HomeGrocer facility (but excluding sale of alcoholic beverages) fits within the uses permitted by the conditional use permit. If Lessee timely requests confirmation that the conditional use permit will allow such use by Lessee and confirmation of same is not received by Lessee within 45 days after such request is made, then Lessee shall have the right to terminate this Lease by giving Lessor written notice of such termination no later than the first to occur of five (5) days after said 45 day period, or July 31, 2000, which termination shall be effective upon Lessor's receipt of such notice. If this Lease is not terminated pursuant to the foregoing provisions of this Section 3.3, Lessor agrees to use its commercially reasonable and diligent efforts to complete construction and deliver the Premises to Lessee in the condition described in the Work Letter on or before the date that is ten (10) months after the later of the date the conditional use permit is issued, and if requested, approval of Lessee's planned use is confirmed. If, despite said efforts, Lessor is unable to deliver the Premises as agreed, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until Lessee receives the Premises including the Building all completed as required herein. If possession is not delivered as required, subject to extension of the delivery date for Force Majeure delays, Lessee may elect to terminate this Lease within ten (10) days after the last date that the Premises were required to be delivered. If Lessee so terminates this Lease, the Parties shall be discharged from all obligations hereunder; provided however that Lessor shall be obligated to reimburse Lessee for out of pocket costs incurred by Lessee with respect to costs of design of the interior of the Premises and for obtaining all requisite building and other permits for construction of the tenant improvements that Lessee would have constructed therein. 3.4 Lessee Compliance. Lessor shall not be required to deliver possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, the Commencement Date shall be deemed to have occurred and Lessee shall be required to perform its obligations as provided in this Lease. 4. Rent. -5- 4.1 Rent Defined. All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ("Rent"). 4.2 Payment. Lessee shall cause payment of Rent to be sent to Lessor in lawful money of the United States, without offset or deduction (except as specifically permitted in this Lease), on or before the day on which it is due. Rent for any period during the term hereof which is for less than one (1) full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. 4.3 Annual Adjustments to Base Rent. Base Rent payable during the Original Term shall be adjusted on the first day of the month that follows the twelfth full month after the Rent Commencement Date, and annually thereafter, by increasing the Base Rent previously in effect by three percent (3%). For example, assuming the Premises constitute 100,800 square feet, the initial Base Rent would be $68,544 per month, the first annual adjustment would increase the Base Rent to $70,600 per month, the second annual adjustment would increase the Base Rent to $72,718 per month, and subsequent adjustments would increase the Base Rent previously in effect by three percent (3%) each year. 5. Security Deposit. See Paragraph 51 for additional provisions relating to the Security Deposit. 6. Use. 6.1 Use. Lessee shall use and occupy the Premises only for the Agreed Use (which may include distribution of alcoholic beverages for off-site consumption). The Premises may be used for other legal uses which are reasonably comparable thereto, subject to Lessee obtaining Lessor's prior written consent, which shall not be unreasonably withheld. Lessor consents to the following additional use, provided that Lessee does not seek any required permits or licenses therefor until Lessor has first obtained the conditional use permit and necessary building permits to allow Lessor to construct the Premises in the manner described in the Work Letter attached as Exhibit B: to the extent legally necessary to enable Lessee to sell off-site distribution alcoholic beverages as part of its retail home grocery distribution business, Lessee may operate an on-site store for the retail sale of alcoholic beverages for off-site consumption, of a size and capacity not larger than the minimum reasonably necessary, in the opinion of Lessee's counsel, to qualify for the license needed for the sale of off-site delivery of alcoholic beverages as part of Lessee's home grocery retail sale and distribution business. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, or creates damage, waste or a nuisance. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements on the Premises or the mechanical or electrical systems therein, and is not significantly more burdensome to the Premises. If Lessor elects to withhold consent, Lessor shall within ten (10) -6- business days after such request give written notification of same, which notice shall include an explanation of Lessor's objections to the change in use. 6.2 Hazardous Substances. (a) Reportable Uses Require Consent. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, by-products or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "Reportable Use" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, and may store on the Premises packaged goods intended for resale to customers, such as, but not limited to, hairspray, household cleaners, automotive products, antifreeze, dog food, plant fertilizer and other items customarily sold to customers in a grocery, food or drug store, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements). (b) Duty to Inform Lessor. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance. (c) Lessee Remediation. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee's expense, take all -7- investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party under Lessee's control. (d) Lessee Indemnification. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from adjacent properties, nor shall Lessee have any liability arising from Lessor's own negligent or intentional acts or omissions). Lessee's obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement. (e) Lessor Indemnification. Lessor shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which existed as a result of Hazardous Substances on the Premises prior to the Commencement Date or which are caused by the negligence or intentional acts or omissions of Lessor, its agents or employees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. (f) Lessor Investigations and Remediations. Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to the Commencement Date, unless such remediation measure is required as a result of Lessee's activities on the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times, upon at least 24 hours' notice, in order to carry out Lessor's investigative and remedial responsibilities. (g) Lessor Termination Option. If a Hazardous Substance Condition (as defined in Paragraph 9.1) occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessor's rights under Paragraph 6.2(d) and Paragraph 13), Lessor may, at Lessor's -8- option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds twelve (12) times the then monthly Base Rent, give written notice to Lessee, within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor's desire to terminate this Lease as of the date one hundred twenty (120) days following the date of such notice. In the event Lessor elects to give a termination notice, Lessee may, within ten (10) days thereafter, give written notice to Lessor of Lessee's commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to twelve (12) times the then monthly Base Rent. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within thirty (30) days following such commitment; provided however that after making such commitment, if Lessee so desires, Lessee shall have a period of ninety (90) days to review the costs of remediation and obtain bids from other firms reasonably satisfactory to Lessor to remediate the Hazardous Substance Condition. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available. If Lessee does not give such notice or Lessee does not provide the required funds or assurance thereof within the time provided, then unless Lessor rescinds its termination notice, this Lease shall terminate as of the date specified in Lessor's notice of termination. 6.3 Lessee's Compliance with Applicable Requirements. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which relate in any manner to the Premises, without regard to whether said requirements are now in effect or become effective after the Commencement Date. Lessee shall, within ten (10) days after receipt of Lessor's written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. 6.4 Inspection; Compliance. Lessor and Lessor's "Lender" (as defined in Paragraph 30 below) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times upon at least 24 hours' prior notice, but generally no more than twice in any one calendar year, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. In exercising their rights hereunder Lessor and Lessor's Lender shall not unreasonably interfere with or materially adversely affect the operation of Tenant's business. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a contamination is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority, and such violation, contamination or request is as a result of Lessee's acts or omissions. In such case, Lessee shall upon request reimburse Lessor for the commercially reasonable cost of such inspections, so long as such inspection is reasonably related to the violation or contamination. -9- 7. Maintenance; Repairs, Utility Installations; Trade Fixtures and Alterations. 7.1 Lessee's Obligations. (a) In General. Subject to the provisions of Paragraph 2.2 (Condition), 2.3 (Compliance), 6.3 (Lessee's Compliance with Applicable Requirements), 7.2 (Lessor's Obligations), 9 (Damage or Destruction), and 14 (Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises, Utility Installations, and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, the elements or the age of such portion of the Premises), including, but not limited to, all equipment or facilities, such as plumbing, heating, ventilating, air- conditioning, electrical, lighting facilities, boilers, pressure vessels, fire protection system, fixtures, interior non-load bearing walls, ceilings, floors, windows, doors, plate glass, skylights, landscaping, driveways, parking lots, fences, retaining walls, signs, sidewalks and parkways located in or on the Premises. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the procurement and maintenance of the service contracts required by Paragraph 7.1(b) below. Lessee's obligations shall include roof repairs (but not replacement) and non-structural restorations, replacements or renewals of all improvements on or in the Premises or the Building or a part thereof, to keep same in good order, condition and state of repair. Lessee shall, during the term of this Lease, keep the exterior appearance of the Building in a first-class condition consistent with the exterior appearance of other similar facilities of comparable age and size in the vicinity, including, when necessary, exterior repainting of the Building. (b) Service Contracts. Lessee shall, at Lessee's sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing and experienced in the maintenance of the following equipment and improvements ("Basic Elements"), if any, if and when installed on the Premises: (i) HVAC equipment, (ii) boiler, and pressure vessels, (iii) fire extinguishing systems, including fire alarm and/or smoke detection, (iv) landscaping and irrigation systems, (v) roof covering and drains, (vi) driveways and parking lots, (vii) clarifiers (viii) basic utility feed to the perimeter of the Building, and (ix) any other equipment, if reasonably required by Lessor. (c) Replacement. Subject to Lessee's indemnification of Lessor as set forth in Paragraph 8.7 below, and without relieving Lessee of liability resulting from Lessee's failure to exercise and perform good maintenance practices, if the Basic Elements described in Paragraph 7.1(b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such Basic Elements, then such Basic Elements shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is the number of months of the useful life of such replacement as such useful life is determined in accordance with generally accepted accounting -10- principles ("GAAP") (including Interest (as defined in Paragraph 13.5) on the unamortized balance) with Lessee reserving the right to prepay its obligation at any time. 7.2 Lessor's Obligations. Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 9 (Damage or Destruction) and 14 (Condemnation), it is intended by the Parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the non-structural aspects of the Premises, or the equipment therein, all of which obligations are intended to be that of the Lessee. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises, and they expressly waive the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease. Except for Lessee's obligation to maintain the non-structural components of the roof and periodically repaint the Building, Lessee is not obligated to maintain any structural or exterior components of the Building, which obligations remain the Lessor's. 7.3 Utility Installations; Trade Fixtures; Alterations. (a) Definitions; Consent Required. The term "Utility Installations" refers to all floor and window coverings, air lines, power panels, electrical distribution, security and fire protection systems, communication systems, antennas and satellite dishes, refrigeration equipment, lighting fixtures, HVAC equipment, plumbing, and fencing in or on the Premises. The term "Trade Fixtures" shall mean Lessee's machinery and equipment that can be removed without doing material damage to the Premises, including but not limited to Lessee's antennas and satellite dishes, and refrigeration equipment. The term "Alterations" shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. "Lessee Owned Alterations and/or Utility Installations" are defined as Alterations and/or Utility Installations made by Lessee. Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Alterations and Utility Installations to the interior of the Building (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any exterior walls, and the cumulative cost thereof in any year during this Lease as extended does not exceed $50,000. (b) Consent. Any Alterations or Utility Installations that Lessee shall desire to make and which require the written consent of the Lessor shall be presented to Lessor in written form with detailed plans. Lessor shall review such detailed plans and give Lessee written notice of consent or rejection within ten (10) days after receipt by Lessor. In the event Lessor does not provide such written consent or rejection within such ten (10) day period, Lessor is deemed to have approved all such plans. At the time Lessor gives consent, Lessor shall state whether the Alteration or Installation will be required to be removed at the end of the Term or any extensions. Failure of Lessor to state in the written consent that the Alteration or Installation should be removed shall be deemed a waiver of Lessor's right to require such removal. Consent shall be deemed conditioned upon Lessee's: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other -11- Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount greater than one month's Base Rent, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to one and one-half times the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor. (c) Indemnification. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic's or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than ten (10) days' notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to one and one-half times the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys' reasonable fees and costs. 7.4 Ownership; Removal; Surrender; and Restoration. (a) Ownership. All Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Unless otherwise provided in this Lease or agreed to by Lessor, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, shall remain the property of Lessee and not be surrendered by Lessee with the Premises. (b) Removal. Lessee shall remove all Lessee Owned Alterations or Utility Installations by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without Lessor's consent under circumstances that required Lessor's consent. (c) Surrender/Restoration. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear, and wear and tear caused by Lessor's own negligent or intentional acts or omissions, excepted. "Ordinary wear and tear" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee Owned Alterations and Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee, and the removal, replacement, or remediation of any soil, material or groundwater contaminated by Lessee. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. The failure by Lessee to timely vacate the Premises -12- pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below. 8. Insurance; Indemnity. 8.1 Payment For Insurance. Lessee shall pay for all insurance required under Paragraph 8 except to the extent of the cost attributable to liability insurance carried by Lessor under Paragraph 8.2(b) in excess of $5,000,000 per occurrence. Premiums for policy periods commencing prior to or extending beyond the Lease term shall be prorated to correspond to the Lease term. Payment shall be made by Lessee to Lessor within ten (10) days following receipt of an invoice. 8.2 Liability Insurance. (a) Carried by Lessee. Lessee shall obtain and keep in force a Commercial General Liability Policy of Insurance protecting Lessee and Lessor against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $5,000,000 per occurrence with an "Additional Insured-Managers or Lessors of Premises Endorsement" and contain the "Amendment of the Pollution Exclusion Endorsement" for damage caused by heat, smoke or fumes from a hostile fire. The Policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. (b) Carried by Lessor. Lessor may at its own expense maintain liability insurance as described in Paragraph 8.2(a), which insurance would be in addition to, and not in lieu of, the insurance required to be maintained by Lessee. If Lessor maintains such insurance, Lessee shall not be named as an additional insured thereunder. 8.3 Property Insurance - Building, Improvements And Rental Value. (a) Building and Improvements. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor, with loss payable to Lessor, any ground lessor, and to any Lender(s) insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full replacement cost of the Premises, as the same shall exist from time to time, or the amount required by any Lenders, but in no event more than the commercially reasonable and available insurable value thereof. If Lessor is the Insuring Party, however, Lessee Owned Alterations and Utility Installations, Trade Fixtures, and Lessee's personal property shall be insured by Lessee under Paragraph 8.4 rather than by Lessor. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage (including the perils of flood and earthquake), including coverage for debris -13- removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence, and Lessee shall be liable for such deductible amount in the event of an Insured Loss. (b) Rental Value. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one (1) year. Said insurance shall provide that in the event the Lease is terminated by reason of an insured loss, the period of indemnity for such coverage shall be extended beyond the date of the completion of repairs or replacement of the Premises, to provide for one full year's loss of Rent from the date of any such loss. Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next twelve (12) month period. Lessee shall be liable for any deductible amount in the event of such loss. (c) Adjacent Premises. [Intentionally Deleted.] 8.4 Lessee's Property/Business Interruption Insurance. (a) Property Damage. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force. (b) Business Interruption. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils. (c) No Representation of Adequate Coverage. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee's property, business operations or obligations under this Lease. 8.5 Insurance Policies. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least A-, VII, as set forth in the most current issue of "Best's Insurance Guide", or such other rating as may be required by a Lender. Neither party shall do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified -14- copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No policy required under this Lease shall be cancelable or subject to modification except after thirty (30) days prior written notice to each party. Both parties shall, at least thirty (30) days prior to the expiration of such policies, furnish the other with evidence of renewals or "insurance binders" evidencing renewal thereof, or the other party may order such insurance and charge the cost thereof to the first party, which amount shall be payable by the other upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same. 8.6 Waiver of Subrogation. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be. Such waiver of all claims and rights of subrogation shall remain in full force and effect irrespective of whether a party fails to carry insurance it is required to carry pursuant to this Lease. 8.7 Indemnity. Except for Lessor's negligence or intentional acts or omissions, Lessee shall indemnify, protect, defend and hold harmless the Premises, Lessor and its agents, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified. 8.8 Exemption of Lessor from Liability. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building of which the Premises are a part, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant or Lessor. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 9. Damage or Destruction. -15- 9.1 (a) Definitions. (i) "Premises Partial Damage" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which can reasonably be repaired in six (6) months or less from the date of the damage or destruction. (ii) "Premises Total Destruction" shall mean damage or destruction to the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in six (6) months or less from the date of the damage or destruction. (iii) "Insured Loss" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved. (iv) "Replacement Cost" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation. (v) "Hazardous Substance Condition" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 6.2(a), in, on, or under the Premises. (b) Notice. Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not Lessor has determined whether the damage is Partial or Total. 9.2 Partial Damage - Insured Loss. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, at Lessor's expense, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that if such damage or destruction is non-structural in nature and the total cost to repair is equal to or less than the monthly Base Rent then in effect, then at Lessor's election, Lessee shall make the repair of such damage or destruction, provided that Lessor makes any applicable insurance proceeds available to Lessee on a prompt basis for that purpose. Lessor covenants to promptly file a claim with its insurer in order to satisfy its obligations under this Section. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, Lessor shall promptly contribute the shortage in proceeds (except as to the deductible which is Lessee's responsibility) as and when required to complete said repairs. -16- 9.3 Partial Damage - Uninsured Loss. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by Lessee's willful misconduct, in which event Lessee shall promptly make the repairs at Lessee's expense, Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) terminate this Lease by giving written notice to Lessee within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such damage. Such termination shall be effective sixty (60) days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within ten (10) business days after receipt of the termination notice to give written notice to Lessor of Lessee's commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within thirty (30) days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available and diligently pursue such repairs to completion. If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice. 9.4 Total Destruction. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, Lessor has the right to (i) terminate this Lease on sixty (60) days written notice to Tenant; or (ii) reconstruct the Premises (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that if such destruction was caused by the gross negligence or willful misconduct of Lessee, then Lessor may elect either to terminate this Lease as above provided, or to require Lessee to reconstruct the Premises. 9.5 Damage Near End of Term. If, at any time during the last six (6) months of the Original Term or any extensions thereof, there is damage for which the cost to repair exceeds six (6) month's Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective sixty (60) days following the date of occurrence of such damage by giving a written termination notice to Lessee within thirty (30) days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, exercising such option (a) in writing, and (b) providing Lessor any shortage in insurance proceeds (or reasonably adequate assurance thereof) needed to make the repairs, such exercise to be on or before the earlier of (i) the date which is ten days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with a commitment to deliver funds (or reasonably adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor's commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished. 9.6 Abatement of Rent; Lessee's Remedies. -17- (a) Abatement. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage shall be abated as of the date of the casualty in proportion to the degree to which Lessee's use of the Premises is impaired, but in no event shall the amount of rent abated be less than the proceeds received by Lessor from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein. (b) Remedies. If Lessor shall be obligated to repair or restore the Premises and does not commence such repair, within thirty (30) days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than sixty (60) days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within thirty (30) days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within said thirty (30) days, this Lease shall continue in full force and effect. "Commence" shall mean either (i) the unconditional authorization of (x) the preparation of the required plans, and (y) the preparation of the application for all requisite building and other permits, or (ii) the beginning of the actual work on the Premises, whichever first occurs. 9.7 Termination-Advance Payments. Upon termination of this Lease pursuant to Paragraph 6.2(g) or Paragraph 9, a full refund of all unearned advance Base Rent and any other advance payments made by Lessee to Lessor within thirty (30) days. Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor, provided such use is proper. 9.8 Waive Statutes. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. 10. Real Property Taxes. 10.1 Definition of "Real Property Taxes:' As used herein, the term "Real Property Taxes" shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license fee imposed upon or levied against any legal or equitable interest of Lessor in the Premises that are obligations incurred during the Term of this Lease, regardless of the date the bill is received, Lessor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Building address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Premises are located. For the purposes of calculating Lessee's liability hereunder, in all cases, any such assessment, bond, charge, fee, levy, or tax shall be amortized -18- over its full life, period, or term. The term "Real Property Taxes" shall also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Premises, but do not include transfer taxes and similar charges imposed on the transfer itself. 10.2 (a) Payment of Taxes. Lessee shall pay the Real Property Taxes applicable to the Premises during the term of this Lease. Subject to Paragraph 10.2(b), and provided that Lessor has provided the property tax statement to Lessee at least thirty (30) days prior to the delinquency date, each payment shall be made at least ten (10) days prior to the delinquency date. Lessee shall promptly furnish Lessor with satisfactory evidence that such taxes have been paid. If any such taxes shall cover any period of time prior to or after the expiration or termination of this Lease, Lessee's share of such taxes shall be prorated to cover only that portion of the tax bill applicable to the period from the Commencement Date through the expiration or earlier termination of this Lease, and Lessor shall reimburse Lessee for any overpayment. If Lessee shall fail to pay any required Real Property Taxes, Lessor shall have the right to pay the same, and Lessee shall reimburse Lessor therefor upon demand. (b) Advance Payment. If Lessee fails to timely pay Rent and incurs a late charge for such failure pursuant to Section 13.4, and this occurs more than once in any calendar year, Lessor may thereafter during the term of this Lease, at Lessor's option, estimate the current Real Property Taxes, and require that such taxes be paid in advance to Lessor by Lessee monthly with the payment of the Base Rent. If Lessor elects to require payment monthly in advance, the monthly payment shall be an amount equal to the amount of the estimated installment of taxes divided by the number of months remaining before the month in which said installment becomes delinquent. When the actual amount of the applicable tax bill is known, the amount of such equal monthly advance payments shall be adjusted as required to provide the funds needed to pay the applicable taxes. If the amount collected by Lessor is insufficient to pay such Real Property Taxes when due, Lessee shall pay Lessor, upon demand, such additional sums as are necessary to pay such obligations. All moneys paid to Lessor under this Paragraph may be intermingled with other moneys of Lessor and shall not bear interest. In the event of a Breach by Lessee in the performance of its obligations under this Lease, then any balance of funds paid to Lessor under the provisions of this Paragraph may at the option of Lessor, be treated as an additional Security Deposit. 10.3 Joint Assessment. If the Premises are not separately assessed, Lessee's liability shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be conclusively determined by Lessor from the respective valuations assigned in the assessors work sheets or such other information as may be reasonably available. 10.4 Personal Property Taxes. Lessee shall pay, prior to delinquency, all taxes assessed against and levied upon Lessee Owned Alterations, Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee. When possible, with Lessor's -19- cooperation, Lessee shall cause such property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said personal property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee's property concurrent with Lessee's payment of Real Property Taxes. 10.5 Protest of Increase. If in any year the Real Property Taxes are increased during the term of this Lease by more than the approximately two percent (2%) per annum increase that is normal under California law, Lessor shall either (i) file a notice as permitted by applicable law protesting such increase and thereafter pursue such protest in a commercially reasonable manner to completion; or (ii) notify Lessee, at least thirty (30) days prior to the deadline for filing any such notice of protest, that Lessor does not intend to file such notice of protest, in which case Lessee shall have the right to protest such increase in Lessor's name. If Lessee chooses to protest any such increase, Lessor shall fully cooperate with Lessee's efforts provided Lessee pays all costs and expenses necessary to conduct such protest. In the event Lessor protests such increase and a reduction in the taxes for the Property results, Lessee shall promptly reimburse to Lessor all costs and expenses incurred by Lessor with respect to such protest. Lessee shall be entitled to the benefit of such reduction, either as a credit against the next payments of Rent and Additional Rent due under this Lease or as a refund if this Lease has expired. If Lessee protests any such increase and the taxes for the Property are reduced as a result of such protest, Lessor and Lessee shall each be entitled to the benefit of such reduction. 11. Utilities. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. 12. Assignment and Subletting. 12.1 Lessor's Consent Required. (a) Lessee shall not voluntarily or by operation of law, assign, transfer, mortgage or encumber (collectively, "assign or assignment") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior written consent, except that Lessee shall have the right to assign this Lease in its entirety or to sublease all or any portion of the Premises without the consent of Lessor to (a) any entity resulting from a merger or consolidation with Lessee, (b) any parent, subsidiary or affiliate of Lessee, (c) a successor corporation related to a non-bankruptcy reorganization or government action, or (d) an entity that acquires all or substantially all of Lessee's assets in California that relate to distribution of grocery products. Nor shall the provisions of this Section 12 apply to any sale of common stock of Lessee through an Initial Public Offering or subsequent offering and trading. (b) Subject to the exceptions described in (a) above, a change in the control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of fifty percent (50%) or more of the voting control of Lessee shall constitute a change in control for this purpose. (c) Subject to the exceptions described in (a) above, the involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, -20- acquisition, financing, transfer, leveraged buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which results or will result in a reduction of the Net Worth of Lessee by an amount greater than fifty percent (50%) of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is greater, shall be considered an assignment of this Lease to which Lessor may withhold its consent. "Net Worth of Lessee" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles. (d) In the event of an assignment or subletting without consent (unless such consent is not required pursuant to the exceptions described in (a) above), Lessor may elect to treat such assignment or subletting as a (a) Default curable after notice per Paragraph 13.1(c); or (b) as a noncurable Breach, in which case Lessor may either: (i) terminate this Lease, or (ii) upon thirty (30) days written notice, increase the monthly Base Rent to one hundred ten percent (110%) of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises held by Lessee shall be subject to similar adjustment to one hundred ten percent (110%) of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the Lease term shall be increased to One Hundred Ten Percent (110%) of the scheduled adjusted rent. (e) Lessee's remedy for any Default of Paragraph 12.1 by Lessor shall be limited to compensatory damages and/or injunctive relief. 12.2 Terms and Conditions Applicable to Assignment and Subletting. (a) Regardless of whether Lessor's consent is required, but subject to any specific agreement by Lessor, any assignment or subletting shall not: (i) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (ii) release Lessee of any obligations hereunder, or (iii) alter the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Breach. (c) Lessor's consent to any assignment or subletting shall not constitute a consent to any subsequent assignment or subletting. (d) In the event of any Breach by Lessee, Lessor may proceed directly against Lessee, or anyone else responsible for the performance of Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefore to Lessor, or any security held by Lessor. -21- (e) Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any, together with a fee of $1,000 as consideration for Lessor's considering and processing said request. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested. (f) Any assignee of, or sublessee under, this Lease shall, by reason of accepting such assignment or entering into such sublease, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented to in writing. 12.3 Additional Terms and Conditions Applicable to Subletting. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein: (a) Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease; provided, however, that until a Breach shall occur in the performance of Lessee's obligations, Lessee may collect said Rent. Lessor shall not, by reason of the foregoing or any assignment of such sublease, nor by reason of the collection of Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such notice from Lessor and shall pay all Rents to Lessor without any obligation or right to inquire as to whether such Breach exists, notwithstanding any claim from Lessee to the contrary. (b) In the event of a Breach by Lessee, Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor under such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor or for any prior Defaults or Breaches of such sublessor. (c) Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent. -22- (e) Lessor shall deliver a copy of any notice of Default by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The sublessee shall have a right of reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee. 13. Default; Breach; Remedies. 13.1 Default; Breach. "Default" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or rules under this Lease. A "Breach" is defined as the occurrence of one or more of the following Defaults, and the failure of Lessee to cure such Default within any applicable grace period: (a) The abandonment of the Premises; or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 8.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of ten (10) days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) an Estoppel Certificate, (v) a requested subordination, (vi) any document requested under Paragraph 42 (easements), or (vii) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of fifteen (15) days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, other than those described in subparagraphs 13.1 (a), (b) or (c), above, where such Default continues for a period of thirty (30) days after written notice; provided, however, that if the nature of Lessee's Default is such that more than thirty (30) days are reasonably required for its cure, then it shall not be deemed to be a uncured Breach if Lessee commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events: (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) becoming a "debtor" as defined in 11 U.S.C. (S) 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within thirty (30) days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged -23- within thirty (30) days; provided, however, in the event that any provision of this subparagraph (e) is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity of the remaining provisions. (f) The discovery that any financial statement of Lessee given to Lessor was materially false and Tenant knew it to be false at the time it was given to Lessor. (g) Intentionally Deleted. 13.2 Remedies. If Lessee fails to perform any of its affirmative duties or obligations, within the applicable grace period, if any (or in case of an emergency, without notice from Lessor), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee upon receipt of invoice therefor. If any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn, Lessor, at its option, may require all future payments to be made by Lessee to be by cashier's check. In the event of a Breach, Lessor may, on written notice, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach: (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Lessee shall immediately surrender possession to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the unpaid Rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of any leasing commission paid by Lessor in connection with this Lease applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent (1%). Commercially reasonable efforts by Lessor to mitigate damages caused by Lessee's Breach of this Lease shall not waive Lessor's right to recover damages under Paragraph 12. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding any unpaid Rent and damages as are recoverable therein, or Lessor may reserve the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 13.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful detainer statute shall also constitute the notice required by Paragraph 13.1. In such case, the applicable grace period required by Paragraph 13.1 -24- and the unlawful detainer statute shall run concurrently, and the failure of Lessee to cure the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. 13.3 Inducement Recapture. Intentionally Deleted. 13.4 Late Charges. Lessee hereby acknowledges that late payment by Lessee of Rent will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor by any Lender. Accordingly, if any Rent shall not be received by Lessor within seven (7) days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a one-time late charge equal to five percent (5%) of each such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of such late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance. 13.5 Interest. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within thirty (30) days following the date on which it was due for non- scheduled payment, shall bear interest from the date when due, as to scheduled payments, or the thirty-first (31st) day after it was due as to non-scheduled payments. The interest ("Interest") charged shall be equal to the prime rate reported in the Wall Street Journal as published closest prior to the date when due plus two percent (2%), but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 13.4. 13.6 Breach by Lessor. (a) Notice of Breach. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by -25- Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than thirty (30) days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such thirty (30) day period and thereafter diligently pursued to completion. (b) Performance by Lessee on Behalf of Lessor. In the event that neither Lessor nor Lender cures said breach within thirty (30) days after receipt of said notice, or if having commenced said cure they do not diligently pursue it to completion, then Lessee may elect to cure said breach at Lessee's expense and offset from Rent until Lessee's reasonable costs of repairs are covered. If Lessee's reasonable costs of repair exceed the remaining financial obligations of Lessee under this Lease, Lessor shall reimburse any remaining balances to Lessee upon the expiration or early termination of this Lease. Prior to seeking such offset or reimbursement, Lessee shall document the cost of said cure and supply said documentation to Lessor. 13.7 Mitigation. Notwithstanding any other provision of this Lease, provided that Lessee reasonably cooperates with Lessor, Lessor shall take commercially reasonable steps to mitigate its damages. 14. Condemnation. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (collectively "Condemnation"), this Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If, in the event of a Condemnation, it is determined, as provided below, that Lessee cannot operate its business in and on the Premises as a result of the Condemnation, Lessee may, as provided below, terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not so terminate this Lease, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and all compensation which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation. 14.1 Inability to Conduct Business. If as a result of a partial Condemnation, it would not be commercially feasible for Lessee to continue to conduct its business in the Premises after a restoration were completed, then Lessee shall have the right to terminate this Lease by giving -26- notice of termination to Lessor, which notice must be given within thirty (30) days after the determination is made, as provided below, that it would no longer be commercially feasible for Lessee to continue the conduct its business in the Leased Premises. In the event of such termination, Lessee shall not be obligated for Restoration of the Leased Premises. (a) If Lessee determines in its reasonable business judgment exercised in good faith that after a taking or proposed taking it would not be commercially feasible to continue to conduct its business in the Premises, Lessee shall so notify Lessor within thirty (30) days of Lessee's receipt of notice of such taking or proposed taking. Lessor shall thereupon determine within thirty (30) days of its receipt of such notice, whether in its reasonable business judgment exercised in good faith, it agrees with Lessee. If Lessor and Lessee do not agree, then the matter shall be submitted for determination by an independent third party, as provided below. (b) The independent third party to decide any dispute as to whether it would be commercially feasible for Lessee to continue to conduct its business in the Premises after a restoration were completed shall be a person presently employed in an executive capacity in the retail warehouse/distribution industry, with at least 10 years recent experience in such industry, provided however such person shall not be employed by or have any direct or indirect interest in any competitor of Lessee (such person, "Qualified Mediator"). If Lessor and Lessee are unable to agree on one Qualified Mediator within fifteen (15) days after the end of said thirty (30) day period, then each shall within ten (10) days thereafter select a Qualified Mediator and the two selected Qualified Mediators shall promptly meet to appoint a third Qualified Mediator who alone shall determine the matter; provided however that if only one party selects a Qualified Mediator within such ten (10) day period, then such Qualified Mediator shall be deemed agreed upon by the parties. The single Qualified Mediator selected as provided above shall promptly determine the matter and immediately report such determination concurrently to Lessor and Lessee. (c) If pursuant to the foregoing provisions it is determined that it is no longer commercially feasible for Lessee to continue the conduct of its business in the Leased Premises, then Lessee may notify Lessor within thirty (30) days of such determination that Lessee has elected to terminate this Lease. If timely notice of termination is given, such termination shall be effective upon the Condemnation, if the notice is timely given prior thereto, or if the notice of termination is timely given, but is given after the Taking, then such termination shall be effective sixty (60) days after such notice is given. 15. Brokers' Fee. 15.1 Additional Commission. [Intentionally Deleted] 15.2 Assumption of Obligations. [Intentionally Deleted] 15.3 Representations and Indemnities of Broker Relationships. Lessee and Lessor each represent and warrant to the other that it has had no dealings with any person, firm, broker or finder (other than the Brokers, if any) in connection with this Lease, and that no one other than -27- said named Brokers is entitled to any commission or finder's fee in connection herewith. Lessee and Lessor do each hereby agree to indemnify, protect, defend and hold the other harmless from and against liability for compensation or charges which may be claimed by any such unnamed broker, finder or other similar party by reason of any dealings or actions of the indemnifying Party, including any costs, expenses, attorneys' fees reasonably incurred with respect thereto. 16. Estoppel Certificates. (a) Each Party (as "Responding Party") shall within ten (10) days after written notice from the other Party (the "Requesting Party") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "Estoppel Certificate" form published by the American Industrial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party. (b) If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such ten day period, the Responding Party is deemed to have agreed that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) if Lessor is the Requesting Party, not more than one month's rent has been paid in advance. Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate, unless the facts are patently or intentionally inaccurate. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee shall deliver to any potential lender or purchaser designated by Lessor the most recently prepared set of those financial statements that are customarily prepared by a public company; and Lessee shall not be required to provide financial statements or other financial information that is different in nature than the financial information provided by Lessee to Lessor to induce Lessor to enter into this Lease. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. 17. Definition of Lessor. The term "Lessor" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or this Lease, Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Except as provided in Paragraph 15, upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, provided the transferee assumes all of the liabilities of the Lessor that arise after the date of the transfer of the Lease, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as herein above defined. Notwithstanding the above, and subject to the provisions of Paragraph 20 below, the original Lessor under this Lease, and all subsequent holders of the Lessor's interest in this Lease shall remain liable and responsible with regard to the potential duties and liabilities of -28- Lessor pertaining to Hazardous Substances as outlined in Paragraph 6 above, to the extent that such duties and liabilities were incurred by the original Lessor and each subsequent Lessor, respectively, during each such Lessor's period of ownership of the Premises. 18. Severability. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof. 19. Days. Unless otherwise specifically indicated to the contrary, the word "days" as used in this Lease shall mean and refer to calendar days. 20. Limitation on Liability. Subject to the provisions of Paragraph 17 above, the obligations of Lessor under this Lease shall not constitute personal obligations of Lessor, the individual partners of Lessor or its or their individual partners, directors, officers or shareholders, and Lessee shall look to the Premises, as well as the income from the Premises, the proceeds from any Condemnation award, the proceeds from any insurance policy and the proceeds from the Security Deposit and the Letter of Credit, and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against the individual partners of Lessor, or its or their individual partners, directors, officers or shareholders, or any of their personal assets for such satisfaction. 21. Time of Essence. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 22. No Prior or Other Agreements; Broker Disclaimer. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon, its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the nature, quality and character of the Premises. Brokers have no responsibility with respect thereto or with respect to any default or breach hereof by either Party. The liability (including court costs and Attorneys' fees), of any Broker with respect to negotiation, execution, delivery or performance by either Lessor or Lessee under this Lease or any amendment or modification hereto shall be limited to an amount up to the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker. 23. Notices. 23.1 Notice Requirements. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given if served in a manner specified in this Paragraph 23. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice. A copy of all notices to Lessor or Lessee shall be -29- concurrently transmitted to such party or parties (but no more than two others for each of Lessor and Lessee) at such addresses as Lessor or Lessee may from time to time hereafter designate in writing. 23.2 Date of Notice. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given forty-eight (48) hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given twenty-four (24) hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed delivered upon confirmation of receipt, provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday or after 5:00 p.m. on a business day, it shall be deemed received on the next business day. 24. Waivers. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach by Lessee. Any payment by Lessee may be accepted by Lessor on account of moneys or damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment. 25. Recording. Either Lessor or Lessee shall, upon request of the other, execute, acknowledge and deliver to the other a short form memorandum of this Lease for recording purposes. The Party requesting recordation shall be responsible for payment of any fees applicable thereto. 26. No Right To Holdover. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to one hundred twenty-five percent (125%) of the Base Rent applicable during the month immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee. 27. Cumulative Remedies. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. 28. Covenants and Conditions; Construction of Agreement. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. In construing this Lease, all headings and titles are for the convenience of the parties only and shall not be considered a part of this Lease. Whenever required by the context, the -30- singular shall include the plural and vice versa. This Lease shall not be construed as if prepared by one of the parties, but rather according to its fair meaning as a whole, as if both parties had prepared it. 29. Binding Effect; Choice of Law. This Lease shall be binding upon the parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 30. Subordination; Attornment; Non-Disturbance. 30.1 Subordination. This Lease and any Option granted hereby shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "Security Device"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof. Lessee agrees that the holders of any such Security Devices (in this Lease together referred to as "Lender') shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof. 30.2 Attornment. Subject to the non-disturbance provisions of Paragraph 30.3, Lessee agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Security Device, and that in the event of such foreclosure, such new owner shall not: (i) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership; (ii) be subject to any offsets or defenses which Lessee might have against any prior lessor, or (iii) be bound by prepayment of more than one (1) month's rent. 30.3 Non-Disturbance. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "Non-Disturbance Agreement") from the Lender which Non-Disturbance Agreement provides that Lessee's possession of the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. Further, within sixty (60) days after the execution of this Lease, Lessor shall use its commercially reasonable efforts to obtain a Non- Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that Lessor is unable to provide the Non-Disturbance Agreement within said sixty (60) days, then Lessee may, at Lessee's option, directly contact Lessor's lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement. 30.4 Self-Executing. The agreements contained in this Paragraph 30 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, -31- Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non- Disturbance Agreement provided for herein. 30.5 Non-Termination. Nothing in this Section 30 grants any Lender or any party taking title to the Premises through any Lender, the right to terminate this Lease, it being agreed that any such rights of Lender or other party to terminate arise out of, and are exercised pursuant to and in accordance with, Section 13 hereof. 31. Attorneys' Fees. If any Party or Broker brings an action or proceeding involving the Premises to enforce the terms hereof or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action, or appeal thereon, shall be entitled to reasonable attorneys' fees and costs. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "Prevailing Party" shall include, without limitation, a Party or Broker who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgment, or the abandonment by the other Party or Broker of its claim or defense. The attorneys' fees award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred. In addition, Lessor shall be entitled to attorneys' fees, costs and expenses incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach, provided such Default or Breach actually occurs and is not merely alleged by Lessor. 32. Lessor's Access; Showing Premises; Repairs. Lessor and Lessor's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times upon at least 24 hours prior notice for the purpose of showing the same to prospective purchasers, lenders, or lessees (only during the last six months of the Original Term or any extension thereof), and making repairs to the Premises as Lessor may deem necessary. All such activities shall be without abatement of rent or liability to Lessee. Lessor may, with Lessee's consent, which shall not be unreasonably withheld, place on the Premises any ordinary "For Sale" signs. During the last six (6) months of the term or any extensions, Lessor may place on the Premises any ordinary "For Lease" signs. Lessee may at any time place on or about the Premises any ordinary "For Sublease" sign. 33. Auctions. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without Lessor's prior written consent. Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to permit an auction. 34. Signs. Except for ordinary "For Sublease" signs, Lessee shall not place any sign upon the Premises without Lessor's prior written consent, which shall not be unreasonably withheld. All signs must comply with all Applicable Requirements. 35. Termination; Merger. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation -32- hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing subtenancies, and in any such case, such tenancy is a direct relationship between Lessor and any such subtenant, and Lessee has no liability of any kind whatsoever for the performance of any obligations under any such relationship. Lessor's failure within ten (10) days following any such event to elect to the contrary by written notice to the holder of any such lesser interest, shall constitute Lessor's election to have such event constitute the termination of such interest. 36. Consents. Except as otherwise provided herein, wherever in this Lease the consent of a Party is required to an act by or for the other Party, such consent shall not be unreasonably withheld, conditioned or delayed. Consenting party's actual reasonable costs and expenses (including but not limited to architects', attorneys', engineers and other consultant fees) incurred in the consideration of, or response to, a request by the other party for any consent, including but not limited to consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by the other party upon receipt of an invoice and supporting documentation therefor. consenting party's consent to any act, assignment or subletting shall not constitute an acknowledgment that no default or breach by the other party of this Lease exists, nor shall such consent be deemed a waiver of any then existing default or breach, except as may be otherwise specifically stated in writing by the consenting party at the time of such consent. The failure to specify herein any particular condition to consenting party's consent shall not preclude the imposition by the consenting party at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within ten (10) business days following such request. 37. Guarantor. [not applicable/deleted] 38. Quiet Possession. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof. 39. Options. 39.1 Definition. "Option" shall mean the right to extend the term of or renew this Lease as set forth in Paragraph 53 below. 39.2 Options Personal To Original Lessee. Each Option granted to Lessee in this Lease is personal to the original Lessee, and cannot be assigned or exercised by anyone other than said original Lessee and only while the original Lessee is in full possession of the Premises and, if requested by Lessor, with Lessee certifying that Lessee has no intention of thereafter assigning or subletting. For purposes hereof, the original Lessee shall be deemed to include a -33- successor lessee to whom Lessee's interest in the Lease is assigned in a transaction that does not require the consent of Lessor pursuant to the provisions of this Lease. 39.3 Multiple Options. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised. 39.4 Effect of Default on Options. (a) Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given three (3) or more notices of separate material Default, whether or not the material Defaults are cured, during the twelve (12) month period immediately preceding the exercise of the Option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 39.4(a). (c) At the election of Lessor, an Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term, (i) Lessee fails to pay Rent for a period of thirty (30) days after such Rent becomes due (without any necessity of Lessor to give notice thereof), (ii) Lessor gives to Lessee two (2) or more notices of separate and material Default during any six (6) month period, whether or not the material Defaults are cured, or (iii) if Lessee commits a Breach of this Lease. (d) The provisions of this Section 39.4 only apply where a Default or Breach has actually occurred, and is not merely alleged by Lessor. 40. Multiple Buildings. Intentionally deleted. 41. Security Measures. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties. 42. Reservations. Lessor reserves to itself the right, from time to time, to grant, without the consent or joinder of Lessee, such easements, rights and dedications that Lessor deems necessary, and to cause the recordation of parcel maps and restrictions, so long as such easements, rights, dedications, maps and restrictions do not materially interfere (which for purposes hereof the term "do not materially interfere" shall mean the interference is minor and not significant) with the use of the Premises by Lessee. Lessee agrees to sign any documents -34- reasonably requested by Lessor to effectuate any such easement rights, dedication, map or restrictions. 43. Performance Under Protest. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest" and such payment shall not be regarded as a voluntary payment and there shall survive the right on the part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. The party holding the funds shall return funds to the other party within thirty (30) days after the ruling that such funds were not owed by that other party. 44. Authority. If either Party hereto is a corporation, trust, limited liability company, partnership, or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each party shall, within thirty (30) days after request, deliver to the other party satisfactory evidence of such authority. 45. Conflict. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions, provided such typewritten or handwritten provisions are initialed by both parties hereto. 46. Offer. Preparation of this Lease by either Party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 47. Amendments. This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification, As long as they do not adversely change Lessee's obligations hereunder, Lessee agrees to make such reasonable non-monetary modifications to this Lease as may be reasonably required by a Lender in connection with the obtaining of normal financing or refinancing of the Premises. 48. Multiple Parties. If more than one person or entity is named herein as either Lessor or Lessee, such multiple Parties shall have joint and several responsibility to comply with the terms of this Lease. 49. Mediation and Arbitration of Disputes. (a) In any case of dispute relating to or arising out of this Agreement, including but not limited to Section 14. above, (in all cases, "Dispute"), the parties shall attempt, in good faith, to mediate such disagreement. Within fifteen (15) days of the request of any party, the parties shall employ the services of a third person, mutually acceptable to the parties, who shall conduct such mediation at a location in the Concord, California area within fifteen (15) days of his or her appointment. The parties shall act reasonably in the selection of the mediator, -35- shall participate in good faith in such mediation and use their best efforts to reach agreement on the matters in dispute. However, if upon completion of such mediation, the parties remain unable to agree, then the parties shall proceed to arbitration as provided in (b) hereafter. (b) Any Dispute shall be settled by binding arbitration conducted in accordance with the Commercial Arbitration Rules of the American Arbitration Association, as then in effect, except as hereinafter provided. (1) Unless the parties agree otherwise, any such arbitration shall be held at a place within the Concord area before one (1) arbitrator who shall be selected by mutual agreement of the parties; if agreement is not reached on the selection of the arbitrator within (15) days after receipt of a demand for arbitration by the other party (the "Initial Selection Period"), then each party shall have fifteen (15) days from the expiration of the Initial Selection Period to select an arbitrator. The arbitrators so selected shall select a neutral arbitrator which neutral arbitrator shall arbitrate the dispute. If either party fails to timely select an arbitrator, the arbitrator selected by the other party shall arbitrate the dispute. (2) The parties shall provide each other with production of all requested documents and records reasonably related to the dispute in a manner that will minimize the expense and inconvenience of both parties. Discovery will not include depositions or interrogatories except as the arbitrator expressly allows on a showing of need. (3) Cost and fees of the arbitrator who conducts the arbitration shall be borne by the non-prevailing party, unless the arbitrator determines otherwise. The award of the arbitrator, which may include equitable relief, shall be final and judgment may be entered upon it in accordance with applicable law in any court having jurisdiction thereof. Any demand for arbitration shall be in writing and must be made within a reasonable time after the Dispute has arisen. In no event shall the demand for arbitration be made after the date that institution of legal or equitable proceedings based upon such Dispute would be barred by applicable statutes of limitations. NOTICE: BY INITIALING IN THE SPACE BELOW YOU ARE AGREEING TO HAVE ANY DISPUTE ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION DECIDED BY NEUTRAL ARBITRATION AS PROVIDED BY CALIFORNIA LAW AND YOU ARE GIVING UP ANY RIGHTS YOU MIGHT POSSESS TO HAVE THE DISPUTE LITIGATED IN A COURT OR JURY TRIAL. BY INITIALING IN THE SPACE BELOW YOU ARE GIVING UP YOUR JUDICIAL RIGHTS TO DISCOVERY AND APPEAL, UNLESS SUCH RIGHTS ARE SPECIFICALLY INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION. IF YOU REFUSE TO SUBMIT TO ARBITRATION AFTER AGREEING TO THIS PROVISION, YOU MAY BE COMPELLED TO ARBITRATE UNDER THE AUTHORITY OF THE CALIFORNIA CODE OF CIVIL PROCEDURE. YOUR AGREEMENT TO THIS ARBITRATION PROVISION IS VOLUNTARY. WE HAVE READ AND UNDERSTAND THE FOREGOING AND AGREE TO SUBMIT DISPUTES ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION TO NEUTRAL ARBITRATION. -36- INITIALED BY LESSOR: INITIALED BY LESSEE: ------- -------- LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BY THE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES. 50. TENANT IMPROVEMENTS. The Lessor will provide a tenant improvement allowance ("TI Allowance") of Three Hundred Sixty Thousand and No/100 Dollars ($360,000.00) to be used for space planning, standard office and warehouse improvements only. The TI Allowance shall be paid by Lessor to Lessee within ten (10) days after the Rent Commencement Date, subject to Lessee providing Lessor with paid invoices that evidence qualifying expenditures in an amount at least equal to the TI Allowance. If less than the full amount is spent by Lessee, then such lesser amount will be reimbursed by Lessor. Any tenant improvements in excess of the TI Allowance shall be paid for by Lessee, although Lessee's Broker has agreed with Lessee that in addition to the TI Allowance to be provided by Lessor to Lessee, Lessee's Broker will pay over to Lessee upon receipt from Lessor, Lessee's Broker's commission, which in the aggregate will be $231,409 when it is fully earned. 51. SECURITY DEPOSIT: 51.1 Within ten (10) business days after execution of this Lease by the Parties, Lessee shall deposit with Lessor a cash Security Deposit, in the amount stated in Paragraph 1.7, for the faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any actual liability, expense, loss or damage which Lessor may suffer or incur by reason thereof. If Lessor properly applies all or any portion of said Security Deposit, Lessee shall within ten (10) business days after written request by Lessor thereof deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this Lease. Within thirty (30) days after the Premises have been vacated pursuant to Paragraph 7.4(c), Lessor shall return all of that portion of the Security Deposit not properly used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease. 51.2 As additional security for the faithful performance of Lessee's obligations under this Lease, Lessee shall, within ten (10) business days following the execution of this Lease by the Parties, deliver to Lessor, an unconditional, irrevocable, transferable letter of credit (the -37- "Letter of Credit"), naming Lessor as beneficiary, in the form of Exhibit C to the Lease, and issued by a financial institution ("Issuer"), reasonably satisfactory to Lessor. The amount available to be drawn, only when the cash Security Deposit stated in Paragraph 1.7 is insufficient, under the Letter of Credit shall be Eight Hundred Thousand Dollars ($800,000). So long as there is no uncured Default or Breach then existing under the Lease, the amount remaining available to be drawn under the Letter of Credit shall be as follows:
Months (counting from the Minimum Amount Available Rent Commencement Date) Under the Letter of Credit Percentage Decrease 01 - 12 $800,000 20% 13 - 24 $640,000 20% 25 - 36 $480,000 20% 37 - 48 $320,000 20% 49 - 60 $160,000 20% 61 - 72 $ 50,000 N/A 73 - 84 $ 50,000 N/A
The foregoing reductions in the face amount of the Letter of Credit shall be accomplished through the delivery of substitute Letters of Credit. Without limiting the generality of the foregoing, no Letter of Credit shall provide for any reduction in its face value other than those resulting from draws on such Letter of Credit. Lessee shall have exclusive right to pursue a reduction in the Letter of Credit at any time during the Lease Term in accordance with the above schedule provided that there is no uncured Default or Breach then existing under the Lease. 51.3 Lessor shall be entitled to draw any portion or all of the amount under the Letter of Credit, only when the cash Security Deposit stated in Paragraph 1.7 is insufficient, or if (i) Lessee fails to replenish the cash Security Deposit as required above, or (ii) a Breach occurs under the Lease, or (iii) Lessee does not deliver to Lessor a replacement letter of credit from Issuer or another financial institution satisfactory to Lessor in the amount and form of the initial Letter of Credit no later than thirty (30) days before the expiration date of the then outstanding Letter of Credit, or (iv) if upon a proposed sale or lease of the Building, Lessee does not deliver to any new landlord a replacement Letter of Credit pursuant to the provisions of Paragraph 51.5 below. The Letter of Credit shall provide for partial draws by Lessor in accordance with this paragraph. Any such draws when made shall be deemed applied to the amounts owing under this Lease (in such order as Lessor may elect). In the event of any draw under the Letter of Credit, only in an amount reasonably necessary to cure a Breach by Lessee that is not cured within any applicable cure periods. After any such draw, Lessee shall within ten (10) business days after demand thereof from Lessor, cause the amount remaining available to be drawn under the Letter of Credit to be increased by an amount equal to the amount drawn. Any improper draws by Lessor upon the Letter of Credit shall be deemed a Breach by Lessor, and Lessee shall be entitled to an offset, equal to the amount drawn, on the Base Rent, and all costs incurred by Lessee. Additionally, if the Letter of Credit was previously reduced as permitted under this Paragraph 51, Lessee shall not be responsible for increasing the Letter of Credit to the original amount and, if -38- consistent with the provisions of this Paragraph 51, the revised amount of the Letter of Credit shall continue to be decreased by the percentage in the schedule above. 51.4 Lessee shall not assign or encumber or attempt to assign or encumber the Letter of Credit and neither Lessor nor its successors or assigns shall be bound by any such assignment or encumbrance or attempted assignment or encumbrance. 51.5 In the event of a sale or other transfer of the Building, Lessee will, if requested by Lessor in writing, at Lessor's sole cost and expense within ten (10) business days after receiving such request, cause the issuing bank of the Letter of Credit to consent to the assignment or to issue a substitute letter of credit on identical terms to the Letter of Credit other than the stated beneficiary, from the same issuing bank naming such transferee as the beneficiary thereof, upon delivery by Lessor of the then outstanding Letter of Credit to Lessee. Lessee's obligations hereunder are contingent upon such delivery by Lessor. The provisions of this paragraph are contingent upon the acceptance of the transferee of all provisions of this Lease, pursuant to Section 12. 52. GENERAL IMPROVEMENTS: As per Work Letter attached as Exhibit B. 53. LESSEE'S EXTENSION OPTIONS. 53.1 Options. Subject to the provisions of Paragraph 39, Lessee shall have the following options to extend the term of this Lease (each an "Extension Option"). (1) an option (the "First Extension Option") to extend the term of this Lease, for the period from the expiration of the Original Term for a period of five (5) years (the "First Extension Period"), by delivering written notice to Lessor of exercise of Lessee's First Extension Option at least six (6) months prior to expiration of the Original Term, but not more than twelve (12) months prior to the expiration of the Original Term, and (2) if Lessee duly exercises the First Extension Option, an additional option (the "Second Extension Option") to further extend the term of this Lease, for an additional five (5) years after the expiration of the First Extension Period (the "Second Extension Period"), by delivering written notice to Lessor of exercise of Lessee's Second Extension Option at least six (6) months prior to the end of the First Extension Period, but not more than twelve (12) months prior to the end of the First Extension Period. Any Extension Option shall terminate if not exercised in the manner provided herein. Any such extension shall be upon all the terms and conditions set forth in this Lease, except as may be expressly modified and fully executed by both parties. 53.2 Fair Market Base Rental. The Base Rent for each Extension Period ("Fair Market Base Rental") shall be determined as set forth below. "Fair Market Base Rental" shall mean the Base Rent at the time or times in question for the applicable space, based on the prevailing rentals then being charged to new tenants in similar buildings in the Greater Concord area, of comparable size, location, quality and age as the Building, with comparable tenant improvements, and taking into account the method for payment of taxes and expenses or increases in taxes and expenses for the space in the building for which Fair Market Base Rental is being determined. Fair Market Base Rental shall also reflect the then prevailing rental -39- structure for comparable buildings in the general vicinity of the Premises, so that if, for example, at the time Fair Market Base Rental is being determined the prevailing rental structure for comparable space and for comparable lease terms includes periodic rental adjustments or escalations, Fair Market Base Rental shall reflect such rental structure. The value of cash and non-cash tenant concessions included in the transactions being used for comparison shall also be taken into account in determining prevailing rentals. 53.3 Determination of Fair Market Base Rental. Upon written notice of Lessee's exercise an Extension Option, Lessor shall within ten (10) days provide Lessee, with written notice of the amount which Lessor contends to be the Fair Market Base Rental. Within ten (10) days after receipt of Lessor's written notice of the Fair Market Base Rental, Lessee shall give Lessor written notice ("Lessee's Response"), either (a) accepting the statement of Fair Market Base Rental set forth in Lessor's notice, or (b) rejecting the Fair Market Base Rental set forth in Lessor's notice and specifying the amount Lessee contends to be the Fair Market Base Rental. If Lessee rejects the Fair Market Base Rental specified by Lessor, then Lessor and Lessee shall endeavor to negotiate a mutually acceptable resolution to their dispute concerning the Fair Market Base Rental. If they are unable to agree on the Fair Market Base Rental within fifteen (15) days after receipt by Lessee's Response, then such rental shall be determined as follows: Lessor and Lessee shall, within ten (10) days, each separately designate a licensed real estate broker who is reasonably active in the leasing of the office/warehouse space in the Greater Concord area to participate in determination of the Fair Market Base Rental. If either Lessor or Lessee fails timely to designate a broker as provided above, then the determination of Fair Market Base Rental shall be made solely by the broker timely designated by the other party and such determination shall be binding on Lessor and Lessee. Within thirty (30) days thereafter, the broker(s) shall each determine the Fair Market Base Rental. If two brokers have been selected as provided above and the brokers do not agree upon the actual Fair Market Base Rental, then if their determinations of Fair Market Base Rental are within ten percent (10%) of one another, then the two statements of Fair Market Base Rental shall be averaged and such amount shall be binding on Lessor and Lessee as the Fair Market Base Rental. If the higher determination exceeds the lower by more than ten percent (10%) of the lower, then the two brokers shall be instructed to appoint, within ten (10) days thereafter, a third broker or appraiser who has significant experience and is then active leasing or appraising office/warehouse space in the Greater Concord area. If the two brokers designated by Lessor and Lessee cannot agree on the appointment of a third broker or appraiser within the time period provided, either Lessor or Lessee may seek the appointment of a third broker or appraiser by the presiding judge for the Contra Costa County Superior Court. The third broker or appraiser shall then determine which of the two final contended Fair Market Base Rental amounts submitted by the parties is closet to the actual Fair Market Base Rental, and such determination shall be binding on Lessor and Lessee as the Fair Market Base Rental. 53.4 Costs and Expenses. All reasonable fees and expenses of the brokers shall be paid as follows: Lessor shall advance the fees and expenses of the broker designated by Lessor and Lessee shall advance the fees and expenses of the broker designed by Lessee. Lessor and Lessee shall each advance one half of any fees and expenses of the third broker or appraiser. The -40- attorneys' fees and expenses of counsel for the respective parties and of witnesses shall be paid and borne by the party engaging such counsel or calling such witness, as the case may be. 53.5 Payments Pending Determination. If the Fair Market Base Rental for any Extension Period has not been determined at such time as Lessee is obligated to pay Base Rent for such Extension Period, Lessee shall pay as Base Rent pending such determination 110% of the Base Rent in effect for such space immediately prior to the Extension Period; provided, that upon the determination of the applicable Fair Market Base Rental, any shortage of Base Rent paid shall be paid to Lessor by Lessee, and any excess of Base Rent shall be paid by Lessor to Lessee. 54. SIGNAGE: All signage must be approved by Lessor and comply with County of Contra Costa codes and regulations. Signage criteria shall be submitted in writing to Lessor prior to installation. Lessee shall be allowed to place signage on the building fronting Fomi Drive (south side) only. 55. ROOF INSTALLATIONS: Lessee, at its sole cost and expense, shall have the option to install (a) antennas and satellite dishes, (b) refrigeration equipment, and (c) heating ventilation and air conditioning equipment on the roof of the Premises subject to applicable codes, provided that the working drawings are submitted to Lessor for its prior review and approval. Exterior roof installations are subject to obtaining a conditional use permit issued by the County of Contra Costa. All associated costs shall be paid by Lessee. Lessor shall deliver standard industrial load roof as provided in the attached Work Letter. If structural enhancement is required as a result of roof installations, the Lessee shall pay such upgrades. Notwithstanding any provision in this Lease to the contrary, Lessee shall have the right to retain all such equipment at the end of the term or any extensions, provided that Lessee returns the roof structure to its original condition, normal wear and tear accepted. 56. [Not applicable/deleted] 57. PARKING: 57.1 Lessee shall have the right to use the entire Premises for parking. Lessor shall apply for land use and building permits using the parking plan shown on the attached site plan attached as Exhibit "D". Lessee, at its sole cost and expense, shall have the option to develop and submit for Contra Costa County approval an alternate parking plan, provided that such alternate parking plan is submitted to Lessor for its prior review and approval, which shall not be unreasonably withheld, conditioned or delayed. Lessor's failure to review and approve the plans within ten (10) days of its receipt of same shall be deemed an approval of such alternate parking plan. Whichever parking plan is approved, Lessee shall have the right to park delivery vehicles around the Premises and stage such vehicles in and around the Premises. -41- 57.2 While not a condition to this Lease, Lessee desires to obtain additional parking in the vicinity of the Premises. Lessor agrees to use best efforts to negotiate a lease for approximately 60,000 square feet of property (the "Lesher Parcel") adjacent to the north side of the Premises for Lessee's use for additional parking. If Lessor is successful in negotiating such a lease (the "Additional Parking Lease"), Lessor shall provide the final draft thereof to Lessee, and Lessee shall have five (5) business days to determine, in its sole and absolute discretion, if the terms and provisions of such lease are acceptable to Lessee. If Lessee notifies Lessor in writing that the Additional Parking Lease is acceptable to Lessee, Lessor shall enter into such lease and upon execution thereof, the Lesher Parcel shall become a part of the Premises hereunder and Lessee shall be deemed to have sublet the Lesher Parcel from Lessor on the terms and provisions of the Additional Parking Lease; provided however that if rent is payable under the Additional Parking Lease (it is possible that no rent will be payable and instead the sole consideration for the lease will be the construction of parking improvements on adjacent property of the landlord thereunder for the benefit of said landlord), the rent payable by Lessee to Lessor hereunder for the Lesher Parcel shall be 110% of such rent (excluding the costs of construction of parking improvements) payable under the Additional Parking Lease. Lessee agrees that Lessee shall be solely responsible for obtaining all necessary permits to construct, and for constructing, all at Lessee's sole cost and expense, the parking improvements to be constructed pursuant to the Additional Parking Lease. 58. OUTSIDE WORK AND STORAGE: At no time shall Lessee be permitted to conduct work activities (except for normal loading and unloading of vehicles) nor store goods or material of any kind outside of the confines of the Premises. IN WITNESS WHEREOF, Lessor and Lessee have executed this Lease as of the date and year first above written. LESSOR: LESSEE: GONSALVES & SANTUCCI, INC., HOMEGROCER.COM, INC., a California corporation a Delaware corporation By: /s/ Barry Silberman By: /s/ Kristin Stred -------------------------------- -------------------------------- Name Printed: Barry Silberman Name Printed: Kristin Stred ---------------------- ---------------------- Title: Vice President Title: Sr. Vice President and ----------------------------- ---------------------------- General Counsel ---------------------------- By: By: /s/ Mary Alice Taylor -------------------------------- -------------------------------- Name Printed: Name Printed: Mary Alice Taylor ---------------------- ---------------------- Title: Title: Chairman and Chief Executive ----------------------------- ---------------------------- Officer ---------------------------- -42- EX-10.43 4 FIRST AMENDMENT LEASE AGREEMENT LINCOLN-RECP EXHIBIT 10.43 TENANT COPY FIRST AMENDMENT TO LEASE AGREEMENT This First Amendment to Lease Agreement (the "Amendment") is made and entered into to be effective as of November 15, 1999, by and between LINCOLN-RECP FULLERTON OPCO, LLC, a Delaware limited liability company ("Landlord") and HomeGrocer.Com, Inc., a Delaware corporation ("Tenant") with reference to the following facts. RECITALS A. Landlord and Tenant have entered into that certain Lease Agreement dated July 8, 1999, (the "Lease"), for the leasing of certain premises containing approximately 98,600 rentable square feet of space located at 590 North Gilbert Street, Fullerton, CA 92834 (the "Premises") as such Premises are more fully described in the Lease. B. Landlord and Tenant wish to amend the size of the Premises arid change the Commencement Date, among other things. NOW, THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Landlord and Tenant hereby agree as follows: 1. Recitals: Landlord and Tenant agree that the above recitals arc true and correct. 2. Definitions: Unless otherwise defined in this Amendment, any capitalized term is hereby given the same meaning as set forth in the Lease. 3. Premises: The square footage shall be amended to be 99,334 rentable square feet. 4. The Commencement Date of the Lease shall be November 1, 1999. 5. The last day of the Term of the Lease (the "Expiration Date") shall be October 31, 2009. 6. Base Rent: The Basic Lease Information and Section 3 of the Lease are hereby modified to provide that the monthly Base Rent payable by Tenant to Landlord is accordance with the following schedule: November 1, 1999 to April 30, 2002 $42,713.62 per month; May 1, 2002 to October 31, 2004 $45,693.64 per month; November 1, 2004 to April 30, 2007 $49,667.00 per month; and May 1, 2007 to October 31, 2009 $53,640.16 per month. 7. Tenant's Share of Operating Expenses. Tax Expenses and Common Area Utilities: The Basic Lease Information and Section 6 and 7 of the Lease are hereby modified to provide that Tenant's Share of Operating Expenses, Tax Expenses and Common Area Utilities Is: 7.934% of the Park. 8. Tenant's Share of Utility Expenses: The Basic Lease Information and Section 7 of the Lease are hereby modified to provide that Tenant's Share of Utility Expenses is: 100% of the Building. 9. Effect of Amendment: Except as modified herein, the terms and conditions of the Lease shall remain unmodified and continue in fall force and effect. In the event of any conflict between the terms and conditions of the Lease and this Amendment, the terms and conditions of this Amendment shall prevail. 10. Authority: Subject to the provisions of the Lease, this Amendment shall be binding upon and inure to the benefit of the parties hereto, their respective heirs, legal representatives, successors and assigns. Each party hereto and the persons signing below warrant that the person signing below on such party's behalf is authorized to do so and to bind such party to the terms of this Amendment. 11. The terms and provisions of the Lease are hereby incorporated in this Amendment. 1 IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written. LANDLORD: LINCOLN-RECP FULLERTON OPCO, LLC, a Delaware limited liability company By: Legacy Partners Commercial, Inc. as Manager for LINCOLN-RECP FULLERTON OPCO, LLC By: /s/: illegible -------------------------------------- Name: ------------------------------------ Title: Senior Vice President of Operations ----------------------------------- Date: 11/6/99 ------------------------------------ TENANT: HOMEGROCER.COM, a Delaware corporation By: /s/: CJ Karaffa -------------------------------------- Name: CJ Karaffa ------------------------------------ Title: Vice President of Operations ----------------------------------- Date: 11/29/1999 ------------------------------------ By: /s/: Daryl L. Stromswold -------------------------------------- Name: Daryl L. Stromswold ------------------------------------ Title: Assistant Secretary ----------------------------------- Date: November 29, 1999 ------------------------------------ If Tenant is a CORPORATION, the authorized officers must sign on behalf of the corporation and indicate the capacity in which they are signing. The Lease must be executed by the president or vice-president and the secretary or assistant secretary, unless the bylaws or a resolution of the board of directors shall otherwise provide, in which event, the bylaws, a certified copy of the resolution, or a Secretary's certificate, as the case may be, must be attached to this Lease. 2 EX-23.1 5 CONSENT OF ERNST & YOUNG Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the reference to our firm under the captions "Selected Financial Data" and "Experts" and to the use of our report dated January 18, 2000, except for Note 9, as to which the date is February 15, 2000, in Amendment No. 6 to the Registration Statement (Form S-1 No. 333-93015) and related Prospectus of HomeGrocer.com, Inc. for the registration of shares of its common stock. Ernst & Young LLP Seattle, Washington March 9, 2000 -----END PRIVACY-ENHANCED MESSAGE-----