S-1 1 ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on September 28, 2009

Registration No. 333-            

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Newegg Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   5734   20-3225548
(State or other jurisdiction of
incorporation or organization)
 

(Primary Standard Industrial

Classification Code Number)

  (I.R.S. Employer
Identification No.)

16839 East Gale Avenue

City of Industry, CA 91745

(626) 271-9700

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Lee C. Cheng, Esq.

General Counsel and Secretary

16839 East Gale Avenue

City of Industry, California 91745

(626) 271-9700

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Julian T. H. Kleindorfer, Esq.

Latham & Watkins LLP

355 South Grand Avenue

Los Angeles, California 90071

(213) 485-1234

 

Alan F. Denenberg, Esq.

Davis Polk & Wardwell LLP

1600 El Camino Real

Menlo Park, California 94025

(650) 752-2000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

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.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨

   Accelerated filer  ¨    Non-accelerated filer  x    Smaller reporting company  ¨
   (Do not check if a smaller reporting company)   

CALCULATION OF REGISTRATION FEE

 

 
Title of Each Class of Securities to Be Registered   Proposed
Maximum
Aggregate Offering
Price (1)
  Amount of
Registration
Fee

Class A Common Stock, par value $0.001 per share

  $175,000,000   $9,765
 
 
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

 

 

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 which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities, and neither we nor the selling stockholders are soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED SEPTEMBER 27, 2009

Preliminary Prospectus

             shares

LOGO

Class A Common Stock

 

 

This is an initial public offering of shares of Class A Common Stock of Newegg Inc. Prior to this offering, there has been no public market for our Class A Common Stock. Newegg is selling              shares and the selling stockholders identified in this prospectus are selling an additional              shares of Class A Common Stock. The selling stockholders include our principal stockholder. We will not receive any proceeds from the sale of shares of Class A Common Stock by the selling stockholders. The estimated initial public offering price of the Class A Common Stock is expected to be between $              and $              per share.

We intend to apply for listing of our Class A Common Stock on the              under the symbol “    .”

Investing in our Class A Common Stock involves a high degree of risk. See “Risk Factors” beginning on page 9.

 

     Per share    Total

Initial public offering price

   $                 $             

Underwriting discounts and commissions

   $                 $             

Proceeds to Newegg, before expenses

   $                 $             

Proceeds to selling stockholders, before expenses

   $                 $             

To the extent the underwriters sell more than              shares of Class A Common Stock, we and certain selling stockholders have granted the underwriters an over-allotment option for a period of 30 days to purchase up to              additional shares of Class A Common Stock at the initial public offering price, less underwriting discounts and commissions.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed on the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of Class A Common Stock to purchasers on                     .

 

 

 

J.P. Morgan   BofA Merrill Lynch   Citi

 

 

 

William Blair & Company     Cowen and Company
ThinkEquity LLC   Needham & Company, LLC   Raymond James

                    , 2009


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[Inside Front Cover]

[To Come]

 


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   9

Forward-Looking Statements and Industry Data

   33

Use of Proceeds

   35

Dividend Policy

   36

Capitalization

   37

Dilution

   39

Selected Consolidated Financial Data

   41

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   43

Business

   65

Management

   81

Executive Compensation

   86

Principal and Selling Stockholders

   109

Related Party Transactions

   111

Description of Capital Stock

   113

Shares Eligible for Future Sale

   117

Material U.S. Federal Income Tax Considerations for Non-U.S. Holders of Common Stock

   119

Underwriting

   122

Legal Matters

   127

Experts

   127

Where You Can Find More Information

   127

Index to Consolidated Financial Statements

   F-1

 

 

You should rely only on the information contained in this prospectus. Neither we nor the selling stockholders have authorized anyone to provide you with information different from that contained in this prospectus. We and the selling stockholders are offering to sell, and seeking offers to buy, our Class A Common Stock only in 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 of any sale of our Class A Common Stock.

No action is being taken in any jurisdiction outside the United States to permit a public offering of our Class A Common Stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction.

As used in this prospectus, references to an active customer refer to a U.S. customer who has purchased from us anytime in the last twelve months and references to a registered user refer to a person who has created an account with us on our primary website, www.newegg.com.

 

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PROSPECTUS SUMMARY

The following summary highlights the information contained elsewhere in this prospectus. This summary is not complete and may not contain all the information you should consider before investing in our Class A Common Stock. You should read the entire prospectus carefully, including the “Risk Factors” beginning on page 9 and the consolidated financial statements and related notes beginning on page F-1 before making an investment decision. Unless the context requires otherwise, the words “Newegg,” “we,” the “Company,” “us,” and “our” refer to Newegg Inc. and its subsidiaries, and the words “our website” and the “Company’s website” refer to our primary website, www.newegg.com. Unless otherwise indicated, all information in this prospectus assumes that the underwriters will not exercise their over-allotment option and the initial public offering price of our Class A Common Stock, or the IPO Price, will be above $12.36 per share, which would extinguish the put right held by holders of our Series B-2 Preferred Stock described below under “—Preferred B-2 Put Right.”

Newegg Overview

We are a leading e-commerce company focused on selling information technology, or IT, products, including computer hardware, software and peripherals, and consumer electronics, or CE, products to consumers and increasingly to small and medium-sized businesses, predominantly through our U.S. website, www.newegg.com. According to the 2009 Internet Retailer’s Top 500 Guide, we are the second largest online-only retailer in the United States as measured by our 2008 net sales of $2.1 billion. Since launching our e-commerce platform in 2001, a majority of our net sales and net income have been generated by selling IT products in the United States. We are leveraging our platform, customer base and brand to expand from IT into CE product sales, and to grow our e-commerce business outside of the United States in China and Canada.

We believe our success is driven by consistently executing on three core competencies, which we call our “Three Pillars”: delivering a compelling online shopping experience, fulfilling customer orders in a reliable and timely manner and providing superior customer service.

We have built a strong brand and a loyal customer base consisting primarily of IT professionals, gamers, do-it-yourself technology enthusiasts, early technology adopters and CE enthusiasts. In 2008, we attracted 70.7% of the unique daily visitors to our U.S. website without incurring a referral, click-through or advertising fee, and generated 74.1% of our U.S. orders from customers who have previously purchased from us. We have also earned numerous awards for customer satisfaction from publications and organizations such as Computer Shopper, ForeSee Results and the National Retail Federation.

We have been profitable every year since launching our e-commerce platform in 2001 and have grown rapidly. We reached $982.1 million in net sales in 2004 and generated $2.1 billion in net sales in 2008, representing a compound annual growth rate of 21.1% over this period. In 2008, we generated operating income of $51.4 million. Recently, we have grown our business in China, focusing on IT products, CE products and household appliances, and we anticipate that our business in China will become an important driver of our future growth. In China, we generated net sales of $31.3 million in all of 2008 and $54.4 million in the first half of 2009.

Industry Overview

The Internet’s development into a significant global medium for communication, content and commerce has led to substantial growth in online shopping. According to the Forrester Research report, “U.S. eCommerce Forecast, 2008 to 2013,” published February 2, 2009, the U.S. e-commerce market was $141.3 billion in 2008 and is expected to grow to $229.1 billion in 2013, representing a 10.1% compound annual growth rate. In addition, Forrester predicts that online retail sales will grow from 5% of total retail sales in 2008 to 8% of total retail sales by 2013.

 

 

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We believe continued growth in the IT and CE product categories will be driven broadly by technological innovation, evolving consumer and enterprise preferences and economic factors. Hardware, software and technical standards evolve quickly to keep pace with the higher levels of functionality and product performance demanded by and available to customers. Consequently, interoperability with prior product generations diminishes quickly, resulting in rapid product obsolescence. Rapid obsolescence, as well as the modular nature of IT and CE products and systems, results in frequent product upgrade cycles and growth of IT and CE product sales.

The market for IT and CE products is characterized by high online penetration rates. According to the Forrester Research report, “The State of Retailing Online 2008,” published May 7, 2008, in the United States, 45% of IT sales and 18% of CE sales in 2007 were generated online. We believe that IT and CE products are well suited for online sales because these products often require a potential customer to research, evaluate and compare a large amount of technical information, product features and consumer reviews, tasks which can be much more comprehensively and efficiently accomplished online. In addition, buying patterns are generally transitioning online as broadband adoption increases, fulfillment capabilities of online retailers become more reliable and consumers and businesses face continuing pressure to save money.

Opportunities and Challenges of Online Retailing

Online retailers have a number of advantages over brick-and-mortar retailers, including lower costs associated with operating a website versus operating physical stores with adequate display space and room for inventory. An online platform allows retailers to:

 

   

carry a broader product selection;

 

   

reach a geographically broader set of customers;

 

   

respond more quickly to changing consumer preferences, product prices, competitive dynamics and market conditions;

 

   

be more flexible in marketing to a specific set of potential customers; and

 

   

provide a personalized shopping experience.

A successful online retailer must acquire, convert and retain customers while developing the processes, methods and infrastructure necessary to do so efficiently and cost-effectively. This requires specific competencies in creating a compelling online shopping experience, ensuring reliable and timely product fulfillment and providing superior customer service. Many online retailers and brick-and-mortar retailers with retail websites have not been able to acquire these critical capabilities.

The Newegg Solution

We believe our success in online retailing is founded on our expertise in three core competencies, which we call our “Three Pillars”:

 

   

Providing a compelling online shopping experience. Our website not only offers a broad selection of products at competitive prices, but also provides easy site navigation, detailed product information and a large set of product reviews and customer testimonials. These features and offerings provide our customers with a wide variety of product choices and address the customer’s desire to touch, feel and test products before purchasing. We also offer website visitors content and information that is not generally available from a visit to a traditional retail outlet, or many other websites. Our core customer base of IT and CE enthusiasts provides useful user-generated content on our U.S. website, which as of June 30, 2009, included over 1,600,000 product reviews and over 30,000 customer testimonials about the Newegg shopping experience. As of June 30, 2009, we carried over 33,000 different stock keeping units, or SKUs, of computer hardware, software and components, communication devices, CE and other products on our U.S. website.

 

 

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Fulfilling orders in a reliable and timely manner. We believe that reliable and timely fulfillment is critical to the customer shopping experience and encourages customer loyalty and repeat purchasing. To this end, we have invested in optimizing our product fulfillment capabilities to enable delivery of most U.S. orders within three business days of order shipment. In 2008, we shipped more than 97.6% of U.S. orders fulfilled directly by us within one business day of payment validation, and for more than 98.2% of the U.S. orders we received, we met or exceeded the promised delivery time to those customers, averaging approximately 2.4 business days from the date of shipment to receipt.

 

   

Providing superior customer service. We have built the Newegg brand on the principle of superior customer service. We train and empower our in-house customer service staff to resolve customer complaints as quickly as possible and to strive to make every customer a repeat customer. As a result, we have won a number of third-party awards and accolades. For example, Computer Shopper named Newegg the “Best Overall Place to Buy Online” in 2004, 2005, 2006, 2007 and 2008, and Internet retail rating site www.ResellerRatings.com has awarded us Platinum Plus status for customer excellence due to our overall customer satisfaction rating of 9.78 out of 10 as of August 14, 2009. Our success in pleasing our customers has also been validated in third-party surveys by Internet Retailer, ForeSee Results and Computer Shopper, which have each ranked Newegg as one of the best online retailers for customer satisfaction.

Our Strategy

Our objective is to become the leading online retailing platform, leveraging our strong market position in the IT and CE product categories. The key elements of our strategy are to:

 

   

retain, grow and expand our customer base;

 

   

expand our sales and establish a market-leading position in China;

 

   

continue to enhance and expand new and existing vendor relationships;

 

   

broaden product, category and service offerings;

 

   

leverage our low-cost Asian infrastructure; and

 

   

pursue selective acquisitions.

Corporate Information

We were formed as a California corporation in 2000 and launched our principal operations in 2001. We were reincorporated in Delaware in 2005. Our principal executive offices are located at 16839 East Gale Avenue, City of Industry, California 91745, and our telephone number is (626) 271-9700. Our corporate and primary e-commerce website is located at www.newegg.com. Information on our website is not part of this prospectus.

Newegg.com® is a registered trademark in the United States and other countries. Our other trademarks and service marks include: Newegg®, Newegg Mall®, Once You Know, You Newegg®, EggXpert®, Shell Shocker®, ABS®, Chief Value®, Fred’s Fresh Deals®, Monstra, Nutrend®, Ozzo, We Make .Com Easy, and design marks that incorporate some of these trademarks as well as other logos. Certain of these trademarks or variants of these trademarks and associated domain names have been registered in other countries and regions, including China and Canada. Unless otherwise indicated, all other trademarks and trade names appearing in this prospectus are the property of their respective owners.

Listing

We intend to apply for listing of our Class A Common Stock on the              under the symbol “    .” There is currently no market for our Class A Common Stock and we cannot assure you that any active or liquid market will develop.

 

 

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The Offering

Class A Common Stock offered:

 

By Newegg

             shares

 

By the selling stockholders

             shares

 

Total

             shares

 

Class A Common Stock to be outstanding after the offering

             shares entitled to one vote per share

 

Class B Common Stock to be outstanding after the offering

             shares entitled to ten votes per share

 

Total Common Stock to be outstanding after the offering

             shares

 

Use of proceeds

We estimate the net proceeds from this offering to us will be approximately $              million, or approximately $             million if the underwriters exercise their over-allotment option in full, based on an initial public offering price of $              per share after deducting estimated offering expenses payable by us and underwriting discounts and commissions. We intend to use these net proceeds for expansion of our business and operations, repayment of certain outstanding indebtedness and for general corporate purposes, including working capital and capital expenditures. We also intend to spend approximately $25.0 million over the next twelve months to expand and fund our operations in China and Canada. We will not receive any proceeds from the sale of shares by the selling stockholders. See “Use of Proceeds.”

 

Over-allotment option

We and certain selling stockholders have granted the underwriters a 30-day option to purchase up to              shares of Class A Common Stock to cover over-allotments, if any.

 

Risk factors

See “Risk Factors” and the other information included in this prospectus for a discussion of factors you should consider carefully before investing in shares of our Class A Common Stock.

Proposed                  symbol

The number of shares of Class A and Class B Common Stock that will be outstanding after this offering is based on the number of shares outstanding at June 30, 2009 and assumes the conversion of all of our outstanding Preferred Stock into Common Stock in connection with this offering, but excludes:

 

   

7,532,630 shares of our Class A Common Stock issuable upon the exercise of options outstanding as of the date of this prospectus at a weighted average exercise price of $5.88 per share; and

 

   

6,580,648 additional shares of our Class A Common Stock reserved for future grants or issuances under our stock option plans as of the date of this prospectus.

 

 

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In addition, unless otherwise indicated, all information in this prospectus assumes:

 

   

the initial public offering price of our Class A Common Stock is above $12.36 per share, which would extinguish a put right held by holders of our Series B-2 Preferred Stock described below under “—Preferred B-2 Put Right;”

 

   

the underwriters will not exercise their over-allotment option to purchase up to an additional              shares of our Class A Common Stock; and

 

   

that no outstanding options to purchase shares of our Class A Common Stock have been exercised.

 

 

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Summary Consolidated Financial Data

The following table summarizes our consolidated financial data for the periods presented and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. The summary consolidated financial data for the years ended December 31, 2004 and 2005 are derived from our consolidated financial statements and related notes not included herein. The financial data for the years ended December 31, 2004 and 2005 have been revised to reflect the adoption of Statement of Financial Accounting Standards No. 160, Noncontrolling Interests and Consolidated Financial Statements—An amendment to ARB No. 51. The summary consolidated financial data for the years ended December 31, 2006, 2007, and 2008 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The unaudited consolidated statement of operations data for the six months ended June 30, 2008 and 2009 and the unaudited consolidated balance sheet data as of June 30, 2009 have been derived from, and are qualified by reference to, our unaudited consolidated financial statements that are included in this prospectus. The unaudited consolidated financial statements include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, that management considers necessary for the fair presentation of the financial information set forth in those statements. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods, and the results for the six months ended June 30, 2009 are not necessarily indicative of results to be expected for the full year or for any other period.

 

    Year Ended December 31,     Six Months Ended
June 30,
 
Consolidated Statements of Income:    
(in thousands, except per share data)   2004     2005     2006     2007     2008     2008     2009  

Net sales

  $ 982,063      $ 1,256,006      $ 1,468,145      $ 1,863,216      $ 2,108,699      $ 1,029,740      $ 1,105,474   

Cost of sales

    904,882        1,144,364        1,325,746        1,670,978        1,873,617        918,065        984,466   
                                                       

Gross profit

    77,181        111,642        142,399        192,238        235,082        111,675        121,008   

Selling, general and administrative expenses

    73,813        108,787        121,577        162,431        183,683        89,339        93,320   
                                                       

Income from operations

    3,368        2,855        20,822        29,807        51,399        22,336        27,688   

Interest income

    (209     (343     (1,167     (1,814     (1,130     (615     (298

Interest expense

    684        1,322        1,600        1,133        1,498        770        542   

Other (income) expense, net

    (12     (167     (137     (856     (251     (135     (82
                                                       

Income before provision for income taxes, loss on equity method investment and net loss attributable to the noncontrolling interest

    2,905        2,043        20,526        31,344        51,282        22,316        27,526   

Provision for income taxes

    508        431        8,155        12,692        22,005        8,955        11,729   

Loss on equity method investment

                                    447        319           
                                                       

Net income

    2,397        1,612        12,371        18,652        28,830        13,042        15,797   

Net loss attributable to the noncontrolling interest

            147        243                                301   
                                                       

Net income attributable to Newegg Inc.

    2,397        1,759        12,614        18,652        28,830        13,042        16,098   

Accretion of Series B-1 and B-2 redeemable convertible Preferred Stock

            885        5,185        6,138        7,304        3,494        4,166   
                                                       

Net income available to common stockholders of Newegg Inc.

  $ 2,397      $ 874      $ 7,429      $ 12,514      $ 21,526      $ 9,548      $ 11,932   
                                                       

Earnings per share of Class A Common Stock (1)(2):

             

Basic

  $ 0.05      $ 0.02      $ 0.09      $ 0.18      $ 0.34      $ 0.12      $ 0.18   
                                                       

Diluted

  $ 0.05      $ 0.02      $ 0.09      $ 0.18      $ 0.34      $ 0.12      $ 0.18   
                                                       

 

 

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    Year Ended December 31,   Six Months Ended
June 30,
Consolidated Statements of Income:    
(in thousands, except per share data)   2004   2005   2006   2007   2008   2008   2009

Weighted average shares of Class A Common Stock outstanding used in computing earnings per share of Class A Common Stock (1)(2):

             

Basic

  52,038   39,029   1   4     5   5     59
                               

Diluted

  52,038   52,435   5   11     5   5     59
                               

Pro forma earnings per share of Class A and Class B Common Stock (unaudited) (3):

             

Basic

          $       $  
                     

Diluted

          $       $  
                     

Pro forma weighted average shares of Class A and Class B Common Stock outstanding used in computing pro forma earnings per share of Class A and Class B Common Stock (unaudited) (3):

             

Basic

             
                     

Diluted

             
                     

 

(1) The weighted average shares of Class A Common Stock outstanding used in computing the 2004 earnings per share of Class A Common Stock was derived from the weighted average shares of Series A convertible Preferred Stock outstanding immediately after our 2005 corporate reorganization as if converted on a 1:1 ratio into Class A Common Stock. There was no stock activity in 2004 through the 2005 reorganization.
(2) Basic and diluted earnings per share for the years ended December 31, 2006, 2007 and 2008 and for the six months ended June 30, 2008 and 2009 are calculated using the two-class method. Refer to Note 3—”Earnings per share” to our consolidated financial statements included elsewhere in this prospectus.
(3) For a description of the pro forma adjustments used to calculate pro forma earnings per share for the year ended December 31, 2008 and for the six months ended June 30, 2009, refer to Note 3—“Earnings per share: Unaudited pro forma earnings per share” to our consolidated financial statements included elsewhere in this prospectus.

The following table presents a summary of our balance sheet data as of June 30, 2009:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the conversion of all outstanding shares of our Preferred Stock into shares of either Class A Common Stock or Class B Common Stock upon the consummation of the offering, and assuming we are not subject to a put right by holders of our Series B-2 Preferred Stock, as discussed below under “—Preferred B-2 Put Right”; and

 

   

on a pro forma as adjusted basis to give further effect to the sale by us of shares of Class A Common Stock in this offering at an assumed initial public offering price of $             per share, after deducting estimated expenses payable by us and underwriting discounts and commissions and the application of a portion of the net proceeds to repay certain indebtedness as described under “Use of Proceeds.”

 

     June 30, 2009
Consolidated Balance Sheet Data:    Actual    Pro Forma    Pro Forma
as Adjusted
(in thousands)     

Cash and cash equivalents

   $ 42,241       $             

Accounts receivable, net

     26,113      

Inventories

     155,032      

Property and equipment, net

     43,437      

Total assets

     287,014      

Long-term debt and leases payable, less current portion

     12,896      

Total liabilities

     194,847      

Total temporary equity

     52,223      

Total stockholders’ equity

     39,944      

 

 

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Preferred B-2 Put Right

Holders of our Series B-2 Preferred Stock may have a right to put those shares to us in exchange for shares of either our Class A Common Stock or Class B Common Stock, depending on the IPO Price in this offering, as summarized below.

 

   

If the IPO Price is equal to or less than $9.26 per share, then each share of Series B-2 Preferred Stock may be exchanged for a number of shares of our Class A Common Stock equal to $12.36 divided by the IPO Price.

 

   

If the IPO Price is greater than $9.26 per share and equal to or less than $12.36 per share, then each share of Series B-2 Preferred Stock may be exchanged at the election of the holder for a number of shares of either our Class A Common Stock or Class B Common Stock, equal to $12.36 divided by the IPO Price.

As of June 30, 2009, 3,236,246 shares of Series B-2 Preferred Stock were outstanding. All information in this prospectus assumes that the IPO Price of our Class A Common Stock will be above $12.36 per share.

 

 

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RISK FACTORS

Investing in Newegg involves substantial risk. You should carefully consider the risks and uncertainties described below, together with all the other information in this prospectus, before you decide to purchase any of our securities. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that are not presently known to us or that we currently believe are not material may also impair our business. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected and you may lose all or part of your investment in Newegg.

Risks Relating to Our Industry and Our Business

A decline in demand for information technology, or IT, and consumer electronics, or CE, products could adversely affect our operating results.

We sell products that consumers may view as discretionary items rather than necessities. Consequently, our results of operations tend to be sensitive to changes in macroeconomic conditions that impact consumer discretionary spending. Challenging macroeconomic conditions also impact our customers’ ability to obtain consumer credit. Other factors, including consumer confidence, employment levels, interest rates, tax rates, consumer debt levels and fuel and energy costs, could reduce consumer spending or change consumer purchasing habits. In 2008 and 2009, many of these factors adversely affected consumer spending and affected our operating results. A continued slowdown in the U.S. or global economy or an uncertain economic outlook could materially adversely affect consumer spending habits and our future operating results.

Our operating results substantially depend on the sale of IT and CE products and, to a much lesser extent, household appliances in China. We could experience declines in product sales due to several factors, including:

 

   

decreased demand for IT or CE products, particularly computer components and parts that have historically generated a significant portion of our net sales;

 

   

poor economic conditions and any related decline in consumer demand for the products we sell;

 

   

increased price competition from our competitors; or

 

   

technological obsolescence of the IT and CE products that we offer.

Additionally, we expect some of our future growth to be driven by product releases or upgrades that we believe will occur in the near future. If such product releases do not occur or do not drive sales of IT products to the extent that we expect, our future sales may be less than we predict, negatively impacting our net sales and net income.

We face intense domestic and international competition and operate in an industry with limited barriers to entry, and some of our competitors may be better positioned than we are.

The e-commerce market is rapidly evolving and intensely competitive with limited barriers to entry. Many of our current and potential online and brick-and-mortar competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing, technical, management and other resources than we do. In addition, some of our competitors have used and may continue to use aggressive pricing or promotional strategies, have stronger supplier relationships with more favorable terms and inventory allocation and may devote substantially greater resources to website and system development than we do. We expect competition will intensify in the future as e-commerce continues to grow worldwide. A number of former competitors, including Circuit City, have recently gone out of business, resulting in more intense competitive efforts directed against us. Increased competition may result in reduced operating margins, reduced profitability, loss of market share and diminished brand recognition.

 

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We compete with retail stores and resellers, including superstores such as Best Buy, Costco, Fry’s and Staples, certain hardware and software vendors such as Dell that sell directly to end users, online retailers such as Amazon.com and TigerDirect.com, and other marketers and resellers of IT and CE products. Certain of our competitors have substantially greater financial resources than we have. There can be no assurance that we will be able to compete effectively against existing competitors, any consolidation of competitors or new competitors that may enter the market.

We could also experience significant competitive pressure if any of our manufacturers and distributors were to initiate or expand their own retail operations. Because our manufacturers and distributors have access to merchandise at a lower cost than us, they could sell products at lower prices and maintain a higher gross margin on their product sales than we can, and the Internet provides them with the ability to directly and relatively inexpensively connect with customers. This could result in our current and potential customers deciding to purchase directly from these manufacturers and distributors. Increased competition from any manufacturer or distributor capable of maintaining high sales volumes and acquiring products at lower prices than us could significantly reduce our market share and adversely impact our operating results.

We also face competition from existing online retailers in international markets we are in or may enter. For instance, in China, we compete with numerous companies, some of which are solely focused on the China e-commerce market, are directly owned and managed by Chinese citizens, have employees based exclusively in and focused on China or have lower cost structures than our Chinese operations. These traits could give them competitive advantages over us, particularly if the Chinese government enacts laws or policies that favor local competitors or restrict or disadvantage us because our Chinese operations are part of a U.S. domiciled company. Other competitors in China and Canada are subsidiaries of established e-commerce competitors in the United States with established local operations and brands, and with greater experience and resources. In other countries that we may enter, there may be incumbent online and multi-channel online/brick-and-mortar competitors presently selling IT and CE products. These incumbents may have advantages that could impede our expansion and growth in these countries.

We face and will continue to face intense competition. These and other competitive pressures may have a material adverse effect on our business, financial condition and results of operations.

We may not succeed in promoting, strengthening or continuing to establish the Newegg brand, which could prevent us from acquiring new customers and increasing revenues.

We believe that brand recognition is a primary competitive factor in the e-commerce market and will be a key factor in maintaining and expanding our customer base, market position and bargaining power with vendors. If we do not or are unable to continue to promote and strengthen the Newegg brand, or if our brand fails to continue to be viewed favorably, we may not be successful in attracting and acquiring new customers, which could have a material adverse effect on our results of operation and financial condition. Additionally, we compete not only for customers, but also for favorable product allocations and cooperative advertising support from our vendors. If we are not successful in maintaining and strengthening our relationships with vendors in existing and new product categories, we may be unable to maintain existing offerings and source new products at competitive prices and with adequate levels of inventory. We may also be unsuccessful in negotiating attractive vendor incentives and payment terms.

We are, or may become, subject to risks associated with our international operations, principally in China, which may harm our business.

We began operations on our affiliated Chinese retail website, www.newegg.com.cn, in 2001 and operations on our Canadian retail website, www.newegg.ca, in October 2008. We have limited operating histories on which to base an evaluation of our business and prospects in these countries. We are investing in building our business

 

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in these markets, and may not be able to successfully manage the challenges associated with our current and future international operations due to risks, such as:

 

   

international economic and political conditions;

 

   

changes in, or impositions of, legislative or regulatory requirements on Internet businesses and companies, including limitations on our ability to directly own or control key assets such as the www.newegg.com.cn website;

 

   

delays or additional costs resulting from import/export controls, duties, tariffs or other barriers to trade;

 

   

currency exchange controls or changes in exchange rates which could make our pricing less competitive or reduce our profit margins; and

 

   

tax laws, regulations and treaties, including U.S. taxes on foreign operations and repatriation of funds.

Any one of the foregoing factors could cause our business, operating results and financial condition to suffer.

If we do not anticipate and respond to changing consumer preferences in a timely manner, our operating results could suffer.

Consumer tastes and preferences will continue to evolve and change, and these changes may have a significant impact on our market and our business. In order for our business to continue to succeed, we must be responsive and adapt dynamically to these changes. Failure to successfully predict and accommodate constantly changing consumer tastes, preferences, spending patterns and other lifestyle decisions, or to effectively address consumer concerns, could have a material adverse effect on our revenue, results of operations and relationship with our customers.

If we are unable to provide a satisfactory customer experience, our reputation would be harmed and we could lose customers.

A critical component of our strategy is providing a high-quality customer shopping experience. Accordingly, the effective performance, reliability and availability of our website and network infrastructure are critical to our reputation and our ability to attract and retain customers. As an online retailer, we cannot offer some of the services or match certain aspects of the shopping experience offered by or available at brick-and-mortar retailers or online retailers that also have brick-and-mortar operations, such as the ability to allow consumers to touch, test and feel products, personally interact with sales or customer service representatives, and receive or return products without waiting or paying for the products to be shipped. The lack of these services and inability to successfully provide an adequate online shopping experience may cause certain consumers to purchase products from our competitors rather than from us. Therefore, it is important that we continue to improve our website content and operations, including efforts to encourage the creation of more high quality and useful user-generated content, such as reviews and commentary, on the products we sell. If we do not continue to make investments in our website development, content and functionality and customer service operations, and as a result, or due to other reasons, fail to provide a high-quality customer experience, we may lose customers, which could adversely impact our operating results.

We maintain all of our U.S. telephone customer support operations in California, and we provide e-mail and online chat support from both California and in various cities in China. Any material disruption or slowdown in our customer support services resulting from telephone or Internet failures, power or service outages, natural disasters, labor disputes or other events could make it difficult or impossible to provide adequate customer support. In addition, the future volume of customer inquiries may exceed our present system capacities. If this occurs, we could experience delays in responding to customer inquiries and addressing customer concerns. Our current level of customer support may also fail to meet the expectations of our customers. Failure to provide satisfactory levels of customer service may harm our reputation, causing potential loss of existing customers and difficulty in acquiring new customers.

 

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An important element of our business strategy is to expand our product offerings into new product categories and broaden the demographic profile of our customer base. For example, in China we carry a broad selection of household appliances. As a result, we may encounter new and significant challenges in managing inventory levels and customer buying patterns associated with new product categories and in developing and improving our customer service infrastructure to provide a satisfactory experience for new customers without alienating our existing customer base.

We expect our quarterly financial results to fluctuate which may lead to volatility in our stock price.

Our net sales and net income vary significantly from quarter to quarter due to a number of factors, including:

 

   

changes in demand for the products we sell, including seasonal fluctuations reflecting traditional retail purchasing patterns;

 

   

changes in the mix of products we sell;

 

   

the degree to which we are successful in attracting visitors to our website and converting those visitors into customers;

 

   

the timing and availability of vendor incentives;

 

   

economic conditions causing reductions in IT and CE-related spending;

 

   

our ability to retain existing customers and encourage repeat purchases;

 

   

the anticipation of new products or upgrades that causes customers to forego purchases of current products;

 

   

our ability to manage our product mix and inventory and our level of inventory write-offs;

 

   

our inability to reduce our fixed costs to compensate for any reduced net sales;

 

   

our ability to manage our fulfillment operations;

 

   

the impact of our growing e-commerce business in China;

 

   

delivery delays at the end of a quarter or during peak holiday seasons;

 

   

changes in advertising and other marketing costs;

 

   

aggressive pricing, marketing campaigns or other initiatives by our competitors;

 

   

increases in the cost of the products we sell due to the rising costs of raw materials, fuel or labor, particularly in countries that account for a significant portion of the manufacturing capacity for IT and CE products; and

 

   

costs of expanding or enhancing our technology or website.

As a result of the variability of these and other factors, our operating results in future quarters may be below the expectations of stock analysts and investors, and could cause our stock price to fall.

We depend on our vendors to obtain sufficient quantities of quality merchandise on favorable payment terms. If we fail to maintain strong vendor relationships or if our vendors are otherwise unable to supply products that meet our standards in a timely manner, our net sales and net income could suffer.

Our contracts or arrangements with suppliers generally do not guarantee the availability of merchandise, or provide for the continuation of particular pricing or other practices. Our suppliers may not continue to sell their inventory to us on current terms or at all, and, if the terms are changed, we may not be able to establish new supply relationships on similar or better terms. In most cases, our relationships with our suppliers do not restrict

 

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them from selling their products through our competitors. We compete with other retailers for favorable product allocations and vendor incentives from product manufacturers and distributors, including marketing dollars and volume-based sales incentive programs. Some of our competitors could enter into exclusive or favorable distribution arrangements for certain products with our vendors, which would deny us complete or partial access to those products and marketing and promotional resources. In addition, some suppliers whose products we offer on our websites, also sell their products directly to consumers. If we are unable to develop and maintain relationships with suppliers that permit us to obtain sufficient quantities of desirable merchandise on favorable terms, our business, results of operations and financial condition could be adversely impacted.

Our relationship with any particular vendor is dependent on our sales of products manufactured or distributed by that vendor. For certain products, we do not currently, and in the future may not be able to, meet the sales volumes or other requirements necessary to receive favorable treatment from the manufacturer of that product. As a result, we may not receive favorable pricing, vendor incentives or other considerations from those vendors. During times of short supply for highly desirable products, we may not receive adequate, or any, allocation of a popular product, leading to lost sales and customer dissatisfaction.

Certain products help create and maintain customer loyalty to our brand. Failing to have adequate supply of these products could damage our ability to retain customers. We currently do not carry the full product portfolio of, and in some cases do not carry any products of, certain well-known brands. As a result, consumers who are searching for those brands may not be able to purchase products from us or purchase them at the most favorable prices, leading to potentially reduced net sales and net income.

Certain vendors provide a significant portion of our merchandise. In the United States, for the year ended December 31, 2008, Ingram Micro, an IT and CE product distributor, and our 10 largest suppliers (including Ingram Micro) accounted for approximately 11.9% and 47.9% of the merchandise we purchased, respectively. Failure to maintain a positive relationship with these key suppliers could impact our ability to sell to our customers the products they want. Political or financial instability, merchandise quality issues, product safety concerns, trade restrictions, work stoppages, tariffs, foreign currency exchange rates, transportation capacity and costs, inflation, outbreak of pandemics and other factors relating to foreign trade are beyond our control. These and other issues affecting our vendors could materially adversely affect our net sales and net income.

We purchase our inventory from vendors on trade accounts typically requiring payment between 0 and 60 days after the date the inventory is shipped to us. As of June 30, 2009 our accounts payable balance was approximately $125.4 million with 23 days of payables outstanding. Our accounts payable balance as of June 30, 2009 represented 43.7% of our liabilities, temporary equity and stockholders’ equity. An adverse change in the vendor payment terms and conditions would significantly increase our working capital requirements and have a material adverse effect on our business, financial condition and results of operations.

We depend on third-party delivery services to deliver our products to us and our customers on a reliable and timely basis, and these third parties may increase the fees that they charge, limit or end their relationship with us with minimal prior notice, or become less reliable.

We use United Parcel Service, or UPS, DHL and other third parties to ship our products. In 2008, UPS delivered 89.4% of our U.S. orders. We do not have long-term agreements with UPS or any other delivery service and we cannot assure you that our relationships with these delivery service providers will continue on terms favorable to us, or at all.

Continued increases in shipping costs could harm our business, financial condition and results of operations by increasing our costs of doing business and reducing our gross margins. Passing these increased costs on to our customers could also cause us to lose sales to competitors. Furthermore, due to competitive pressures, we are increasingly either heavily discounting or not charging our customers for shipping. As our online competitors continue to use and expand programs that provide for free or reduced shipping charges, we expect to increasingly

 

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offer similar programs to maintain and build our customer base, which will have the effect of decreasing net sales from freight and decreasing our margins.

In addition, if our relationships with these delivery services are terminated or impaired, or if these delivery services are unable to deliver products for us, whether through labor shortage, slow down or stoppage, deteriorating financial or business conditions, responses to terrorist attacks or for any other reason, we would be required to use alternative carriers for the shipment of products to our customers. Changing carriers could have a negative effect on our business and operating results due to reduced visibility of order and delivery status and delays in order processing and product delivery, and we may be unable to engage alternative carriers on a timely basis, upon terms favorable to us, or at all.

In 2008, we initiated shipping with DHL in order to provide a lower cost shipping solution to our customers, predominantly on smaller form factor products. However, our average delivery time with DHL is longer than the average delivery time using UPS. As a result, we may face more customer dissatisfaction or suffer an erosion of our reputation as a merchant that can promptly fulfill orders due to the longer average delivery times for customers using DHL.

We are highly dependent upon general transportation infrastructure, including common carriers, to fulfill customer orders. The transportation network is subject to a variety of disruptive causes, including labor disputes or port strikes, acts of war or terrorism and natural disasters. If our delivery times increase unexpectedly due to these or any other reasons, we could suffer a disruption of our business and delayed or lost net sales and our brand could be damaged.

Our technology and fulfillment infrastructure and processes have limited capacity, are not fully redundant and our software may contain undetected errors or design flaws.

If the volume of traffic on our websites or the number of purchases made by our customers increases substantially, we may experience unanticipated system disruptions, slower response times, reduced levels of customer service and impaired quality and delays in reporting accurate financial information.

We may be unable to accurately project the rate or timing of traffic flow, including any traffic increases, or successfully and cost-effectively upgrade our systems and infrastructure in time to accommodate higher traffic levels on our websites. Any such upgrades to our systems and infrastructure could require substantial investments. In addition, we may be unable to upgrade and expand our transaction processing systems in an effective and timely manner or to integrate any newly developed or purchased functionality with our existing systems, which may cause unanticipated system disruptions, slower response times, reduced levels of customer service, impaired quality or delayed order fulfillment, any of which could result in a material adverse effect on our business and financial condition and harm our reputation. Because our business is seasonal, the greatest demands on our infrastructure are during the holiday season and the impact of any service disruption during those times would be heightened.

Our technology and fulfillment infrastructure and processes may contain undetected errors or design flaws that may cause our websites to fail and materially impact our business and results of operation. In the past, we have experienced website interruptions and delays when implementing improvements to our principal website, resulting in lost net sales and customer dissatisfaction during the period required to restore access and to correct errors and design flaws. In the future, we may encounter the same and additional issues, such as scalability limitations, in current or future technology infrastructure releases. A delay in the implementation of any future version of our technology infrastructure and processes could substantially harm our business and results of operations.

Not all of our infrastructure, processes and systems are fully redundant. As a result, the risks above apply not only to the failure of our systems as a whole, but may also apply if a subset of our systems were to fail.

 

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We depend on third-party search engines and referral sources to attract visitors to our websites, and if we are unable to attract these visitors or convert them into customers in a cost-effective manner, our business and results of operations could be harmed.

Our success depends on our ability to attract consumers to our websites and convert them into customers in a cost-effective manner. In 2008, approximately 35.6% of our U.S. website visitors were referred to us through paid and unpaid search engine listings, shopping comparison sites and other sources that provide a link to our websites. These third parties utilize various algorithms and key words to determine the websites that they display in response to certain search criteria. If these methods are changed, it could cause fewer consumers to click through to our websites and adversely affect our financial results. We also sometimes pay these third parties to include or highlight our websites in their search results. If such third parties modify or terminate their relationship with us or increase the price they charge to us, if our competitors offer them greater fees for traffic or if any free third-party website on which we rely begins charging fees for listing or placement, our expenses could rise and traffic to our websites could decrease, resulting in harm to our operations.

Our success also depends on our ability to convert our website visitors into paying customers, a process which is partially reliant upon our ability to identify and purchase relevant key word search terms, provide relevant content on our sites and effectively target our other marketing programs, such as Internet portal referrals, e-mail campaigns and affiliate programs. Recent changes in New York and other state tax laws have imposed sales tax collection obligations on Internet retailers employing commission-based affiliates who are residents of those states. This and future changes by other states may require changes in affiliate compensation methods and restrictions on affiliate promotional activities that could make this marketing channel less efficient and cost-effective. If we are unable to attract visitors to our websites and convert them into customers in a cost-effective manner, our business and financial results may be harmed.

We may become liable for collecting and paying more sales taxes, and other fees and penalties, which could have an adverse effect on our business.

We currently collect sales or other similar taxes only on the shipment of goods to customers in the states of California, New Jersey and Tennessee, which are the only states where we have a physical presence. We also currently file corporate income tax returns in California, New Jersey and Tennessee. Other states or jurisdictions could seek to impose or enforce corporate income, sales tax collection or other tax obligations on us because we engage in and facilitate online commerce.

To the extent we are not subject to certain tax obligations, we enjoy a competitive advantage to the extent our competitors are subject to those obligations. Several states have enacted, and a number of states and the U.S. Congress have been considering, various initiatives that could impose broad sales and use tax collection obligations on Internet retailers. Federal, state and local governments could accelerate efforts to pass Internet sales tax initiatives in response to pressure to make up budgetary shortfalls resulting from recessionary economic conditions and the failure to collect sales and use taxes on Internet purchases under current self-assessment regimes. Any of these initiatives would increase total costs to our customers, which could adversely affect our net sales.

We are closely monitoring developments in this area. The imposition by national, state and local governments of various tax obligations upon Internet commerce could create significant administrative burdens for us as well as substantially impair the growth of our e-commerce business, which could adversely affect our net sales and profitability. Because our principal website and product deliveries are available in all 50 states, certain U.S. territories and Canada, some or all of those jurisdictions may require us to register or qualify to do business in their jurisdictions. If we fail to collect and remit or pay required sales, income or other taxes in a jurisdiction, or qualify or register to do business in a jurisdiction that requires us to do so or if we have failed to do so in the past, we could face material liabilities for taxes, fees, interest and penalties. If various jurisdictions impose new tax obligations on our business activities, our net sales and net income in those jurisdictions could decrease significantly, which could harm our financial results.

 

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Our rapid historical and planned growth will place pressure on our resources and infrastructure.

Our success depends upon our ability to manage the growth of our operations effectively. Our recent and planned growth has placed, and is expected to continue to place, a strain on our operations and managerial resources. As of June 30, 2009, approximately 15.0% of our U.S. workforce has been employed with us for less than one year, and many of our current systems, policies and procedures have only recently been implemented. In addition, none of the members of our senior management team in China have been employed continuously in their current roles with us for more than two years. To be successful, we will need to improve our operational and financial systems, procedures and controls, successfully manage international operations and hire additional personnel. Our efforts may not be successful, and we may be unable to improve our systems, procedures and controls in a timely manner. Delays or problems associated with any of these initiatives could harm our business and operating results. These initiatives will also cause our operating expenses to increase. If we fail to accurately estimate and assess our growth, or fail to increase net sales to match our increased operating expenses, our operating results and financial condition could suffer.

We rely on the services of key personnel, any of whom could be difficult to replace.

We rely upon the continued service and performance of key technical, fulfillment and senior management personnel. If we lose any of these personnel, our business could suffer. Our future success depends on our retention of executives and key employees, including Tally Liu, our Chief Executive Officer and Chairman of our Board of Directors, or Board, and Fred Chang, President of Newegg China and the Vice Chairman of our Board, who we refer to as our Principal Stockholder. We rely on these and other employees to manage our company, develop our business strategy and manage our strategic relationships. All of our senior management and key personnel are employees at will, and as a result, any of these employees could leave with little or no prior notice. If any member of our senior management team or other key personnel leaves our company, our ability to successfully operate our business and execute our business strategy could be adversely affected. We may also have to incur significant costs in identifying, hiring, training and retaining replacements of departing employees.

In the past few years, we have experienced significant turnover in our senior management ranks, including turnover in the individuals who previously served as our Chief Executive Officer, President and Chief Operating Officer. Our current Chairman and Chief Executive Officer assumed these roles in August 2008. In addition, four of our executive officers joined us after August 2007. This lack of management continuity could result in operational and administrative inefficiencies and added costs and may make recruiting for future management positions more difficult. In addition, we must successfully integrate any new management personnel into our organization in order to achieve our operating objectives, and changes in other key management positions may affect our financial performance and results of operations while new management becomes familiar with our business. Accordingly, our future financial performance will depend to a significant extent on our ability to motivate and retain key management personnel, particularly those with sales, marketing, operations and technology expertise.

Competition for qualified personnel in our industry is intense. Our employees, including our executives, are often solicited by recruiters to leave us. We have experienced difficulty in attracting and retaining the management and personnel necessary to support the rapid growth of our business, and we may experience similar difficulties in the future. If we are unable to attract, assimilate and retain employees with the necessary skills, we may not be able to successfully operate or grow our business.

If use of the Internet with respect to online commerce and online sales of IT and CE products does not continue to increase as rapidly as we anticipate, our business will be harmed.

Our future growth is in part expected to be driven by an overall increase in e-commerce, and in particular, growing penetration of online IT and CE product sales. If the online market for IT and CE products does not

 

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continue to increase at the pace we anticipate, our business may suffer. Specific factors that could negatively influence consumers’ purchasing of IT and CE products online include:

 

   

concerns about buying IT and CE products without a physical storefront, face-to-face interaction with sales personnel and the ability to physically handle and examine products;

 

   

delivery time associated with Internet orders;

 

   

pricing that does not meet consumer expectations or is higher than the pricing of competing brick-and-mortar merchants;

 

   

concerns about the security of online transactions and the privacy of personal information;

 

   

delayed shipments or shipments of incorrect or damaged products; and

 

   

inconvenience associated with returning or exchanging purchased items.

We could experience, and be liable for, data security breaches.

If third parties, such as hackers, are able to circumvent our network security and penetrate our technology systems, or if we lose, misuse, misplace or provide third parties with improper access to the personal or credit card information of our customers or the personal information of our employees, we could be subject to significant liability. This liability could include claims for unauthorized credit card purchases, identity theft or other similar fraud claims. This liability could also include claims for other misuses of personal information, such as engaging in unauthorized marketing activities. These claims could result in investigations, litigation, fines and penalties. Remediation of and liability for loss or misappropriation of customer or employee personal information could have a material adverse effect on our business and financial results. We could incur additional expenses if new regulations regarding the use and protection of personal information are introduced or if government agencies, such as the Federal Trade Commission, or state agencies investigate our privacy practices and find them to be deficient.

We rely on encryption and authentication technology licensed from third parties to secure transmission of confidential information such as customer credit card numbers. Advances in technology, the expertise of hackers, new discoveries in the field of cryptography or other events or developments could result in a compromise or breach of the technology that we use to protect customer and employee information. Significant capital investment and other resources may be required to protect against such security breaches or alleviate problems caused by such breaches. We cannot guarantee that our current or future security measures will prevent security breaches. Failures to prevent such security breaches may harm our reputation and have a material adverse effect on our business, financial condition and results of operations.

System failures, including failures caused or experienced by third-party service providers, increased demand, natural disasters or other catastrophic events, could prevent or inhibit access to our websites and our ability to process and fulfill orders, which could reduce our net sales and harm our reputation.

Our success depends on our ability to successfully receive and fulfill orders and to promptly deliver such orders to our customers. We could lose existing customers or fail to attract new customers, potentially resulting in a decline in net sales, if our websites are inaccessible or if our transaction processing systems, order fulfillment processes or network infrastructure are not operational or performing to our customers’ satisfaction.

Any Internet network interruptions, latency or problems with our websites’ availability could prevent customers from accessing, browsing and placing orders on our websites, and impact our ability to fulfill orders or bill customers, which may cause customer dissatisfaction and damage our reputation and brand. We have experienced brief computer system interruptions in the past, and we believe others will occur from time to time in the future. Our systems and operations are vulnerable to damage or interruption from a number of sources, including the following:

 

   

natural disaster or other catastrophic event such as earthquake, fire, power loss or interruption, telecommunications failure, hurricane, volcanic eruption, flood or terrorist attack. For example, our

 

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headquarters and the majority of our infrastructure, including some of our servers, are located in Southern California, a seismically active region. In addition, California has in the past experienced power outages as a result of limited electric power supply;

 

   

computer malware, physical or electronic break-ins and similar disruptions;

 

   

failure by third-party vendors, including data center and bandwidth providers, to provide steady and high-speed access to our websites. Any disruption in our network access or co-location services, which are the services that house our servers and provide Internet access to them, provided by these third-party providers or any failure of these third-party providers to handle existing or higher volumes of use could significantly harm our business. Any financial or other difficulties our providers face could also adversely affect our business; and

 

   

incidents of fraud.

We have not yet created redundancy for all of our information technology systems and data, and we do not presently maintain backup copies of all of our data. We have a limited disaster recovery plan in effect and may not have sufficient insurance for losses that may occur from natural disasters, catastrophic events or the resulting business interruption. We are generally self-insured outside of the United States. Any substantial damage to, or disruption of, our technology infrastructure could cause interruptions or delays, loss of data or reduced website availability, which could have a material adverse effect on our business, financial condition and results of operations.

We do not presently maintain back-up power systems at some of our order processing centers, or OPCs. Any interruption in some or all of our OPC operations for a significant period of time, including failure of our order processing applications, interruptions resulting from the expansion of our existing facilities or the transfer of operations to a new facility, could seriously damage our reputation and brand and harm our business and results of operations.

Our expansion into new products, services, technologies and geographic regions subjects us to additional business, legal, financial and competitive risks.

An important element of our business strategy is to expand into new product categories, services, technologies and regions, such as our international expansion into China and Canada, our expansion into new product categories beyond IT and CE and our plans to offer various e-commerce services for third parties. In directing our focus into new areas, we face numerous risks and challenges, including alienating our core customer base, facing new competitors and having the increased need to develop new strategic relationships. We cannot assure you that our strategy will result in increased net sales or net income. Furthermore, growth into new business areas may require changes to our existing business model and cost structure, modifications to our infrastructure and exposure to new regulatory and legal risks related to operating in new jurisdictions, any of which may require expertise in areas in which we have little or no experience. These risks may pose a material adverse risk to our business, results of operations and financial condition.

International operations expose us to currency exchange and repatriation risks and we cannot predict the effect of future exchange rate fluctuations on our business and operating results.

We have operations outside the United States, in Canada and China. We have currency fluctuation exposure arising from both sales and purchases denominated in foreign currencies, as well as intercompany transactions. Significant changes in exchange rates between foreign currencies in which we transact business and the U.S. dollar may adversely affect our results of operations and financial condition. Historically, we have not entered into any hedging activities, and, to the extent that we continue not to do so in the future, we may be vulnerable to the effects of currency exchange-rate fluctuations.

An increase in our China sales and operations will result in a larger portion of our net sales and expenditures being denominated in Chinese Renminbi, or RMB. The Chinese government controls the procedures by which

 

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RMB is converted into other currencies, and conversion of RMB generally requires government consent. As a result, RMB may not be freely convertible into other currencies at all times. If the Chinese government institutes changes in currency conversion procedures, or imposes restrictions on currency conversion, those actions may negatively impact our operations and could reduce our operating results. In addition, significant fluctuations in the exchange rate between RMB and U.S. dollars may adversely affect our expenses and results of operations as well as the value of our assets and liabilities. These fluctuations may also adversely affect the comparability of our period-to-period results. If we decide to repatriate funds from our Chinese operations, we will be required to comply with the procedures and regulations of applicable Chinese law. Any changes to these procedures and regulations, or our failure to comply with those procedures and regulations, could prevent us from repatriating funds from our Chinese operations, which could adversely affect our financial condition. If we are able to repatriate funds from our Chinese operations, these funds could be subject to U.S. corporate income tax.

In addition, our international operations expose us to currency fluctuations as we translate the financial statements of our foreign operations to the U.S. dollar. Although the effect of currency fluctuations on our financial statements has not generally been material in the past, there can be no assurance that the effect of currency fluctuations will not be material in the future.

A significant increase in merchandise returns could harm our business, financial condition and results of operations.

Our return policies generally allow merchandise purchased on our websites to be returned within 30 days of the original invoice date for a full refund or within one year of the original invoice date for a replacement, less, in both cases, certain restocking fees. In 2008, we provided refunds totaling approximately 2.4% of our gross sales for merchandise returns. If merchandise returns increase significantly, our business, results of operations and financial condition could be harmed.

Our inventory is subject to obsolescence, rapid devaluation, theft and damage.

We purchase most of the merchandise that we sell on our websites from manufacturers or distributors. We assume inventory damage, theft, obsolescence and price erosion risks for products that we purchase directly. These risks are especially significant because most of the merchandise we sell on our websites is characterized by rapid technological change, obsolescence and price erosion. In 2008, we recorded inventory write-offs or write-downs totaling $3.5 million, or 0.2% of our cost of goods sold. We may also sell obsolete or dated merchandise at a discount or loss. If there were unforeseen product developments or if vendors were to change their terms and conditions, our inventory risks could increase. We also periodically take advantage of cost savings associated with certain opportunistic bulk inventory purchases offered by our vendors. These bulk purchases increase our exposure to inventory obsolescence. Our success depends on our ability to sell our inventory rapidly, purchase inventory at attractive prices relative to its resale value and manage customer returns and the shrinkage resulting from theft, loss and misrecording of inventory. If we are unsuccessful in any of these areas, we may be forced to write down or write off substantial amounts of inventory, or sell it at a discount or loss.

We are subject to payment method-related risks.

We accept payments using a variety of methods, including credit cards, debit cards, credit accounts (including promotional financing), gift certificates and bank checks. As we offer new payment options to our customers, we may be subject to additional regulations, compliance requirements and incidents of fraud. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profit margins.

We rely on third parties to provide payment processing services, including the processing of credit cards, debit cards, electronic checks and promotional financing. If these companies become unwilling or unable to provide these services to us, our business could be disrupted. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or

 

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be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers, process electronic funds transfers or facilitate other types of online payments, and our business and operating results could be adversely affected.

We are and may continue to be subject to intellectual property infringement claims, disputes or litigation.

Third parties have, and likely will in the future, assert allegations and claims of intellectual property infringement against us. Any such claims, disputes or litigation, even if resolved in our favor, could be time-consuming and costly, and could divert our management’s efforts from growing our business. Uncertainties resulting from the initiation and continuation of any litigation could harm our operations.

If any parties prevail in their intellectual property rights claims, we may be required to pay significant licensing fees, damages and attorney’s fees, and may even be liable for punitive damages if we are found to have willfully infringed third parties’ proprietary rights. We may have to stop using certain technology or solutions and need to develop or acquire alternative, non-infringing technology or solutions, which could require significant time and resources. In addition, we may need to obtain a license to use certain technologies, although such licenses may not be available on reasonable terms or at all and may result in substantial payments and royalties, which would significantly increase our operating expenses. If we cannot develop non-infringing technology or license the appropriate technology at commercially reasonable rates, an intellectual property claim successfully asserted against us could cause significant business interruptions in our operations, which could restrict our ability to compete effectively and have a material adverse effect on our financial condition and results of operation.

On November 5, 2007, Soverain Software LLC, or Soverain, filed a patent infringement lawsuit against us in the United States District Court for the Eastern District of Texas, seeking, among other things, a judgment that Newegg has infringed certain patents held by Soverain, an injunctive order against the alleged infringing activities and an award for damages. If an injunction is granted, it could force us to stop or alter certain aspects of our business activities, such as aspects of our shopping cart and session identification. This case is scheduled for a jury trial in Tyler, Texas, in February 2010. We cannot be sure that the outcome of such a trial will be favorable to us and the monetary liability and other negative operational or financial impact from any adverse verdict may be greater than what we expect.

Existing or new regulation could expose us to liability and costly changes in our business operations and could reduce customer demand for our products.

In addition to tax laws, we are subject to federal and state consumer protection laws, including laws protecting the privacy of customer non-public information and regulations prohibiting unfair and deceptive trade practices, as well as laws governing businesses, the Internet and e-commerce. Additional laws may be adopted with respect to the Internet and online retailing, the effect of which on e-commerce is uncertain. These laws may cover issues such as user privacy, spyware and the tracking of consumer activities, marketing e-mails and communications, other advertising and promotional practices, money transfers, pricing, content and quality of products and services, taxation, electronic contracts and other communications, intellectual property rights and information security. Furthermore, it is not clear how existing laws such as those governing issues such as property ownership, sales and other taxes, trespass, data mining and collection, and personal privacy apply to the Internet and e-commerce. As we expand into international markets, such as China and Canada, we will be required to comply with foreign laws, which may be materially different than U.S. laws. Any such foreign law, any new U.S. law, or the interpretation or application of existing laws to the Internet or other online services, may have a material adverse effect on our business, financial condition and results of operations by, among other things, impeding the growth of the Internet, subjecting us to fines, penalties, damages or other liabilities, requiring costly changes in our business operations and practices and reducing customer demand for our products and services. We do not maintain insurance coverage to cover the types of claims or liabilities that could arise as a result of such laws or changes in laws or regulations.

 

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We are partially dependent on third parties to perform a number of our fulfillment, distribution and other retail functions. If such parties are unwilling or unable to continue providing these services, our business could be harmed.

In 2008, approximately 7.0% of our net sales in the United States were generated by the sale of products fulfilled through third parties. These third parties provide various services on our behalf, including inventory maintenance and merchandise shipment. We have no effective means to ensure that these third parties will continue to perform these services to our satisfaction, in a manner satisfactory to our customers or on commercially reasonable terms. Our customers could become dissatisfied and cancel their orders or decline to make future purchases if these third parties fail to deliver products on a timely basis. If our customers become dissatisfied with the services provided by these third parties, our reputation and our brand could suffer.

In addition, we maintain an ancillary site, www.neweggmall.com, which offers e-commerce services designed for third-party retailers and manufacturers whereby these third parties will offer their products on our websites. We cannot guarantee that the quality of fulfillment and service provided by these third parties will be satisfactory to our customers and our reputation could potentially be harmed by the failure of these third parties to meet our service standards.

We may be subject to product liability claims that could be costly and time consuming.

We sell products manufactured by third parties on our websites, some of which may be defectively designed or manufactured. If any product that we sell were to cause physical injury or injury to property, an injured party could bring claims against us as the retailer of the product. Furthermore, we also offer in-house brands of IT components and peripherals on our websites, which could potentially create more exposure for us with respect to product liability than if we simply acted as a retailer of third-party products. Our insurance coverage may not be adequate. If a successful claim were brought against us in excess of our insurance coverage, it could adversely affect our operating results and financial condition. Even unsuccessful claims could result in the expenditure of funds and management time in defending them and could have a negative impact on our reputation.

We may not be able to adequately protect our intellectual property rights.

We rely on trademark and copyright law, trade secret protection and confidentiality or licensing agreements with employees, customers, partners and others to protect our proprietary rights. These steps may be inadequate, agreements may be violated or there may be inadequate remedy for a violation of an agreement. Our competitors may independently develop equivalent proprietary information and rights, or may otherwise gain access to our trade secrets or proprietary information, which could affect our ability to compete in the market. We cannot be certain that the steps that we have taken will adequately protect our proprietary rights, especially in countries such as China, where the laws or enforcement of the laws may not protect our rights to the same extent or in the same way as in the United States. In addition, third parties may infringe or misappropriate our proprietary rights, and we could be required to enforce our intellectual property rights, which could require significant expenses and management time. For instance, the www.newegg.cn domain name is presently registered by an unaffiliated third party in China and while we have initiated legal proceedings to acquire that domain name and have prevailed in initial proceedings, the opposing party is appealing the verdict. We do not have certainty that we will ultimately prevail under applicable local laws. If we do not prevail, potential customers and web traffic in China may be steered to websites operated by unaffiliated third parties and our brand may be adversely impacted. We have registered and common law trademark rights in the United States and certain foreign jurisdictions, as well as pending trademark applications for a number of marks and associated domain names. Even if we obtain approval for such pending applications, the resulting registrations may not adequately cover our trademarks or protect us against infringement or dilution by others. Effective trademark, service mark, copyright, patent and trade secret protection may not be available in every country or jurisdiction in which our products may be made available online, which may cause our business and operating results to suffer. In addition, we may be unable to acquire or protect relevant domain names in the United States and in other countries. If we are not able to acquire or protect

 

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our trademarks, domain names or other intellectual property, we may experience difficulties in achieving and maintaining brand recognition and customer loyalty.

We may not have sufficient quantities of merchandise on hand to meet our customers’ expectations.

During the current global economic downturn, many manufacturers have decreased production as a means to reduce losses. If vendors have a limited amount of inventory to allocate, they may choose to allocate a greater share of their limited inventory to our competitors who have stronger supplier relationships or greater buying power, or we may simply not be allocated enough inventory to meet the demands of our customers and potential customers. If we do not have sufficient inventory on hand, this may lead to reduced market share in certain products and categories, lost sales and damage to our reputation.

We have limited experience developing or owning real estate.

We currently own over 250,000 square feet of office and warehouse space in California, Taiwan and China. We have also acquired the land use rights for a 492,000 square foot parcel of land for 50 years in the district of Jiading, a suburb of Shanghai, China. See additional discussion of this facility under “Business—Facilities—Jiading Facility Contract and Plans for a Regional Headquarters.” We may consider additional real estate investments to meet our expanding business needs, including additional office and distribution locations in the United States and internationally. Accordingly, we are subject to the risks associated with developing and owning significant amounts of real estate. In particular, the value of the assets could decrease, and the costs associated with ownership could increase, due to changes in demographic trends, local real estate market conditions, occurrence of natural disasters, as well as the impact of environmental liabilities. This is particularly true in China, where real estate prices have fluctuated drastically in recent years. Our present management team has limited or no experience in overseeing the purchase and development of real estate, particularly in China, and our planned real estate projects may require substantial amounts of their time and corporate resources.

Our websites could become obsolete if we do not respond to technological change.

Our primary Internet retail websites, especially www.newegg.com and www.newegg.ca and our affiliated website, www.newegg.com.cn, require substantial development and maintenance efforts. To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our websites. The Internet and the e-commerce industry are characterized by rapid technological change, the emergence of new industry standards and practices, and changes in customer requirements and preferences. Therefore, we may be required to license technologies, enhance our existing websites, develop new services and technology that address the increasingly sophisticated and varied needs of our current and prospective customers and adapt to technological advances and emerging industry and regulatory standards and practices in a cost-effective and timely manner. There can be no assurance that any technology licenses will be available on commercially reasonable terms. Substantial investments will be required to remain technologically competitive and our failure to do so may harm our business and results of operations.

We could be subject to risks associated with information posted on our websites by third parties.

Our websites feature reviews by registered users of many of the products we sell. Although these reviews are generated by registered users of our website, and not by us, it is possible that a claim could be made against us based on the content of the reviews and ratings posted on our websites. We could also suffer from damaged relationships with our vendors. If we become liable for information posted on our websites by third parties, we could be harmed and may be forced to discontinue certain services and to remove content, which are vital to our ability to provide a high quality Internet shopping experience.

 

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Our business may be harmed if we sell pirated, counterfeit, illegal or “gray market” items.

We have received in the past, and we anticipate we will receive in the future, communications alleging that certain items sold through our websites infringe third-party patents, copyrights, trademarks and trade names or other intellectual property rights, or may be “gray market” products. These and future claims could result in increased costs of doing business as a result of legal expenses, adverse judgments or settlements and reputational harm, and require us to change our business practices in a way that would be less efficient and more costly. Key manufacturers and vendors, for instance, may be less likely to offer us favorable terms or authorization to carry their products if we sell their “gray market” products. In addition, litigation could result in interpretations of the law that require us to change our business practices or otherwise increase our costs. We do not have enough, or any, insurance coverage to cover all of the types of claims that could be asserted in such litigation. If a claim were brought against us successfully, it could expose us to significant liability, which if incurred, could have a material adverse effect on our business and operations.

Our pricing strategy may not meet customers’ price expectations or result in net income.

Demand for our products is generally highly sensitive to price. Our pricing strategies have had, and may continue to have, a significant impact on our net sales and net income. We often offer discounted prices, free or discounted shipping or bundled products as a means of attracting customers and encouraging repeat purchases. Such offers and discounts may reduce our margins. In addition, our competitors’ pricing and marketing strategies are beyond our control and can significantly impact the results of our pricing strategies. If we fail to meet our customers’ price expectations in any given period, or if our competitors decide to engage in aggressive pricing strategies, our business and results of operations would suffer.

We may undertake acquisitions to expand our business, which may pose risks to our business and dilute the ownership of our stockholders.

From time to time, we may selectively pursue acquisitions of businesses, assets, technologies or services. Integrating any newly acquired businesses, assets, technologies or services may be expensive and time-consuming. We do not have experience acquiring and integrating businesses, and may not be successful in doing so. To finance any acquisitions, it may be necessary for us to raise additional funds through public or private financings. Additional funds may not be available on terms that are favorable to us, and in the case of equity financings, would result in dilution to our stockholders. If we do complete any acquisitions, we may be unable to operate such acquired businesses profitably or otherwise implement our strategy successfully. If we are unable to integrate any newly acquired entities, assets or technologies effectively, our business and results of operations could suffer. The time and expense associated with finding suitable and compatible businesses, technologies or services could also disrupt our ongoing business and divert our management’s attention. Future acquisitions by us could also result in large write-offs or assumptions of debt and contingent liabilities, any of which could substantially harm our business and results of operations.

 

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Risks Relating to Doing Business in China

We have a limited operating history in China and may not be able to manage the challenges associated with our current and future plans for expansion into the Chinese market.

Our affiliated Chinese retail website, www.newegg.com.cn, began operations in 2001 and has a limited operating history on which to base an evaluation of our business and prospects in China. Moreover, our China operations have incurred operating losses since inception, and there is no assurance when our operations will become profitable, if at all. Additional future losses in our China operations could have a material adverse effect on our results of operations.

We may not be able to successfully manage the challenges associated with our current and planned Chinese operations due to risks, such as:

 

   

lack of widely available or widely utilized electronic payment systems;

 

   

an underdeveloped parcel delivery infrastructure;

 

   

consumer expectations and purchasing behaviors that we may not adequately understand;

 

   

a dynamic competitive environment;

 

   

a product mix that includes household goods, in addition to IT and CE products;

 

   

the need for multiple and convenient physical locations at which customers can elect to pick up ordered products;

 

   

vendor terms that generally provide for cash on delivery;

 

   

restrictions imposed by local labor practices and laws on our business and operations;

 

   

difficulties and costs of staffing and managing foreign operations;

 

   

exposure to foreign business practices and legal standards;

 

   

unexpected changes in regulatory requirements;

 

   

the imposition of governmental controls and restrictions;

 

   

political, social and economic instability and the risk of war, terrorist activities or other international incidents;

 

   

large geography;

 

   

natural disasters and public health emergencies;

 

   

potentially adverse tax consequences; and

 

   

the failure of local laws to provide a sufficient degree of protection against infringement of our intellectual property.

Furthermore, the difficulties otherwise associated with addressing these risks are compounded by language and cultural differences, as well as the geographic distance from our headquarters in the United States. Our management team has relatively limited experience in creating or overseeing foreign operations, and our operations in China may divert substantial amounts of their time. We may not be able to grow our operations in China at the rate or with the level of success we anticipate, or at all. We are likely to experience difficulty in forecasting the growth of our Chinese e-commerce business which may adversely affect our operating results. We may experience greater difficulty than we anticipate in applying our U.S. developed e-commerce platform to the Chinese market. Furthermore, due to the manner in which manufacturers distribute their products in China, we have been unable to leverage our U.S. vendor relationships to benefit our China operations. We must also pay our vendors for products to be sold in China on much shorter terms than we do in the United States, often cash on

 

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delivery, creating the need to fund working capital requirements in China. Even if our Chinese operations do continue to grow, we may not be able to match the quality, scale and profitability of our U.S. operations. We will also have to manage a local workforce, which may subject us to uncertainties or foreign regulatory policies. These difficulties could materially harm our operating results.

The success of our Chinese operations depends on the continued growth of the Internet as a retail marketplace and the related expansion of Internet infrastructure in China.

The success of our Chinese strategy depends upon the continued and widespread acceptance and adoption of the Internet in China as a vehicle to purchase products. If Chinese customers or manufacturers are unwilling to use the Internet to conduct business at sufficient levels, or at all, our business expansion in China will fail. The commercial acceptance and use of the Internet in China may not continue to develop at historical rates, or may not develop as quickly as we expect. The use of the Internet as a distribution channel is at an early stage in China. Internet and broadband penetration rates in China are relatively low compared to the United States. Many of our current and potential customers in China have limited experience with the Internet as a retail channel. The growth of the Internet in China, and in turn, the growth of our business in China, may be inhibited by concerns over privacy and security, including concerns regarding computer viruses, worms and other types of harmful software code, reliability issues arising from outages or damage to Internet infrastructure, delays in development or adoption of new standards and protocols to handle the demands of increased Internet activity, decreased accessibility, increased government regulation and taxation of Internet activity. In addition, our growth may be adversely affected if the Internet infrastructure in China does not keep pace with the growth in Internet activity and is unable to support the demands placed upon it, or if there is any delay in the development of enabling technologies and performance improvements.

Electronic payment mechanisms have not been widely adopted and are not widely trusted in China, which limits our ability to sell products on the Internet and requires us to ensure that we have an adequate control environment and systems to prevent theft.

Currently in China, electronic payment systems have significantly less penetration than in the United States. Consumers in China typically transact in cash, even if they have access to debit or credit cards, and as a result, our practice is to take cash on delivery for such purchases. Reliance on cash on delivery for purchases causes us to be less efficient in fulfillment. For example, prospective customers may have the ability to order the same product from multiple sources intending to pay only for the product that arrives first, resulting in significantly higher product return rates. Even if standard electronic payment systems are adopted and widely utilized in China, there can be no assurance that we will be able to effectively implement such a system. These difficulties may potentially hinder the growth and profitability of our Chinese operations. Furthermore, a cash-based transaction system creates complexity in our control environment. Finally, collection of payment, often in cash, by delivery or other personnel leaves us more vulnerable to theft.

The parcel delivery infrastructure in China is poorly developed and we cannot currently rely on third-party delivery services as we do in the United States.

Currently, third-party parcel delivery services in China are not capable of meeting most of our parcel delivery needs. Therefore, for those metropolitan areas where we operate or plan to open an OPC, we deliver a substantial amount of our products through a local delivery system developed, owned and operated by us, and we otherwise rely on the State Postal Bureau, or China Post, the government mail carrier or on third-party local delivery services where the cost is higher and our ability to control the quality of service is lower. We have limited experience in operating a courier service and cannot assure you that we will be able to do so consistently, reliably, or in a scalable manner. If we are unable to do so, our reputation, results of operations and prospects in China may be harmed. In addition, as we only recognize revenue upon delivery, delays in delivery of products would delay recognition of revenue and would adversely affect our operating results.

 

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Changes in the political and economic policies of China could have a material and adverse effect on the overall economic growth of China, which could reduce the demand for our products.

The Chinese economy differs from the economies of most developed countries in many respects, including the amount of government involvement, the level of development, the growth rate, the control of foreign exchange and the allocation of resources.

The Chinese government exercises significant control over China’s economic growth through the allocation of resources, control of the incurrence and payment of foreign currency-denominated obligations, setting of monetary policy and provision of preferential treatment to particular industries or companies. Changes in any of these policies, laws and regulations could adversely affect the overall economy in China or the industries in which we operate, which could harm our business. While the Chinese economy has grown significantly in the past 30 years, the growth has not been consistent geographically. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such a slowdown will not have a negative effect on our business. For example, due in part to the impact of the global crisis in financial services and credit markets and other factors, the growth rate of China’s gross domestic product decreased to 6.8% in the fourth quarter of 2008 and then to 6.1% in the first quarter of 2009, down from 11.9% reached in the second quarter of 2007. As a result, beginning in September 2008, the Chinese government, among other measures, adopted looser macroeconomic measures and monetary policies, such as reducing interest rates and decreasing the statutory reserve rates for banks. In addition, in November 2008 the Chinese government announced an economic stimulus package in the amount of $586 billion. While China’s economic growth rate has increased since the first quarter of 2009 to 7.9% in the second quarter of 2009, the Chinese government stated that its recovery momentum was not yet stable. We cannot assure you that the various macroeconomic measures, monetary policies and the economic stimulus package adopted by the Chinese government to guide economic growth and the allocation of resources will be effective in sustaining the recovery in the growth rate of the Chinese economy. In addition, such measures, even if they benefit the overall Chinese economy in the long-term, may adversely affect us if they reduce the disposable income of our Chinese customers.

We control our affiliated website in China, www.newegg.com.cn, by means of contractual arrangements. Our business could be adversely affected by the complexity of and uncertainties in China’s regulation of these contractual arrangements and Internet businesses and companies.

The Chinese government extensively regulates the Internet industry including foreign ownership of, and the licensing and permit requirements pertaining to, companies that do or conduct business online. These Internet-related laws and regulations are relatively new and evolving, and their interpretation and enforcement involve significant uncertainty. In addition, the Chinese government restricts foreign investment in Internet and online retail businesses. Accordingly, we operate our affiliated website, www.newegg.com.cn, and our online retail business in China through Shanghai Newegg E-Business Co., Ltd., or Newegg E-Business, a company wholly-owned by two Chinese citizens who are relatives of our Principal Stockholder. Newegg E-Business holds licenses and approvals necessary to operate our business in China. We have contractual arrangements with Newegg E-Business and its stockholders that allow us to substantially control Newegg E-Business. These contractual arrangements may not be as effective in providing control over Newegg E-Business as direct ownership. For example, Newegg E-Business could fail to take actions required for our business or fail to maintain our website despite its contractual obligation to do so. If Newegg E-Business fails to perform under its agreements with us, we may have to rely on legal remedies under Chinese law, which may not effectively protect us. Some of these contractual arrangements must be registered or filed with the Chinese government to be enforceable and we have not done so to date. In addition, we cannot assure you that the stockholders of Newegg E-Business will act in our best interests.

Although we believe we comply with current applicable Chinese regulations, we cannot assure you that the Chinese government would agree that these operating arrangements comply with current or future Chinese licensing, registration or other regulatory requirements and policies. If the Chinese government determines that

 

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we do not comply with applicable law, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, confiscate or block Newegg E-Business’ website, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers or take other regulatory or enforcement actions against us that could be harmful to our business.

Uncertainties with respect to the Chinese legal system could have a material adverse effect on our Chinese operations.

We conduct all of our Chinese operations through directly or indirectly owned business entities domiciled in China or through Newegg E-Business. Because many laws and regulations are relatively new and the Chinese legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not uniform and enforcement of these laws, regulations and rules involves uncertainties. We cannot predict the effect of future developments in the Chinese legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, the preemption of local regulations by national laws, or the overturn of local government’s decisions by higher level government. These uncertainties may limit legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and diversions of resources and management attention.

China’s consumer protection laws require product distributors to bear joint and several liability with producers. As such we could incur substantial liability as a result of deficiencies for products sold by us, particularly if the producer of such products goes bankrupt. China has also adopted mandatory rules with respect to the warranty period to be provided by distributors of products, which may be further extended in the future, resulting in additional costs to our business.

Furthermore, the relatively new labor and employment regulations in China, which strive to impose greater protection of workers’ rights, may adversely affect our operating results. Due to the fact that these laws are relatively new, there are still significant uncertainties in the interpretation and enforcement of these laws, and their effects depend on how the national and local governments choose to interpret and enforce them. If we do not fully comply with these new laws, we may risk incurring strict penalties for non-compliance. Furthermore, these new laws expand the legal rights of employees, which may hinder our ability to make changes to our workforce in the most efficient manner, thus potentially adversely affecting our results of operations and financial condition.

The Foreign Corrupt Practices Act, lax enforcement of Chinese anti-corruption laws and our policies requiring compliance with applicable laws may place us at a competitive disadvantage to competing businesses that do not follow such laws.

Despite Chinese laws prohibiting such practices, corruption, extortion, bribery, pay-offs and other fraudulent practices occur from time-to-time in China. It is our policy for employees to not engage in any such practices and to remain compliant with applicable laws governing such matters, including the requirements of the United States Foreign Corrupt Practices Act and Chinese anti-bribery and anti-corruption laws. Other companies that may compete with us, both foreign and local, may not operate to the same standard of compliance that we do. If our competitors engage in certain unethical or illegal practices, they may receive preferential treatment in obtaining or retaining business licenses or permits, or in avoiding undue harassment. As such, our policies in this regard may put us at a competitive disadvantage, which may have a material adverse effect on our results of operations and financial condition, particularly with respect to our ability to profitably grow our business in China.

Contract drafting, interpretation and enforcement in China involve significant uncertainty.

We have entered into numerous contracts governed by Chinese law, many of which are material to our Chinese business operations. As compared with contracts in the United States, contracts governed by Chinese law tend to contain less detail and are not as comprehensive in defining contracting parties’ rights and

 

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obligations. As a result, contracts in China are highly susceptible to disputes and legal challenges. In addition, contract interpretation and enforcement in China is not as developed as in the United States, and the result of any contract dispute is subject to significant uncertainties. Therefore, we cannot assure you that we will avoid disputes under our Chinese contracts, and if such disputes arise, we cannot assure you that we will prevail. Any dispute involving such contracts, even if without merit, may materially adversely affect our reputation and business operations in China.

There are financial risks related to the corporate income tax laws of China that could adversely affect our business.

Certain Newegg subsidiaries in China currently qualify for favorable tax status, including an exemption from the five percent Chinese business tax on qualifying service revenues and reduced corporate income tax rates. In the future, we may not qualify for favorable tax status or the Chinese authorities may eliminate our favorable tax status entirely, which would increase our costs for doing business in China. Moreover, we may be subject to adverse tax consequences if Chinese or U.S. tax authorities were to determine that the revenues generated in China by intercompany service transactions were not computed on an arms-length basis. Such a determination may result in lengthy and potentially costly negotiations under the competent authority provisions of any applicable income tax treaty, which may be settled on terms unfavorable to us. Additional taxes may also require us to increase the cost to purchase products from our affiliated website, www.newegg.com.cn, which could impair our ability to grow our market share and our long term expansion prospects in China.

We face risks related to health epidemics and other outbreaks.

Our business could be adversely affected by the effects of avian influenza, SARS, swine flu or other epidemics or outbreaks of disease. In 2005 and 2006, there were occurrences of avian influenza in various parts of China, including a few confirmed human cases, and in 2008, a national crisis erupted in China over the safety of its milk and milk products supply. Any prolonged recurrence of avian influenza, SARS, food contamination, or other adverse public health developments in China may interrupt our business operations and have a material adverse effect on our operations and financial results. For instance, health or other government regulations adopted in response to an epidemic or outbreak, or a severe disruption or increase in the pricing of basic food stuffs, may require temporary closure of our offices, increase our China compensation costs and prevent key Newegg personnel in China from working efficiently and effectively.

Dividends we receive from our subsidiaries located in China are subject to China’s withholding tax.

The Corporate Income Tax Law, or the CIT Law, came into effect on January 1, 2008. The CIT law imposes a maximum income tax rate of 20% on dividends payable to foreign investors classified as “non-resident enterprises,” to the extent that such dividends are derived from sources within China. However, such rate has been reduced to 10% pursuant to the Implementing Regulations for the PRC Corporate Income Tax Law issued by the State Council. In addition, a lower tax rate may be applied if there is a tax treaty arrangement between China and the jurisdiction of incorporation of the relevant foreign investor. Our foreign holding companies incorporated in the Cayman Islands invested in and established our China-based subsidiaries, such as Newegg Tech and Newegg Trading (China) Co., Ltd. Because the Cayman Islands does not have a tax treaty arrangement with China, dividends we receive from our China-based subsidiaries are subject to a 10% withholding tax rate as of January 1, 2008 under the CIT Law.

Restrictions on currency exchange may limit our ability to utilize our revenues effectively.

Substantially all of the revenues and operating expenses of our China operations are denominated in RMB. The RMB is currently freely convertible for current account transactions, which includes dividend distributions as well as trade and service-related foreign exchange matters. By contrast, the RMB is restricted for “capital account” transactions which include foreign direct investment. Our subsidiaries in China may currently purchase foreign exchange for settlement of “current account transactions,” including payment of dividends, without first

 

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obtaining approval from the State Administration for Foreign Exchange, or SAFE. Our subsidiaries in China may also retain foreign exchange in their respective current accounts, subject to a ceiling approved by the SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, it is possible that the relevant Chinese governmental authorities may limit or eliminate our ability to purchase and retain foreign exchange in the future. Because a significant amount of our future revenues may be denominated in RMB, all existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China as well as our expenditures denominated in foreign currencies.

Foreign exchange transactions relating to capital accounts are still subject to limitations and require approvals from SAFE. This could affect the ability of our subsidiaries in China to obtain foreign exchange through debt or equity financing, including by means of loans or capital contributions from us.

We may suffer currency exchange losses if the RMB depreciates relative to the U.S. dollar.

Our reporting currency is the U.S. dollar. However, substantially all the revenues of our China operations are denominated in RMB. If the RMB depreciates against the U.S. dollar, our revenues as expressed in our U.S. dollar-denominated financial statements will decline in value. On May 19, 2007, the People’s Bank of China announced a policy to expand the maximum daily floating range of RMB trading prices against the U.S. dollar in the inter-bank spot foreign exchange market from 0.3% to 0.5%. The international reactions to the RMB revaluation and widening of the RMB’s daily trading band have generally been positive. However, with the increased floating range of the RMB’s value against foreign currencies, it may appreciate or depreciate in value against the U.S. dollar or other foreign currencies in the long term, depending on the fluctuation of the basket of currencies against which it is currently valued. In addition, the types of hedging transactions available in China to reduce our exposure to exchange rate fluctuations are limited. We may decide to enter into hedging transactions in the future; however, the availability and effectiveness of such hedges may be limited and we may not be able to successfully hedge our exposure, if at all. In addition, our currency exchange losses may be magnified by China exchange control regulations that restrict our ability to convert RMB into U.S. dollars.

We may not be able to obtain cash from distributions to the extent such distributions are restricted by Chinese law or future debt covenants.

Current laws and regulations in China permit our subsidiaries in China to pay dividends to us only out of their accumulated distributable profits, if any, determined in accordance with their articles of association and Chinese accounting standards and regulations. The ability of our subsidiaries in China to make dividends and other payments to us may be restricted by factors that include changes in foreign exchange and other laws and regulations. In particular, under Chinese law, our subsidiaries in China may only pay dividends after 10% of their after-tax profits have been set aside as reserve funds, unless such reserves have reached at least 50% of their registered capital. Such reserves may not be distributed as cash dividends. Our subsidiaries in China are also required to allocate a portion of their after-tax profits, as determined by their respective boards of directors, to employee welfare and bonus funds, which cannot be distributed to their stockholders. In addition, if our operating subsidiaries in China incur debt on their own behalves in the future, the instruments governing such debt may restrict their ability to pay dividends or make other payments to us. Moreover, the profit available for distribution from our operating subsidiaries in China is determined in accordance with generally accepted accounting principles in China. The calculation of profit under generally accepted accounting principles in China may differ from the one that we must perform in accordance with accounting principles generally accepted in the United States of America. As a result, whether our subsidiaries in China have sufficient profit to enable dividend distributions to us or our stockholders in the future will depend on both generally accepted accounting principles in China as well as accounting principles generally accepted in the United States of America.

 

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Risks Relating to this Offering

There is no public market for our securities and an active trading market may not develop, which may affect the price of our Class A Common Stock and your ability to resell it.

There is no existing trading market for our Class A Common Stock or any of our securities. Although the underwriters have informed us that they intend to make a market in our shares, they have no obligation to do so and may discontinue making a market at any time without notice. Accordingly, we cannot assure you that a liquid market will develop for shares of our Class A Common Stock, that you will be able to sell your Newegg shares at any particular time or that the prices that you receive when you sell your shares of our Class A Common Stock will be favorable. The liquidity of any market for our shares will depend on a number of factors, including:

 

   

the number of stockholders;

 

   

the limitations on the nature and number of our stockholders;

 

   

our operating performance and financial condition;

 

   

the market for similar securities; and

 

   

the interest of securities dealers in making a market in the shares of our Class A Common Stock.

In addition, we may have difficulty attracting the attention of market analysts to cover us in their research. As a result, trading prices and your ability to sell your Newegg shares may be limited and adversely affected.

Depending on the initial public offering price of our Class A Common Stock, we may be subject to a put right by the holders of our Series B-2 Preferred Stock that could require us to issue additional shares of our Common Stock.

Under the terms of our Amended and Restated Certificate of Incorporation, if the initial public offering price, or IPO Price, of the Class A Common Stock is equal to or less than $9.26 per share, holders of Series B-2 Preferred Stock could request that each share of Series B-2 Preferred Stock held by such holder be redeemed by us by payment of a number of shares of Class A Common Stock equal to $12.36 divided by the IPO Price. If the IPO Price of the Class A Common Stock is equal to or greater than $9.27 per share but equal to or less than $12.36 per share, upon the closing of this offering, each Series B-2 Preferred Stock share will be redeemed by us by payment of a number of shares of either Class A Common Stock or Class B Common Stock equal to $12.36 divided by the IPO Price. See “Dilution—Preferred B-2 Put Right” for further discussion with respect to these rights.

After the offering, you will hold single-vote per share Class A Common Stock while the majority of Newegg’s voting power will be held by the holders of ten-vote per share Class B Common Stock. Our Principal Stockholder will continue to have substantial control over Newegg after this offering, which will severely limit your ability to influence or direct the outcome of key corporate actions and transactions, including a change in control.

Following the offering, you and all other investors in this offering will hold Class A Common Stock, which entitles each holder of such stock to one vote per share. All holders of Newegg’s Series A Preferred Stock and Series B-2 Preferred Stock prior to the offering who did not convert their shares into Class A Common Stock to sell in the offering may hold shares of Class B Common Stock that will entitle each holder of such stock to ten votes per share.

Our Principal Stockholder and entities affiliated with our Principal Stockholder will own or control approximately     % of the outstanding shares of our Class B Common Stock, which will have approximately     % of the voting power of all our shares, after this offering. As a result, our Principal Stockholder would be able to control matters requiring approval by our stockholders, including the election of directors, the approval of mergers and other extraordinary transactions. Mr. Chang may have interests that differ

 

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from yours and may vote in a way with which you disagree and which may be adverse to your interest. Furthermore, Mr. Chang will continue to control a majority of the outstanding votes as long as he holds more than 5% of our combined equity. The concentration of ownership could have the effect of delaying, preventing or deterring a change in control of our company, could deprive you and other holders of Class A Common Stock of an opportunity to receive a premium for your Class A Common Stock as part of a sale of our company and could negatively affect the market price of our Class A Common Stock.

We are a “controlled company” within the meaning of the                          rules and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.

After completion of this offering, our Principal Stockholder will continue to control a majority of the voting power of our outstanding common stock. As a result, we will be a “controlled company” within the meaning of the                              corporate governance standards. Under these rules, a company of which more than 50% of the voting power is held by an individual, group or another company, is a “controlled company,” and may elect not to comply with certain corporate governance requirements, including the requirement that a majority of our Board consists of independent directors. Following this offering, we intend to utilize this exemption to have an equal number of independent and non-independent directors. Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the                         .

A large number of additional shares may be sold in the near future, which may cause the market price of your Newegg shares to decline significantly, even if our business is doing well.

Sales of a substantial amount of our Class A Common Stock in the market, or the perception that these sales may occur, could adversely affect the market price of your Newegg shares. After this offering, we will have outstanding              shares of our Class A Common Stock. This includes the              shares we are selling in this offering, which may be resold immediately, and              shares which will become available for resale 180 days after the date of this prospectus (subject to extension in certain circumstances) under the terms of a lock-up agreement the holders of those shares have entered into with the underwriters of this offering. However, the underwriters of this offering can waive this restriction and allow these stockholders to sell their shares at any time after this offering. As restrictions on resale end, the market price of the Class A Common Stock could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them. For a more detailed description, see “Shares Eligible for Future Sale.”

Some provisions of our charter, bylaws and Delaware law inhibit potential acquisition bids and other actions that you may consider favorable.

Upon completion of this offering, our corporate documents and Delaware law will contain provisions that may enable our Board to resist a change in control of our company even if a change in control were to be considered favorable by you and other stockholders. These provisions include:

 

   

the authorization of undesignated Preferred Stock, the terms of which may be established and shares of which may be issued without stockholder approval;

 

   

advanced notice procedures required for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; and

 

   

a requirement that Board vacancies be filled by a majority of our directors then in office.

In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or consolidating with us except under certain circumstances.

 

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These provisions, the existence of Class B Common Stock with ten votes per share, and the fact that our Principal Stockholder holds a majority of such shares and overall voting power, could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to take certain corporate actions such as elect directors of your choosing.

New stockholders will incur substantial and immediate dilution as a result of this offering.

The price at which we are offering our Class A Common Stock is substantially higher than the book value per share of our outstanding Class A Common Stock. As a result, your Newegg shares will incur substantial and immediate dilution. At an assumed initial public offering price of $             per share, purchasers in this offering would experience dilution of approximately $             per share, representing the difference between our historical net tangible book value per share after giving effect to this offering and the assumed initial public offering price. In addition, you and other investors in this offering will have contributed     % of the aggregate price paid by all purchasers of our Common Stock but will own only approximately     % of our Common Stock outstanding (calculated on an as-converted basis) after this offering. In addition, we have issued options to acquire our Class A Common Stock at prices significantly below the assumed initial public offering price. To the extent such options are ultimately exercised, there will be further dilution to you and other investors in this offering. There will also be further dilution to the extent the holders of Series B-2 Preferred Stock exercise their put right. See “Dilution—Preferred B-2 Put Right.”

We have broad discretion as to the use of proceeds from this offering and may not use the proceeds effectively.

We estimate the net proceeds to us of this offering to be approximately $             million. Our management will retain broad discretion as to the allocation of the proceeds and may spend these proceeds in ways in which our stockholders may not agree. The failure of our management to apply these funds effectively could result in unfavorable returns and uncertainty about our prospects, both of which could cause the price of your Newegg shares to decline.

We do not expect to pay any dividends on our Class A Common Stock for the foreseeable future.

We do not anticipate that we will pay any dividends to holders of our Class A Common Stock in the foreseeable future. Accordingly, investors must rely on sales of their Newegg shares as the only way to realize any gains on their investment. Investors seeking or expecting cash dividends should not purchase our Class A Common Stock.

 

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FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus, including the sections entitled “ Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” contains forward-looking statements. In particular, statements regarding our plans, strategies, prospects and expectations regarding our business are forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks, uncertainties and other factors include, among others:

 

   

that our operations, business and net sales will not grow as anticipated;

 

   

that seasonal fluctuations in Internet usage, retail purchasing patterns and advertising are likely to affect our business;

 

   

that competition in the e-commerce market may affect our operating margins, profitability, market share and brand recognition;

 

   

that our e-commerce business in China will not be successful;

 

   

that our net sales or net income may decline if consumer demand for IT or CE products decreases or changes;

 

   

that our net sales or net income may decrease due to legislation or regulations that have been or may be enacted to impose or increase taxes on sales of products, or income generated from such sales, in any of the jurisdictions where we sell products;

 

   

that our ability to successfully operate our business and execute our business strategy may be impaired if members of our senior management team or other key personnel end their employment relationship with us;

 

   

that our operating margin may decrease as we invest in our employees, system infrastructures and property and equipment;

 

   

that we may incur future stock-based compensation charges;

 

   

that we will continue to make significant capital expenditure investments in 2009;

 

   

that we may be unable to upgrade our information technology systems and infrastructure to accommodate future traffic and service levels on our websites;

 

   

that selling and marketing and general and administrative expenses will increase in the future;

 

   

that our exposure to foreign currency risk will increase as we increase our operations and sales in China and Canada;

 

   

that our existing cash, cash equivalents, marketable securities and cash generated from operations will not be sufficient; and

 

   

other statements regarding our future operations, financial condition, financial performance and prospects and business strategies.

Forward-looking statements include all statements that are not historical facts. In some cases, you can identify forward-looking statements by terminology such as “anticipates,” “believes,” “continue,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” “could,” “would,” “will” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or

 

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achievements. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this prospectus. You should be aware that the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933, as amended, or the Securities Act, do not exempt from liability any forward-looking statements that we make in connection with this offering.

This prospectus contains estimates and other data concerning our industry, such as market size and growth rates that we obtained from reports generated by Forrester Research, Inc., Internet Retailer, IDC, the McKinsey Global Institute, Euromonitor International and Gomez. These industry publications and reports generally indicate that they have obtained their information from sources believed to be reliable, but the sources do not guarantee the accuracy and completeness of their information. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

 

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USE OF PROCEEDS

We estimate that the net proceeds from our sale of              shares of Class A Common Stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the price range set forth on the front cover of this prospectus, after deducting estimated offering expenses and underwriting discounts, will be approximately $             million, or $             million if the underwriters’ over-allotment option to purchase additional shares is exercised in full. A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering by $             million, assuming the number of shares offered by us, as set forth on the front cover of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions. We will not receive any proceeds from the sale of shares of our Class A Common Stock by the selling stockholders.

We presently intend to use the net proceeds of this offering in the next twelve months as follows:

 

   

approximately $25.0 million to expand our international operations, including to build our Asian headquarters and a regional warehouse, fund operating expenses in China and improve logistics infrastructure of our Canadian operations;

 

   

approximately $8.6 million to repay: (i) a $7.5 million outstanding loan bearing interest at 6.3% per annum, due October 2010, and personally guaranteed by our Principal Stockholder, and (ii) a $1.1 million outstanding loan bearing interest at 6.048%, due October 2014; and

 

   

the balance for working capital and general corporate purposes, including IT and logistics infrastructure improvement, additional facilities and equipment, the creation of redundant IT infrastructure, efforts to increase market share through product and shipping promotional activities, branding campaigns and launching third party e-commerce fulfillment and marketing service platforms.

We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products, websites or technologies or to enter into strategic relationships with third parties. We have no present understandings, commitments or agreements to enter into any acquisitions or investments. The amount actually expended for the purposes listed above will depend upon a number of factors, including the growth of our sales and customer base, competitive developments in e-commerce, the actual cost of capital expenditures and our cash flow from operations and the growth of our business. Our management will have broad discretion over the uses of the net proceeds from this offering. Pending these uses, we intend to invest the net proceeds from this offering in short-term, investment-grade interest-bearing securities, such as money market accounts, certificates of deposits, commercial paper and guaranteed obligations of the U.S. government.

 

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DIVIDEND POLICY

We have never declared or paid dividends on any of our Common Stock or Preferred Stock. We currently intend to retain any future earnings to finance the operations, growth and development of our business, and we do not anticipate that we will declare or pay any cash dividends on any of our Common Stock in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our Board and will be dependent upon our financial condition, results of operations, capital requirements, restrictions under any existing indebtedness and other factors our Board deems relevant.

 

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CAPITALIZATION

The following table presents a summary of our cash and cash equivalents and capitalization data as of June 30, 2009:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the conversion of all outstanding shares of our Preferred Stock into shares of either Class A Common Stock or Class B Common Stock upon the consummation of the offering, and assuming we are not subject to a put right by holders of our Series B-2 Preferred Stock, as discussed under “Dilution—Preferred B-2 Put Right”; and

 

   

on a pro forma as adjusted basis to give further effect to the sale by us of shares of Class A Common Stock at an assumed initial public offering price of $             per share, after deducting estimated expenses payable by us and underwriting discounts and commissions and the application of a portion of the net proceeds to repay certain indebtedness as described in “Use of Proceeds.”

This table should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

     June 30, 2009
(Unaudited)
     Actual     Pro
Forma
   Pro Forma
As Adjusted
(in thousands, except share data)                

Cash and cash equivalents

   $ 42,241      $      $             
                     

Total long-term debt and leases payable, including current portion

   $ 15,300      $      $  

Temporary equity:

       

Single Vote Series B-1 redeemable convertible Preferred Stock, $0.001 par value; 10,517,799 shares authorized; none issued or outstanding as of June 30, 2009 (unaudited) and on a pro forma and pro forma as adjusted basis as of June 30, 2009 (unaudited)

            

Series B-1 redeemable convertible Preferred Stock, $0.001 par value; 10,517,799 shares authorized; 1,614,823 shares issued and outstanding as of June 30, 2009 (unaudited); aggregate liquidation preference of $10,000, aggregate redemption value of $20,000; none issued and outstanding on a pro forma and pro forma as adjusted basis as of June 30, 2009 (unaudited)

     14,093        

Series B-2 redeemable convertible Preferred Stock, $0.001 par value; 4,854,369 shares authorized; 3,236,246 shares issued and outstanding as of June 30, 2009 (unaudited); aggregate liquidation preference of $20,000, aggregate redemption value of $40,000; none issued and outstanding on a pro forma and pro forma as adjusted basis as of June 30, 2009 (unaudited)

     38,130        
                     

Total temporary equity

     52,223        
                     

Stockholders’ equity:

       

Series A convertible Preferred Stock, $0.001 par value; 59,000,000 shares authorized; 48,777,573 shares issued and outstanding as of June 30, 2009 (unaudited); none issued and outstanding on a pro forma and pro forma as adjusted basis as of June 30, 2009 (unaudited)

     49        

Class A Common Stock, $0.001 par value; 142,000,000 shares authorized; 112,395 shares issued and outstanding as of June 30, 2009 (unaudited);             shares issued and outstanding on a pro forma basis and              shares issued on a pro forma as adjusted basis as of June 30, 2009 (unaudited)

            

Class B Common Stock, $0.001 par value; 59,000,000 shares authorized; none issued or outstanding as of June 30, 2009 (unaudited);             shares issued and outstanding on a pro forma and pro forma as adjusted basis as of June 30, 2009 (unaudited)

            

Additional paid-in capital

     4,314        

Loans receivable from stockholder

     (888         

Accumulated other comprehensive income

     2,289        

Retained earnings

     34,480        
                     

Total Newegg Inc. stockholders’ equity

     40,244        

Noncontrolling interest

     (300     
                     

Total stockholders’ equity

     39,944        
                     

Total capitalization

   $ 107,467      $                 $             
                     

 

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The numbers of pro forma and pro forma as adjusted shares of our Class A Common Stock and Class B Common Stock as issued and outstanding in the table above are based on the number of shares outstanding as of June 30, 2009:

 

   

excluding 5,774,756 shares of our Class A Common Stock issuable upon the exercise of outstanding options at a weighted average exercise price of $5.15 per share;

 

   

excluding 8,338,522 additional shares of our Class A Common Stock reserved for future grant or issuance under our stock option plans; and

 

   

assuming no over-allotment exercise.

 

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DILUTION

Our pro forma net tangible book value as of June 30, 2009 was approximately $                 million, or $             per share of Common Stock. Pro forma tangible net book value per share represents our total tangible assets less total liabilities divided by the number of shares of Common Stock outstanding as of June 30, 2009 after giving effect to the conversion of our Preferred Stock. Our pro forma net tangible book value as adjusted as of June 30, 2009 would have been $             million, or $             per share of Common Stock after giving effect to the sale of              shares of Class A Common Stock in this offering at an assumed IPO Price of $             per share, and after deducting estimated offering expenses payable by us and underwriting discounts and commissions. This represents an immediate increase in pro forma net tangible book value of $             per share of Common Stock to existing stockholders and an immediate dilution in pro forma net tangible book value of $             per share to investors purchasing Class A Common Stock in this offering.

The following table illustrates this per share dilution:

 

Assumed initial public offering price per share of Class A Common Stock

   $             

Pro forma net tangible book value per share of Common Stock as of June 30, 2009

  

Increase in net tangible book value per share of Common Stock attributable to this offering

  

Pro forma net tangible book value per share of Common Stock as adjusted after this offering

  

Dilution per share of Common Stock to new investors in this offering

   $             
      

If all of our outstanding options had been exercised, our pro form net tangible book value as of June 30, 2009 would have been $             million , or $             per share, and the pro forma as adjusted net tangible book value after this offering would have been $             million, or $             per share, causing dilution to new investors of $             per share.

The following table summarizes, on a pro forma as adjusted basis as of June 30, 2009, the total number of shares of Common Stock purchased from us, the total consideration paid to us and the average price per share of Common Stock paid to us by existing stockholders and by new investors in this offering, assuming an initial offering price of $             per share of Class A Common Stock and before deducting estimated underwriter discounts and commissions and estimated offering expenses payable by us:

 

     Shares Purchased     Total Consideration     Average
Price per
Share
     Number    Percent     Amount    Percent    

Existing stockholders for Common Stock

            

New investors for Class A Common Stock

            

Total

      100      100  
                          

If the underwriters exercise their over-allotment option in full, our existing stockholders would own     % and our new investors would own     % of the total number of shares of our Common Stock outstanding after this offering.

Assuming the exercise in full of all options outstanding and exercisable as of June 30, 2009, the average price per share paid by our existing stockholders would be reduced by $             per share to $             per share of Common Stock.

 

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Preferred B-2 Put Right

Holders of our Series B-2 Preferred Stock may have a right to put those shares to us in exchange for shares of either our Class A Common Stock or Class B Common Stock, depending on the IPO Price in this offering, as summarized below.

   

If the IPO Price is equal to or less than $9.26 per share, then each share of Series B-2 Preferred Stock may be exchanged for a number of shares of our Class A Common Stock equal to $12.36 divided by the IPO Price.

 

   

If the IPO Price is greater than $9.26 per share and equal to or less than $12.36 per share, then each share of Series B-2 Preferred Stock may be exchanged at the election of the holder for a number of shares of either our Class A Common Stock or Class B Common Stock, equal to $12.36 divided by the IPO Price.

As of June 30, 2009, 3,236,246 shares of Series B-2 Preferred Stock were outstanding. All information in this prospectus assumes that the IPO Price of our Class A Common Stock will be above $12.36 per share.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

You should read the following selected consolidated financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. The summary consolidated financial data as of and for the years ended December 31, 2004 and 2005 are derived from our consolidated financial statements and related notes not included herein. The financial data as of and for the years ended December 31, 2004 and 2005 have been revised to reflect the adoption of Statement of Financial Accounting Standards No. 160, Noncontrolling Interests and Consolidated Financial Statements—An amendment to ARB No. 51. The consolidated financial data as of and for the years ended December 31, 2006, 2007, and 2008 are derived from audited consolidated financial statements included elsewhere in this prospectus. The consolidated financial data as of and for the six months ended June 30, 2008 and 2009 have been derived from, and are qualified by reference to, our unaudited consolidated financial statements that are included in this prospectus. The unaudited consolidated financial statements include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, that management considers necessary for the fair presentation of the financial information set forth in those statements.

 

Consolidated Statements of Income:   Year Ended December 31,     Six Months Ended
June 30,
 
(in thousands, except for share data)   2004     2005     2006     2007     2008     2008     2009  

Net sales

  $ 982,063      $ 1,256,006      $ 1,468,145      $ 1,863,216      $ 2,108,699      $ 1,029,740      $ 1,105,474   

Cost of sales

    904,882        1,144,364        1,325,746        1,670,978        1,873,617        918,065        984,466   
                                                       

Gross profit

    77,181        111,642        142,399        192,238        235,082        111,675        121,008   

Selling, general and administrative expenses

    73,813        108,787        121,577        162,431        183,683        89,339        93,320   
                                                       

Income from operations

    3,368        2,855        20,822        29,807        51,399        22,336        27,688   

Interest income

    (209     (343     (1,167     (1,814     (1,130     (615     (298

Interest expense

    684        1,322        1,600        1,133        1,498        770        542   

Other (income) expense, net

    (12     (167     (137     (856     (251     (135     (82
                                                       

Income before provision for income taxes, loss on equity method investment and net loss attributable to the noncontrolling interest

    2,905        2,043        20,526        31,344        51,282        22,316        27,526   

Provision for income taxes

    508        431        8,155        12,692        22,005        8,955        11,729   

Loss on equity method investment

                                447        319          
                                                       

Net income

    2,397        1,612        12,371        18,652        28,830        13,042        15,797   

Net loss attributable to the noncontrolling interest

           147        243                             301   
                                                       

Net income attributable to Newegg Inc.

    2,397        1,759        12,614        18,652        28,830        13,042        16,098   

Accretion of Series B-1 and B-2 redeemable convertible Preferred Stock

           885        5,185        6,138        7,304        3,494        4,166   
                                                       

Net income available to common stockholders of Newegg Inc.

  $ 2,397      $ 874      $ 7,429      $ 12,514      $ 21,526      $ 9,548      $ 11,932   
                                                       

Earnings per share of Class A Common Stock (1)(2):

             

Basic

  $ 0.05      $ 0.02      $ 0.09      $ 0.18      $ 0.34      $ 0.12      $ 0.18   
                                                       

Diluted

  $ 0.05      $ 0.02      $ 0.09      $ 0.18      $ 0.34      $ 0.12      $ 0.18   
                                                       

Weighted average shares of Class A Common Stock outstanding used in computing earnings per share of Class A Common Stock (1)(2):

             

Basic

    52,038        39,029        1        4        5        5        59   
                                                       

Diluted

    52,038        52,435        5        11        5        5        59   
                                                       

 

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Consolidated Statements of Income:   Year Ended December 31,   Six Months Ended
June 30,
(in thousands, except for share data)   2004   2005   2006   2007   2008   2008   2009

Pro forma earnings per share of Class A and Class B Common Stock (unaudited) (3):

             

Basic

          $       $  
                     

Diluted

          $       $  
                     

Pro forma weighted average shares of Class A and Class B Common Stock outstanding used in computing pro forma earnings per share of Class A and Class B Common Stock (unaudited) (3):

             

Basic

             
                     

Diluted

             
                     

 

(1) The weighted average shares of Class A Common Stock outstanding used in computing the 2004 earnings per share of Class A Common Stock was derived from the weighted average shares of Series A convertible Preferred Stock effective immediately after our 2005 corporate reorganization as if converted on a 1:1 ratio into Common Stock. There was no stock activity in 2004 through the 2005 reorganization.
(2) Basic and diluted earnings per share for the years ended December 31, 2006, 2007 and 2008 and for the six months ended June 30, 2008 and 2009 are calculated using the two-class method. Refer to Note 3—“Earnings per share” to our consolidated financial statements included elsewhere in this prospectus.
(3) For a description of the pro forma adjustments used to calculate pro forma earnings per share for the year ended December 31, 2008 and for the six months ended June 30, 2009, refer to Note 3—“Earnings per share: Unaudited pro forma earnings per share” to our consolidated financial statements included elsewhere in this prospectus.

 

Consolidated Balance Sheet Data:

   December 31,     June 30,  
   2004     2005     2006     2007     2008     2008     2009  
(in thousands)                                     

Cash and cash equivalents

   $ 9,031      $ 39,725      $ 61,659      $ 83,491      $ 84,404      $ 68,258      $ 42,241   

Accounts receivable, net

     4,356        11,249        15,547        20,632        31,081        20,401        26,113   

Inventories

     58,067        73,117        100,277        138,543        161,265        122,207        155,032   

Property and equipment, net

     25,509        38,654        42,261        48,773        46,063        48,851        43,437   

Total assets

     104,983        169,873        227,855        300,251        340,047        268,327        287,014   

Long-term debt and leases payable, less current portion

     13,333        11,995        12,811        16,623        14,027        15,356        12,896   

Total liabilities

     108,818        144,861        189,737        243,165        265,579        196,578        194,847   

Total temporary equity

            29,049        34,635        40,753        48,057        44,247        52,223   

Total stockholders’ equity (deficit)

     (3,835     (4,237     3,483        16,333        26,411        27,504        39,944   

Consolidated Statements of Cash Flows
Data:

   December 31,     June 30,  
   2004     2005     2006     2007     2008     2008     2009  
(in thousands)                                           

Net cash provided by (used in) operating activities

   $ 8,284      $ 10,943      $ 38,928      $ 30,153      $ 27,227      $ (9,027   $ (37,808

Net cash used in investing activities

     (17,266     (10,958     (8,871     (8,626     (8,790     (5,421     (2,852

Net cash provided by (used in) financing activities

     5,553        30,657        (8,308     (146     (18,360     (1,648     (1,506

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with our selected consolidated financial data and the consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under the section entitled “Risk Factors” and elsewhere in this prospectus, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

We are a leading e-commerce company operating in North America and China. Our focus is on selling IT products including computer hardware, software and peripherals, and CE products to consumers and increasingly to small and medium-sized businesses. Since launching our e-commerce platform in 2001, a majority of our net sales and net income have been generated by selling IT products in the United States through our principal U.S. website, www.newegg.com. We have succeeded in building and leveraging our platform, customer base and brand to expand from IT into CE product sales and in growing our e-commerce business outside of the United States in China and Canada.

We have been profitable every year since launching our e-commerce platform in 2001 and have grown rapidly. We generate net sales principally from the sale of IT and CE products and, to a lesser extent, through amounts billed to customers for shipping and handling costs, or freight revenue. In 2008, we generated net sales of $2.1 billion, income from operations of $51.4 million and net income of $28.8 million. For the first half of 2009, we had net sales of $1.1 billion, income from operations of $27.7 million and net income of $15.8 million. As of June 30, 2009, our U.S. website had 12.6 million registered users and 4.1 million active customers.

Our U.S. business model allows us to deploy our capital efficiently. We are able to do this through targeted capital investment, careful management of our working capital and a focus on profitable operations. Since our launch in 2001, we have fueled our growth largely by reinvesting our profits into our business, with limited funding from external sources. Our deep knowledge of our U.S. customers’ buying patterns and the scale of our U.S. business have allowed us to efficiently manage our inventory levels. Our brand recognition in the United States among our target customers allows us to minimize customer acquisition costs. For December 31, 2006, 2007 and 2008, our advertising and marketing expense as a percentage of net sales has been approximately 1.1%, 1.2% and 1.0%, respectively, which we believe is lower as a percentage of net sales than many of our competitors. In our China operations, because our vendors typically require payment by us upon receipt of goods from them, we will require greater levels of working capital as our sales grow.

Our results of operations are affected by the health of the overall economy in general, as well as the market for IT and CE products in particular. The current economic downturn, which began in late 2007, has had an adverse effect on our overall sales growth, although increasing penetration of online sales and the overall growth of our business has mitigated its impact. For example, the failure of one of our principal competitors, Circuit City, during this time period may have driven incremental business to our website notwithstanding the overall difficult market for IT and CE products. If conditions continue to be challenging, it may have an adverse effect on our future results and render it difficult for us to anticipate future trends and inventory requirements.

The rapidly changing market for IT and CE products also impacts our results as major software and hardware introductions by our vendors can drive sales in a given period. Similarly, our results are impacted by seasonal trends, including the holiday and back-to-school shopping periods. Increasingly, competitive pressures are requiring us to offer shipping at little or no cost to the customer. As a result, we anticipate that shipping will evolve from a historically profitable component of our business to a cost that helps drive product sales.

 

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In the last two years, we have been taking significant steps to expand our sales beyond the United States, with a focus on China and Canada. For 2006, 2007 and 2008, and the first half of 2008 and 2009, the percentage of sales outside of the United States has been 0.6%, 0.7%, 1.6%, 1.2% and 5.6%, respectively. In particular, we are in the process of building our e-commerce business in China. The implementation of our e-commerce platform in the Chinese market, while presenting substantial opportunities for growth, presents many challenges, and we expect to experience significant challenges as we attempt to scale the business to a level that will generate net income. In particular, we will need to overcome low penetration of electronic payment systems, limited local delivery networks and infrastructure, small order sizes, localized and inconsistent government regulation and a consumer base that is not familiar with our brand. In addition, vendors generally offer only cash on delivery payment terms so our working capital requirements in China will grow if our business grows, which is different than what we have experienced in the United States. We also must learn to manage a business in China that includes household appliances, a new product category for us.

We were originally incorporated in California on February 4, 2000, as Newegg Computers and operated in concert with several other affiliated companies under common ownership and management. On September 29, 2005, these affiliates were reorganized to become either direct or indirect subsidiaries of Newegg Computers. On the same date, Newegg Computers was reincorporated in Delaware as Newegg Inc. and converted from an S corporation to a C corporation for federal income tax purposes.

Strategic Initiatives

Our key strategic initiatives include growing our online retail operations in China, expanding our sales to small and medium-sized businesses, growing our online retail operations in Canada and applying our e-commerce platform to other product categories. In 2008, we began expanding our sales efforts in China by opening order processing centers, or OPCs, in several major metropolitan areas. In the third quarter of fiscal 2009, we launched www.biz.newegg.com, a website targeted to the needs of small and medium-sized businesses and added the ability for approved business customers to make purchases via purchase orders, or POs, and to obtain 30-day payment terms. In October of 2008, we launched an e-commerce website, www.newegg.ca, to offer IT and CE products for sale to the Canadian market. We have successfully expanded our business focus from the sale of just IT products to also include CE products, as well as household appliances principally in China, and we plan to continue to expand into other product categories and service offerings.

Geographic Presence

Our corporate headquarters, marketing, purchasing, core customer service and logistics operations are located in and around the City of Industry, California. We maintain regional OPCs in Southern California, Tennessee, New Jersey and Metropolitan Toronto to fulfill customer orders in the United States and Canada, and several smaller OPCs in China, each generally intended to fulfill or distribute orders predominantly in their immediate metropolitan areas. We have opened and operate global support service operations in China, including website development, e-mail and live chat customer service, management information systems support, product management and other back-office support, in order to benefit from lower costs there. We also provide website development shared services from our Taipei, Taiwan location.

Performance Metrics

We review various performance metrics to help us evaluate our financial condition and operating performance. Management reviews the following financial metrics by geography: product sales, freight revenue, product and freight margin, vendor incentives, income from operations and adjusted EBITDA, which is measured by net income adjusted to add back our provision for income taxes, interest income, interest expense and non-cash expenses relating to depreciation, amortization and stock-based compensation expense. In addition, management reviews certain non-financial measures such as the number of total visits to our website, average order value, active customers, number of new customers, activity by new and repeat customers, shipping and delivery times and customer satisfaction ratings.

 

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Basis of Presentation

General

We report consolidated operations in U.S. dollars and operate in two geographic segments: North America and China. The North America segment is comprised of our operations in the United States and Canada. For further discussion of financial information about our geographical areas and reportable segments, see Note 17, “Segment and geographical information,” to our consolidated financial statements, which are included elsewhere in this prospectus.

Net Sales

Our net sales consist primarily of online retail sales to end users of IT and CE products. Major IT product categories include hard drives, personal computers and laptops, memory products, and central processing units, or CPUs. Major CE product categories include home video equipment, digital cameras, video games and consoles and home audio equipment. We offer a broad selection of brand-name products and sell our in-house brands, ABS and Rosewill, for certain IT components and peripherals, which are manufactured to our specifications by third parties. We recognize revenue from the sale of products upon customer receipt of the items ordered. However, in North America, payment generally occurs when customers place orders, their payment methods are approved and items are shipped. This results in our deferring recognition of revenue from the time of actual payment to the time ordered items are received by our customer, which is generally a few days later.

We believe the principal factors affecting our net sales include the number of unique visits to our website, our ability to convert those visits to orders and the average order value. We seek to increase each of these three measures in order to increase our net sales. The number of orders we received has increased each year since we began operations in 2001. Average order value and our ability to convert visits to orders have fluctuated from time to time, and we anticipate that they will continue to do so in the future in response to economic conditions, product mix, new product releases, the level of competition we face, the type of marketing channels we utilize and purchasing patterns of our customer base.

Our net sales are reported net of anticipated returns, allowances and credit card chargebacks, which are all estimated from historical experience. We also offer discounts, mail-in rebates and customer promotional programs, which we record as reductions in sales based on anticipated redemption rates estimated from historical experience. Freight revenues are recorded for amounts billed to our customers and are recognized at the time of product delivery. Revenue from the sale of gift cards is deferred and included in net sales when the cards are redeemed. We record revenue from the sale of third-party extended warranty programs on a net basis and include solely our commission on warranty sales at the time of sale.

Cost of Sales

Our cost of sales is primarily composed of the cost of the products we sell. Our cost of sales also includes the cost of shipping goods to us and to our customers, charges and reserves related to scrapped, refurbished, lost, slow-moving or obsolete inventory, and prior to February 2005, the estimated cost of fulfilling extended warranties.

Cost of sales is partially offset by payments we earn under vendor incentive programs, or VIPs, such as marketing development funds that vendors give to us to advertise their products, cooperative marketing programs jointly funded with vendors, price protection refunds to offset reductions in the manufacturer’s suggested retail price and volume incentive rebates. These VIPs are typically conditioned on our purchase or the sale of minimum quantities of products from the manufacturer, and therefore we treat these program payments as reductions to the prices we pay to vendors for their products. However, when the inventory relating to a vendor incentive program

 

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is still on hand at the end of an accounting period, the related payment is recorded as a reduction to inventory for the period. Reimbursements from VIPs are often received up to two quarters after they are earned, resulting in accounts receivable from such vendors.

Selling, General and Administrative Expenses

The largest component of our selling, general and administrative expenses is employee compensation costs. As of June 30, 2009, we employed 2,062 full-time employees, of which approximately half were based in China. Employees based in China perform e-commerce services and various shared service functions such as website development and maintenance, customer service, general administration, product management, purchasing and marketing. We also employ temporary personnel to meet our needs in areas such as customer service and fulfillment during seasonal peaks in orders. We expect our compensation costs to increase as we add new employees in order to service our anticipated growth initiatives in China, Canada and the United States. In 2008, we began recognizing stock-based compensation expense for stock option grants and stock grants we awarded or modified in 2008. Our stock option grants typically vest between four and eight years from the date of grant.

Other significant components of selling, general and administrative expenses include payment and credit card processing fees and direct costs for advertising and marketing (which include search engine referral fees). In addition, selling, general and administrative expenses includes depreciation and amortization, professional fees, litigation costs, rent expense, information technology expenses, warehouse costs, office expenses and other general corporate costs.

Interest Income and Expense

Interest income is earned on cash invested in money market accounts or certificates of deposit. Interest expense includes the interest we are charged on our debt and capital leases.

Other (Income) Expense, Net

Other (income) expense, net, consists of foreign exchange gains and losses and other non-operating items.

Provision for Income Taxes

The provision for income taxes is composed of federal, state, local and foreign taxes based on income. Prior to 2005, we were organized as an S Corporation and were exempt from federal income taxes in the United States.

Net Loss Attributable to the Noncontrolling Interest

We sell our products on www.newegg.com.cn in China through a series of contractual relationships with Shanghai Newegg E-Business Co., Ltd., or Newegg E-Business, which is domiciled in China and whose capital stock is wholly-owned by two citizens of China who are relatives of our Principal Stockholder.

Because Newegg E-Business is a variable interest entity and we are the primary beneficiary of the activities of that entity, its financial results are included in our consolidated financial statements for the years ended December 31, 2006, 2007 and 2008 and the first half of 2008 and 2009. SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51,” or SFAS 160, requires an entity to present most noncontrolling interests as a component of equity and also requires an entity to present net income and consolidated comprehensive income attributable to the parent and the noncontrolling interest separately in the consolidated financial statements.

Upon adoption of SFAS 160 on January 1, 2009, operating results from Newegg E-Business are reported as a component of stockholders’ equity in the consolidated balance sheets for all periods presented. Net income attributable to us in the consolidated statements of income excludes the net loss attributable to Newegg E-Business as compared to the previous standard, where net loss attributable to minority interests was included in the determination of net income attributable to us.

 

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For a further discussion of this relationship, see Principles of Consolidation in Note 2, “Summary of Significant Accounting Policies,” to our consolidated financial statements, which are included elsewhere in this prospectus.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales, costs and expenses, as well as the disclosure of contingent assets and liabilities and other related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of our assets and liabilities that are not readily apparent from other sources. In many instances, we could have reasonably used different accounting estimates. Actual results could differ from those estimates, and we include any revisions to our estimates in our results for the period in which the actual amounts become known.

We believe the critical accounting policies described below affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our historical consolidated financial condition and results of operations:

Revenue Recognition

We recognize revenue on our product sales to customers when persuasive evidence of an arrangement exists, both title and risk of loss are passed to the customer upon delivery of the products, the sales price is fixed or determinable and collectability is reasonably assured. We generally require payment by credit card upon placement of an order, and to a limited extent, grant credit to business customers on 30-day terms. Net sales are reported net of estimated returns and allowances, and credit card chargebacks, based on historical experience. Amounts billed to customers for shipping and handling costs are included in net sales. Amounts collected, or amounts invoiced and due, related to net sales where receipt by the customer has not yet occurred or revenue cannot be recognized, are reflected on the balance sheet as deferred revenue and are recognized when the applicable revenue recognition criteria have been satisfied.

For all products that are directly shipped from suppliers to customers, a practice we refer to as virtual fulfillment, we take title to these products only upon shipment. Because we bear the inventory and credit risks when we take title, sales under these arrangements are recognized at the gross sales amount upon receipt of the product by the customer.

We offer extended warranty programs for various products on behalf of an unrelated third-party. We account for the sale of separate extended warranty programs in accordance with Emerging Issues Task Force, or EITF No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent.” We record revenue from the sale of extended warranty programs on a net basis at the time of sale, as we are not the primary obligor of the extended warranty program and have no ongoing obligation. Revenue earned from the sale of extended warranties during the years ended December 31, 2006, 2007 and 2008 and the first half of 2008 and 2009 was not material to the consolidated financial statements.

We frequently offer sales incentives including discounts, mail-in rebates, and other customer promotional programs, which are recorded as reductions of revenue in accordance with EITF No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).”

Sales are reported net of estimated returns and allowances and credit card chargebacks, based on historical experience. Our return policy is generally 30 days. At each period end, we analyze the pattern of returns over the trailing 24 months and record a reserve to reverse the estimated sales that are expected to be returned. Historically, our actual return rate has not fluctuated materially from these estimates. We also estimate a reserve

 

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for credit card chargebacks based on historical experience. The effect of these chargebacks on revenues has historically not been significant.

Payments Received from Vendors

We engage in the preferential placement of advertisements for certain products and links on our website on behalf of sponsoring vendors and manufacturers to ensure greater visibility with consumers. We may also promote certain products in trade magazines and other advertising or marketing programs. The amounts we will receive under these and other VIPs are accounted for in accordance with EITF No. 02-16, “Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor.” We account for such payments as a reduction of the price we pay vendors for their products. Such price reductions are recognized as a reduction of cost of sales in the consolidated statements of income or, if the product inventory is still on hand at the reporting date, as a reduction to inventory in the consolidated balance sheets. Amounts due to us from vendors pursuant to VIPs, net of allowances, are included in the accompanying consolidated balance sheets in accounts receivable. On a limited basis, we receive direct reimbursements for costs incurred by us in advertising our vendors’ products. In these instances, the amounts we receive are recorded as an offset to marketing expenses in our consolidated statements of income.

Allowance for Doubtful Accounts

We maintain an allowance for uncollectible receivables relating to VIPs. We determine the sufficiency of the vendor receivables allowance based upon historical experience and other factors. Amounts received from vendors may vary from amounts recorded in the event of non-compliance with certain elements of vendor programs. If actual experience with these factors varies significantly from our estimates, we may be required to adjust our allowance. Historical variances of these amounts from our estimates have not resulted in material adjustments to our financial statements. In addition, as we increasingly extend 30-day credit terms to our business customers, we expect our allowance for uncollectible receivables to increase.

Cost of Sales

Inventory consists of finished goods available-for-sale and is valued at the lower of cost or market, determined using the first in, first out method. We purchase inventory from suppliers both domestically and internationally, primarily in Taiwan and China. We believe that our products are generally available from more than one supplier, and we maintain multiple sourcing arrangements for most products we offer. Because of the continued demand for our products, we primarily purchase products in bulk quantities to take advantage of quantity discounts and to ensure inventory availability. Inventory is reported net of inventory reserves for slow-moving, obsolete or scrap product, which are established based on specific identification of slow-moving items and the evaluation of overstock considering anticipated sales levels. Generally, we fully reserve for inventory if it remains unsold for 180 days. If actual market conditions are less favorable than those anticipated by management, additional reserves may be required.

In-bound freight-related costs are included as part of the cost of merchandise held for resale. Out-bound shipping and handling costs for product shipments to our customers are also included in cost of sales.

Income Taxes

We utilize the liability method of accounting for income taxes. Significant judgment is required in determining the consolidated provision for income taxes and evaluating our tax positions. In the ordinary course of business, there are many transactions and calculations for which the ultimate tax settlement is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite our belief that our tax return positions are supportable, we believe that it is more likely than not that those positions may not be fully sustained upon review by tax authorities. We are required to file income tax returns in the United States and various foreign jurisdictions, which requires us to

 

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interpret the applicable tax laws and regulations in effect in such jurisdictions. Such returns are subject to audit by the various federal, state and foreign taxing authorities, who may disagree with respect to our tax positions. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. We review and update our estimates in light of changing facts and circumstances, such as the closing of a tax audit, the lapse of a statute of limitations or a material change in estimate. To the extent that the final tax outcome of these matters differs from our expectations, such differences will impact income tax expense in the period in which such determination is made.

Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109, ‘Accounting for Income Taxes,’” relating to uncertain tax positions which prescribes a recognition threshold and measurement process for recording in our consolidated financial statements uncertain tax positions taken, or expected to be taken, in a tax return. FIN 48 also provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The standard requires us to recognize the financial statement effects of an uncertain tax position when it is more likely than not that such position will be sustained upon audit. The adoption of this standard effective January 1, 2007 had no material effect on our consolidated financial statements. As of December 31, 2008, we have increased our accrual for uncertain tax benefits as discussed in Note 10, “Income Taxes,” to our consolidated financial statements.

In addition to estimates inherent in the recognition of taxes payable, we estimate the likelihood that we will be able to recover our deferred tax assets each reporting period. Realization of our deferred tax assets is dependent upon future taxable income. To the extent we believe it is more likely than not that some portion or all of our net deferred tax assets will not be realized, we establish a valuation allowance recorded against deferred tax assets. Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence including past operating results, estimates of future taxable income and the feasibility of ongoing tax planning strategies. As further discussed in Note 10, “Income Taxes,” to our consolidated financial statements, we have established a valuation allowance against certain deferred tax assets relating to net operating losses for certain taxable entities which are not expected to be realizable within the prescribed carryforward periods. In the event we were to determine that such deferred tax assets would be realizable in the future, we would adjust the valuation allowance, which would reduce the provision for income taxes. If additions to the valuation allowance are warranted in the future, such adjustments would increase the provision for income taxes.

Stock-Based Compensation

The following table summarizes our stock option and stock grants to our employees and a non-employee member of our Board since 2006:

 

Date of Issuance

   Number of
Shares
Granted
   Number of
Shares Subject
to Options
Granted
   Exercise
Price
Per Share
   Estimated Fair
Value of
Common Stock
Per Share
   Intrinsic Value
Per Share

February 2008

      3,555,878    $ 7.45    $ 7.45    $ 0

October 2008

      2,418,200      5.16      5.16      0

November 2008

      400      5.16      5.16      0

March 2009

   107,019              5.18      5.18

September 2009

      1,759,874      8.27      8.27      0

We account for stock-based compensation in accordance with Statement of Financial Accounting Standard No. 123 (Revised 2004), “Share-Based Payment,” or SFAS 123R, which was adopted on January 1, 2006. SFAS 123R requires all stock-based awards to employees and directors to be recognized as stock-based compensation expense based upon their fair values over the requisite service period for awards expected to vest. We adopted SFAS 123R by utilizing the “modified prospective” method. This method requires the stock-based compensation

 

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expense to be recognized beginning January 1, 2006 for all new stock-based awards granted after this date and for all awards that remain unvested as of that date. For the first half of 2008 and 2009, stock-based compensation expense totaled $0.6 million and $1.9 million respectively. For the year ended December 31, 2008, stock-based compensation expense totaled $2.4 million, which includes expense related to an award modification. For the years ended December 31, 2006 and 2007, we had no stock-based compensation.

We use the Black-Scholes-Merton option pricing model to estimate the fair value of stock-based payment awards on the date of grant. Determining the fair value of stock-based awards at the grant date under this model requires judgment, including estimating our value per share of Class A Common stock, volatility, expected term and risk-free rate. The assumptions used in calculating the fair value of stock-based awards represent our best estimates. These estimates involve inherent uncertainties and the application of management judgment. The assumptions we used in the valuation model are based on subjective future expectations combined with management judgment. If any of the assumptions used in the Black-Scholes-Merton model change significantly, stock-based compensation for future awards may differ materially from the awards granted previously.

In the absence of a public trading market, our Board, in conjunction with an unrelated valuation firm, considered numerous objective and subjective factors to determine its best estimate of the fair market value of our common stock as of the date of each option grant, including but not limited to, the following factors: (i) the rights, preferences and privileges of our preferred stock relative to the common stock; (ii) our performance and stage of development; (iii) the prices paid for our preferred stock in August 2008; and (iv) the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options. In valuing our Class A Common Stock, we first determine a business enterprise value by taking an average of the values calculated under three valuation approaches—one income valuation approach and two market valuation approaches. In connection with the grant of options in October and November 2008, we determined our business enterprise value using the average of these three approaches and the implied value of the Company based on recent transactions involving the sale and purchase of our Series A Preferred Stock. Once we determine our business enterprise value, that value is allocated to our Class A Common Stock on a non-marketable minority interest basis. We have various classes of securities, and it is necessary for us to value each class of security for purposes of arriving at the value of the Class A Common Stock. We used an options-based methodology for allocating the estimated aggregate value to each of our securities using the Black-Scholes-Merton pricing model.

The income approach quantifies the present value of the future cash flows that management expects to achieve from continuing operations. These future cash flows are discounted to their present values using a rate corresponding to our estimated weighted average cost of capital. The discount rate reflects the risk inherent in our cash flows and the market rates of return available from alternative investments of similar type and quality as of the valuation date. Our weighted average cost of capital was calculated by weighting the required return on interest-bearing debt and common equity capital in proportion to their estimated percentages in our capital structure.

The market approach considers multiples of financial metrics based on acquisition values or quoted trading prices of comparable public companies. By reference to the trading and transaction values of publicly traded peers, we calculate a multiple of key metrics implied by their trading price or acquisition values. Based on the range of these observed multiples, we apply judgment in determining an appropriate multiple to apply to our metrics in order to derive an indication of value. As these multiples are observed in public company prices, we apply a marketability discount to reflect the fact that our common stock is not traded on a public exchange. The amount of the discount varies based on our expectation of effecting a public offering of our common stock within the ensuing twelve months.

The valuation of our Class A Common Stock underlying the stock option exercise price has changed significantly between February 2008 and September 2009. The following significant events and changes in key assumptions have impacted our valuation at various dates.

 

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In February 2008, we granted 3,555,878 options at an exercise price of $7.45 per share, which was the fair value of our Class A Common Stock based on the most recent contemporaneous valuation. The contemporaneous valuation was based on an equal weighting of the income and market approaches. We applied a marketability discount of 10% based on our expectation of effecting a public offering of our Class A Common Stock within the ensuing twelve months. While we believed at the time there was a high likelihood of a public offering within the ensuing twelve months, we applied this marketability discount to reflect lack of similar transactions and changing market dynamics.

In October and November 2008, we granted a total of 2,418,600 options at an exercise price of $5.16 per share, which was the fair value of our Class A Common Stock based on the most recent contemporaneous valuation. The fair value of our Class A Common Stock decreased from the previous valuation due to a higher marketability discount of 15%, lower market multiples for comparable companies due to an overall decrease in valuations in the public markets and reduced projections of debt-free cash flow due to increased uncertainty about the direction and stability of the global economy. During August 2008, we exercised our right of first refusal and repurchased approximately 3.3 million shares of our Series A convertible Preferred Stock for $15.0 million, or $4.60 per share. In addition, one of our stockholders sold a portion of his holdings to a third party that is unrelated to us at a price of $5.21 per share. The value of our company implied by these transactions was consistent with the valuation implied using the other three methods. We increased the marketability discount on our Class A Common Stock from the previous valuation to reflect a reduced expectation of a successful near to medium-term liquidity event given the state of the capital markets.

In 2008, our CEO earned an annual bonus of $0.6 million which was subsequently paid in 107,019 shares of Class A Common Stock in March 2009. The number of shares issued in March 2009 was based on a valuation of $5.18 per share, which was the fair value of our Class A Common Stock based on the most recent contemporaneous valuation. The Class A Common Stock value includes the application of a 15% marketability discount which was unchanged from the previous valuation. The price reflected the continued uncertainty in the financial markets and market multiples of comparable public companies.

On September 27, 2009, we granted 1,759,874 options to purchase Class A Common Stock at an exercise price of $8.27 per share. The period from March to September 2009 has seen a significant increase in public market valuations, including the valuations of companies in our peer group. This has resulted in an increase in market multiples that we apply to our financial metrics. We also continue to experience growth of our business in North America and higher growth of our business in China. We expect this growth to continue at a steady but declining rate for several years to come and future growth in debt-free cash flow will be tempered by expansion in China as we accommodate the shorter payment terms generally provided by vendors in China. This has resulted in an increase in our debt-free cash flow used in the income approach. We have also selected underwriters to begin the initial public offering process and have observed an increase in the market for initial public offerings. As such, we have reduced our non-marketability discount to 5% to reflect the expectation of a public offering of our Class A Common Stock within the ensuing twelve months. As such, we have concluded that the fair market value of our Class A Common Stock is $8.27 per share as of the date of grant of these options based on our most recent contemporaneous valuation. We believe each of the assumptions underlying this contemporaneous valuation are reasonable in light of current market events, our expectations with regard to an initial public offering and plans for future expansion of the business. Each of these assumptions are subject to a high degree of uncertainty and our actual earnings growth, timing and price range of a future initial public offering and future market valuations for our Class A Common Stock may vary significantly from these estimates. Such variances in these estimates can result in future grants of options with valuations that are materially different from the valuation of these grants.

The risk-free interest rate is based on the United States Treasury yield of those maturities that are consistent with the expected term of the stock option in effect on the grant date of the award. Dividend rates are based upon historical dividend trends and expected future dividends. As we do not have significant historical experience of similar awards, the average expected life of our stock options was determined according to the “SEC simplified method” as described in SAB No. 107, Shared Based Payment, which is the midpoint between the vesting date

 

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and the end of the contractual term. As we have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future, a zero dividend rate is assumed in our calculation. Because our stock is not publicly traded and we have no historical data on the volatility of our stock, our expected volatility is estimated by analyzing the historical volatility of comparable public companies.

The amount of stock-based compensation we recognize during a period is based on the portion of the awards that are ultimately expected to vest. We estimate option forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.

Results of Operations

The following table sets forth, for the periods indicated, summary information from our consolidated statements of income (in thousands, except percentages):

 

    Year Ended December 31,     Six Months Ended June 30,  
    2006     % of Net
Sales
    2007     % of Net
Sales
    2008     % of Net
Sales
    2008     % of Net
Sales
    2009     % of Net
Sales
 

Net sales

  $ 1,468,145      100.0   $ 1,863,216      100.0   $ 2,108,699      100.0   $ 1,029,740      100.0   $ 1,105,474      100.0

Cost of sales

    1,325,746      90.3        1,670,978      89.7        1,873,617      88.9        918,065      89.2        984,466      89.1   
                                                                     

Gross profit

    142,399      9.7        192,238      10.3        235,082      11.1        111,675      10.8        121,008      10.9   

Selling, general and administrative expenses

    121,577      8.3        162,431      8.7        183,683      8.7        89,339      8.7        93,320      8.4   
                                                                     

Income from operations

    20,822      1.4        29,807      1.6        51,399      2.4        22,336      2.2        27,688      2.5   

Interest income

    (1,167   (0.1     (1,814   (0.1     (1,130   (0.1     (615   (0.1     (298   (0.0

Interest expense

    1,600      0.1        1,133      0.1        1,498      0.1        770      0.1        542      0.0   

Other (income) expense, net

    (137   (0.0     (856   (0.0     (251   (0.0     (135   (0.0     (82   (0.0
                                                                     

Income before provision for income taxes, loss on equity method investment and net loss attributable to the noncontrolling interest

    20,526      1.4        31,344      1.7        51,282      2.4        22,316      2.2        27,526      2.5   

Provision for income taxes

    8,155      0.6        12,692      0.7        22,005      1.0        8,955      0.9        11,729      1.1   

Loss on equity method investment

                            447      0.0        319      0.0               
                                                                     

Net income

    12,371      0.8        18,652      1.0        28,830      1.4        13,042      1.3        15,797      1.4   

Net loss attributable to the noncontrolling interest

    243      0.0                                            301      0.0   
                                                                     

Net income attributable to Newegg Inc.

    12,614      0.9        18,652      1.0        28,830      1.4        13,042      1.3        16,098      1.5   

Accretion of Series B-1 and B-2 redeemable convertible Preferred Stock

    5,185      0.4        6,138      0.3        7,304      0.4        3,494      0.4        4,166      0.4   
                                                                     

Net income available to common stockholders of Newegg Inc.

  $ 7,429      0.5   $ 12,514      0.7   $ 21,526      1.0   $ 9,548      0.9   $ 11,932      1.1
                                                                     

Comparison of the Six Months Ended June 30, 2008 to the Six Months Ended June 30, 2009

Net Sales. Net sales grew 7.4%, from $1.03 billion in the first half of 2008 to $1.11 billion in the first half of 2009. Sales in China grew from $12.7 million to $54.4 million and sales in North America grew from $1.02 billion to $1.05 billion. North American growth was driven by a 22.6% increase in sales of CE products in the United States, from $96.1 million in the first half of 2008 to $117.8 million in the first half of 2009. The majority of our growth in CE product sales in the United States came from increased sales of home video, home audio and video game console products. Sales of IT products in the United States were flat in the first half of 2009 relative

 

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to the first half of 2008. Increased sales of personal computers and laptops were offset by decreased sales of memory and CPUs. The decreased sales of memory and CPUs were due to lower average selling prices resulting from competitive pricing in the marketplace. As the economy recovers, we expect that average selling prices will stabilize and possibly increase over time.

North American growth was also driven by a 39.3% increase in visits to our U.S. website, which resulted in a 26.0% increase in active customers, from 3.3 million as of June 30, 2008 to 4.1 million as of June 30, 2009. The resulting increase in the total number of orders from the first half of 2008 to the first half of 2009 was partially offset by a decrease in average order value from approximately $212 in the first half of 2008 to approximately $183 in the first half of 2009. The decrease in average order value was a result of competitive pricing in the marketplace, decreases in the average selling price of certain IT components including memory, CPUs and laptops, and a slight decrease in the number of items per order. We expect these trends to fluctuate over time.

Freight revenue generated by product shipments decreased 7.4% from $48.2 million in the first half of 2008 to $44.7 million in the first half of 2009 primarily due to increased promotional shipping programs and discounts provided to our customers in 2009 to stimulate product sales. We have increasingly offered free delivery in order to drive product revenue growth and expect to continue to do so in future periods.

Gross Profit. Our gross profit grew 8.4% from $111.7 million in the first half of 2008 to $121.0 million in the first half of 2009. Gross margin increased from 10.8% of net sales in the first half of 2008 to 10.9% in the first half of 2009.

Product gross profit primarily consists of product sales less the cost of products sold, inbound freight costs, inventory reserves and write-offs. Product gross profit increased $0.3 million, or 0.5%, from $70.2 million in the first half of 2008 to $70.5 million in the first half of 2009. As a percentage of net sales, our product gross margin decreased from 6.8% in the first half of 2008 to 6.4% in the first half of 2009. This decrease was primarily due to increased promotional pricing in order to compete with the prices offered by our competitors and a decrease in the average selling price of certain IT products, including memory, CPUs and laptops. We monitor market conditions regularly and adjust our pricing as necessary to remain competitive in the marketplace.

Amounts we earn under VIPs, which reduce the cost of inventory sold, increased by $17.1 million, or 50.3%, from $34.0 million in the first half of 2008 to $51.1 million in the first half of 2009. As a percentage of net sales, these incentives increased 1.3 percentage points, from 3.3% in the first half of 2008 to 4.6% in the first half of 2009. We believe vendor incentives increased as manufacturers attempted to stimulate market activity through the increased use of product promotions and advertising on our website to offset the impact of the negative macroeconomic environment. We also believe that manufacturers re-allocated more marketing funds to us that were previously allocated to other retailers that either went bankrupt, like Circuit City, or were perceived as being less efficient or effective retail channels. We are uncertain whether manufacturers will continue to offer similar levels of marketing programs in future periods.

Our freight profit consists of the amount we charge our customers for shipping orders to them, less related outbound shipping costs. For the first half of 2008, the amount we billed to customers for shipping and handling totaled $48.2 million and our related outbound shipping costs were $40.7 million, resulting in a freight profit of $7.5 million. For the first half of 2009, the amount we billed to customers for shipping and handling totaled $44.7 million and our related outbound shipping costs were $45.3 million, resulting in a freight loss of $0.6 million. This resulted in a freight profit decrease of $8.1 million, or 108.3%. This decrease was due to increased use of shipping promotions to drive sales of our products and to compete with shipping promotions offered by our competitors.

One of the key elements of our long-term strategy is to establish a market-leading position and expand our sales in China. In an effort to accomplish this, for the first half of 2009, our short-term strategy in China has been to increase market share by offering competitive prices, including free shipping promotions, which has resulted in negative gross profit of approximately $0.3 million. We believe that we have been successful in growing our

 

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market share, and going forward, intend to manage our business to try to generate gross profits on future sales in the China market. As China net sales become a greater percentage of our consolidated net sales, our consolidated gross profit margin will likely be adversely impacted, at least in the near term.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $4.0 million, or 4.5%, from $89.3 million in the first half of 2008 to $93.3 million in the first half of 2009. The first half of 2008 includes a reserve for legal matters that was not incurred in the first half of 2009. Excluding these costs, selling, general and administrative expenses increased $6.8 million, or 7.8% from the first half of 2008 to the first half of 2009. Salary and other compensation expenses increased $2.1 million, or 6.0%, primarily due to the increase in the number of full-time employees from 1,963 employees at June 30, 2008 to 2,062 at June 30, 2009, including recent additions to senior management in China to help focus and grow our operations in China. In addition, stock-based compensation increased $1.3 million, from $0.6 million in the first half of 2008 to $1.9 million in the first half of 2009, related to grants awarded in February and October of 2008 and an award modification in October 2008.

We also experienced a $1.0 million, or 4.9%, increase in credit card and payment processing fees from the first half of 2008 to the first half of 2009. This increase in expense was primarily caused by an increase in net sales in North America.

Advertising and marketing expenses increased $2.4 million, or 23.2%, from $10.4 million in the first half of 2008 to $12.8 million in the first half of 2009. As a percentage of net sales, advertising and marketing expenses were fairly consistent at approximately 1% in the first half of both 2008 and 2009. Depreciation and amortization expense increased slightly from $5.3 million in the first half of 2008 to $5.5 million in the first half of 2009.

Interest Income and Expense. Interest income decreased from $615,000 in the first half of 2008 to $298,000 in the first half of 2009. This decrease was reflective of overall decreases in the average cash balances and interest rates in the first half of 2009, as compared to the first half of 2008. Interest expense decreased from $770,000 in the first half of 2008 to $542,000 in the first half of 2009. This decrease was due to a decrease in the average outstanding debt balance in the first half of 2009, as compared to the first half of 2008.

Other (Income) Expense, Net. Other income, net was approximately $82,000 in the first half of 2009, compared to other income, net of approximately $135,000 in the first half of 2008.

Income Taxes. Our provision for income taxes increased to $11.7 million in the first half of 2009, from $9.0 million in the first half of 2008. Our effective tax rate increased from 40.7% in the first half of 2008 to 42.6% in the first half of 2009, due primarily to increases in the valuation allowance on certain deferred tax assets and foreign income not taxed at the federal income tax rate.

Comparison of the Year Ended December 31, 2007 to the Year Ended December 31, 2008

Net Sales. Net sales grew 13.2%, from $1.86 billion in 2007 to $2.11 billion in 2008. Sales in China grew from $13.4 million to $31.3 million and sales in North America grew from $1.85 billion to $2.08 billion. North American growth was driven by a 42.5% increase in visits to our U.S. website, which resulted in a 22.7% increase in active customers, from 3.2 million in 2007 to 4.0 million in 2008. The resulting increase in the total number of orders from 2007 to 2008 was partially offset by a decrease in average order value from approximately $224 in 2007 to approximately $203 in 2008. The decrease in average order value was a result of competitive pricing in the marketplace and a decrease in the number of items per order.

Sales of IT products in the United States grew 9.7% from $1.59 billion in 2007 to $1.74 billion in 2008. The majority of our growth in IT product sales in the United States came from increased sales of personal computers, laptops, hard drives and printers and scanners. CE product sales in the United States grew $54.2 million from $175.5 million in 2007 to $229.7 million in 2008, a 30.9% increase. The majority of our growth in CE product sales in the United States came from increased sales in the home video, home audio, and video game console categories.

 

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Freight revenue generated by product shipments in 2008 increased 11.9% from $87.7 million in 2007 to $98.1 million in 2008 primarily due to an increase in sales order volume, offset by increased promotional shipping programs and discounts provided to our customers in 2008 to stimulate product sales.

Gross Profit. Our gross profit grew 22.3% from $192.2 million in 2007 to $235.1 million in 2008. Gross margin increased from 10.3% of net sales in 2007 to 11.1% in 2008.

Product gross profit grew $0.8 million, or 0.6%, from $127.0 million in 2007 to $127.7 million in 2008. As a percentage of net sales, our product gross margin decreased from 6.8% in 2007 to 6.1% in 2008. This decrease was primarily due to increased promotional pricing in order to compete with the prices offered by our competitors, particularly within our CE categories.

Amounts we earned under VIPs, which reduce the cost of inventory sold, increased by $43.3 million, or 86.0%, from $50.4 million in 2007 to $93.7 million in 2008. As a percentage of net sales, these incentives increased 1.7 percentage points, from 2.7% in 2007 to 4.4% in 2008. We believe the vendor incentives increased as we continued to establish and expand our marketing relationships with certain manufacturers, and manufacturers attempted to stimulate market activity through the increased use of product promotions and advertising on our website to offset the impact of the negative macroeconomic environment.

Our outbound shipping costs increased $11.7 million, or 16.1%, from $72.8 million in 2007 to $84.5 million in 2008. This increase was proportionate to the increase in our net sales. However, our resulting freight profit decreased $1.2 million, or 8.3%, from $14.9 million in 2007 to $13.7 million in 2008, mostly due to increased fuel surcharges and our efforts to remain competitive with other online retailers offering free or low-cost shipping. As a result, our freight margin as a percentage of net sales decreased 0.2%, from 0.8% in 2007 to 0.6% in 2008.

Our net sales in China did not have a material impact on our consolidated gross profit during 2007 or 2008.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $21.3 million, or 13.1%, from $162.4 million in 2007 to $183.7 million in 2008. Salary and other compensation expenses increased $13.7 million, or 23.3%, from 2007 to 2008, primarily due to the fact that our average number of full-time employees increased by approximately 235 employees and due to a $2.1 million increase in bonus compensation from 2007 to 2008. Furthermore, included in salary and other compensation expenses in 2008 is stock-based compensation totaling $2.4 million resulting from 2008 option grants and an award modification in 2008, whereas no expense was recognized in 2007 as there were no grants vesting during 2007.

We also experienced a $5.1 million, or 13.8%, increase in credit card and payment processing fees from 2007 to 2008, which is consistent with the increase in net sales from 2007 to 2008. In addition, depreciation and amortization expense increased $3.1 million, or 38.7%, from 2007 to 2008, primarily due to our Edison, New Jersey OPC which opened in September 2007, for which we incurred a full year of depreciation expense in 2008, but only four months of depreciation expense in 2007.

Interest Income and Expense. Interest income decreased from $1.8 million in 2007 to $1.1 million in 2008. This decrease was due to decreases in interest rates in 2008, as compared to 2007. Interest expense increased from $1.1 million in 2007 to $1.5 million in 2008. This increase was due to an increase in the average outstanding debt balance in 2008, as compared to 2007.

Other (Income) Expense, Net. Other income, net was $0.3 million in 2008 compared to other income, net of $0.9 million in 2007.

Income Taxes. Our provision for income taxes increased to $22.0 million in 2008, from $12.7 million in 2007. Our effective tax rate increased to 43.3% in 2008, from 40.5% in 2007. The increase in our provision for income taxes primarily resulted from increases in federal and state income taxes, driven by higher taxable income in 2008, as compared to 2007. The increase in our provision also includes an increase in the valuation allowance on certain deferred tax assets and foreign income not taxed at the federal income tax rate in 2008.

 

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Comparison of the Year Ended December 31, 2006 to the Year Ended December 31, 2007

Net Sales. Net sales grew 26.9%, from $1.47 billion in 2006 to $1.86 billion in 2007. Sales in China grew from $8.4 million to $13.4 million and sales in North America grew from $1.46 billion to $1.85 billion. North American growth was driven by a 41.6% increase in visits to our U.S. website, which resulted in a 12.8% increase in active customers, from 2.9 million in 2006 to 3.2 million in 2007. The total number of orders increased by approximately 27% from 2006 to 2007, while the average order value remained consistent at approximately $224 in both 2006 and 2007.

Sales of IT products in the United States grew 26.6% from $1.25 billion in 2006 to $1.59 billion in 2007. The majority of our growth in IT product sales in the United States came from increased sales in hard drives, personal computers, laptops, software, memory, cases, and CPUs. We believe the release of Microsoft Vista positively impacted software sales, as well as sales of memory, hard drives, and CPUs, as consumers needed additional system requirements to accommodate the new software. CE product sales in the United States grew $49.9 million from $125.6 million in 2006 to $175.5 million in 2007, a 39.6% increase. The majority of our growth in CE product sales in the United States came from increased sales in the home video and video game console categories.

Freight revenue generated by product shipments in 2007 increased 14.1% from $76.8 million in 2006 to $87.7 million in 2007 primarily due to an increase in sales order volume, offset by increased promotional shipping programs and discounts provided to our customers in 2007 to stimulate product sales.

Gross Profit. Our gross profit grew 35.0% from $142.4 million in 2006 to $192.2 million in 2007. Gross margin increased from 9.7% of net sales in 2006 to 10.3% in 2007.

Product gross profit grew $38.5 million, or 43.5%, from $88.5 million in 2006 to $127.0 million in 2007. As a percentage of net sales, our product gross margin increased from 6.0% in 2006 to 6.8% in 2007. This increase is primarily due to the fact that we were able to secure better product pricing as we expanded our vendor base to include more direct manufacturers and therefore, we decreased our reliance on distributors who charged higher prices for similar products.

Amounts we earned under VIPs, which reduce the cost of inventory sold, increased by $15.8 million, or 45.8%, from $34.6 million in 2006 to $50.4 million in 2007. As a percentage of net sales, these incentives increased 0.3%, from 2.4% in 2006 to 2.7% in 2007. The vendor incentives increased as we established and developed more relationships with direct manufacturers, and collectively with these direct manufacturers we developed marketing programs to ensure greater visibility of their products with consumers.

Our outbound shipping costs increased $15.3 million, or 26.7%, from $57.4 million in 2006 to $72.8 million in 2007. This increase was proportionate to the increase in our net sales. However, our resulting freight profit decreased $4.5 million, or 23.1%, from $19.4 million in 2006 to $14.9 million in 2007, mostly due to our efforts to remain competitive with other online retailers offering free shipping. As a percentage of net sales, our freight margin decreased 0.5%, from 1.3% in 2006 to 0.8% in 2007, which was due to increased use of shipping promotions in 2007 to stimulate sales of our products and compete with shipping promotions offered by our competitors.

Our net sales in China did not have a material impact on our consolidated gross profit during 2006 or 2007.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $40.9 million, or 33.6%, from $121.6 million in 2006 to $162.4 million in 2007. Salary and other compensation expenses increased $14.3 million, or 32.1%, from 2006 to 2007, primarily due to the increase in the number of full-time employees from 1,474 employees at the end of 2006 to 1,995 employees at the end of 2007, including senior management positions in finance, product management, marketing, and logistics.

 

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We also experienced a $5.6 million, or 17.6%, increase in credit card and payment processing fees from 2006 to 2007, primarily caused by an increase in net sales, partially offset by our ability to secure lower transaction fees from changing credit card processors in September 2006 and other initiatives to reduce these fees.

Advertising and marketing expenses increased by $5.8 million, or 36.3%, from 2006 to 2007, but as a percentage of net sales, this only represented an increase of 0.1%. Professional fees increased $5.5 million, most of which relates to a $5.2 million charge related to the resolution of a legal dispute. Depreciation and amortization increased $2.0 million from 2006 to 2007, primarily due to 2007 capital expenditures related to Southern California warehouse infrastructure. Other expenses within selling, general and administrative expenses increased $7.7 million, which includes a $2.2 million increase in rent expense primarily related to our expanded facilities in New Jersey, a $2.9 million increase in warehouse and office expenses and a $0.6 million increase in travel expenses.

Interest Income and Expense. Interest income increased from $1.2 million in 2006 to $1.8 million in 2007. This increase was due to overall increases in the average cash balances in 2007, as compared to 2006. Interest expense decreased from $1.6 million in 2006 to $1.1 million in 2007. This decrease was due to a decrease in the average outstanding balance under a now expired line of credit in 2007, as compared to 2006.

Other (Income) Expense, Net. Other income, net, was $0.9 million in 2007 compared to other income, net, of $0.1 million in 2006.

Income Taxes. Our provision for income taxes increased to $12.7 million in 2007, from $8.2 million in 2006. Our effective tax rate increased to 40.5% in 2007, from 39.7% in 2006. The increase in our provision for income taxes primarily resulted from increases in federal and state income taxes, driven by higher taxable income in 2007, as compared to 2006. The increase in our provision was partially offset by a benefit from the decrease in the valuation allowance on certain deferred tax assets and foreign income not taxed at the federal income tax rate in 2007.

 

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Quarterly Financial Information

The following tables present unaudited quarterly results of operations, in dollar amounts and as a percentage of net sales, for the last ten quarters. This information has been derived from our unaudited consolidated financial statements and has been prepared by us on a basis consistent with our audited consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, which management considers necessary for a fair presentation of the information for the periods presented. Our quarterly financial results, including our net sales, gross profit and income from operations, have fluctuated in the past and may continue to fluctuate in the future based on a number of factors, many of which are beyond our control. Factors that may cause our net sales and operating results to vary or fluctuate include those discussed in the “Risk Factors” section of this prospectus.

 

     Three Months Ended  
    Mar. 31,
2007
    Jun. 30,
2007
    Sept. 30,
2007
    Dec. 31,
2007
    Mar. 31,
2008
    Jun. 30,
2008
    Sept. 30,
2008
    Dec. 31,
2008
    Mar. 31,
2009
    Jun. 30,
2009
 
(in thousands)      

Net sales

  $ 477,639      $ 435,438      $ 446,713      $ 503,426      $ 538,959      $ 490,781      $ 505,466      $ 573,493      $ 573,712      $ 531,762   

Cost of sales

    429,251        393,256        398,746        449,725        483,743        434,322        445,114        510,438        509,460        475,006   
                                                                               

Gross profit

    48,388        42,182        47,967        53,701        55,216        56,459        60,352        63,055        64,252        56,756   

Selling, general and administrative expenses

    38,104        37,051        39,521        47,755        45,390        43,949        44,996        49,348        47,386        45,934   
                                                                               

Income from operations

    10,284        5,131        8,446        5,946        9,826        12,510        15,356        13,707        16,866        10,822   

Interest income

    (410     (225     (448     (731     (359     (256     (294     (221     (189     (109

Interest expense

    262        262        256        353        410        360        342        386        269        273   

Other (income) expense, net

    (204     (157     (110     (385     (41     (94     54        (170     (110     28   
                                                                               

Income before provision for income taxes, loss on equity method investment and net loss attributable to the noncontrolling interest

    10,636        5,251        8,748        6,709        9,816        12,500        15,254        13,712        16,896        10,630   

Provision for income taxes

    4,307        2,126        3,542        2,717        3,995        4,960        6,130        6,920        7,187        4,542   

Loss on equity method investment

                                       319               128                 
                                                                               

Net Income

    6,329        3,125        5,206        3,992        5,821        7,221        9,124        6,664        9,709        6,088   

Net loss attributable to the noncontrolling interest

                                                            54        247   
                                                                               

Net income attributable to Newegg Inc.

    6,329        3,125        5,206        3,992        5,821        7,221        9,124        6,664        9,763        6,335   

Accretion of Series B-1 and B-2 redeemable convertible Preferred Stock

    1,436        1,500        1,566        1,636        1,709        1,785        1,865        1,945        2,037        2,129   
                                                                               

Net income available to common stockholders of Newegg Inc.

  $ 4,893      $ 1,625      $ 3,640      $ 2,356      $ 4,112      $ 5,436      $ 7,259      $ 4,719      $ 7,726      $ 4,206   
                                                                               

 

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     Three Months Ended  
As a Percent of Net Sales:   Mar. 31,
2007
    Jun. 30,
2007
    Sept. 30,
2007
    Dec. 31,
2007
    Mar. 31,
2008
    Jun. 30,
2008
    Sept. 30,
2008
    Dec. 31,
2008
    Mar. 31,
2009
    Jun. 30,
2009
 

Net sales

  100.0   100.0   100.0   100.0   100.0   100.0   100.0   100.0   100.0   100.0

Cost of sales

  89.9      90.3      89.3      89.3      89.8      88.5      88.1      89.0      88.8      89.3   
                                                           

Gross profit

  10.1      9.7      10.7      10.7      10.2      11.5      11.9      11.0      11.2      10.7   

Selling, general and administrative expenses

  8.0      8.5      8.8      9.5      8.4      9.0      8.9      8.6      8.3      8.6   
                                                           

Income from operations

  2.2      1.2      1.9      1.2      1.8      2.5      3.0      2.4      2.9      2.0   

Interest income

  (0.1   (0.1   (0.1   (0.1   (0.1   (0.1   (0.1   (0.0   (0.0   (0.0

Interest expense

  0.1      0.1      0.1      0.1      0.1      0.1      0.1      0.1      0.0      0.1   

Other (income) expense, net

  (0.0   (0.0   (0.0   (0.1   (0.0   (0.0   0.0      (0.0   (0.0   0.0   
                                                           

Income before provision for income taxes, loss on equity method investment and net loss attributable to the noncontrolling interest

  2.2      1.2      2.0      1.3      1.8      2.5      3.0      2.4      2.9      2.0   

Provision for income taxes

  0.9      0.5      0.8      0.5      0.7      0.9      1.2      1.2      1.3      0.8   

Loss on equity method investment

                           0.1           0.0             
                                                           

Net income

  1.3      0.7      1.2      0.8      1.1      1.5      1.8      1.2      1.7      1.2   

Net loss attributable to the noncontrolling interest

                                          0.0      0.0   
                                                           

Net income attributable to Newegg Inc.

  1.3      0.7      1.2      0.8      1.1      1.5      1.8      1.2      1.7      1.2   

Accretion of Series B-1 and B-2 redeemable convertible Preferred Stock

  0.3      0.3      0.4      0.3      0.3      0.4      0.4      0.4      0.4      0.4   
                                                           

Net income available to common stockholders of Newegg Inc.

  1.0   0.4   0.8   0.5   0.8   1.1   1.4   0.8   1.3   0.8
                                                           

Our business is subject to seasonal fluctuations in demand due to changes in buying patterns by our customers. We have historically experienced higher sales in the fourth quarter due to the holiday season, and, to a limited extent, the first quarter due to residual holiday purchases. We have historically experienced our lowest sales volume of the year in the second quarter. We expect the historical seasonality trends to continue to have a material impact on our results of operations and financial condition.

Our net sales have grown as a result of continued expansion in our active customer base. The overall growth of our net sales over the periods presented may obscure the seasonality of our results and reduce the significance of quarter to quarter comparisons of our operating results. We expect that our net sales will continue to increase, particularly as we expand internationally.

On a year over year basis, quarterly gross profit has generally trended upward over the periods presented. However, in the quarter ended June 30, 2009, gross margin decreased in comparison to the quarter ended June 30, 2008, due to increased promotional pricing in order to compete with the prices offered by our competitors, decreases in the average selling price of certain IT products, freight losses related to the increased use of shipping promotions to stimulate sales of our products and compete with shipping promotions offered by our competitors, and an acceleration of sales in China, which generated negative gross profit for the first half of 2009.

 

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The following table presents unaudited quarterly non-financial performance measures for the last ten quarters. These performance measures have fluctuated in the past and may continue to fluctuate in the future based on a number of factors, many of which are beyond our control. Factors that may cause these performance measures to vary or fluctuate include those discussed in the “Risk Factors” section of this prospectus.

 

    Three Months Ended—United States
(in thousands, except average order value)
    Mar. 31,
2007
  June 30,
2007
  Sept. 30,
2007
  Dec. 31,
2007
  Mar. 31,
2008
  June 30,
2008
  Sept. 30,
2008
  Dec. 31,
2008
  Mar. 31,
2009
  June 30,
2009

Registered users

    7,324     7,786     8,233     8,821     9,391     9,903     10,471     11,305     12,033     12,630

Active customers

    2,957     2,952     3,001     3,241     3,293     3,251     3,400     3,976     4,112     4,095

Number of orders taken

    2,294     2,137     2,123     2,596     2,681     2,471     2,618     3,492     3,337     2,961

Total visits

    52,296     49,496     50,097     64,661     68,399     67,867     74,771     97,457     98,412     91,437

Average order value taken

  $ 227   $ 226   $ 227   $ 216   $ 210   $ 214   $ 212   $ 182   $ 181   $ 185

Liquidity and Capital Resources

We have historically funded our operations through cash generated from operations, vendor financing, credit facilities, bank loans, equity and capital lease financings. As of June 30, 2009, we had cash and cash equivalents of $42.2 million, representing a decrease of $42.2 million from $84.4 million as of December 31, 2008. This decrease in cash and cash equivalents is normal for this time of year and consistent with the seasonality of our business. The decrease in cash was primarily due to the $37.8 million cash used in operations, primarily paying down accounts payable, $2.9 million in capital expenditures, and $1.5 million of repayments of long-term debt and principal payments under capital leases during the first half of 2009. Our December 31, 2008 cash balance increased $0.9 million from the December 31, 2007 cash balance of $83.5 million. The increase in cash was primarily due to cash generated from operations of $27.2 million, offset by $15.0 million used to repurchase preferred stock, $8.5 million used for capital expenditures, and $3.3 million of repayments of long-term debt and principal payments under capital leases in 2008. Our cash and cash equivalents consist primarily of cash on deposit, certificates of deposit, and money market accounts that are readily convertible into cash and purchased with original maturities of three months or less. Amounts receivable from credit card processors are also considered cash equivalents as they are both short-term and highly liquid in nature and are typically converted to cash within three business days.

Operating Activities

Our operating cash flows and cash position fluctuate quarterly due to the seasonality of our business. We historically experience higher sales in the fourth quarter due to the holiday season and therefore experience an increase in our cash position at year-end, as compared to the first, second and third quarters when sales are lower.

In North America, we generally require payment from customers by credit card upon placement of an order, and to a lesser extent, we grant credit to business customers on 30-day terms. Credit card payments typically settle within three business days. In China, we generally require payment upon delivery of a customer’s order. In the United States, our vendors generally provide us 30-day credit terms for inventory products purchased. As inventory turns every 17 to 25 days, our operating activities have historically allowed us to generate positive cash flows. This trend may be adversely affected by our continued expansion into China due to the lack of or shorter deferred payment terms from vendors in China, who often require payment upon delivery of the products from the vendor to us.

Because our business is subject to seasonality trends and changes in consumer buying patterns, our inventory balance historically has fluctuated, as has our inventory turnover—from 17 days during peak periods to 25 days

 

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during slower periods. In anticipation of higher sales during the holiday season, we typically begin building up our inventory levels in the third quarter. As a result of this inventory build-up and faster inventory turnover during the fourth quarter, our accounts payable and cash balances are typically at their highest levels at year-end. As sales begin to slow in the first and second quarters, inventory levels decrease, inventory turnover lengthens, and accounts payable and cash balances decrease as we pay our vendors. We expect these historical seasonality trends to continue to have a material impact on our financial condition, operating cash flows and results of operations.

Depreciation and amortization expenses have increased in absolute dollars as a result of increased capital expenditures, but over time have remained consistent as a percentage of net sales. The completion of phases I and II of the Jiading, China facility by the end of the first quarter of 2010 will lead to an increase in depreciation and amortization expense.

For the first half of 2009, net cash used in operating activities was $37.8 million. Net cash used in operating activities consists of net income as adjusted for non-cash expenses and changes in operating assets and liabilities. Net income was $15.8 million for the first half of 2009. Non-cash expenses, comprised of bad debt expense, allowance for obsolete and excess inventory, depreciation and amortization and stock-based compensation, totaled $9.3 million. Changes in operating assets and liabilities represented a $62.9 million use of cash, primarily driven by decreases in accounts payable, deferred revenue, and accrued expenses and other liabilities of $45.8 million, $16.2 million, and $7.3 million, respectively, partially offset by decreases in inventories and accounts receivable of $4.9 million and $4.4 million, respectively.

For the year ended December 31, 2008, net cash provided by operating activities was $27.2 million. Net income was $28.8 million in 2008. Non-cash expenses, primarily comprised of bad debt expense, allowance for obsolete and excess inventory, depreciation and amortization, deferred income taxes and stock-based compensation, totaled $14.6 million. Changes in operating assets and liabilities represented a $16.2 million use of cash, primarily driven by increases in inventories and accounts receivable of $26.4 million and $11.0 million, respectively, partially offset by increases in accounts payable and accrued expenses and other liabilities of $14.8 million and $11.5 million, respectively.

For the year ended December 31, 2007, net cash provided by operating activities was $30.2 million. Net income was $18.7 million in 2007. Non-cash expenses, primarily comprised of bad debt expense, allowance for obsolete and excess inventory, depreciation and amortization and deferred income taxes, totaled $9.9 million. Changes in operating assets and liabilities represented a $1.6 million source of cash, primarily driven by increases in accounts payable and deferred revenue of $21.9 million and $20.4 million, respectively, partially offset by an increase in inventories of $38.6 million.

Investing Activities

For the years ended December 31, 2006, 2007, and 2008 and the first half of 2009, net cash used in investing activities has primarily consisted of payments to acquire property and equipment. There have been no other significant investing activities. We expect that we will continue to make significant capital expenditure investments in the future, particularly as we expand our international operations in China and Canada.

In June 2008, we entered into a land use rights contract with Jiading District Bureau of Housing and Land Administration, under which we were granted the land use rights for a 492,000 square foot parcel of land for 50 years, located in a new industrial park in the district of Jiading, a suburb of Shanghai, China. We have paid approximately $3.2 million to the local Chinese government for such land use rights, which is recorded in “other assets” in our consolidated balance sheets and is being amortized over the 50-year term. We intend to develop the parcel over the course of several development phases into our China headquarters. Phase I, which includes an office building and ancillary structures, and phase II, which includes a regional OPC, are expected to be complete by the end of the first quarter of 2010, with a total estimated construction cost of $10 million. Under the terms of the agreement, we must provide a minimum of $25.0 million of capital over a two-year period to one or more of our China subsidiaries to fund real estate business development activities and operations for certain of our China subsidiaries based in Jiading. As of June 30, 2009, we have met this commitment.

 

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Financing Activities

For the first half of 2009, net cash used in financing activities totaled $1.5 million and consisted primarily of repayments of long-term debt and principal payments under capital leases. Net cash used in financing activities remained relatively flat in the first half of 2009 as compared to the first half of 2008.

For the year ended December 31, 2008, net cash used in financing activities totaled $18.4 million, consisting primarily of the repurchase of preferred stock, and, to a lesser extent, repayment of long-term debt and principal payments under capital leases. For the year ended December 31, 2007, net cash used in financing activities totaled $0.1 million, consisting primarily of repayments of long-term debt. For the year ended December 31, 2006, net cash used in financing activities totaled $8.3 million, consisting primarily of repayments under our now expired line of credit.

We anticipate that our existing cash and funds generated from operations will be sufficient to meet our working capital needs and expected capital expenditures for at least 12 months. Our future capital requirements may, however, vary materially from those now planned or anticipated. Changes in our operating plans, lower than anticipated net sales, increased expenses or other events, including those described in “Risk Factors,” may cause us to seek additional debt or equity financing in the future. Financing may not be available on acceptable terms, on a timely basis, or at all, and our failure to raise adequate capital when needed could negatively impact our growth plans and our financial condition and results of operations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not included in our consolidated financial statements. Additionally, we do not have an interest in, or relationships with, any special-purpose entities.

Contractual Obligations

The following table summarizes our outstanding contractual obligations as of December 31, 2008 and the effect those obligations are expected to have on our cash liquidity and cash flow in future periods:

 

     Payments Due by Period
(in thousands)    2009    2010    2011    2012    2013    Thereafter    Total

Long-term debt payments (3)(4)

   $ 2,324    $ 13,961    $ 1,118    $ 948    $ 389    $ 603    $ 19,343

Operating leases

     3,834      2,958      1,677                     8,469

Capital lease payments (3)

     1,378      1,148      1,124      749                4,399

Purchase commitments

     78,509                               78,509

Standby letter of credit (1)

     5,000                               5,000

Unrecognized tax benefits (2)

                              545      545
                                                

Total contractual obligations

   $ 91,045    $ 18,067    $ 3,919    $ 1,697    $ 389    $ 1,148    $ 116,265
                                                

 

(1) In lieu of cash for the security deposit for one of our OPCs.
(2) Unrecognized tax benefits under FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of Statement of Financial Accounting Standards No. 109, ‘Accounting for Income Taxes’,” for which we cannot make a reasonably reliable estimate of the period of payment.
(3) Including interest.
(4) Includes $7.5 million due October 2010 and $1.1 million due October 2014, that we expect to repay with the proceeds of this offering.

 

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Quantitative and Qualitative Disclosures about Market Risk

We do not use financial instruments for speculative trading purposes, and do not hold any derivative financial instruments that could expose us to significant market risk. Our primary market risk exposures are changes in interest rates and foreign currency fluctuations.

Interest Rate Risk

At December 31, 2008 and June 30, 2009, we had outstanding long-term borrowings, primarily mortgage debt, in the aggregate amount of $12.9 million and $12.0 million, respectively, with the majority of our long-term borrowings having fixed interest rates. Therefore a 1% increase or decrease in LIBOR would not materially impact our interest expense.

Foreign Currency Risk

We have currency fluctuation exposure arising from both sales and purchases denominated in foreign currencies, as well as intercompany transactions. Significant changes in exchange rates between foreign currencies in which we transact business and the U.S. dollar may adversely affect our results of operations and financial condition. Historically, we have not entered into any hedging activities, and, to the extent that we continue not to do so in the future, we may be vulnerable to the effects of currency exchange-rate fluctuations.

We expect our exposure to foreign currency risk will increase as we increase our operations and sales in China, Canada and other foreign countries. Although the effect of currency fluctuations on our financial statements has not been material in the past, there can be no assurance that the effect of currency fluctuations will not be material in the future. Based on the balance of our foreign-denominated cash and cash equivalents, at December 31, 2008 and June 30, 2009, an assumed 10% negative currency movement would not have a material impact.

Inflation

Inflation has not had a material impact upon our operating results. Although we do not expect it to have such an impact in the near future, we cannot assure you that our business will not be affected by inflation in the future.

Related Party Transactions

For a description of our related party transactions, see “Related Party Transactions.”

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board, or FASB, issued SFAS No. 166, “Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140.” SFAS 166 eliminates the concept of a qualifying special-purpose entity; removes the scope exception from applying FIN 46R to qualifying special-purpose entities; changes the requirements for derecognizing financial assets; and requires enhanced disclosure. SFAS 166 is effective beginning in the first quarter of 2010. We are currently evaluating the impact that the adoption of SFAS 166 will have on our consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).” SFAS 167 replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance. It also requires an ongoing reassessment of whether an entity is the primary beneficiary and requires additional disclosures about an enterprise’s involvement in variable interest entities. SFAS 167 is effective beginning in the first quarter of 2010. We are currently evaluating the impact that the adoption of SFAS 167 will have on our consolidated financial statements.

 

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In July 2009, the FASB issued SFAS No. 168, “The FASB Accounting Codification and the Hierarchy of Generally Accepted Accounting Principles.” SFAS 168 supersedes SFAS No. 162 issued in May 2008. SFAS 168 will establish the Financial Accounting Standards Board Accounting Standards Codification as the source of authoritative accounting principles generally accepted in the United States of America recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases issued by the SEC are also sources of authoritative generally accepted accounting principle for SEC registrants. SFAS 168 is effective in the third quarter of 2009. The adoption of SFAS 168 will not impact our consolidated financial statements other than references to authoritative accounting literature in future periods will be made in accordance with the codification.

 

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BUSINESS

Overview

We are a leading e-commerce company focused on selling IT products including computer hardware, software and peripherals and CE products to consumers and increasingly to small and medium-sized businesses, predominantly through our U.S. website, www.newegg.com. According to the 2009 Internet Retailer’s Top 500 Guide, we are the second largest online-only retailer in the United States as measured by our 2008 net sales of $2.1 billion. Since launching our e-commerce platform in 2001, a majority of our net sales and net income have been generated by selling IT products in the United States. We are leveraging our platform, customer base and brand to expand from IT into CE product sales and to grow our e-commerce business outside of the United States in China and Canada.

We have built a strong brand and a loyal customer base consisting primarily of IT professionals, gamers, do-it-yourself technology enthusiasts, early technology adopters and CE enthusiasts. In 2008, we attracted 70.7% of the unique daily visitors to our U.S. website without incurring a referral, click-through or advertising fee, and generated 74.1% of our U.S. orders from customers who have previously purchased from us. We have also earned numerous awards for customer satisfaction from publications and organizations such as Computer Shopper, ForeSee Results and the National Retail Federation.

We believe our success is driven by consistently executing on three core competencies, which we call our “Three Pillars”:

Providing a Compelling Online Shopping Experience. To attract new customers and retain repeat customers, we have made our primary e-commerce websites, and www.newegg.com in particular, content-rich and user-friendly. We provide detailed product information for almost every item we offer and feature over 1,600,000 product reviews from registered Newegg users to help customers make their purchasing decisions. As of June 30, 2009, our U.S. website carried over 33,000 stock keeping units, or SKUs, in a range of categories including computer hardware and software, computer components and CE. We seek to offer extremely deep product selection at competitive prices in our core IT categories, including computer components and hardware. For instance, as of June 30, 2009, our U.S. website featured 533 SKUs of motherboards and 164 SKUs of central processing units, or CPUs.

Fulfilling Orders in a Reliable and Timely Manner. We fulfill customer orders in a timely and reliable manner. For example, we shipped more than 97.6% of the U.S. orders fulfilled directly by us within one business day of payment validation in 2008. In the same year, we met or exceeded the promised delivery time to our U.S. customers over 98.2% of the time, averaging approximately 2.4 business days from the date of shipment to receipt. Our ability to provide timely delivery is enabled by strategically located order processing and distribution centers, or OPCs. We also have a proprietary warehouse and inventory management technology platform that is closely integrated with our website, with features including real-time inventory updates as products are ordered that help us better understand and anticipate consumer demand and to distribute inventory closer to such demand.

Providing Superior Customer Service. To maintain a high quality customer service experience, we maintain our U.S. call center near our Southern California headquarters so that we can monitor training and service levels and respond quickly to customer feedback. Live chat and e-mail support is provided from our offices both in the United States and China to maximize the number of hours that support is available to our customers. We try to grant our customer service representatives a high level of authority to help solve any problems customers may have in the most efficient manner. To further ensure quality customer service, we do not outsource any customer service functions.

We have been profitable every year since launching our e-commerce platform in 2001 and have grown rapidly. We reached $982.1 million in net sales in 2004 and generated $2.1 billion in net sales in 2008,

 

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representing a compound annual growth rate of 21.1% over this period. In 2008, we generated operating income of $51.4 million. Recently we have grown our business in China, focusing on IT products, CE products and household appliances and we anticipate that our business in China will become an important driver of our future growth. In China, we generated net sales of $31.3 million in all of 2008 and $54.4 million in the first half of 2009.

Our corporate headquarters are located in the City of Industry, California, and we operate U.S. OPCs in Southern California, New Jersey and Tennessee. We also maintain offices in Taipei, Taiwan and in various cities in China where we provide operational support services to www.newegg.com. We currently operate OPCs in eight metropolitan areas in China to fulfill orders generated on our affiliated website, www.newegg.com.cn, and have offices in eight Chinese cities. Many of our executives and senior employees are originally from and have extensive experience working in Taiwan and China, reducing language and cultural barriers and allowing us to more effectively manage our China operations. As of June 30, 2009, we had 2,062 full-time employees, approximately half of whom were located in China.

Industry Overview

The Internet’s development into a significant global medium for communication, content and commerce has led to substantial growth in online shopping. According to the Forrester Research report, “U.S. eCommerce Forecast, 2008 to 2013,” published February 2, 2009, the U.S. e-commerce market was $141.3 billion in 2008 and is expected to grow to $229.1 billion in 2013, representing a 10.1% compound annual growth rate. In addition, Forrester predicts that online retail sales will grow from 5% of total retail sales in 2008 to 8% of total retail sales by 2013.

The computer hardware, software and peripherals category is one of the largest U.S. e-commerce segments and CE is one of the fastest growing segments. According to the Forrester Research report, “U.S. eCommerce Forecast, 2008 to 2013,” published February 2, 2009, the U.S. computer hardware, software and peripherals e-commerce market is expected to grow from $27.2 billion in 2009 to $36.0 billion in 2013, representing a 7.3% compound annual growth rate, and the CE segment is expected to grow from $12.5 billion in 2009 to $19.2 billion in 2013, representing an 11.3% compound annual growth rate.

We believe continued growth in the IT and CE product categories will be driven broadly by technological innovation, evolving consumer and enterprise preferences and economic factors. Hardware, software and technical standards evolve quickly to keep pace with the higher levels of functionality and product performance demanded by and available to customers. Consequently, interoperability with prior product generations diminishes quickly, resulting in rapid product obsolescence. Rapid obsolescence, as well as the modular nature of IT and CE products and systems, results in frequent product upgrade cycles and growth of IT and CE product sales.

We believe that the outlook for IT is favorable due to the confluence of many factors. The release of Windows 7 by Microsoft may drive increased sales of new software applications and hardware components and peripherals as enterprises and consumers upgrade their personal computers, or PCs, to take advantage of the enhanced usability and capabilities of Windows 7. We believe IT spending is poised to rebound after the current recession ends as small and medium-sized businesses who already constitute a significant portion of the market for IT products, increase IT spending levels to enhance their competitive positioning and improve business productivity.

The market for IT and CE products is characterized by high online penetration rates. According to the Forrester Research report, “The State of Retailing Online 2008,” published May 7, 2008, 45% of IT sales, and 18% of CE sales in 2007 were generated online. We believe that IT and CE products are well suited for online sales because these products often require a potential customer to research, evaluate and compare a large amount of technical information, product features and consumer reviews, tasks which can be much more comprehensively and efficiently accomplished online. In addition, buying patterns are generally transitioning

 

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online as broadband adoption increases, fulfillment capabilities of online retailers become more reliable and consumers and businesses face continuing pressure to save money.

Opportunities and Challenges of Online Retailing

Online retailers have a number of advantages over brick-and-mortar retailers, including lower costs associated with operating a website versus operating physical stores with adequate display space and room for inventory. An online platform allows retailers to:

 

   

carry a broader product selection;

 

   

reach a geographically broader set of customers;

 

   

respond more quickly to changing consumer preferences, product prices, competitive dynamics and market conditions;

 

   

be more flexible in marketing to a specific set of potential customers; and

 

   

provide a personalized shopping experience.

A successful online retailer must acquire, convert and retain customers while developing the processes, methods and infrastructure necessary to do so efficiently and cost-effectively. This requires specific competencies in creating a compelling online shopping experience, ensuring reliable and timely product fulfillment and providing superior customer service. Many online retailers and brick-and-mortar retailers with retail websites have not been able to acquire these critical capabilities.

Online Shopping Experience

A compelling shopping experience is required to acquire, convert and retain customers, yet many aspects of the shopping experience present significant challenges for online retailers.

Customer Interface and Merchandising. Because online shoppers cannot touch or feel products, online retailers must find ways to supplant the physical shopping experience with a content-rich, user-friendly interface that makes it easy for shoppers to find, research and compare products, answer their questions and direct them toward a buying decision. Shoppers must also feel comfortable enough with the reliability and reputability of an online retailer to make a purchase online. Many online retailers lack the resources to build and support a robust website, and to ensure the availability of relevant information on it. Establishing a reputation for reliability also takes time and requires retailers to invest in their brand.

Selection. Many online retailers fail to acquire the most desirable products at attractive prices because of poor vendor relationships, a lack of scale and a weak understanding of the preferences of their target customer base. Some vendors with predominately non-Internet distribution channels are hesitant or do not sell to many online retailers for fear of alienating their existing channel partners and eroding product margins by shifting business toward the online channel which they perceive to compete primarily on price.

Pricing. Many online retailers are unable to offer customers competitive prices because they lack scale, a low cost infrastructure and strong supplier relationships. Without economies of scale, retailers are unable to negotiate attractive terms with suppliers. Many retailers that have scale lack an efficient infrastructure and have high operating costs.

Product Delivery and Fulfillment

Reliable and timely fulfillment is an important component of the e-commerce shopping experience and critical to customer satisfaction and retention.

 

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Timely Fulfillment. Delivering customer purchases quickly and efficiently is critical to customer satisfaction, and helps to bridge the gap between online retail and the instant gratification that customers can get from purchasing products in a physical store. Many online retailers have failed to develop the technology and implement the systems required to process customer orders in a timely and accurate fashion. Others sell out-of-stock products because they lack systems which provide inventory reports in real time, resulting in extended fulfillment delays. As a result, delivery times and accuracy suffer, and customers become dissatisfied.

Inventory Management. Many online retailers lack the scale and resources to ensure consistent availability of products and lack the infrastructure and expertise to optimize inventory levels and pricing or to promote and distribute their products rapidly across broad geographies. As a result, the customer experience suffers due to a high number of late or inaccurate orders, and costs associated with excess inventory and inefficient delivery reduce profitability.

Customer Service

A high level of customer service both during and after a transaction is essential to reduce new customer acquisition costs and to improve sales and margins from existing customers. Unlike traditional retail stores where customers interact face to face with store personnel, online customers cannot pose questions to salespeople in person and online retailers can only serve their customers remotely. Online retailers often only offer limited customer service channels such as Frequently Asked Questions, or FAQs, or entirely outsource the function to outside service personnel that are not well trained and integrated with the rest of the retailer’s organization. As a result, customers can be frustrated by slow or unresponsive service or customer service agents who lack the expertise or authority to resolve issues to the satisfaction of our customer.

As a result of these challenges, cost-effective customer acquisition, consistent conversion and long-term retention are difficult to achieve.

The Newegg Solution

We believe the foundation of our success lies in our expertise in three core competencies: providing a compelling online shopping experience, fulfilling orders in a reliable and timely manner and providing superior customer service. We believe that our success in developing these core competencies has created a strong brand and a loyal customer base of IT professionals, gamers, do-it-yourself technology enthusiasts, early technology adopters and CE enthusiasts.

Compelling Online Shopping Experience

We believe that Internet shoppers come to www.newegg.com because we deliver a compelling online shopping experience. Our website not only offers a broad selection of products at competitive prices, but also provides easy site navigation, detailed product information and a large set of product reviews and customer testimonials. These features and offerings address the customer’s desire to touch, feel and test products before purchasing. We also offer website visitors content and information that is not generally available from traditional retail outlets or many other websites.

Content-Rich and User Friendly Website. We have created a user-friendly website, www.newegg.com, which is easy to navigate and contains many features that provide valuable information for shoppers. Our website is organized into 9 major product categories, including computer hardware, PCs and laptops, electronics, software, networking, digital cameras, gaming, home and garden and cell phones. Our customers can locate products in a number of ways, such as by brand, category, price, SKU or degree of popularity, facilitating easy navigation among our various products. We provide detailed product descriptions, over 150,000 multi-sided product pictures as of March 31, 2009, and clear pricing information. In addition, as of March 31, 2009, our website contained links to over 1,200 manufacturer websites and over 38,000 rich media files.

 

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Our website features additional sections for our Daily Deals, testimonials, top searches, real-time updates, or RSS feeds, customer service, account information, tools and resources. We attempt to keep the website focused on the customer experience and avoid features that add little or no value to customers looking for products and services. In order to minimize clutter on our website and to enhance our credibility with customers, we only accept advertising from vendors and partners whose services and products we sell or utilize on our website.

Volume and Quality of User-Generated Content. Newegg’s core customer base of IT and CE enthusiasts provides useful user-generated content on our website. As of June 30, 2009, there were over 1,600,000 product reviews and over 30,000 customer testimonials about the Newegg shopping experience on our U.S. website. This content further engages our community and provides useful information not typically found at traditional retailers to help our customers make informed buying decisions. We have added community tools and functionalities, like our interactive EggXpert forum, which allows customers to publicly discuss their shopping experience and to have their questions or concerns addressed by Newegg moderators, administrators and customer support specialists. The EggXpert forum taps into the knowledge and expertise of our customer base to assist customer purchasing choices, thereby enhancing the shopping experience and promoting customer loyalty.

Broad and Deep Product Selection. We offer a broad selection of brand-name IT and CE products, as well as in-house brands of computer hardware and peripherals under the ABS and Rosewill labels. As of June 30, 2009, our U.S. website offered over 33,000 SKUs of IT, CE and other products. Our extensive product offerings enable us to meet the needs of a sophisticated, selective customer base, and are difficult to match by brick-and-mortar retailers due to shelf space constraints. Based on publicly available data, we believe we carry a deeper selection of many computer products and components than our major competitors. For instance, as of June 30, 2009, our U.S. website, carried 915 SKUs of hard drives, 1,732 SKUs of memory products, 164 SKUs of CPUs, 935 SKUs of video graphics adapter cards, 728 SKUs of computer monitors, and 1,582 SKUs of personal computers and laptops.

We are able to obtain favorable allocations of many desirable products due to our strong supplier relationships and our purchasing volume. We are a significant customer for many of our vendors, particularly in product categories such as high-performance computer components. We work with manufacturers to merchandise, promote and price their products in a manner that enhances their brands and build their market share. In addition, we offer our vendors a manufacturer portal where they can access updated sales and inventory data and view and respond to customer reviews.

Competitive Pricing. We believe that we offer a compelling value proposition, allowing us to attract new customers and retain existing customers. We are able to offer our customers competitive prices due to our focus on maintaining a low cost infrastructure and by leveraging our growing scale and supplier relationships. Our experienced product management team cost-effectively matches customer demand with supply, minimizing inventory and allowing us to offer product without the infrastructure costs typically associated with brick-and-mortar retailers. In addition, our strong supplier relationships allow us to negotiate favorable pricing and VIPs. To further attract customers, we offer Daily Deals on our websites, as well as Shell Shocker promotions, which feature products at significantly discounted prices, often with free or discounted shipping.

Reliable and Timely Fulfillment

We believe that reliable and timely fulfillment is critical to the customer shopping experience and encourages repeat purchasing behavior. To this end, we have carefully located our U.S. inventory and fulfillment centers to enable delivery of most U.S. orders within three business days of shipment.

Timely Fulfillment. In the United States, our integrated order fulfillment system allows us to efficiently process and ship items from heavily automated OPCs, ensuring reliable and timely delivery of products to our customers. In 2008, we shipped out more than 97.6% of U.S. orders fulfilled directly by us within one business day of payment validation and more than 98.2% of the time, we met or exceeded the promised delivery time to

 

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our U.S. customers, averaging approximately 2.4 business days from the date of shipment to receipt by the customer. Our network of OPCs in the United States features highly efficient picking and packing systems, and each order is verified at least twice to reduce errors. We ship certain products directly to customers from vendors who meet our quality fulfillment standards, a practice which we refer to as virtual fulfillment. We also have a policy of not accepting back-orders for out-of-stock inventory in order to minimize delays and meet the high standards of timely fulfillment to which our customers have become accustomed.

Optimal Inventory Management. We maintain multiple sourcing arrangements for most products we offer to ensure consistent availability. Our product managers make real-time decisions to optimize inventory levels, promotions and pricing using research and analysis provided by our support staff. We balance inventory levels at our U.S. OPCs based on local product demand, allowing us to lower freight costs by using ground delivery services. In the United States, for example, we shipped approximately 71.2% of our order packages in 2008 using ground delivery services. Our product managers are assigned targets for sales volume, profitability and inventory turns. Our technology infrastructure provides us with real-time information on inventory positions in our OPCs, a capability which very few online retailers can match. This allows us to efficiently merchandise our high volume product offerings, coordinate shipment orders from the OPC located closest to the customer and restock in a timely manner to meet customer needs and demands.

Superior Customer Service

We have built the Newegg brand on the principle of superior customer service, which is critical to our success. We train and empower our in-house customer service staff to resolve customer complaints as quickly as possible and to strive to make every customer a repeat customer.

Our Customer Service Philosophy. We believe that a brand’s online success is closely dependent on understanding and optimizing the relationship between the consumer and the merchant. We regard each live customer contact, complaint or service request as a critical opportunity in our relationship with that customer, because in online retail, a customer contact usually occurs only when something has gone wrong. Due to the ease of online customers to click from one online store to another, it is even more crucial in the online retail space to make certain that customer interactions end positively. Accordingly, we believe that it is critical to maintain quality control over customer interactions in order to create and maintain customer loyalty and trust in our brand.

Dedicated Customer Support. We believe that we offer our customers exceptional service. Our customer support staff is available by phone, live-chat or e-mail to provide assistance regarding products ordered, order status and shipping and billing information. We maintain the entire customer service function in-house, and as of June 30, 2009, employ 233 customer service representatives. We train and empower these representatives to address customer complaints, typically without requiring supervisor approval. Our Southern California call center, servicing North America customers, is available during business hours. To enhance our service capabilities and maintain increased access, we operate a China-based customer service center that is available seven days a week via e-mail and during regular business hours via instant messaging.

The Newegg Customer

Our slogan—Once You Know, You Newegg®—stands for the proposition that once someone shops at Newegg, we believe they will become a repeat customer. Our slogan also reflects our belief that customers who are knowledgeable about technology and IT and CE products prefer to shop with us. We believe our compelling online shopping experience, our reliable and timely fulfillment and our superior customer service have helped build a strong and loyal customer base. The IT product segment has attractive characteristics, including a well-educated, affluent, IT trendsetting and early adopter customer demographic, as well as relatively high purchase frequency. This facilitates an easier shopping experience with a higher probability of transacting online. We believe a growing number of our customers are now procuring IT hardware and peripherals and software for small and medium-sized businesses. Over the last few years, we have expanded into CE products. As of June 30,

 

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2009, our U.S. website had 12.6 million registered users and 4.1 million customers who purchased a product from us in the past year, many of whom are IT professionals, gamers and CE enthusiasts.

Awards and Accolades

Since we first launched our business, our customers have submitted a large number of positive reviews relating to their shopping experiences with us, many of which are posted on top technology product and shopping portals such as Bizrate.com, Shopping.com and Epinions.com. We have also been rated a number of times as a top e-commerce site for IT and electronics products. For example, Computer Shopper named Newegg the “Best Overall Place to Buy Online” in 2008, 2007, 2006, 2005 and 2004 and Internet retail rating site www.ResellerRatings.com has awarded us Platinum Plus status for customer excellence due to our overall customer satisfaction rating of 9.78 out of 10 as of August 14, 2009. Our success in pleasing our customers has also been validated in third-party surveys—sources such as Internet Retailer, ForeSee Results and Computer Shopper have ranked Newegg as one of the best online retailers for customer satisfaction.

In recent years, we have also received a number of national awards and ratings for excellent customer service. The 2008 American Customer Satisfaction Index, produced by the University of Michigan and ForeSee Results, ranked Newegg the #1 Internet retailer for customer satisfaction. In 2008, we placed 6th in the National Retail Federation/American Express Customer Choice Awards for customer service in all retail channels. We have also been recognized as the Best Consumer Direct Dealer in 2007 by TWICE magazine, a leading CE publication, and received similar accolades from other top industry publications and rating services including Forbes.com and CNET.com.

Our Strategy

Our objective is to become the leading online retailing platform, leveraging our strong market position in the IT and CE categories. The key elements of our strategy include:

Retain, Grow and Expand Our Customer Base

We intend to continue to add and improve features to our website to give consumers more product information, improve site navigation and streamline the purchasing process. We also plan to expand our current customer base into new demographics by providing a wider range of product offerings, greater personalization and segmentation within the website interface and by attracting non-core customers through targeted marketing campaigns. We intend to further expand our customer base beyond individual consumers into the enterprise markets, with a focus on small and medium-sized businesses. In the third quarter of 2009, we launched www.biz.newegg.com and added the capability for approved business customers to make purchases with traditional payment terms via purchase orders, or POs, and to obtain 30-day payment terms.

Expand Our Sales in China and Establish a Market-Leading Position

We believe China presents an attractive growth opportunity. By launching our Chinese operations in 2001, we established ourselves as an early entrant to the Chinese market. While the Chinese e-commerce market is at an early stage of development, we are establishing scale and building a leading position. During the twelve month period ended June 30, 2009, we generated $72.9 million of net sales in China, principally from the sale of IT products, CE products and household appliances. We intend to leverage our early entry into the market and our core competencies to become an e-commerce leader in China. We believe our e-commerce platform and process expertise coupled with strong local relationships in China and our understanding of the culture and needs of the Chinese consumer position us for success in the Chinese e-commerce market.

 

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Continue to Improve and Expand Relationships with Our Vendors

The success of our strategy depends, in part, upon our ability to offer customers a broad selection of products at competitive prices. We are pursuing deeper relationships with our existing vendors and new relationships with key IT and CE vendors. We intend to leverage our scale with our supplier base to seek better pricing, more favorable business terms or preferential product allocations from our vendors.

Broaden Product, Category and Service Offerings

We have successfully expanded our category offerings from just IT products to also include CE products and, in China, household appliances. We intend to continue to explore other product categories and service offerings. This could include SKU expansion within existing categories or into new categories, such as private label products and adjacent services, such as warranty sales and third-party installation services. We may also offer e-commerce services including inventory and warehouse management, order fulfillment and shipping, and software and IT development services for third parties. In China, we also plan to expand our e-commerce platform to other product categories beyond IT products, CE products and household appliances.

Leverage Our Low-Cost Asian Infrastructure

We intend to continue to utilize our China-based operations and personnel to provide us with a cost advantage for our growing global business. Our international operation support centers, strategically located in lower cost regions within China and Taiwan, provide us with a technically skilled workforce at a much lower cost than comparably experienced U.S.-based personnel. These centers have developed the majority of our proprietary technology platform and provide low cost marketing, content, customer support, software development, IT and back-office support services for our U.S. operations. Our low-cost Asian infrastructure represents a competitive advantage by enabling us to enhance our customers’ shopping experience, build out technology infrastructure and provide superior customer service at a lower cost. We are able to successfully manage Chinese support operations because many of our senior managers and executives are Chinese, know the language, and have a deep understanding of the culture and business climate. We plan to maintain and grow our low-cost infrastructure by selectively hiring additional personnel to perform these services.

Pursue Selective Acquisitions

We plan to evaluate and pursue strategic transactions that may broaden our product or service offering, add to our customer base, or expand our geographic presence. We expect to make acquisitions of companies, technologies or assets and participate in joint ventures when we believe they will cost-effectively improve or accelerate our website development efforts or complement our existing product offerings.

Newegg’s Chinese Online Retail Solution and Opportunity

We have an established presence in China and have become a leading Chinese e-commerce vendor through our affiliated e-commerce website, www.newegg.com.cn. We established our first Chinese e-commerce operations in Shanghai in 2001, and have since opened eight OPCs serving several major metropolitan areas. We plan to open additional OPCs in China over the next year to meet continued strong demand and strategically and cost-effectively expand geographical coverage in response to high utilization rates. We anticipate that our sales in China will represent a key driver of our future growth. In China we generated net sales of $31.3 million in all of 2008 and $54.4 million in the first half of 2009.

China is becoming a more consumer-driven economy, and is expected to become the third largest consumer market by 2020, according to the McKinsey Global Institute. According to IDC (September 2009), total IT spending in China was $68.4 billion in 2008, and is expected to grow to $101.0 billion in 2012, representing a compound annual growth rate of 10.2%. Euromonitor International estimates that the CE market in China was

 

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$107.4 billion in 2008, and will grow to $211.0 billion in 2012, representing a compound annual growth rate of 18.4%. According to IDC (October 2008), business-to-consumer online shopping was a $1.1 billion market in 2008 in China. We believe the Chinese e-commerce market is positioned for tremendous growth, driven by wider availability of broadband access, rising discretionary incomes, increasing preference for consumption relative to savings, particularly among younger Chinese, and improving payment processing, delivery and fulfillment infrastructures.

We believe the Chinese consumer has historically been underserved, particularly relative to consumers in the United States, in terms of product selection and quality, convenience, customer experience and service. For various reasons, the Chinese consumer has had a relatively limited set of products from which to choose, including the localized and fragmented nature of the brick-and-mortar Chinese retail market. Chinese retailers have historically lacked the necessary scale, technology, supply chain and inventory management competencies and delivery infrastructures to ensure timely and reliable order fulfillment. We believe our solution provides the Chinese consumer with substantially greater levels of product selection and quality, a better customer experience and a higher level of customer service than otherwise available in the Chinese market.

While the Chinese e-commerce opportunity is attractive, challenges to new entrants in the Chinese e-commerce market exist, creating substantial barriers to entry for our potential international and local competitors. Local expertise and relationships are necessary to establish supplier relationships and navigate the complex legal and regulatory environments. Furthermore, a strong understanding of the tastes and preferences of the Chinese consumer is critical to cost-effectively delivering a compelling online shopping experience.

We believe that we are better positioned than many local competitors and large U.S. competitors to succeed in the Chinese e-commerce market for a number of reasons. Unlike many new entrants or local competitors, we are utilizing a technology platform and operational practices which we have successfully employed in the United States to deliver a locally tailored e-commerce offering to the Chinese market. We believe our expertise in providing a compelling online shopping experience and superior customer service transfers well to the Chinese market. We offer a broad and deep selection of compelling products suited to local tastes at the right price points. As of June 30, 2009, our Chinese website carried over 12,600 SKUs of computer hardware, software, and components, communications devices, CE and other products. For the three months ended June 30, 2009, our Chinese website sold an average of more than 3,600 orders per day. In addition, unlike many large U.S. competitors, our management and senior employees possess local Chinese expertise, an intimate understanding of the preferences of the Chinese consumer and a diverse set of relationships. We have a large presence in China, with 1,096 employees, including 388 who are principally focused on our China e-commerce business, as of June 30, 2009.

The Chinese market also presents unique fulfillment challenges. While cost effective, rapid and reliable delivery systems exist for inter-city delivery, China suffers from an intra-city delivery problem—delivery service options are often limited to individual or small scale couriers and motorcycle messengers. We have adapted to local limitations by establishing a local delivery network composed of direct couriers and messengers hired by us and third-party shipping and delivery service providers to address the local Chinese delivery issue. Unlike many U.S. e-commerce competitors, we have improved our local supply chain by strategically sourcing and locating multiple direct couriers to efficiently fulfill and deliver orders in and to major Chinese metropolitan areas.

Electronic payment systems and products are still developing in China and have far less penetration than in the U.S. market. Accordingly, we take payment by cash or debit card on delivery.

Canada E-Commerce Website

In October 2008, we launched an e-commerce website, www.newegg.ca, to offer IT and CE products for sale in the Canadian market. Currently, all operations which support the www.newegg.ca website are located in the United States. Most orders are presently fulfilled from OPCs in California and New Jersey, and are delivered

 

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to our Canadian customers via third-party shipping companies. The remaining orders are fulfilled from virtual fulfillment facilities located within Canada operated by vendors. In the longer term, we intend to establish one or more strategically located Canadian OPCs designed to further increase delivery efficiencies for our Canadian customers. To that end, in August 2009, we entered into a lease of a 55,000 square foot facility in Mississauga, Ontario, which we plan to build into an OPC by October 2009.

Newegg’s Operational Expertise

Our Suppliers and Merchandise

In 2008, we purchased 52.8% of our inventory from distributors and 47.2% directly from manufacturers or other sources in the United States. Ingram Micro, an IT and CE product distributor, and our 10 largest suppliers (including Ingram Micro) accounted for approximately 11.9% and 47.9% of the merchandise we purchased, respectively, in 2008 in the United States. To ensure a steady supply of products and optimized pricing and allocation, we maintain multiple sourcing arrangements for most of our products. As we increase in scale in particular product categories, we expect to increase our purchases directly from manufacturers and, where appropriate, to become an authorized reseller. We believe our ability to establish direct relationships with manufacturers will provide improved product pricing, better access to VIPs and preferred product allocation. We believe that manufacturers and distributors consider us an important channel in certain product categories such as after-market computer components (e.g., high end video graphics cards), where we are one of the largest channels online or offline, and are gaining significant traction with vendors in related categories like CE and home appliances. In addition, we have created a manufacturer portal where our vendors access reports regarding inventory and purchase history of the manufacturers’ product, our vast record of customer reviews, and information about our customer purchases of their products. Our vendors use this information to assist in their marketing and product development efforts.

The table below shows our leading product categories and examples of manufacturers and vendors whose products we sell:

 

Category

  

Representative Brands

   SKU Count
as of June 30, 2009

IT Products

     

Hard Drives

   Hitachi, Samsung, Seagate, Western Digital    915

Personal Computers and Laptops

   Acer America, ASUS, Hewlett-Packard, Sony Vaio, Toshiba    1,582

Memory Products

   Corsair Memory, Crucial, G.Skill, Kingston Technology, OCZ Technology    1,732

CPUs

   AMD, Intel    164

CE Products

     

Home Video Equipment

   Panasonic, Samsung, Sharp, Toshiba    751

Digital Cameras

   Canon USA, Nikon, Olympus America, Panasonic, Sony    855

Video Games and Consoles

   Microsoft, Nintendo, Sony Playstation    4,337

Home Audio Equipment

   Onkyo, Pioneer, Polk Audio    619

 

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Fulfillment Operations

We strive to exceed customer expectations by fulfilling orders rapidly and accurately. As an online retailer without face-to-face customer interaction, successful fulfillment is critical to our efforts to build and maintain customer trust and loyalty. In 2008, we shipped more than 97.6% of U.S. orders fulfilled directly by us within one business day of payment validation, and more than 98.2% of the time, we met or exceeded the promised delivery time to our U.S. customers, averaging 2.4 business days from the date of shipment to receipt by the customer. In 2008, our U.S. average daily shipping volume was approximately 33,600 packages per day, and on our busiest day, we processed and shipped 109,289 packages. We currently operate one shift at each of our U.S. OPCs, with some overtime shifts during peak seasons.

Our scalable technology platform and order process flows are an integral part of our fulfillment operation. When we order product from a supplier, we track the receipt of the merchandise and can “material optimize,” or direct, the inventory to a specific OPC to match customer demand in a geographical area. The geographical placement of our OPCs is designed to enable us to reach 99.0% of the population of the continental United States in three business days or less using ground shipping, predominantly via UPS.

When a customer order is received, we match the order to our inventory, and distribute a specific order-fulfillment assignment to one or more OPCs for processing. We use advanced, “pick-to-light” picking systems to allow our OPC staff to fulfill small-item orders quickly. Each order is verified at least twice, resulting in a high degree of order accuracy. Once the product has been shipped, our inventory system automatically updates the inventory level, ensuring that the purchasing department is aware of when to order additional inventory. Our customers can track the shipping status of their purchases through links we e-mail and provide on our website. Our inventory management and tracking systems also have redundant capabilities to enable each facility, if necessary, to fulfill most U.S. orders. This redundancy could allow us to continue fulfilling most orders, albeit less efficiently, as long as a single OPC is operational.

In all, we have almost 1,000,000 square feet of warehouse space strategically located in OPCs in California, New Jersey and Tennessee. We presently fulfill our Canadian product sales from our California and New Jersey OPCs, but have leased and intend to begin fulfilling certain Canadian orders from a 55,000 square foot warehouse located in Ontario, Canada. We have a reverse logistics facility in Southern California that processes order returns and replacements.

We believe the best approach in serving our customers is to maintain reasonable inventory levels and to ship directly from our own inventory. We stock and ship the vast majority of our products. In the U.S., we utilized virtual fulfillment for approximately 6.8% of our total net product sales in 2008. This shipment method is utilized typically for very large items such as televisions and products that are purchased infrequently and where shipping and handling challenges are higher. We strive to only use virtual fulfillment vendors that we believe are capable of meeting our stringent on-time and accurate delivery requirements.

Our customers may choose various shipping methods including basic ground delivery and expedited overnight shipping. In the U.S. in 2008, 71.2% of our order packages shipped via ground delivery service. While UPS accounted for 89.4% and Federal Express 2.0% of our total product shipments in 2008 in the U.S., on July 1, 2008, we began to offer a lower-priced shipping alternative via DHL that accounted for approximately 14.5% of our order shipments during the first half of 2009. The DHL option, however, entails a two to five day average transit time. Shipping costs are based on the type of delivery service requested, shipping distance, package dimensions and delivery location. Due to the large volume of our UPS shipments, we have UPS personnel and delivery vehicles located at most of our OPCs to ensure that delivery is accomplished in a timely manner.

Our standard return policy allows merchandise purchased on our websites to be returned within 30 days of the original invoice date for a full refund or for a replacement, in both cases less certain restocking fees. Products with value representing only 2.4% of our gross sales were returned to us in 2008, demonstrating the success of

 

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our focus on our three core competencies: providing a compelling online shopping experience, fulfilling orders in a reliable and timely manner and providing superior customer service.

In China, we have operations in Shanghai, Beijing, Chengdu, Guangzhou, Jinan, Nanjing, Wuhan and Xian. As of June 30, 2009, in China we employ 111 order fulfillment personnel, 109 delivery personnel, and six administrative staff. Orders are fulfilled from OPCs, and either held for pickup by the customer or delivered via locally-based motorcycle messengers employed or contracted by Newegg. If the delivery address is outside the range of our messenger network, we ship the order via common mail and freight carriers throughout China. In 2010, we intend to open additional OPCs designed to efficiently fulfill and deliver orders to certain other major Chinese metropolitan areas.

Technology and Intellectual Property

Our technology systems are a critical component of our success and are designed to enhance efficiency and scalability. Our strategy is to develop proprietary software and license technologies from third parties as appropriate in order to simplify and improve the customer shopping experience, as well as facilitate our fulfillment, financial and customer service operations.

Our website incorporates proprietary technology internally developed on a primarily Microsoft .NET platform. It provides product descriptions, search and ordering functionalities and product reviews. Our transaction level data are housed in our data warehouse that as of August 18, 2009, had over 29.5 terabytes of information. We have deployed Cognos business intelligence software to analyze our data and improve the consumer experience. We utilize secure encryption technology to send and receive confidential financial information during the transaction process. Our website response time is consistently ranked in the Top 10 in the Gomez Retail Product Order Benchmark, an independent measure of website performance for the top 25 Internet retailers.

Our inventory availability is coordinated through our technology platform and website. We have added functionality to update our website when items become out of stock in our fulfillment centers. This feature limits the number of orders placed for out-of-stock items, allowing us to avoid shipment delays and minimizing customer dissatisfaction by eliminating backorder merchandise.

Online fraud is a constant threat to security and reliability of e-commerce retailers. We work with third-party vendors to assist us in monitoring our network security devices and to secure our online payment systems. We have also developed proprietary tools to monitor our online traffic for suspicious activities. Our website has earned certifications from organizations and agencies like VeriSign and Trustwave based on our meeting their information protection and fraud prevention standards.

We have developed and deployed a scalable back office platform that allows us to monitor transactions and changes to financial data as well as provide our management with daily updates. We utilize both proprietary and third-party applications for accepting and validating customer orders, placing and tracking orders with suppliers, managing inventory and assigning it to customer orders and ensuring proper shipment of products to customers.

We have software for our fulfillment operations that tracks customer orders from placement through packing and shipping. We have installed sophisticated, “pick-to-light” conveyor systems and associated software. We have also developed software modules that efficiently manage the sorting and picking process of our products. Our systems are integrated with those from our primary U.S. shipping vendors, UPS, FedEx and DHL to facilitate tracking of the orders after shipment.

We have software for our call center that facilitates our phone and e-mail interactions. We license third-party software to support our live chat functions.

We presently have two co-located data centers at facilities in Los Angeles, California and Edison, New Jersey to provide redundancy for our e-commerce data centers, including customer data.

 

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We regard protection and enforcement of our rights to intellectual property and proprietary rights, particularly domain names, copyrights and trade secrets, as critical to our success. We rely on a combination of contractual restrictions and copyright, trademark and trade secret laws to protect our proprietary rights, confidential information and technology. For instance, our standard contracts with third parties and our employees and service providers include confidentiality provisions. We are the registered owners of numerous domain names, including www.newegg.com, www.newegg.ca and their variants. We pursue the registration of our domain names in the United States, China, Canada and a number of other countries and regions. Newegg E-Business is the owner of the www.newegg.com.cn website. See “Related Party Transactions.”

As of June 30, 2009, we employed 526 engineers, quality assurance personnel, content writers and web developers to support and improve our technology infrastructure. The majority of these employees are located in China and Taiwan.

Customer Service and Support

One of our cornerstones is to provide superior customer service. We believe that our ability to establish and maintain ongoing relationships with our customers and generate repeat visits and purchases depends, in significant part, on the strength of our customer support team. To maintain control over the quality of service, we have chosen not to outsource any of our e-mail, live chat or call center customer service operations. Moreover, we have purposely maintained our call center near our Southern California headquarters in order to ensure the ability to carefully monitor training and service levels and to respond quickly to customer feedback.

Our customer support personnel are responsible for handling general customer inquiries, answering customer questions about the ordering process and products ordered and investigating the status of orders, shipments and payments. We also train and empower our customer support staff to solve issues and remedy situations in most instances without having to get approval from their supervisor. We believe that our policies have helped to increase customer satisfaction with the Newegg shopping experience.

Our customer service department is available over the telephone and on live chat Monday through Friday from 8 a.m. to 5 p.m. Pacific Standard Time, and our e-mail is supported seven days a week during extended hours. We operate a highly redundant international communications infrastructure that is highly scalable. Our communications infrastructure is integrated into our call-centers that answer our customer phone calls, chat conversations and e-mails. Our U.S. customer inquiries via telephone are answered by personnel located in the United States and customer inquiries via chat and e-mail responses are shared between our customer service personnel in China and in the United States.

Marketing

We have designed our marketing strategy to generate consumer traffic, increase Newegg’s brand recognition, acquire customers cost efficiently, build a loyal customer base and maximize repeat purchases. To date, we have benefited greatly from word of mouth, referrals and positive product reviews. In 2008, we attracted 70.7% of our website visitors without incurring a referral, click-through or advertising fee. We utilize web analytics tools to assist in making our marketing decisions and to maximize the return on marketing expenditures. In 2008, our marketing expenditures totaled $21.7 million, or 1.0% of net sales.

We conduct the majority of our marketing efforts online through targeted marketing via affiliates, search engines, shopping comparison sites and e-mail programs. We manage a comprehensive network of affiliate websites who receive commission on sales by directing traffic to our websites. We also bid for specific keywords on search engine websites, such as Google, Yahoo! and MSN Bing, in order to receive optimum visibility in the displayed results when visitors browse for product on these sites. Our broad and changing product selection enables us to utilize a large quantity of keywords that we frequently test and measure for their effectiveness. Other marketing channels include click-through based advertising on shopping comparison engines, targeted

 

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e-mails, display and banner advertisements on high-traffic portals, social networking via major social media sites and our own branded portal, and onsite promotions and cross-selling opportunities on our websites. Our offline marketing activities include advertisements in various technology publications, print and electronic catalogs, box inserts, event participation, public relations and targeted broadcast and major media print and broadcast activities designed to increase our brand awareness.

Investments

We may also pursue opportunities to leverage our experience, operating infrastructure, platform, technology and customer base to broaden the scope of our business. These opportunities could involve investments in, or partnerships with, third parties. For example, we own a 23.9% interest in OmniHealth Group, Inc., a Taiwanese medical information and service company.

Competition

The online retail market for IT and CE products in the United States and internationally is competitive, growing rapidly and has low barriers to entry. Online retailers have historically competed on price. We have focused on providing compelling value to our customers by delivering an easy-to-navigate and highly informative website, significant product breadth and depth, efficient fulfillment capabilities and a high level of customer service. In the United States, we compete with other broad-based online retailers, such as Amazon.com and Buy.com; IT-focused product providers, such as CDW, Dell and TigerDirect.com; and traditional brick-and-mortar retailers such as Best Buy, Costco, Fry’s, Radio Shack, Staples and Walmart. In China, we compete with China-based e-commerce providers, such as 360buy.com, Dangdang.com, Joyo.com and Taobao.com; and traditional brick-and-mortar retailers based in China.

Employees

As of June 30, 2009, we employed 938 full-time employees in the United States and 1,124 full-time employees in Asia for a total of 2,062 full-time employees. Of our global employee base, in our largest functional areas we employed 650 in logistics, 526 in IT, 210 in product management and 233 in customer service. During the holiday season, we have historically added temporary workers to augment our full-time work force. None of our employees are represented by a labor union and we have never experienced a work stoppage.

Facilities

We currently operate the following principal facilities:

 

Description of Use

   Approximate
Square
Footage
 

Operating
Segments

  

Lease
Expirations

     (in thousands)         

Corporate office facilities

   103   North America    From 2009 through 2010

Corporate office facilities

   148   China    From 2010 through 2011

Fulfillment and warehouse operations

   1,004   North America    From 2010 through 2012

Fulfillment and warehouse operations

   241   China    From 2009 through 2011

Our corporate headquarters are located in City of Industry, California. We also own or lease additional corporate office facilities and fulfillment and warehouse operations throughout the United States, principally in

 

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New Jersey, Tennessee, and Canada. Outside of the United States, we also own or lease corporate office facilities and fulfillment and warehouse operations, principally in China, with one additional facility in Taiwan. Our Asia headquarters are in Shanghai and we have OPCs located throughout China directly serving several metropolitan areas. We periodically evaluate our facility requirements as necessary and believe our existing and planned facilities will be sufficient for our needs for at least the next twelve months.

Jiading Facility Contract and Plans for a Regional Headquarters

In June 2008, we entered into a land use rights grant contract with Jiading District Bureau of Housing and Land Administration, under which we were granted the land use rights for a 492,000 square foot parcel of land for 50 years, located in a new industrial park in the district of Jiading, a suburb of Shanghai, China. We have paid approximately $3.2 million, which is being amortized over the 50-year term, to the local Jiading government for such land use rights. We intend to develop the parcel over the course of several development phases into our Asia headquarters. Plans for phase I include an office building and ancillary structures, and plans for phase II include a regional OPC. Phase I and phase II have combined estimated construction costs of approximately $10.0 million. Subsequent to the completion of phases I and II, the following phases of constructions are expected to include a Research and Development center and other commercial facilities. Plans for the phase I and phase II developments have received approval from the district government of Jiading, and construction work on both phases has commenced. Under the terms of our agreement with the Jiading government, we must provide a minimum of $25.0 million of capital to one or more of the local subsidiaries to fund real estate and business development activities over a two-year period. As of June 30, 2009, we have met this commitment. We expect these new capital projects to support our anticipated growth in management and employee headcount and operations.

Government Regulation

We are subject to U.S. federal and state consumer protection laws, including laws protecting the privacy of customer non-public information and regulations prohibiting unfair and deceptive trade practices. Other existing and future laws cover issues such as user privacy, spyware and the tracking of consumer activities, marketing e-mails and communications, other advertising and promotional practices, money transfers, pricing, content and quality of products and services, taxation, electronic contracts and other communications and information security.

There is also great uncertainty over whether or how existing laws governing issues such as property ownership, sales and other taxes, auctions, libel and personal privacy apply to the Internet and commercial online services. These issues may take years to resolve. For example, tax authorities in a number of states, as well as a Congressional advisory commission, are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes. New legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the Internet and commercial online services could result in significant additional taxes or regulatory restrictions on our business.

Our operations in China are governed by laws and regulations of China.

Legal Proceedings

On November 5, 2007, Soverain Software LLC, or Soverain, filed a patent infringement lawsuit against us in the United States District Court for the Eastern District of Texas, seeking, among other things, a judgment that Newegg has infringed certain patents held by Soverain, an injunctive order against the alleged infringing activities and an award for damages. If an injunction is granted, it could force us to stop or alter certain aspects of our business activities, such as aspects of our shopping cart and session ID. This case is scheduled for a jury trial in Tyler, Texas, in February 2010. Although we have and continue to deny Soverain’s allegations and defend

 

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against its claims vigorously, and we believe that we have substantial and meritorious defenses, neither the outcome of the litigation, nor the amount and range of potential damages or exposure associated with the litigation, can be assessed with certainty.

In addition to the Soverain lawsuit, from time to time, we may become involved in legal proceedings arising in the ordinary course of our business. We are not presently involved in any legal proceeding in which the outcome, if determined adversely to us, would be expected to have a material adverse effect on our business, operating results or financial condition. However, there can be no assurance with respect to the outcome of any legal proceeding, and we could suffer monetary liability or an operational impact from such proceedings, lawsuits and other claims that could differ materially from what we expect.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth information about our executive officers, directors and certain key employees as of June 30, 2009:

 

Name

   Age   

Position

Tally Liu

   58   

Chairman of the Board and Chief Executive Officer

Fred Chang

   52   

Vice Chairman of the Board and President of Newegg China

Michael Amkreutz

   39   

Vice President of Product Management

Lee Cheng

   37   

General Counsel and Corporate Secretary

Anthony Chow

   44   

Acting President of Newegg.com.cn

Dr. Shih-Chi Lee

   60   

Executive Vice President and Director

Bernard Luthi

   45   

Vice President of Marketing

Joel Miller

   49   

Chief Human Resources Officer

Richard Quiroga

   49   

Vice President of Finance

Jing (James) Wu

   39   

Chief Technology Officer

Deven Parekh

   39   

Director

Tally Liu has served as our Chief Executive Officer and Chairman of the Board since August 2008 and as a member of our Board since June 2005. Mr. Liu served as our President and Vice Chairman from February 2008 to August 2008 and as the Chairman of the Audit and Compensation Committees from October 2005 until February 2008. Prior to joining Newegg, from June 2006 to February 2008, Mr. Liu was a consultant in the media sector. From October 1978 to June 2006, Mr. Liu held various positions within Knight Ridder, a media company specializing in newspaper and Internet publishing, including as Vice President of Finance and Administration, Vice President of Finance and Advanced Technology, Vice President and Chief Financial Officer for the San Jose Mercury News, Vice President for the Boca Raton News and Senior Vice President of Finance and Operations for Knight Ridder Digital. Mr. Liu was formerly a Certified Public Accountant and holds a Bachelors degree in Business Administration from National Chen Chi University in Taiwan and a Masters degree in Business Administration from Florida Atlantic University.

Fred Chang co-founded Newegg and served as our Chairman of the Board since our inception in 2001 until August 2008. From August 2001 to August 2008, Mr. Chang also served as our Chief Executive Officer. He served as our director and the acting President of Newegg China from August 2008 to March 2009. From April 2009 to August 2009, he continued to serve as our director. He assumed his current role as the President of Newegg China and Vice Chairman of the Board in August 2009. Prior to forming Newegg, Mr. Chang founded and served as Chief Executive Officer of ABS Computer Technologies, our predecessor entity. Mr. Chang holds a Bachelors degree in Applied Mathematics from the Chinese Culture University of Taiwan.

Michael Amkreutz has served as our Vice President of Product Management since September 2007. From 2005 to 2007, Mr. Amkreutz was Vice President of Sales and Product Marketing at HANNspree North America, a visual display technology company. From 2003 to 2005, Mr. Amkreutz served as Vice President, Market and Product Planning for Proview Technology Holdings, Ltd, a branded monitor manufacturer. Prior to his experience at Proview, Mr. Amkreutz served for six years in various management positions at Sharp Electronics and Toshiba Consumer Products. Mr. Amkreutz holds a Bachelors degree in Business Administration and Marketing from Western Washington University and a Bachelors degree in Mathematics from Rutgers University.

Lee Cheng has served as our General Counsel and Corporate Secretary since September 2005. Prior to Newegg, Mr. Cheng worked as an attorney at the law firm of Latham & Watkins LLP. Mr. Cheng has also served as the Vice President and General Counsel of GeneFluidics, Inc., a medical diagnostics company, and as the Vice President of Administration and Legal Affairs at LightCross, Inc., an optical networking components company. He entered private practice at the law firm of Dow, Lohnes & Albertson and also worked as an Associate with

 

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the law firm of Gray, Cary, Ware & Freidenrich (now DLA Piper). Mr. Cheng is a member of the State Bar of California. Mr. Cheng holds a Juris Doctor from U.C. Berkeley, Boalt Hall School of Law and a Bachelors degree, magna cum laude, in History and Science from Harvard University.

Anthony Chow has served as our Acting President of Newegg.com.cn since July 2008 as well as Acting President of OZZO Logistics since December 2008. Mr. Chow served as our Vice President of Business Development from January 2007 to July 2008. From 1998 to 2005, Mr. Chow was the CEO & President of STI, Inc., an importer of cellular phone accessories from Asia for distribution in the United States. Mr. Chow holds a Bachelors degree in Electrical Engineering from the University of Toledo, Ohio.

Dr. Shih-Chi Lee has served as our Executive Vice President of Corporate Planning and Partner Relationships since December 2005. From 2001 to 2005, Dr. Lee was a Partner in the Global Strategic Investment Management Fund, a Taiwan-based technology investment company. Prior to Global Strategic Investment Management Fund, Dr. Lee served for 14 years at various positions at Microtek Lab, Inc., the U.S. subsidiary of a manufacturer of scanning and imaging products and a public company in Taiwan, including six years as its President. Dr. Lee holds a Bachelors degree in Mathematics from National Taiwan University and a Masters degree and a Ph.D. in Mathematics from Brandeis University.

Bernard Luthi has served as our Vice President of Marketing since October 2008, as well as Vice President of Merchandising since December 2006. From 2004 to 2006, Mr. Luthi served as Vice President, Category & Vendor Marketing for PC Mall, a value-added direct marketer of technology products, services and solutions. Prior to his experience at PC Mall, Mr. Luthi served in various management positions including Director of Product Marketing at Ingram Micro, an IT and CE product distributor, from 1994 to 2004. Mr. Luthi has a Bachelors degree in Business Administration from California State University, Los Angeles.

Joel A. Miller has served as our Chief Human Resources Officer since July 2008. From 2006 to 2007, Mr. Miller served as Executive Vice President, Human Resources of Guitar Center, Inc., a musical instrument retailer. Mr. Miller served as Chief People Officer of Aegis Living, LLC in 2005, a private assisted living firm. Mr. Miller has over 15 years of executive management experience in the human resources field, including international experience leading human resources in over 15 countries and serving in an expatriate role in China while with Procter & Gamble. Mr. Miller holds a Bachelors degree in Management Engineering from Rensselaer Polytechnic Institute.

Richard Quiroga has served as our Vice President of Finance since December 2006. From 2004 to 2006, Mr. Quiroga served as Senior Vice President of Finance for Joe’s Jeans Inc. (formerly Innovo Group Inc.), a branded denim apparel designer. From 1996 to 2003, Mr. Quiroga served in various financial roles including Vice President of Finance and Corporate Controller at EarthLink, Inc., a U.S. Internet service provider. Mr. Quiroga has over 25 years of experience as a financial professional beginning as an external auditor at PricewaterhouseCoopers LLP (formerly Coopers & Lybrand). Mr. Quiroga is a Certified Public Accountant and holds a Bachelors degree in Accounting from Loyola Marymount University.

Jing (James) Wu has served as our Chief Technology Officer since August 2008. From October 2007 to August 2008, Mr. Wu served as our Chief Architecture Officer. Since joining our predecessor in February 2000, Mr. Wu has held a variety of positions in our Management Information Systems, or MIS department. Prior to joining Newegg, Mr. Wu served as an information consultant for the Oil Refinery Industry of China in Xinjiang. Mr. Wu holds a Bachelors degree in Computer Science from Sichuan University of Science and Technology in China.

Deven Parekh has served as a member of our Board since September 2005, and as the Chairman of our Audit and Compensation Committees since February 2008. Mr. Parekh has served as a Managing Director at Insight Venture Partners, a venture capital firm specializing in software and Internet companies, since 2000. From 1992 to 1999, Mr. Parekh was employed at Berenson Minella & Company, a New York-based merchant

 

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banking firm. In addition to Newegg, Mr. Parekh serves on the board of a number of private companies. Mr. Parekh received a Bachelors degree, magna cum laude, in Economics from the Wharton School of the University of Pennsylvania and is a Henry Crown Fellow of the Aspen Institute. Mr. Parekh has been appointed to our Board as the nominee of the holders of our Series B Preferred Stock pursuant to the terms of our Amended and Restated Certificate of Incorporation.

There are no family relationships among any Newegg executive officers or directors.

Board Composition

Our Board currently consists of four members—Fred Chang, Dr. Shih-Chi Lee, Tally Liu and Deven Parekh. Mr. Parekh is not, and has never been, employed by our company or our subsidiaries. In addition, we anticipate adding two independent directors to our Board prior to the consummation of this offering.

Under Delaware law, our directors may be removed for cause by the affirmative vote of the holders of our capital stock representing a majority of the voting power of such capital stock. Upon the completion of this offering, Mr. Chang will beneficially own shares representing more than 50% of the combined voting power of our capital stock, and as such, is able to elect our entire Board. As a result, we are, and will continue to be upon completion of the offering, a “controlled company” under the                  rules. “Controlled companies” under those rules are companies of which more than 50% of the voting power is held by an individual, a group or another company. In addition, our Board does not consist of a majority of independent directors. As a “controlled company,” we are eligible to, and we intend to, take advantage of certain exemptions from corporate governance requirements provided in the rules, including the requirement that a majority of our Board consist of independent directors. Upon completion of this offering, we intend to have an equal number of independent and non-independent directors, although it is also our intent that all Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee members be independent.

Board Committees

Our Board currently has an Audit Committee and a Compensation Committee. Upon completion of this offering, we intend to form a Nominating and Corporate Governance Committee.

Audit Committee

If this offering is completed, we anticipate that our Audit Committee will consist of three members, including Mr. Parekh, and that all of the committee members will meet the independence requirements of Rule 10A-3 promulgated under the Securities Exchange Act of 1934, as amended, and as defined in the                                                                                                    qualification standards. In addition, one of our Audit Committee members will qualify as an “audit committee financial expert” as that term is defined in the rules and regulations established by the Securities and Exchange Commission, or SEC. The functions of this committee will include:

 

   

reviewing with our independent auditors and management significant issues that may arise regarding accounting principles and financial statement presentation, as well as matters concerning the scope, adequacy and effectiveness of our financial controls;

 

   

evaluating these matters with our independent auditors and with internal financial personnel;

 

   

reviewing and approving all related-party transactions;

 

   

pre-approving audit and non-audit services to be rendered by our independent auditors;

 

   

reviewing, pre-approving and evaluating the engagement and retention of our independent registered public accounting firm to perform audit services and any permissible non-audit services;

 

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reviewing our financial statements and periodic reports and discussing the statements and reports with our independent auditors and management;

 

   

establishing procedures for the receipt, retention and treatment of complaints received by us regarding accounting, financial controls and auditing matters;

 

   

reviewing and discussing with management our policies with respect to risk assessment and risk management and any significant financial risk exposures and the actions management has taken to mitigate such exposures;

 

   

preparing the audit committee report required by SEC regulations; and

 

   

performing an annual self-evaluation.

Both our independent auditors and internal financial personnel regularly meet privately with the audit committee and have unrestricted access to this committee.

Compensation Committee

If this offering is completed, we anticipate that our Compensation Committee will consist of three members, including Mr. Parekh, and that all of the committee members of our Compensation Committee will be non-employee directors, as defined in Rule 16b-3 of the Exchange Act, be outside directors, as defined pursuant to Section 162(m) of the Internal Revenue Code of 1986, as amended, and satisfy the                          independence requirements. The functions of this committee will include:

 

   

reviewing our compensation philosophy;

 

   

reviewing and, as it deems appropriate, recommending to our Board, policies, practices and procedures relating to the compensation of our directors, officers and other managerial employees and the establishment and administration of our employee benefit plans;

 

   

exercising authority under our employee benefit plans;

 

   

reviewing and approving executive officer and director indemnification and insurance matters;

 

   

advising and consulting with our officers regarding managerial personnel and development; and

 

   

performing an annual self-evaluation.

The Compensation Committee has the exclusive authority to approve the compensation package and arrangements of our Chief Executive Officer.

Nominating and Corporate Governance Committee

If this offering is completed, we anticipate that our Nominating and Corporate Governance Committee will consist of three members, including Mr. Parekh, and that all of the committee members will meet the independence requirements of the                         . The functions of this committee will include:

 

   

identifying qualified candidates to become members of our Board;

 

   

selecting nominees for election of directors at the next annual meeting of stockholders (or special meeting of stockholders at which directors are to be elected);

 

   

selecting candidates to fill vacancies of our Board;

 

   

developing and recommending to our Board our corporate governance guidelines;

 

   

overseeing the annual evaluation of our Board;

 

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reviewing and considering possible conflicts of interest that may arise between us and any director; and

 

   

performing an annual self-evaluation.

Compensation Committee Interlocks and Insider Participation

Our Compensation Committee currently consists of Messrs. Deven Parekh and Tally Liu. Mr. Liu also serves as our Chief Executive Officer and will resign from the Compensation Committee, effective upon the completion of this offering. Mr. Parekh is not, and has never been, employed by our company or our subsidiaries.

 

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EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

This Compensation Discussion and Analysis discusses our compensation programs, policies and decisions made during 2008 and 2009 for each of the following named executive officers: Tally Liu, our President from February 2008 to August 2008 and our Chief Executive Officer and Chairman of our Board since August 2008; Richard Quiroga, our Vice President of Finance; Dr. Shih-Chi Lee, our Executive Vice President; Michael Amkreutz, our Vice President, Product Management; and Lee Cheng, our General Counsel and Corporate Secretary. The compensation programs, policies and decisions pertaining to Fred Chang, who was our Chief Executive Officer at various times from our founding until August 2008 and remains our principal stockholder, Vice Chairman of our Board and President of Newegg China, is discussed solely under the heading “—Compensation to our Principal Stockholder.”

Compensation Objectives and Components

We believe that attracting and retaining the best available personnel for positions of substantial responsibility is critical to the success of our business, fulfilling our corporate mission and achieving our strategic goals for the benefit of our stockholders. Our compensation policies are a key instrument in motivating and rewarding these employees.

We have designed our compensation programs to motivate our named executive officers by aligning pay and performance and subjecting a significant portion of their compensation to the achievement of annual financial performance goals, goals for their respective departments and their own personal performance measures. We also seek to build an ownership mentality among all of our employees, including our named executive officers, and to align their interests with those of our stockholders through equity-based long-term incentive awards that link executive compensation to stockholder return. Our compensation programs are also designed to recognize employee contributions over time and provide for employee retention. Consistent with our performance-based philosophy, a substantial portion of each named executive officer’s compensation is based on performance- and incentive-based programs.

Our Compensation Committee believes that each employee, including our named executive officers, should be employed at will. As a result, none of our employees has any contractual severance benefits, other than accelerated vesting of equity grants upon a qualifying termination in conjunction with certain acquisitions of us.

To implement the objectives above, each of our named executive officers receives a compensation package that includes:

 

   

base salary;

 

   

short-term cash incentives in the form of annual, performance-based cash bonuses;

 

   

long-term equity incentives in the form of stock option grants, and, in Mr. Liu’s case, annual performance-based equity incentive awards settled in shares of Class A Common Stock along with a tax gross-up on Mr. Liu’s tax expense relating to any payout of such stock; and

 

   

perquisites, which in Mr. Liu’s case includes a monthly housing and car allowance.

We discuss each of these components below.

Base Salary

Base salaries provide competitive, fixed compensation for attracting and retaining high-performing executive talent and rewarding individual achievements and contributions. Base salaries are based on the level of responsibilities and the experience of the individuals and form a stable part of each named executive officer’s compensation package.

The Compensation Committee reviews base salaries for our named executive officers annually, or in conjunction with promotions or significant changes in the scope and complexity of their responsibilities. In each case, the Compensation Committee reviews and takes into account the compensation recommendations of our

 

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human resources department, the performance evaluations for the named executive officer against objectives established and communicated at the beginning of each year, the scope of their responsibilities, our financial performance, retention considerations and general economic and competitive conditions. Our Chief Executive Officer also provides recommendations to the Compensation Committee on the base salaries o