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FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-30199
CoolSavings, Inc.
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(Exact name of registrant as specified in its charter)
State of Delaware 36-4462895
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State of Incorporation I.R.S. Employer I.D. No.
360 N. Michigan Avenue, 19th Floor, Chicago, Illinois 60601
(312) 224-5000
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(Address of principal executive offices and telephone number)
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Former name, former address and former fiscal year,
if changed since last report
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.001
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [ X ]
As of June 30, 2002 (the end of the Registrant's most recently
completed second fiscal quarter), the aggregate market value of the
Registrant's voting stock held by non-affiliates of the Registrant
(assuming for this purpose that executive officers, directors and 10%
stockholders that are affiliates) was approximately $707,088, based on the
closing sales price of $0.05 on such date. As of March 1, 2003, there were
39,093,660 shares of the Registrant's common stock issued and outstanding.
COOLSAVINGS, INC.
Form 10-K Annual Report
Fiscal Year Ended December 31, 2002
TABLE OF CONTENTS
Page
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PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . 4
Item 2. Properties. . . . . . . . . . . . . . . . . . . . 23
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . 24
Item 4. Submission of Matters to a Vote of
Security Holders. . . . . . . . . . . . . . . . . 25
PART II
Item 5. Market for the Company's Common Equity and
Related Stockholder Matters . . . . . . . . . . . 26
Item 6. Selected Financial Data . . . . . . . . . . . . . 27
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . 30
Item 7A. Quantitative and Qualitative Disclosures
about Market Risk . . . . . . . . . . . . . . . . 46
Item 8. Financial Statements and Supplementary Data . . . 47
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . . . . . 85
PART III
Item 10. Directors and Executive Officers of the Registrant 85
Item 11. Executive Compensation. . . . . . . . . . . . . . 89
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters. . 92
Item 13. Certain Relationships and Related Transactions. . 99
Item 14. Controls and Procedures . . . . . . . . . . . . . 99
PART IV
Item 15. Exhibits, Financial Statement Schedule and
Reports on Form 8-K . . . . . . . . . . . . . . . 100
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . 101
CERTIFICATIONS. . . . . . . . . . . . . . . . . . . . . . . 103
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements in this annual report regarding our business that are not
historical facts, including the statements under "Business-Overview" and
other statements regarding our expectations, beliefs, hopes, intentions or
strategies, are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Where possible, we have
identified such forward-looking statements by use of words such as
"forecast," "believe," "expect," "intend," and similar expressions. Known
and unknown risks, uncertainties and other factors, both general and
specific to the matters discussed in this annual report, may cause our
actual results and performance to differ materially from the future results
and performance expressed in, or implied by, such forward-looking
statements. These risks, uncertainties and other factors include, without
limitation, our ability to obtain additional debt and/or equity financing,
the uncertainties related to our unproven business model in a rapidly
evolving marketplace, our ability to protect our patents, trademarks and
proprietary rights and the other factors described under "Item 1. Business
- - Risk Factors". Except as expressly required by the federal securities
laws, we undertake no obligation to update or revise any forward-looking
statements as a result of new information, future events or developments,
changed circumstances or any other reason.
We own United States service mark registrations for the mark
COOLSAVINGS, as well as several other service marks, including, among
others, COOLSAMPLES, SAVINGSCENTER, SQUEALS OF THE DAY, COOLCATALOGS,
COOLCAMPUS, COOLCASH, COOLCOLLEGES, COOLDINING, COOLEVENTS, COOLGROCERS,
COOLNEIGHBORHOODS, COOLSUPERMARKETS, DINELINE, EVENTSLINE, REWARDS WHEREVER
YOU SHOP, and our stylized piggy-bank logo. We also own common law rights
in these and other marks. In addition, we have applied for United States
federal registrations of several service marks, including our SAVE. THEN
SHOP., COOLPOINTS, COOLCOINS, COOLSCHOOLS, COOLSTAMPS, SAVE THEN DINE, and
COOLSAVINGS COUPON MANAGER. We have also obtained a trademark registration
in Australia for COOLSAVINGS and have registration applications pending in
the United Kingdom, Australia and Canada.
PART I
ITEM 1. BUSINESS
OVERVIEW
CoolSavings is an online direct marketing and media company with a
database of more than 24 million registered households. We help marketers
reach their target consumers by leveraging our broad distribution network,
sophisticated analytics and proprietary technology. Our mission is to be
the leading provider of promotional offers to consumers while most
effectively connecting marketers to their best customers. Utilizing a
growing database of registered consumers, we supply marketers with a single
resource for accessing and engaging a dynamic group of shoppers. Through
our customized, integrated direct marketing and media products, advertisers
can target a wide array of incentives, including printed and electronic
coupons, personalized e-mails, rebates, trial offers, samples, sales
notices, and sweepstakes, to promote sales of products or services and
drive customers into brick-and-mortar stores or online web sites. In
addition, our proprietary database technology tracks consumer response,
shopping preferences and site behavior at the household and shopper level
to provide our clients with an unprecedented breadth of sophisticated
consumer data from which to make smarter marketing decisions.
Our web site, coolsavings.com, offers consumers convenient and
personalized incentives for goods and services from a broad range of
advertisers, including brick-and-mortar retailers, online retailers,
consumer packaged goods manufacturers, travel and financial service
providers. In the last 18 months, we have broadened our offerings to
provide advertisers with the means of distributing promotional offers to
consumers at the advertisers' own web sites, via an Internet distribution
network and through direct mail. Using our proprietary technology,
advertisers are able to market to their own consumers by providing to them
printable coupons directly from the advertiser web sites, via e-mail and
online advertising banners. In 2002, we developed and launched the
CoolSavings Marketing Network, an Internet distribution network for our
advertisers to distribute promotional offers to visitors of our network
partners' web sites. Also in 2002, we launched a cooperative direct mail
service. This service targets registered CoolSavings members who are
highly active shoppers and proven direct mail responders.
We were incorporated as Interactive Coupon Marketing Group, Inc. in
Michigan in December 1994. In November 1998, we changed our corporate name
to coolsavings.com inc. In September 2001, coolsavings.com inc. merged
with and into CoolSavings, Inc., a Delaware corporation which was then its
wholly owned subsidiary. Currently, we operate as one business segment.
Beginning in 2001, we entered into a series of transactions with
Landmark Communications, Inc. and Landmark Ventures VII, LLC (together,
"Landmark") whereby Landmark made loans to and equity investments in our
Company. This series of transactions, (collectively, the "Landmark
Transaction") resulted in a change in control of our Company. Landmark's
principal business interests are in the media industry, and it owns and
operates entities engaged in newspaper and other print publishing,
television broadcasting and cable television programming services. Landmark
has experience in building value and improving operating, marketing and
financial performance in companies that it owns or controls.
THE COOLSAVINGS SOLUTION
Our web site and marketing network offer convenient and personalized
incentives for goods and services from a broad range of advertisers,
including national brick-and-mortar chains, consumer packaged goods
manufacturers, large consumer service providers, and online retailers. We
offer a wide array of promotional services for advertisers including
printed and electronic coupons, personalized e-mails, rebates, samples,
trial offers, sales notices, gift certificates, and banner advertisements.
Additionally, our advertisers can reach consumers via our direct mail
product or through promotion on our marketing network.
BENEFITS TO COOLSAVINGS ADVERTISERS
The benefits to advertisers of using CoolSavings include:
. Access to a large audience of qualified, receptive shoppers.
Advertisers are able to reach millions of active shoppers who
visit our web site or the web sites of our marketing network
partners looking for shopping values, and who are willing to
provide demographic data about themselves and others in their
households. Advertisers can reach our database of consumers
electronically or through traditional direct mail.
. Cost-effective performance. We believe we provide advertisers
with a cost-effective solution for customer acquisition and
retention. Unlike most other direct marketing providers, we
can test creative elements of a campaign for effectiveness with
results available in days. We can quickly learn from each
campaign, regardless of the promotions used, how to make future
campaigns more effective, to re-target responding members with
more focused offers and to convert new customers into loyal
customers. Our advertisers are able to target information
about ongoing sales promotions and events to the appropriate
customers at the appropriate times and make rapid improvements
to those efforts.
. Insight into shopping behavior. Most advertisers have only
limited means of tracking their customers' preferences and
behavior. With our member's permission, we acquire information
from the initial member registration, from each visit by a
member to our web site, or in response to an email offer. As a
result, we have rich data that we can analyze to provide
insight into the interests and preferences of an advertiser's
customers. Advertisers can leverage our consolidated database
to find predictive correlations that can lead to more effective
targeting, regardless of the types of promotions used. This
information can be used by our advertisers to acquire new
customers with appropriate incentives, refine follow-on
promotions and identify co-promotion opportunities.
. Single source online direct marketing solution. We offer
advertisers a single source for a full range of promotional
incentives that can be targeted to any stage in the
customer lifecycle. Redeemable both online and in-store,
these tools include printable coupons for brick-and-mortar
stores, electronic codes for online purchases, targeted
e-mails, mail-in rebates, lead generation for trial
subscriptions and samples, notices of ongoing sales where
no certificate is necessary, promotional contests and banner
advertisements. Advertisers can also use combinations of
incentives for customized promotions.
. Ability to coordinate online and offline promotions. For
advertisers that have both an online and offline presence, we
can identify prospective customers and then track their
activities whether shopping online or, with the cooperation of
the advertiser, in stores. We enable these businesses to
provide incentives, such as coupons and savings notices,
redeemable in their offline stores. With the advertiser's
support, we can track the redemption of in-store coupons by
scanning their unique bar codes and adding the shopping
preference information to our database. We also help
offline companies without a web presence identify and reward
customers with online incentives that their customers can bring
into a store or use on another web site.
. Lower total cost of ownership and improved time to market. Our
investments in infrastructure, technology and technical
personnel allow our advertisers to deploy their promotional
campaigns without the need to lease, buy or continually upgrade
the required hardware and software systems, providing
significant cost savings over an in-house solution. In
addition, using both our infrastructure and our targeted
direct marketing processes and expertise, we enable our
advertisers to deploy their online marketing campaigns rapidly
and reliably. In particular, we power clients' own incentive
campaign with our proprietary coupon technology solution.
As a result, our advertisers can remain focused on their
core businesses while providing compelling offers to consumers.
. Multiple distribution vehicles. Advertisers can reach our
millions of registered members via promotions at our web site,
through our marketing network, in cooperative mailings with
other advertisers, or directly with their own consumers by
licensing our proprietary technology for use at their own web
sites.
THE COOLSAVINGS STRATEGY AND SERVICES
Our mission is to be the leading provider of promotional offers to
consumers while most effectively connecting marketers to their best
customers. In pursuit of that mission, the key elements of our strategy
are to:
. Extend brand awareness and expand our member and advertiser
base. We believe strong brand recognition is a powerful
tool to attract new advertisers and members. We intend to
continue to promote our brand online, with advertising
campaigns on high traffic web sites and cooperative campaigns
with advertisers and affiliate networks. We believe our
marketing efforts will expand our member base while preserving
its current demographic characteristics, which will strengthen
the services we provide to advertisers. As we expand our
membership, we expect that our services will be attractive to
additional advertisers, which will in turn make our site more
attractive to consumers by providing a broader array of
available promotional offers.
. Enhance member profiles. As we make available additional
promotional offers and services on our web site and through
e-mail, we can tailor online promotions to specific members.
As our members use our site and respond to advertiser
promotions, we continually enrich our database and develop
deeper data for predictive modeling and targeting purposes. We
plan to continue upgrading our tracking and data mining tools
to provide additional insight into member interests and
shopping preferences.
. Develop third-party relationships. We intend to continue to
pursue relationships to further build our brand, expand our
reach to consumers and advertisers and enhance our services.
DELIVERY OF INCENTIVES
On behalf of our advertisers, we deliver a variety of promotional
incentives to targeted segments of our member base. The cost of our
promotional services generally rises with the degree of targeting or
customization we provide because, in our experience, these efforts
generally result in higher response rates for the advertisers. In
addition, we charge some of our advertisers based upon the performance of
the promotional offers that we deliver for them.
The coolsavings.com web site is a fast, easy to use experience for
finding coupons and special offers from brands and stores. To use our
service, consumers register with us, provide demographic data about
themselves, their household and shopping interests, and choose whether to
receive our direct e-mails. We track our members' page views of and
responses to promotions in our member database. With an advertiser's
cooperation, we can also track the redemption of incentives.
The promotional services that we provide our advertisers include:
. CoolOffers. Online and offline businesses can deliver
incentive offers, including printed and electronic coupons,
rebates, sales notices and gift certificates, to targeted
segments of our member base via our web site and our targeted
e-mail programs.
. Solo Targeted and Direct E-Mail. Our members can elect to
receive periodic e-mails notifying them of offers that may be
of personal interest. This allows us to send targeted e-mails
to these members on the basis of their demographic profiles and
shopping preferences. The e-mails are targeted either through
pre-selected criteria, our Select Response customized survey
questions, or using customized models we develop for particular
campaigns. Member permission is at the heart of our e-mail
program. Therefore, promotional e-mail is only sent to
registered members who have opted-in to receive them. In
addition, we may allow a marketer to send direct mail campaigns
to our member data file.
. Coupon Technology. Clients with a need to offer secure,
trackable print-at-home coupons may do so by licensing the use
of our Coupon Technology ASP Solution. This allows the client
to offer an electronic coupon on their website, through their
e-mails, or through their electronic advertisements. We
provide the technology, reporting, tracking and production
services to the client.
. Lead Generation. We provide advertisers a method of generating
leads by providing free samples or trial offers of their
products or services to our members. These offers are targeted
to our members by demographic profile and shopping preferences.
To receive free samples, members voluntarily provide the
advertiser with contact information such as name, e-mail and
mailing address, as well as other data about their households.
. Category Newsletters. We help our advertisers obtain new
customers, generate sales and achieve increased brand awareness
through highly targeted, content-driven monthly e-mails. These
e-mails present an advertiser's products and services to
members in conjunction with topical content which they have
specifically requested.
. Direct Mail. We provide advertisers an additional communi-
cation channel by combining postal and e-mail communications
in convergent campaigns. Refreshed monthly with new names,
our postal list currently includes more than 10 million
consumers that have opted in to receive special offers.
ANALYTIC AND RESEARCH SERVICES
By analyzing individual, demographic and correlative information in
our database, we provide advertisers several methods to gain insight into
our members' preferences. We can also apply our analytic infrastructure to
analyze the databases of our advertisers upon their request. We use
sophisticated data mining tools to help our advertisers execute effective
promotional campaigns, and we use the collected information to create
predictive models to make future targeting even more effective. Using e-
mail, we can also contact and survey members who have responded to a
specific offer.
SALES AND MARKETING
We have built a sales organization dedicated to developing and
maintaining close relationships with advertisers and advertising agencies.
Our sales force is organized into four regions to effectively manage the
breadth and diversity of our 350 key strategic advertisers, manufacturers
and agencies. We intend to continue to optimize these relationships and
expand our reach into five vertical industry segments: financial services,
retail, personal and professional services, media and entertainment, and
consumer packaged goods and manufacturing.
Our marketing department is dedicated to promoting the CoolSavings
brand, acquiring members for our service, and initiating product and
service improvements that meet the needs of our members and advertisers.
In the past, to attract members and increase brand awareness, we have used
a variety of advertising methods, including a national offline branding
campaign that included television, print, outdoor media and radio.
Currently and historically, we have made heavy use of online advertising
consisting of online banner advertisements on high-traffic web sites such
as portals and search engines. We also have developed network affiliate
programs in which other companies send consumers to the CoolSavings web
site and receive a fee per each resulting member registration. Some of our
advertisers provide links from their own web sites that click through to
offers on CoolSavings.
OPERATIONS AND TECHNOLOGY
We have developed a proprietary system to target and personalize
promotional offers from our advertisers to our members. There are five
main components of our system:
. our web server technology, which allows us to display offers of
interest for each member;
. our database, which processes the offers and stores the
information about our members and their activity on our site;
. our data mining and targeting modules, which we use to
determine the members to whom we will deliver offers and the
most appropriate offers for each member;
. CoolSavings Coupon Manager, our software program that produces
high-quality coupons and other secure certificates on a
member's personal computer printer for in-store or mail-in use;
and
. our proprietary administration software, SavingsCenter, which
we and our advertisers use to create and target our clients'
offers.
Our system has been designed around industry-standard architecture
and is designed to provide availability 24 hours-a-day, seven days-a-week.
Occasionally in the past, we have disconnected our servers to make upgrades
or maintenance checks on our system. Our system has been available to the
public approximately 99.7% of the time since our launch in 1997.
Our web servers and the database behind our system, as well as our
data mining servers, are located at the Exodus Communications data center
in Oak Brook, Illinois. Currently, all site traffic is directed to the
Exodus system, and we maintain a fully redundant version of our entire
system at our Chicago headquarters.
INTELLECTUAL PROPERTY
We currently hold two United States Patents, No. 5,761,648, entitled
"Interactive Marketing Network and Process Using Electronic Certificates"
and No. 5,855,007, entitled "Electronic Coupon Communication System."
In addition to our patents, we have registered trademarks, service
marks and copyrights in the United States and other countries. We also own
common law rights in several other marks, and have registration
applications pending in the United States and other countries.
We regard the protection of our intellectual property, including our
patents, copyrights, service marks, trademarks, trade dress and trade
secrets, as important to our future success. We rely on a combination of
these intellectual property rights and contracts to protect the services we
have created and our competitive position in the marketplace. We have
generally entered into confidentiality and invention assignment agreements
with our employees and contractors. Where we have considered it necessary,
we have required nondisclosure agreements with our suppliers and
advertisers in order to protect confidential information about our business
plans and technology. Despite these precautions, these arrangements and
the other steps which we have taken may not protect our trade secrets or
prevent another company from copying important parts of our service. While
we have registered our trademarks and service marks in the U.S. and other
countries, protection of these marks may not be available in every country
where we may do business. See "Item 3. Legal Proceedings" for further
discussion.
COMPETITION
The market for online direct marketing and media services is rapidly
evolving and intensely competitive. Barriers to entry for companies in our
market are low, and current and potential competitors can launch new web
sites and/or services at a relatively low cost.
Our ability to compete depends on many factors, both within and
beyond our control. These factors include:
. advertiser identification and retention;
. brand recognition and credibility;
. pricing of our services;
. breadth of our service offerings for advertisers and consumers;
. reliability of service and quality of advertiser support;
. advertiser and member acquisition costs;
. membership size and demographics;
. ability to source and activate members;
. frequency of use and consumer response rates;
. technological expertise; and
. general demand for online marketing services.
We believe we are well-positioned to compete in our market as a
result of the breadth and sophistication of our services, the size and
demographics of our member audience, our experienced workforce, our
proprietary technology and our established brand recognition.
We face competition from traditional direct marketers, including
leading distributors of traditional coupons by mail or newspaper inserts
and from companies offering affinity rewards tied to responses to
advertisements. A leading distributor of traditional newspaper-insert
coupons, which has significant existing relationships with advertisers such
as consumer packaged goods companies, has begun to compete against us
directly by delivering their promotions over the Internet. We compete with
other web sites, portals and advertising networks, as well as traditional
offline media such as television, radio and print, for a share of
advertisers' total advertising budgets and for consumers' attention.
We also encounter competition from a number of other sources,
including content aggregation companies, companies engaged in advertising
sales networks, advertising agencies and other companies that facilitate
Internet advertising.
EMPLOYEES
As of March 1, 2003, we had 108 full-time employees, 39 of whom were
engaged in technology and product development, 35 in sales and marketing,
15 in client and member services and 19 in finance, administration and
operations. We have never had a work stoppage and our employees are not
covered by any collective bargaining agreement. We consider our relations
with our employees to be good.
AVAILABLE INFORMATION
We maintain an Internet web site at http://www.coolsavings.com that
includes a hypertext link to the Securities and Exchange Commission's (SEC)
web site (http://www.sec.gov) where our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all
amendments to those reports are available without charge, as soon as
reasonably practicable following the time that they are filed with or
furnished to the SEC. Alternatively, all materials that we file with the
SEC may be read and copied at the SEC's Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Information related to the operation
of the Public Reference Room can be obtained by calling the SEC at 1-800-
SEC-0330.
RISK FACTORS
You should carefully consider the risks, uncertainties and other
factors described below because they could materially and adversely affect
our business, financial condition, operating results, cash flow and
prospects, and/or the market price of our common stock.
WE MAY NOT BE ABLE TO SECURE FINANCING TO MEET OUR SHORT AND LONG
TERM CAPITAL NEEDS
At December 31, 2002, we had $4.9 million of cash and cash
equivalents. We are in default under the terms of an amended and restated
senior secured loan and security agreement dated July 30, 2001 (the
"Amended and Restated Loan Agreement") with Landmark. The entire loan plus
accrued interest, totalling $5.7 million at December 31, 2002, is
immediately due and payable at the option of Landmark. Secondly, Landmark
could redeem its holding of $23.1 million of our Series B Preferred Stock
as of December 31, 2002 at any time. Although Landmark has funded our
recent cash needs, Landmark has reserved its rights with respect to all
breaches and defaults, and Landmark is under no obligation to advance us
any additional funds. If we are unable to generate sufficient cash flows
from operations or obtain continuing financing, we may be unable to operate
our business.
We have received a report from our independent auditors for our
fiscal year ended December 31, 2002 containing an explanatory paragraph
that describes the uncertainty as to our ability to continue as a going
concern due to our historical negative cash flow and because, as of the
date they issued their report, we did not have access to sufficient
committed capital to meet our anticipated needs for at least the next 12
months. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
WE HAVE A HISTORY OF NET LOSSES AND EXPECT TO CONTINUE TO INCUR NET
LOSSES
We incurred net losses of $8.3 million in 2002, $29.2 million in 2001
and $39.2 million in 2000. As of December 31, 2002, our accumulated
deficit was $97.9 million. We expect to continue to incur net losses
through 2003. We may not be able to achieve or sustain profitability in the
future.
OUR UNPROVEN BUSINESS MODEL MAKES IT DIFFICULT TO EVALUATE OUR
BUSINESS
We launched our web site in February 1997, and operate in a market
that continues to change. We face risks, uncertainties, expenses and
difficulties frequently encountered by companies in new and rapidly
evolving markets, including the Internet advertising and direct marketing
markets. To address these risks and uncertainties, we must, among other
things:
. maintain relationships with existing advertisers and attract
additional advertisers;
. attract members who actively and repeatedly take advantage of
our offers and who make purchases, request information and
otherwise interact with our advertisers;
. attract, integrate, motivate and retain qualified personnel;
. enhance our brand recognition;
. develop new promotions and services;
. continue to upgrade and develop our systems and infrastructure
to accommodate growth in membership and service enhancements;
. anticipate and adapt to the evolving Internet advertising and
direct marketing markets and changes in advertisers'
promotional needs and policies;
. maintain and defend our intellectual property rights; and
. respond to changes in government regulations.
We may not be successful in accomplishing these objectives. Further,
we may not be able to generate or secure the necessary funding to achieve
these objectives. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources."
OUR COMMON STOCK IS VOLATILE, HAS LIMITED PUBLIC LIQUIDITY AND MAY
LEAD TO LOSSES BY INVESTORS AND RESULT IN SECURITIES LITIGATION
Our common stock currently trades on the OTC Bulletin Board (OTCBB).
Stockholders may have difficulty buying and selling our stock on the OTCBB.
Since the OTCBB is a broker driven marketplace, we are dependent on
professional market makers to facilitate trading of our stock on the OTCBB.
If market makers do not register to trade our stock on the OTCBB,
stockholders may not have a public market for the purchase and sale of our
securities.
The market price of our common stock has been volatile and may be
subject to wide fluctuations. Since our public offering in May 2000, the
per share price of our common stock has fluctuated from a high of $7.13 per
share to a low of $0.03 per share. Factors that might cause the market
price of our common stock to fluctuate include, without limitation:
. quarterly variations in our operating results;
. operating results that vary from the expectations of securities
analysts and investors or from our own forecasts;
. interpretation of the effect of our Series B Preferred Stock
and Series C Preferred Stock on our overall capital structure;
. changes in expectations as to our future financial performance,
including our own forecasts and financial estimates by
securities analysts and investors;
. changes in market valuations of other Internet companies;
. changes in governmental regulation of the Internet or Internet
advertising, including any governmental inquiry of another
Internet company;
. loss of major advertisers;
. resolution of our pending or future patent litigation or other
changes in the status of our intellectual property rights;
. pursuit of significant claims or legal proceedings against us;
. announcements of technological innovations or new services by
us or our competitors;
. announcements by us or our competitors of significant
contracts, acquisitions, dispositions, strategic partnerships,
joint ventures or capital commitments;
. changes in our liquidity position;
. changes in key personnel;
. future sales of our common stock, including sales of common
stock acquired upon conversion of our Series B Preferred Stock;
. announcements of material events related to outstanding loans
to us; and
. volatility in the equity markets.
The market prices of the securities of Internet-related and
technology companies are often highly volatile and subject to wide
fluctuations that bear little relation to actual operating performance of
these companies. Also, some companies that have experienced volatility in
the market price of their stock have been subject to securities class
action litigation. Any securities class action litigation involving us
likely would result in substantial costs and a diversion of senior
management's attention and resources, and likely would harm our stock
price.
WE DERIVE MOST OF OUR REVENUES FROM CONTRACTS WITH OUR ADVERTISERS
THAT MAY BE CANCELLED ON 30-DAYS NOTICE
A majority of our current advertising contracts permit either party
to terminate the contract upon 30-days advanced written notice. We may be
unsuccessful in securing longer commitments. Some advertisers prefer short-
term contracts because they use our service to promote limited-time
promotional events or seasonal products and services. The possibility that
our advertising contracts can be terminated on 30-days advance written
notice makes it difficult for us to forecast our revenues. We may not be
able to renew our existing contracts or attract new advertisers.
OUR OPERATING RESULTS ARE SUBJECT TO SEASONAL FLUCTUATIONS
Our operating results are subject to seasonal fluctuations that may
make our stock price more volatile. Advertising sales in traditional
media, such as television and radio, generally are lower in the first and
third calendar quarters of each year. Further, Internet traffic typically
decreases during the summer months, which in turn may reduce the amount of
advertising to sell and deliver. We anticipate that our future revenues
will continue to reflect these seasonal patterns.
WE DEPEND ON COMPELLING PROMOTIONAL OFFERS BY OUR ADVERTISERS
Our members' usage of our services, and the resulting attractiveness
of our service to advertisers, depends upon the quality of the promotional
offers we deliver and our members' interest in them. In addition, under
some of our advertising contracts, our revenues depend on members'
responsiveness to specific promotions. We currently consult with our
advertisers about the type and frequency of incentives they offer, but we
cannot control their choice of promotions or their fulfillment of
incentives. If our advertisers' promotional offers are not attractive to
our members, we will not be able to maintain or expand our membership or
generate adequate revenues based on the size of our membership or on the
responses we produce. Moreover, if our members are not satisfied with the
offers our advertisers make available to them or with the products or
services they receive upon redemption of offers, their negative experiences
might result in publicity that could damage our reputation, which would
harm our efforts to attract and retain members and advertisers.
WE DEPEND ON THE SUCCESSFUL INTRODUCTION OF NEW SERVICES AND FEATURES
To retain and attract members and advertisers, we believe that we
will need to continue to introduce additional services and new features on
our web site. These new features and services may require us to spend
significant funds on product development and on educating our advertisers
and consumers about our new service offerings. New services and features
may contain errors or defects that are discovered only after introduction.
Correcting these defects may result in significant costs, service
interruptions, loss of advertisers' and members' goodwill and damage to our
reputation. In addition, our successful introduction of new technologies
will depend on our advertisers' ability to adapt to using these
technologies, over which we have no control. If we introduce a service or
feature that is not favorably received, our current members may use our web
site and other services less frequently, our existing advertisers may not
renew their contracts, and we may be unable to attract new members and
advertisers.
WE MUST BE ABLE TO ESTABLISH AND MAINTAIN RELATIONSHIPS WITH
OPERATORS OF OTHER WEB SITES TO ATTRACT NEW MEMBERS
We advertise on third-party web sites using banner advertisements to
attract potential new members. Competition for banner and sponsorship
placements on the highest traffic web sites is intense, and we may not be
able to enter into these relationships on commercially reasonable terms, or
at all. Even if we enter into or maintain our current relationships with
other web site operators, those sites may not attract significant numbers
of users or increase traffic to our web site.
INTELLECTUAL PROPERTY LITIGATION AGAINST US CONTINUES TO BE COSTLY
AND COULD RESULT IN THE LOSS OF SIGNIFICANT RIGHTS
We expect that, as the number of services and competitors in Internet
advertising and direct marketing grows, we will be increasingly subject to
intellectual property infringement, unfair competition and related claims
against us. Third parties may also seek to invalidate our United States
Patents, No. 5,761,648, entitled "Interactive Marketing Network and Process
Using Electronic Certificates" and No. 5,855,007, entitled "Electronic
Coupon Communication System." Currently, we are a defendant in two
lawsuits filed by a competitor, each of which alleges that our technology
or business methods infringe on the competitor's patent. The lawsuits
seek, among other things, to prevent us from using methods that allegedly
violate the competitor's patents. In addition, competitors have in the
past, and may in the future, name our customers as defendants in these
suits, which may cause these customers to terminate their relationships
with us. Our efforts to defend these actions may not be successful. Our
failure to prevail in this litigation could result in:
. our paying monetary damages, which could be tripled if the
infringement is found to have been willful;
. an injunction requiring us to stop offering our services in
their current form;
. our having to redesign our technology and business methods,
which could be costly and time-consuming, even where a redesign
is feasible; or
. our having to pay fees to license intellectual property rights,
which may result in unanticipated or higher operating costs.
Because of the ongoing technical efforts of others in our market and
the relatively recent introduction of our technology, we may continue to be
involved with one or more of our competitors in legal proceedings to
determine the parties' rights to various intellectual property, including
the right to our continued ownership of our existing patents. Our failure
to prevail in these proceedings could harm our business. See "Item 3 -
Legal Proceedings"
We cannot predict whether other third parties will assert claims of
infringement or similar charges against us, or whether any past or future
claims will harm our business. We believe that participants in our market
increasingly are attempting to obtain patent protection for their business
methods. We cannot predict when or if patents will result from these
efforts, or whether any of these third parties' patents will cover aspects
of our business. The details of currently pending United States patent
applications are not publicly disclosed until either the patent is issued
or 18 months from filing, depending on the application filing date. Any
third-party claim, with or without merit, could be time-consuming, result
in costly litigation and damages, cause us to reduce or alter our services,
delay or prevent service enhancements or require us to enter into royalty
or licensing agreements.
In addition, legal standards regarding the validity, enforceability
and scope of intellectual property in Internet-related businesses are
unproven and continue to evolve. In this legal environment, we may be
required to license other parties' proprietary rights in an effort to
clarify our ability to conduct business or develop new services. Royalty
or licensing agreements, if required, might not be available on terms
acceptable to us, or at all. If there is a successful claim of
infringement against us and we are unable to develop non-infringing
technology or license the infringed or similar technology on a timely
basis, our business could be substantially harmed.
PROTECTING OUR PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS MAY BE
COSTLY AND MAY DISTRACT OUR MANAGEMENT
We regard the protection of our patent rights, copyrights, service
marks, trademarks, trade dress and trade secrets as important to our future
success. However, the steps we take to protect these and other proprietary
rights will be costly, may require significant management resources and may
be inadequate. If the steps we take are not adequate, we may lose license
revenues, and potential competitors may be more inclined to offer similar
products and services. Either of these possibilities could harm our
business.
PATENTS
Although we have two issued United States patents and several pending
United States and foreign patent applications directed to different aspects
of our technology and business processes:
. our United States patents and any other patent we may obtain
could be successfully challenged by third parties, which could
limit or deprive us of the right to prevent others from
exploiting the electronic certificate issuing and processing
method or other inventions claimed in our current or future
patents;
. current and future competitors could devise new methods of
competing with our business that are not covered by our issued
patents or any other patents we may obtain, or against which
our issued patents and any other patents we may obtain may be
ineffective;
. our pending patent applications may not result in the issuance
of patents;
. our ability to receive royalties for use of our patents
by third parties may be limited; and
. a third party may have or obtain one or more patents that cause
specific aspects of our business to be restricted or that
require us to pay license fees.
We cannot predict how United States laws and court decisions may
impact our proprietary rights. Any such impact would need to be assessed
in the context of a particular situation. We are also uncertain whether
countries other than the United States will grant patents for inventions
pertaining to Internet-related businesses, or as to the extent of
protection those foreign patents would afford if issued. As in the United
States, the legal standards applied abroad for intellectual property in
Internet-related businesses are evolving and unproven. Any ruling or
legislation that reduces the validity or enforceability of our patents may
seriously harm our business.
We presently have one lawsuit pending against a company we believe
has infringed on our patents. We believe that we have settled that
lawsuit, and the court in that case issued an initial report and
recommendation concurring with our belief and specifying proposed
settlement terms. That initial report and recommendation has been appealed
by the defendant to the Federal Circuit, and is awaiting disposition. This
litigation has been costly, and, if the above described settlement is not
finalized, the lawsuit may continue over the course of several years. The
outcome of this lawsuit, as well as any other lawsuits we may file, may not
be favorable to us. We may not prevail and prevent others from infringing
on our patents and using our proprietary rights. Furthermore, one company
we sued and an affiliate of that company have filed two separate lawsuits
against us seeking damages or to prevent us from using features of our
system or business. Both companies in the above described lawsuits are
taking steps in the United States Patent and Trademark Office to contest
our patent rights. On May 2, 2000, the United States Patent and Trademark
Office granted the request for re-examination of our Patent. Therefore,
our United States Patent No. 5,761,648, "Interactive Marketing Network and
Process Using Electronic Certificates" (the "'648 Patent") will be re-
examined. The re-examination may result in the '648 Patent being narrowed
in scope or declared invalid.
We expect that, like other participants in our market, we will
increasingly be subject to infringement claims as the number of services
and competitors in our industry segment grows. Any infringement claim,
regardless of its merit, could be time-consuming, result in costly
litigation, cause service modifications or delays or require us to enter
into royalty or licensing agreements. Licenses for third party patents
might not be available on terms that are acceptable to us, or at all.
TRADEMARKS, COPYRIGHTS AND TRADE SECRETS
We rely on a combination of laws and contractual restrictions to
establish and protect our proprietary rights. The contractual arrangements
and other steps we have taken to protect our intellectual property may not
prevent misappropriation of our proprietary rights or deter independent
third-party development or use of similar intellectual property. In
addition, we have registered and have applied for registration of
trademarks and service marks in the United States and in other countries.
However, our pending registrations might not be issued and our registered
marks may not prevent others from using similar marks.
DOMAIN NAMES
We currently hold the Internet domain name coolsavings.com, as well
as various other related names. The requirements for holding domain names
could change. As a result, we may not acquire or maintain the
"coolsavings.com" domain name in the United States or all of the countries
in which we wish to conduct business in the future. This could impair our
efforts to increase brand recognition and to increase traffic to our web
site. We also could be subject to disputes over our ownership of our
domain names, which could be costly and disruptive.
LICENSES
As of March 1, 2003, we have granted licenses to eight competitors
under our patent, several on the condition that they restrict their coupon
distribution in ways acceptable to us. Several of these license agreements
involve the payment to us of royalties or license fees. Total revenues
generated under these licenses for 2002 were $0.3 million. If the nature
or scope of the licenses were disputed, we would need to institute
proceedings to enforce our rights under these agreements or under our
patent. In that case, if we did not institute proceedings to enforce our
rights, or if we did not succeed in such proceedings, then our license
revenues could decrease substantially or entirely.
WE MAY LOSE BUSINESS OR INCUR LIABILITIES TO OUR ADVERTISERS DUE TO
UNCERTAINTIES OR INACCURACIES IN OUR DATABASE INFORMATION
It is important to our advertisers that we accurately record our
members' demographics, and track our delivery of offers and advertisements
and, in some instances, redemptions of incentives that are offered to our
members. If the systems we have developed to record information about our
members' demographic profiles, usage of our web site and other member
information do not perform as intended, we may not be able to accurately
evaluate our members' household characteristics or the success of an
advertiser's promotional campaign. We rely on the accuracy of the
demographic, income and other information provided by our registering
members. If advertisers perceive our tracking and evaluations to be
unreliable or if our members' self-reported information proves to be
inaccurate, we may lose current and potential advertisers, suffer erosion
in our advertising rates or face disputes over proper advertising charges.
FAILURE TO PROMOTE AND PROTECT OUR BRAND WILL HARM OUR BUSINESS
We believe that strengthening our brand will be increasingly
important because our market is competitive and has low barriers to entry.
Our ability to promote and position our brand depends on the success of our
marketing efforts and whether we can provide high quality services that
motivate our members to use our services. If our brand enhancement
strategy is unsuccessful, our business will be harmed.
WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE
COMPETITORS
The market for e-marketing services is new, rapidly evolving and
intensely competitive. Barriers to entry for companies in our market are
low, and current and potential competitors can launch new web sites and e-
marketing services at relatively low cost.
Many of our current and potential competitors have longer operating
histories, greater brand recognition, larger customer or user bases, and
significantly greater financial, marketing, technical and other resources
than we do. In addition, our competitors may be acquired by, receive
investments from or enter into other commercial relationships with larger,
well-established and well-financed companies. Therefore, some of our
competitors may be able to devote greater resources to marketing and
promotional campaigns, adopt more aggressive pricing policies and devote
substantially more resources to web site and systems development. They may
also try to attract advertisers by offering free services. Increased
competition may cause us to lose brand recognition and market share
and could otherwise harm our business.
OUR FAILURE TO ATTRACT, ASSIMILATE AND RETAIN HIGHLY SKILLED
PERSONNEL MAY SERIOUSLY HARM OUR BUSINESS
Our future success depends on the continued services of our senior
management and other key sales and technical personnel, particularly
Matthew Moog, our President and Chief Executive Officer, David Arney, our
Chief Financial Officer, John J. Adams, our Chief Operating Officer, Ken
Treske, our Chief Marketing Officer, Charlie Kingery, our Senior Vice
President of Sales, and David Desser, our Vice President of Business
Affairs and General Counsel.
Our future success also depends on our ability to identify, attract,
retain and motivate highly skilled employees. Competition for the best
employees in our industry remains intense. We have occasionally
encountered and may continue to encounter difficulties in hiring and
retaining highly skilled employees, particularly qualified software
developers for our web site and database systems. We may be unable to
retain our key employees or identify, attract, assimilate or retain other
highly qualified employees in the future.
OUR REPUTATION AND BUSINESS COULD BE DAMAGED IF WE ENCOUNTER SYSTEM
INTERRUPTIONS OR CAPACITY LIMITATIONS
We seek to generate a high volume of traffic and transactions on our
web site. Our database must also handle a large volume of member data and
information about members' usage of our web site. The satisfactory
performance, reliability and availability of our web site, database systems
and network infrastructure are critical to our reputation and our ability
to attract and retain large numbers of members. Our revenues depend on
promotional offers being readily available for members and our ability to
process their coupon downloads, e-mail responses or other transactions on
our web site. Any system interruptions that result in the unavailability
of our service or reduced member activity would impair the effectiveness of
our service to advertisers. Interruptions of service may also inhibit our
ability to attract and retain members, which in turn will hinder our sales
and marketing efforts. We have experienced periodic system interruptions,
which may occur from time to time in the future.
Additionally, acts of sabotage, known as denial of service attacks,
on prominent, high traffic web sites have caused extended interruptions of
service on those web sites. Like other operators of web sites, we could
also face system interruptions or shutdowns as a result of a denial of
service attack.
A substantial increase in rate of traffic on our web site will
require us to expand and upgrade our technology, processing systems and
network infrastructure. Any unexpected upgrades could be disruptive and
costly. In addition, our existing systems may encounter unexpected problems
as our member base expands. Our failure to handle the growth of our
databases could lead to system failures, inadequate response times or
corruption of our data. We may be unable to expand and upgrade our systems
and infrastructure to accommodate this growth in a timely manner. Any
failure to expand or upgrade our systems could damage our reputation and
our business.
Furthermore, the increased use of the Internet has caused frequent
interruptions and delays in accessing and transmitting data over the
Internet. If the use of the Internet continues to grow rapidly, the
Internet's infrastructure may not continue to support the demands placed on
it, and its performance and reliability may decline. Interruptions or
delays in Internet transmissions may disrupt our members' ability to access
advertisers' offers on our web site and our ability to send targeted e-
mails. We also rely on web browser technology to create and target
promotional offers. If access to these web-based systems is interrupted,
our ability to disseminate new offers will be impaired, which could cause
lost revenues or disputes with our advertisers.
WE RELY ON THIRD-PARTY SERVICE AND EQUIPMENT PROVIDERS, AND ANY
DISRUPTION OR FAILURE IN THE SERVICES OR THE COMPUTER HARDWARE THEY PROVIDE
WILL HARM OUR BUSINESS
We rely on a third-party service provider to provide access to our
web site and support its operation. Our web site infrastructure is co-
located at the suburban Chicago facility of Exodus Communications, Inc.
which filed for protection under Chapter 11 of the U.S. Bankruptcy Code in
2001 and was acquired by Cable and Wireless PLC in February 2002. Our
support arrangement with this provider is for a term of one year and may be
canceled on 30 days notice in certain circumstances. In the event this
arrangement is terminated, we may not be able to find alternative service
providers on a timely basis, on terms acceptable to us or at all. In
addition, we rely on software licenses from third parties. If these
licenses are terminated or if such software is no longer supported by its
manufacturer, we may not be able to find and install satisfactory alternate
software on a timely basis, on terms acceptable to us or at all.
Our success and our ability to attract new members and motivate our
members to respond to our advertisers' offers depends on the efficient and
uninterrupted operation of our computer and communications hardware
systems. Our web servers and the database behind our system, as well as the
servers we use to perform data analysis, are currently located at Exodus, a
Cable and Wireless Service data center in Oak Brook, Illinois. Currently,
all site traffic is directed to the Exodus system and we maintain a
redundant version of our entire system at our Chicago headquarters. The
computer systems at each of our two hosting sites are vulnerable to damage
or interruption from floods, fires, power loss, telecommunication failures,
and other natural disasters. In addition, the backup system in our Chicago
facility has only two hours of emergency back-up power. The occurrence of a
natural disaster or other unanticipated problems at our facility or at the
Exodus facility could result in interruptions in or degradation of our
services. Our business interruption insurance may not adequately compensate
us for resulting losses.
Furthermore, the computer servers running our system are vulnerable
to general mechanical breakdown or component failure, computer viruses,
physical or electronic break-ins, sabotage, vandalism and similar
disruptions, which could lead to loss or corruption of data or prevent us
from posting offers on our web site, sending e-mail notifications of new
offers or delivering coupons or other certificates to our members.
WE DEPEND ON INTERNET SERVICE PROVIDERS TO DELIVER OUR E-MAIL
TRANSMISSIONS
We send e-mail messages on behalf of advertisers to our members who
have requested to receive e-mail from us; we also assemble and transmit e-
mail newsletters to our members which contain promotions from multiple
advertisers. In order for our members to receive our e-mails, we depend on
Internet Service Providers (ISPs) to accept and deliver those messages to
our members.
Due to the proliferation of unsolicited e-mail, many ISPs are
developing technologies to limit or eliminate the delivery of unsolicited
e-mail to their members. Although we send e-mail only to those members who
specifically have requested we do so, the technologies being developed or
currently in use may not respect the choice made by our members. We, along
with others in the industry that send e-mail, have at various times
experienced the failure of an ISP to deliver e-mails to their customers who
also are our members.
Many of our members use an e-mail service provided by one of the
relatively small number of large ISPs. If one or more of those ISPs fails
to deliver our e-mail transmissions, our inability to communicate with
those members could harm our business. In such a circumstance, we may not
be able to send the volume of e-mail requested by an advertiser.
Additionally, our inability to communicate with those members may cause
them to stop visiting our web site. If our database of e-mail addresses
shrinks materially as a result of the failure of one or more ISPs to
deliver our e-mail, advertisers may be less willing to purchase our e-mail
products and services.
WE MAY BE SUBJECT TO CLAIMS OR REGULATORY INVESTIGATIONS AS A RESULT
OF OUR DATA ANALYSIS ACTIVITIES
The information in our database is an integral part of our business.
We do not sell member identifying information to third parties without the
consent of the member. Furthermore, we send our e-mail notices and
newsletters to members who have elected to receive them. Some people who
receive promotions from us may be unhappy that we contacted them. In
addition, we provide advertisers with aggregate information regarding
member demographics, shopping preferences and past behavior. Our use of
this aggregated information may cause dissatisfaction among our members or
otherwise lead to negative publicity. There has been substantial publicity,
governmental investigations and litigation regarding privacy issues
involving the Internet and Internet-based advertising. To the extent that
our data mining and/or other activities conflict with any privacy
protection initiatives or if any private or personally identifiable
information is inadvertently made public, we may become a defendant in
lawsuits or the subject of regulatory investigations relating to our
practices in the collection, maintenance and use of information about, and
our disclosure of these information practices to, our members. Litigation
and regulatory inquiries of these types are often expensive and time
consuming, and their outcome is uncertain. We may need to spend significant
amounts on our legal defense, and senior management may be required to
divert its attention from other aspects of our business. Furthermore, a
judgment or decree may be entered against us which could require us to pay
damages or to make changes to our present and planned products or services.
OUR BUSINESS WILL BE HARMED IF OUR ONLINE SECURITY MEASURES FAIL
Because our efforts to attract and retain members depend, in part, on
potential members' expectations of privacy in using our services, our
business could be damaged by any security breach of our database or web
site. We may be required to spend significant capital and other resources
to protect against security breaches or to alleviate problems caused by
these breaches. Someone circumventing our security measures could
misappropriate proprietary information, corrupt our database or otherwise
interrupt our operations. We could also be subject to liability as a result
of any security breach or misappropriation of our members' personal data.
This could include claims for unauthorized purchases with credit card
information, impersonation or other similar fraud claims, as well as claims
based upon other misuses of personal information, such as unauthorized
marketing. These claims could result in costly litigation and could limit
our ability to attract and retain advertisers and members. Our security
measures may fail to prevent security breaches. Any failure to prevent
security breaches will damage our reputation and harm our business.
WE MAY BE LIABLE FOR SUPPLYING INACCURATE PROMOTIONAL INFORMATION TO
CONSUMERS
Our employees may make errors in posting our advertisers' promotions.
We may face liability if the promotional information in the offers
available to our members is inaccurate. Additionally, any negative
publicity generated as a result of inaccurate information in the offers we
deliver could damage our reputation and diminish the value of our brand
name.
WE MAY BE HARMED IF OUR ADVERTISERS FAIL TO HONOR THEIR PROMOTIONS ON
OUR WEB SITE OR TO COMPLY WITH APPLICABLE LAWS
Our success depends largely upon retailers honoring our electronic
and printed coupons and upon advertisers reliably delivering and accurately
representing the listed goods and services. We have occasionally received,
and expect to continue to receive, complaints from our members about
retailers' failure to honor our coupons or about the quality of the goods
and services featured in our promotions. These complaints may be
accompanied by requests for reimbursement or threats of legal action
against us. Any resulting reimbursements or related litigation could be
costly for us, divert management attention, or increase our costs of doing
business. In addition, our advertisers' promotion of their goods and
services may not comply with federal, state and local laws. Our role in
facilitating advertisers' sales activities may expose us to liability under
these laws. If we are exposed to this kind of liability, we could be
required to pay substantial fines or penalties, redesign our web site or
business processes, discontinue some of our services or otherwise spend
resources to limit our liability.
WE DEPEND ON WIDESPREAD ACCEPTANCE OF ONLINE DIRECT MARKETING AND
PROMOTIONS AND THE CONTINUED GROWTH OF ONLINE COMMERCE
Our success depends on the continued growth and acceptance by both
consumers and advertisers of online direct marketing and other promotional
services available through the Internet. Although incentive promotions and
direct marketing have been provided for many years through newspaper
inserts, direct mailing and other conventional marketing and sales
channels, they have only recently been offered on the Internet. Many of our
current or potential advertising customers, particularly traditional
offline businesses, have little or no experience using the Internet for
advertising purposes, and may be reluctant to spend money on our services.
As a result, we face a longer sales cycle when dealing with traditional
offline businesses. At times, these sales cycles can last more than a year.
In addition, some traditional retailers may not readily accept our
computer-generated certificates as valid, in part because of their
cashiers' lack of familiarity with them and the risk that these coupons can
be counterfeited. The other services we offer, including the use of
targeted e-mails to alert consumers to savings opportunities, also
represent new marketing methods whose acceptance by consumers and
advertisers is less certain than traditional marketing methods. Although we
do not send unsolicited e-mail, commonly known as "spam," negative public
perception associated with "spam" could reduce the demand for our services.
In addition, we are dependent upon the continued growth of the
Internet as a medium for commerce. Demand for services and products sold
over the Internet is uncertain for a number of reasons, including concerns
related to network reliability and poor performance. Furthermore, concerns
about the security of transactions conducted on the Internet and consumer
privacy may inhibit the growth of the Internet generally, and online
commerce in particular. Any compromise of security involving Internet-based
transactions could result in negative publicity and deter people from using
the Internet or from using it to conduct transactions that involve
transmitting confidential information, such as registering for membership
or purchasing goods and services. Changes in or insufficient availability
of telecommunications services to support the Internet also could result in
slower response times and reduced usage of the Internet. If use of the
Internet does not continue to grow, grows more slowly than expected or does
not become a viable commercial marketplace, our business will suffer.
CHANGES IN CONSUMER AND ADVERTISER TRENDS COULD HARM OUR BUSINESS
We derive substantially all of our revenues from fees charged to
advertisers for our promotional services. Therefore, we will be affected by
changing trends in retail advertising, such as the trend away from periodic
promotions and toward "everyday low prices." In addition, many of our
advertisers are national retailers and suppliers of consumer products and
services. These businesses are affected by the general economy as well as
consumer confidence, which has at times diminished despite otherwise strong
financial conditions. Consumer spending also can be affected by trends
related to lifestyle, such as changing tastes in fashion or entertainment.
WE MAY NOT BE ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL DEVELOPMENTS
AND EVOLVING INDUSTRY STANDARDS
The Internet is characterized by rapidly changing technology,
evolving industry standards, frequent new service and product
announcements, introductions and enhancements, and changing consumer and
advertiser demands. Our future success will depend on our ability to adapt
our services to rapidly changing technologies and evolving industry
standards and to continually improve the performance, features and
reliability of our services. For example, we may be required to adapt our
services to be compatible with Internet-connected devices other than
traditional personal computers, such as handheld and wireless devices. We
may also need to adapt to evolving standards resulting from the convergence
of the Internet, television and other media. The widespread adoption of new
Internet, networking or telecommunications technologies or other
technological changes could require us to incur substantial expenditures to
modify or adapt our services or infrastructure.
FEDERAL, STATE AND LOCAL GOVERNMENTS MAY FURTHER REGULATE THE
INTERNET, INTERNET ADVERTISING AND PRIVACY WHICH COULD SUBSTANTIALLY HARM
OUR BUSINESS
The adoption or modification of laws or regulations relating to the
Internet, Internet-based advertising and privacy, and the application of
traditional legal principles to on-line activities, could harm our
business. In particular, our business could be severely damaged by any
regulatory restrictions on our collection or use of information about our
members.
Laws and regulations that apply to Internet advertising and
communications and Internet users' privacy are becoming more prevalent. For
example, the United States Congress and Federal Trade Commission have
adopted laws and regulations regarding the online collection and use of
information from children and the content of Internet communications, and
various states regulate e-mail marketing and online privacy. However, even
in areas where there has been some legislative action, the laws governing
the Internet remain largely unsettled. There is no single government body
overseeing our industry, and some existing state laws have different and
sometimes inconsistent application to our business. It may take years to
determine whether and how existing laws, such as those governing
intellectual property, privacy, libel, taxation, determination of proper
state jurisdiction taxation and the need to qualify to do business in a
particular state, apply to the Internet, Internet advertising and online
activities in general. Also, we have conducted trivia quizzes and other
contests and sweepstakes on our web site, which may be subject to gaming
and sweepstakes laws. Our attempts to comply with these laws may be
inadequate, in part because the effect of these laws on our activities is
often unclear. In addition, since our web site can be accessed from
foreign counties, our business may be subject to foreign laws and
regulations. Activities that may be acceptable in the United States may
not be acceptable in foreign jurisdictions.
We expect that regulation of the Internet and Internet advertising
will intensify. New laws could slow the growth in Internet use and
otherwise adversely affect the Internet as a commercial medium, which would
harm our business. For example, a number of proposals to restrict the
collection of information about Internet users and to tax Internet-based
transactions are under consideration by federal, state, local and foreign
governmental organizations. A three-year federal moratorium on new taxes on
Internet access expired in October 2001, and was extended in November 2001
for two years. This moratorium does not preempt state tax laws; there is no
federal law preempting the levy of state sales taxes to online e-commerce
activities. The taxation of online transactions or other new regulations
could increase our costs of doing business or otherwise harm us by making
the Internet less attractive for consumers and businesses. The application
of existing laws such as those governing intellectual property and privacy
to the Internet and Internet advertising lends additional uncertainty to
our business.
Any application of existing laws and regulations to the Internet; new
legislation or regulation that imposes stricter restrictions on privacy,
consumer protection or advertising practices; any government investigation
of our privacy practices or other business methods; or the application of
laws from jurisdictions whose laws do not currently apply to us could:
. create uncertainty in the marketplace that could reduce demand
for our services;
. limit our ability to collect and to use data from our members,
which could prevent us from attracting and retaining
advertisers;
. result in expensive litigation, costly and disruptive efforts
to respond to governmental investigations and burdensome fines
or penalties;
. increase the cost of delivering our services to advertisers;
. reduce the effectiveness of our targeted promotional
services; or
. in some other manner harm our business.
OUR SERIES B PREFERRED STOCKHOLDER HAS THE ABILITY TO EXERCISE
SIGNIFICANT CONTROL OVER US WHICH MAY DETER THIRD PARTIES FROM ACQUIRING US
The holder of our Series B Preferred Stock has the ability to control
all matters requiring approval by our stockholders, including the election
and removal of directors and the approval of any merger, consolidation or
sale of all or substantially all of our assets. In addition, pursuant to
the terms of our Certificate of Incorporation, the Series B Preferred
stockholder is entitled to designate not less than a majority of the Board
of Directors of the Company. Among other limitations, without the approval
of the holders of at least a majority of the outstanding shares of Series B
Preferred Stock, we may not:
. amend our charter document or our bylaws;
. merge or consolidate with any other company or sell all or
substantially all of our assets;
. make acquisitions of other businesses or assets or enter into
joint ventures or partnerships with other entities that would
involve the payment of consideration of $1 million or more;
. purchase, redeem or otherwise acquire for value any shares of
our capital stock (with certain exceptions); or
. authorize or issue equity securities or securities exercisable
for or convertible into equity securities other than for cash
and shares issuable upon conversion and exercise of securities
outstanding on the date of issuance of the Series B Preferred
Stock and shares issuable under our 2001 Stock Option Plan.
These restrictions provide the holder of the Series B Preferred Stock
with significant control over us and may discourage others from initiating
potential merger or other change of control transactions. In addition, if
the holder of the Series B Preferred Stock were to convert a portion of the
Series B Preferred Stock and sell the common stock issued on conversion,
the price of our common stock could decrease substantially.
ITEM 2. PROPERTIES
Our executive and operating offices are currently located in Chicago,
Illinois, in a 48,373 square foot leased facility. We occupy 31,919 square
feet, have sublet 6,119 square feet, and are attempting to sublet the
remaining unoccupied space. The lease expires in 2010. In 2002, we
terminated the lease agreement for 14,035 square feet of our office
facility. We also lease 3,251 square feet of office space in San Francisco,
California, pursuant to a lease that expires on July 31, 2005, and 3,078
square feet of office space in New York City, New York, pursuant to a lease
that expires on June 30, 2005, each for use as a sales office.
ITEM 3. LEGAL PROCEEDINGS
On October 21, 1998, we instituted a lawsuit in the Northern District
of Illinois against Catalina Marketing International, Inc. ("Catalina
Marketing"), and its affiliate Supermarkets Online, Inc. for infringement
of our '648 Patent seeking unspecified damages and a permanent injunction
against further infringement. The defendants filed counterclaims alleging
invalidity of our patent and sought unspecified damages and injunctive
relief. In addition, on February 18, 2000, Catalina Marketing filed a
request for re-examination of our '648 Patent with the United States Patent
and Trademark Office, which request was granted on May 2, 2000. Therefore,
our '648 Patent will be re-examined, which may result in the patent being
narrowed in scope or declared invalid. On February 21, 2003, we settled
this lawsuit and agreed to pay Catalina Marketing $0.4 million. The
settlement dismissed all claims and counterclaims of the parties, including
claims for attorneys' fees and expenses, with prejudice. The payment of
this settlement was shared with a third party, resulting in a net expense
to us of $0.2 million. We recorded this net expense as a charge to general
and administrative expense in 2002.
On November 15, 1999, Catalina Marketing filed a separate lawsuit
against us in the United States District Court for the Middle District of
Florida. The complaint alleges that our systems and methods infringe
Catalina Marketing's United States Patent No. 4,674,041 (the "'041
Patent"), and seeks to enjoin us from further infringing its patent. The
case was transferred to the U.S. District Court for the Northern District
of Illinois, which ruled that we did not infringe the '041 patent. On May
8, 2002, the United States Court of Appeals for the Federal Circuit
affirmed-in-part, reversed-in-part, and vacated-in-part the non-
infringement ruling of the U.S. District Court for the Northern District of
Illinois. As a result of this ruling, this litigation is not concluded.
The case has been remanded to the Northern District for further proceedings
to determine whether we have any liability for infringement of the '041
patent. Discovery in this case is ongoing, and trial has been set for
January 2004. We will continue to defend the action vigorously. An
unfavorable outcome for us is considered neither probable nor remote by
management at this time, and an estimate of possible loss or range of
possible losses cannot currently be made.
On February 12, 2000, Supermarkets Online, Inc., an affiliate of
Catalina Marketing filed a lawsuit against us in the United States District
Court for the Central District of California. The complaint alleges that
our systems and methods infringe its United States Patent No. 6,014,634
(the "'634 Patent"), and seeks unspecified damages and injunctive relief.
The lawsuit is currently stayed, except that fact discovery is permitted.
This stay may be lifted at any time. We have filed with the Patent and
Trademark Office a request for re-examination of the '634 patent, which
request for re-examination was granted in March 2001. An unfavorable
outcome for us is considered neither probable nor remote by management at
this time, and an estimate of possible loss or range of possible losses
currently cannot be made.
On August 23, 1999, we instituted a lawsuit in the Northern District
of Illinois against Brightstreet.com, Inc. ("Brightstreet") for infringe-
ment of the '648 Patent, seeking unspecified damages and a permanent
injunction against further infringement. Brightstreet filed counterclaims
alleging invalidity and unenforceability of our patent and seeking
unspecified damages and injunctive relief. The parties agreed to a
settlement of the lawsuit in open court on October 29, 2001. Subsequently,
Brightstreet objected to the report and recommendation of the court that
the written settlement agreement we presented most accurately reflected the
agreement reached by the parties. On July 8, 2002, the United States
District Court for the Northern District of Illinois fully adopted the
report and recommendation of the Magistrate Judge concurring with our
belief that the litigation had been settled, denied Brightstreet's
objections to the report and recommendation, adopted the written settlement
agreement we presented, and dismissed the case with prejudice. On
August 9, 2002, Brightstreet appealed the ruling of the District Court to
the United States Court of Appeals for the Federal Circuit (the "Federal
Circuit"). Both parties have submitted written positions to the Federal
Circuit. A date for our argument has not been set by the Federal Circuit.
An unfavorable outcome for us is considered neither probable nor remote by
management at this time, and an estimate of possible loss or range of
possible losses cannot currently be made.
The foregoing pending lawsuits, while pending for at least three
years, are nevertheless in the pre-trial discovery stage (except to the
extent we may have reached a settlement in the Brightstreet lawsuit) and
may not be resolved favorably to us. For example, we may not prevail and
prevent others from using our proprietary rights. We may be required to
alter or stop selling our services, or to pay costs and legal fees or other
damages in connection with these cases and the various counterclaims that
have been asserted against us, and our patents or future patents may be
found invalid or unenforceable. Furthermore, additional counterclaims,
separate lawsuits or other proceedings may be brought against us to
invalidate our patents or force us to change our services or business
methods.
In October 2002, we received a demand for arbitration from Coupco,
Inc. ("Coupco") relating to a dispute over our obligation to pay royalties
under our Patent License Agreement with Coupco which was executed on
April 6, 2000. We have opposed Coupco's demand and are currently
investigating the factual and legal bases for Coupco's demand; however, we
have recorded a charge in 2002 of $0.2 million for the full amount of the
demand.
In February 2003, we received notice of entry of an order by the
United States Bankruptcy Court of the Northern District of California,
Division 3 approving a Settlement Agreement and Mutual Release with
Netcentives, Inc. (the "Settlement"). Pursuant to the Settlement, we
recorded a gain of $0.3 million in our financial statements as a reduction
of cost of revenues in 2002. In addition, the Settlement with Netcentives,
Inc. released us from any past or future obligation of payments to
Netcentives, Inc. We had recorded a charge of $0.3 million for unpaid
service fees to Netcentives, Inc. in 2001. This charge was reversed
against cost of revenues in 2002.
Currently, we are also involved in other legal proceedings arising in
the ordinary course of business, none of which is expected to have a
material adverse effect on our financial position or results of operations.
We may be involved in additional litigation, investigations or other
proceedings in the future. Any litigation, investigation or proceeding,
with or without merit, could be costly and time-consuming and could divert
our management's attention and resources, which in turn could harm our
business and financial results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during
the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
MARKET INFORMATION.
Our common stock is traded on the OTC Bulletin Board under the symbol
"CSAV.OB." From May 19, 2000 through November 20, 2001, our common stock
was traded on the NASDAQ National Market under the symbol "CSAV." The
following table presents the per share high and low close prices of our
common stock for the periods indicated as reported by the OTC Bulletin
Board or the NASDAQ National Market, as the case may be.
High Low
----- -----
Fiscal Year Ended December 31, 2002
First Quarter 2002 $0.18 $0.08
Second Quarter 2002 0.15 0.05
Third Quarter 2002 0.13 0.03
Fourth Quarter 2002 0.16 0.06
Fiscal Year Ended December 31, 2001
First Quarter 2001 $1.94 $0.42
Second Quarter 2001 0.52 0.28
Third Quarter 2001 0.42 0.15
Fourth Quarter 2001 0.25 0.05
On March 1, 2003, the closing sales price of our common stock was
$0.30, and our common stock was held by approximately 1,800 holders of
record.
We have never declared nor paid any cash dividends on our common
stock. We currently anticipate that we will retain any future earnings for
the development and operation of our business. Accordingly, we do not
anticipate paying cash dividends on our capital stock in the foreseeable
future.
The holders of the Series B Preferred Stock are entitled to receive
8% per annum "in-kind" stock dividends. As of December 31, 2002, 1,822,567
shares of Series B Preferred Stock were issuable with respect to accrued,
but not declared, dividends. Dividends are declared quarterly on
January 1, April 1, July 1, and October 1.
RECENT SALES OF UNREGISTERED SECURITIES
During the fourth quarter of 2002, we issued and sold unregistered
securities in the amounts, at the times and for the aggregate amounts of
consideration listed as follows:
Under a securities purchase agreement dated November 12, 2001 between
us and Landmark (the "Securities Purchase Agreement"), Landmark was granted
the right to purchase additional shares of Series B Preferred Stock at
$0.1554 per share (the "Landmark Shortfall Rights") upon the occurrence of
certain events (the "Shortfall Events"). As a result of our failure to
maintain current assets at levels specified in the Securities Purchase
Agreement, a Shortfall Event occurred as of June 30, 2002. On October 24,
2002, Landmark exercised its Landmark Shortfall Rights under the Securities
Purchase Agreement with respect to such Shortfall Event for 17,825,212
shares of Series B Preferred Stock and paid us $2.8 million ($0.1554 per
share). The Series B Preferred Stock has certain conversion rights and has
an 8% annual dividend, payable quarterly in additional shares of Series B
Preferred Stock. As a result of defaults under an amended and restated
senior secured loan and security agreement dated July 30, 2001 (the
"Amended and Restated Loan Agreement"), Landmark may at its option require
us to redeem all of the issued and outstanding Series B Preferred Stock at
any time.
In December 2002, at our request, Landmark applied the $8.8 million
of principal and $0.7 million of accrued interest then outstanding under a
grid note, as amended (the "Grid Note") (which principal amount was
advanced by Landmark in multiple drawdowns when additional Shortfall Events
occurred, and includes an additional loan related to our obligation to
reimburse Landmark for legal fees in connection with the Landmark
Transaction) against the purchase of 60,967,777 shares of Series B
Preferred Stock ($0.1554 per share).
The recipient of the above securities in each such transaction
represented their intention to acquire the securities for investment only
and not with a view to, or for sale in connection with, any distribution
thereof and appropriate legends were affixed to the share certificates and
instruments issued in such transactions. All recipients had access, through
their relationship with us, to information about us. The above shares were
issued in reliance on the exemption from registration provided by Section
4(2) of the Securities Act of 1933, as amended, and Regulation D
thereunder.
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data set forth below for the years ended
December 31, 2002, 2001 and 2000 and the balance sheet data as of
December 31, 2002 and 2001 have been derived from audited financial
statements included elsewhere within this annual report. The statement of
operations data for the years ended December 31, 1999 and 1998 and the
balance sheet data as of December 31, 2000, 1999 and 1998 are derived from
audited financial statements that do not appear in this report.
You should read the selected financial data set forth below along
with the financial statements and related notes with "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
which are included elsewhere in this report.
Year Ended December 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(in thousands, except share and per share data)
Statement of Operations Data:
Net revenues. . . . . . . . . . $ 26,360 $ 22,173 $ 39,866 $ 12,916 $ 1,143
Cost of revenues. . . . . . . . 3,030 5,739 7,172 1,851 428
---------- ---------- ---------- ---------- ----------
Gross profit. . . . . . . . . . 23,330 16,434 32,694 11,065 715
---------- ---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing . . . . . 14,281 17,814 42,335 17,933 2,494
Product development . . . . . 4,002 6,092 8,353 4,574 1,217
General and administrative. . 8,858 18,184 21,384 5,691 2,350
Lease exit costs. . . . . . . 2,110 -- -- -- --
Loss on asset impairment. . . 1,233 -- -- -- --
---------- ---------- ---------- ---------- ----------
Total operating expenses. . 30,484 42,090 72,072 28,198 6,061
---------- ---------- ---------- ---------- ----------
Loss from operations. . . . . (7,154) (25,656) (39,378) (17,133) (5,346)
Interest (expense) income,
net . . . . . . . . . . . (1,133) (583) 138 265 40
Amortization of debt
discount . . . . . . . . . -- (3,096) -- -- (435)
Other settlement expense. . -- (219) -- -- --
Extraordinary gain. . . . . -- 327 -- -- --
---------- ---------- ---------- ---------- ----------
Net loss. . . . . . . . . . . $ (8,287) $ (29,227) $ (39,240) $ (16,868) $ (5,741)
========== ========== ========== ========== ==========
Loss applicable to common
stockholders. . . . . . . . $ (9,196) $ (30,658) $ (59,108) $ (16,868) $ (5,741)
========== ========== ========== ========== ==========
Historical loss per common
share, basic and diluted. . $ (0.24) $ (0.78) $ (1.63) $ (0.57) $ (0.27)
========== ========== ========== ========== ==========
Weighted average shares used
to compute historical basic
and diluted loss per
common share. . . . . . . . 39,093,660 39,093,660 36,313,759 29,804,681 21,547,177
========== ========== ========== ========== ==========
December 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents . . . $ 4,867 $ 5,144 $ 7,041 $ 17,489 $ 4,895
Working (deficit) capital . . . (1,299) (10,761) (1,623) 15,703 3,788
Total assets. . . . . . . . . . 14,005 17,964 29,150 29,590 6,371
Long-term debt,
including current portion . . 5,592 14,281 4,389 878 300
Total convertible redeemable
preferred stock . . . . . . . 25,041 12,058 -- -- --
Total stockholders' (deficit)
equity. . . . . . . . . . . . (24,219) (15,023) 9,743 19,120 4,594
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition
and results of operations along with the financial statements and the
related notes included elsewhere in this report. This discussion contains
forward-looking statements based on our current expectations, assumptions,
estimates and projections. These forward-looking statements involve risks
and uncertainties. Our actual results and performance could differ
materially from those expressed in or implied by these forward-looking
statements as a result of numerous risks, uncertainties and other factors,
many of which are described in "Item 1. Business - Risk Factors" and
elsewhere in this report. See "Cautionary Note Regarding Forward-Looking
Statements."
OVERVIEW
Beginning in 2001, we entered into a series of transactions with
Landmark whereby Landmark made loans to and equity investments in our
business. This series of transactions resulted in a change in control of
our company. Landmark's principal business interests are in the media
industry, and it owns and operates entities engaged in newspaper and other
print publishing, television broadcasting and cable television programming
services. Landmark has experience in building value and improving
operating, marketing and financial performance of companies that it owns or
controls.
RECENT DEVELOPMENTS
INVESTMENT BY LANDMARK COMMUNICATIONS, INC. IN COOLSAVINGS, INC.
GRID NOTE
Under the terms of that certain Securities Purchase Agreement dated
July 30, 2001, we agreed that if certain events occurred prior to
December 31, 2002, defined therein as "Shortfall Events", Landmark would
have the right to acquire additional shares of Series B Preferred Stock at
a price of $0.1554 per share. Among other things, Shortfall Events would
occur if we failed to maintain an excess of current assets over current
liabilities at or above prescribed amounts. The number of shares would
equal the "Shortfall Amount" (generally the cash needed by us in connection
with a Shortfall Event) divided by $0.1554. Under a letter agreement dated
November 12, 2001, we agreed that when Shortfall Events occurred, Landmark
could elect to loan us the Shortfall Amount under the Grid Note.
As Shortfall Events occurred during 2001, Landmark loaned us an
aggregate of $17.3 million under the Grid Note. On November 12, 2001,
pursuant to the Securities Purchase Agreement, Landmark exercised its
rights to apply $10,000 of principal and $108 of accrued interest then
outstanding to the purchase of 65,057,936 shares of the Company's $0.001
par value Cumulative Preferred Series B stock (the "Series B Preferred
Stock") at a price per share of $0.1554. On February 28, 2002, Landmark
loaned us an additional $1.5 million under the Grid Note, bringing the
outstanding principal balance (including advances made in 2001) to $8.8
million. This balance included $8.0 million related to Shortfall Events
and $0.8 million related to our obligation to reimburse Landmark for legal
fees related to the Landmark Transaction.
On December 20, 2002, Landmark, at our request, applied the $8.8
million of principal and $0.7 million of accrued interest then outstanding
under the Grid Note against the purchase of 60,967,777 shares of Series B
Preferred Stock ($0.1554 per share). As of December 31, 2002, the Grid
Note had no outstanding principal or accrued interest balance. The Grid
Note bears interest at eight percent (8%) per annum and may evidence up to
$20.0 million in advances.
SALE OF SERIES B PREFERRED STOCK
On November 12, 2001, pursuant to the Securities Purchase Agreement,
Landmark exercised its rights to apply $10,000 of principal and $108 of
accrued interest then outstanding to the purchase of 65,057,936 shares of
our Series B Preferred Stock at a price per share of $0.1554. On
November 12, 2001, pursuant to the Securities Purchase Agreement, we agreed
that Landmark could elect to loan us the Shortfall Amount under the Grid
Note.
On October 24, 2002, in connection with one Shortfall Event which
occurred on June 30, 2002 (related to the amount of current assets over
current liabilities at such date), Landmark exercised its right to purchase
17,825,212 shares of Series B Preferred Stock and paid us $2.8 million
($0.1554 per share).
On December 20, 2002, Landmark, at our request, applied the $8.8
million of the principal and $0.7 million of accrued interest then
outstanding under the Grid Note against the purchase of 60,967,777 shares
of Series B Preferred Stock ($0.1554 per share).
The Series B Preferred Stock has certain conversion rights and has an
8% annual dividend, payable quarterly in additional shares of Series B
Preferred Stock. As a result of the defaults under the Amended and
Restated Loan Agreement, Landmark may at its option require us to redeem
for cash all of the issued and outstanding Series B Preferred Stock at any
time.
As of March 1, 2003, Landmark holds 150,422,669 shares of Series B
Preferred Stock (and has rights with respect to accrued dividends thereon)
and holds a warrant to purchase 11,099,832 shares of our common stock.
Landmark's ownership will continue to grow through the issuance of
additional shares of Series B Preferred Stock and warrants as "in-kind"
payments for dividends and interest accruing on the Series B Preferred
Stock and a $5.0 million senior secured note (the "Senior Secured Note"),
respectively.
CALL OPTION AGREEMENT
In April 2002, Landmark acquired 10,889,636 shares of our common
stock from Lend Lease International Pty. Limited of Australia. Contem-
poraneously with the purchase, we entered into a call option agreement with
Landmark, whereby we have the right to acquire, subject to certain terms
and conditions, all 10,889,636 shares of common stock from Landmark. The
call price is $0.08 per share plus seven percent interest thereon,
compounded annually. We can exercise this call option at any time after
April 5, 2003 and prior to March 31, 2008, subject to certain terms and
conditions. We do not have any right to call any other shares of our
capital stock held by Landmark.
LEGAL PROCEEDINGS
In May 2002, the United States Court of Appeals for the Federal
Circuit affirmed-in-part, reversed-in-part, and vacated-in-part the non-
infringement ruling of the U.S. District Court for the Northern District of
Illinois in a lawsuit filed against us by Catalina. The complaint alleges
that our systems and methods infringe Catalina's '041 Patent, and seeks to
enjoin us from further infringing its patent. As a result of the ruling,
this litigation is not concluded. The case has been remanded to the
Northern District for further proceedings to determine whether we have any
liability for infringement of the '041 Patent. Discovery in this case is
ongoing, and trial has been set for January 2004. We will continue to
defend the action vigorously.
In October 2002, we received a demand for arbitration from Coupco
relating to a dispute over our obligation to pay royalties under our
April 6, 2000 Patent License Agreement with Coupco. We have opposed
Coupco's demand and are currently investigating the factual and legal bases
for Coupco's demand; however, we have recorded a charge in 2002 for the
full amount of the demand.
On February 12, 2000, Supermarkets Online, Inc., an affiliate of
Catalina Marketing filed a lawsuit against us in the United States District
Court for the Central District of California. The complaint alleges that
our systems and methods infringe its United States Patent No. 6,014,634
(the "'634 Patent"), and seeks unspecified damages and injunctive relief.
The lawsuit is currently stayed, except that fact discovery is permitted.
This stay may be lifted at any time. We have filed with the Patent and
Trademark Office a request for re-examination of the '634 patent, which
request for re-examination was granted in March 2001. An unfavorable
outcome for us is considered neither probable nor remote by management at
this time, and an estimate of possible loss or range of possible losses
currently cannot be made.
On August 23, 1999, we instituted a lawsuit in the Northern District
of Illinois against Brightstreet.com, Inc. ("Brightstreet") for infringe-
ment of the '648 Patent, seeking unspecified damages and a permanent
injunction against further infringement. Brightstreet filed counterclaims
alleging invalidity and unenforceability of our patent and seeking
unspecified damages and injunctive relief. The parties agreed to a
settlement of the lawsuit in open court on October 29, 2001. Subsequently,
Brightstreet objected to the report and recommendation of the court that
the written settlement agreement we presented most accurately reflected the
agreement reached by the parties. On July 8, 2002, the United States
District Court for the Northern District of Illinois fully adopted the
report and recommendation of the Magistrate Judge concurring with our
belief that the litigation had been settled, denied Brightstreet's
objections to the report and recommendation, adopted the written settlement
agreement we presented, and dismissed the case with prejudice. On
August 9, 2002, Brightstreet appealed the ruling of the District Court to
the United States Court of Appeals for the Federal Circuit (the "Federal
Circuit"). Both parties have submitted written positions to the Federal
Circuit. A date for our argument has not been set by the Federal Circuit.
An unfavorable outcome for us is considered neither probable nor remote by
management at this time, and an estimate of possible loss or range of
possible losses cannot currently be made.
In February 2003, we received notice of entry of an order by the
United States Bankruptcy Court of the Northern District of California,
Division 3 approving the Settlement with Netcentives, Inc. Pursuant to the
Settlement, we recorded a gain of $0.3 million in the financial statements
as a reduction of cost of revenues in 2002. In addition, the Settlement
released us from any past or future obligation of payments to Netcentives,
Inc. We had recorded a charge of $0.3 million for unpaid service fees to
Netcentives, Inc. in 2001. This charge was reversed against cost of
revenues in 2002.
On October 21, 1998, we instituted a lawsuit in the Northern District
of Illinois against Catalina Marketing and its affiliate Supermarkets
Online, Inc. for infringement of our United States '648 Patent, seeking
unspecified damages and a permanent injunction against further
infringement. Catalina Marketing filed counterclaims alleging the
invalidity of our patent and sought unspecified damages, attorneys' fees
and injunctive relief. On February 21, 2003, we settled this lawsuit and
agreed to pay Catalina Marketing $0.4 million. The settlement dismissed
all claims and counterclaims of the parties, including claims for
attorneys' fees and expenses, with prejudice. The payment of this
settlement was shared with a third party, resulting in a net expense to us
of $0.2 million. We recorded this net expense as a charge to general and
administrative expense in 2002.
We have incurred and expect to continue to incur significant legal
fees in connection with out current litigation. We are defending
vigorously these actions and continue to explore the possibility of
settlement. In addition to the costs of litigation, a final judgement
against the Company in any of the aforementioned litigation could have a
material adverse effect on our business. See "Item 1. Business - Risk
Factors: Intellectual Property Litigation Against Us Continues To Be Costly
And Could Result In The Loss Of Significant Rights."
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our significant accounting policies are more fully described in
Note 1 of our Notes to Financial Statements. The financial statements have
been prepared with generally accepted accounting principles. However,
certain of our accounting policies are particularly important to the
portrayal of our financial position and results of operations and require
significant judgements by our management. The preparation of the financial
statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting
periods. Management bases its estimates and judgements on historical
experience and various other factors that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgements about the carrying value of assets and liabilities that are not
readily apparent from other sources. Our critical accounting policies are
as follows:
. revenue recognition
. estimation of sales credits and the allowance for doubtful
accounts
. capitalization of web site development costs
. valuation of long-lived and intangible assets
REVENUE RECOGNITION
We recognize revenue from the sale of products and services when a
contract has been signed, the product or service has been provided, the fee
is fixed and determinable and the collection of the resulting receivable is
reasonably assured. We assess whether the fee is fixed and determinable
based on contract terms for particular products and services. If the
product or service being provided is derived from activity recorded on our
website, we are able to determine the quantity and value based on contract
terms. If the product or service is exclusively dependent on tracking from
a customer's website, the revenue is recognized upon confirmation of the
product or service delivered from the customer. Revenue subject to time-
based contracts is recognized ratably over the duration of the contract.
Deferred revenue represents the portion of revenue that has not been
recognized related to time based contracts. For contracts based on certain
performance or delivery criteria, revenue is recognized in the month
performance is delivered to the customer.
ESTIMATION OF SALES CREDITS AND THE ALLOWANCE FOR DOUBTFUL ACCOUNTS
Sales credits arise in the ordinary course of business. Adjustments
to the actual billing may arise due to variances in the systems tracking
devices between us and our customers. We estimate this difference to be
approximately 1.5% of sales and therefore have established a credit memo
reserve as a reduction to the recorded revenue on a monthly basis. The
adequacy of this reserve is monitored and adjusted as customer trends and
economic trends develop. We perform ongoing credit evaluations of our
customers and adjust credit limits based upon payment history and
customer's current credit worthiness, as determined by our review of their
current credit information. We continuously monitor collections and
payments, current economic trends and changes in payment terms when
evaluating the adequacy of the allowance for doubtful accounts.
CAPITALIZATION OF WEB SITE DEVELOPMENT COSTS
The cost of developing and enhancing the functionality of our web
site, including costs incurred to ensure links to databases and media
sources are working properly, are capitalized and amortized over 24 months.
Management performs periodic reviews of the continued use of web site
functionality in future periods and the related development costs that are
being or have been capitalized. Write-offs of current and previously
capitalized costs and the related amortization are recognized in the period
management decides there is no future need for the functionality. Any such
write-off could have a significant negative impact on our earnings.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS
We assess the impairment of identifiable intangibles and long-lived
assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. If the future cash flows
(undiscounted and without interest) expected to result from the use of the
related assets are less than the carrying value of such assets, an
impairment has occurred and a loss is recognized to reduce the carrying
value of the long-lived assets to fair value, which is determined by
discounting estimated future cash flows.
HOW WE GENERATE REVENUE
ONLINE DIRECT MARKETING SERVICES REVENUE
We generate substantially all of our revenues by providing online
marketing services to our advertisers.
We charge our advertisers on a variety of bases, the most common of
which include:
. the number of offers delivered to members, commonly sold on a
cost per thousand, or CPM, basis;
. the number of times members click on an incentive linking the
member to the advertiser's web site (known as a click-through
response);
. the number of purchases made or qualified leads generated; and
. the number of registered members in our database.
Our pricing depends upon a variety of factors including, without
limitation, the degree of targeting, the duration of the advertising
contract and the number of offers delivered. The degree of targeting refers
to the number of identified household or member attributes, such as gender,
age, or product or service preferences, used to select the audience for an
offer. Generally, the rates we charge our advertisers increase as the
degree of targeting and customization increases. Revenues subject to time-
based contracts are recognized ratably over the duration of the contract.
For contracts based on certain performance or delivery criteria, revenues
are recognized in the month performance is delivered to the customer. Most
of our advertising contracts have stated terms of less than one year and
may include earlier termination provisions. In 2002, our largest
advertiser accounted for 4.2% of our revenues and our top five advertisers
together accounted for approximately 16.0% of our revenues.
Our revenues for each period depend on a number of factors including
the number of advertisers sending promotional offers to our members, the
size of our membership base and the responsiveness of our members to each
promotion. We believe that our revenues are subject to seasonal
fluctuations in accordance with general patterns of retail advertising
spending, which is typically highest during the fourth quarter. In
addition, expenditures by advertisers tend to be cyclical, reflecting
overall general economic conditions and consumer buying patterns. If
purchasing patterns or timing of purchasing by advertisers were to change,
our operations and quarter-to-quarter comparisons could be materially
affected.
LICENSING REVENUE
We license portions of our intellectual property, including our
issued patents, to third parties. Approximately 1% of our revenues was
generated from royalties and license fees and other miscellaneous sources
during the year ended December 31, 2002.
EXPENSES
COST OF REVENUES
Our cost of revenues consists primarily of Internet connection
charges, web site equipment depreciation, salaries of operations personnel,
fulfillment costs related to member loyalty incentives and other related
operations costs.
SALES AND MARKETING
Sales and marketing expenses include salaries, sales commissions,
employee benefits, travel and related expenses of our direct sales force,
advertising and promotional expenses, marketing, and sales support
functions. Marketing costs associated with increasing our member base are
expensed in the period incurred.
PRODUCT DEVELOPMENT
Product development costs include expenses for the development of new
or improved technologies designed to enhance the performance of our
service, including salaries, amortization of capitalized web site
development costs, and related expenses for our technology department, as
well as costs for contracted services and equipment.
GENERAL AND ADMINISTRATIVE
General and administrative expenses include salaries, employee
benefits and expenses for our executive, finance, legal and human resources
personnel. In addition, general and administrative expenses include fees
for professional services and occupancy costs.
LEASE EXIT COSTS AND LO