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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, 2003
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, 2003 (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 are affiliates) was approximately $10,840,255, based on the
closing sales price of $0.82 on such date. As of March 1, 2004, there were
39,225,044 shares of the Registrant's common stock issued and outstanding.
(This number represents the number of shares that are required to be
reported here. This report describes additional shares of common stock
that are issuable upon conversion of outstanding shares of preferred stock
and the exercise of outstanding warrants and outstanding stock options.)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed
pursuant to Regulation 14A under the Securities and Exchange Act of 1934,
in connection with the Registrant's 2004 Annual Meeting of Stockholders,
are incorporated by reference into Part III of this report.
COOLSAVINGS, INC.
Form 10-K Annual Report
Fiscal Year Ended December 31, 2003
TABLE OF CONTENTS
Page
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PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . 5
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . 23
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . 23
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 . . . . . . . . . . . . 25
Item 6. Selected Financial Data . . . . . . . . . . . . . . 26
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . 29
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk . . . . . . . . . . . . . . . . . 47
Item 8. Financial Statements and Supplementary Data . . . . 48
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure. . . . . . . 86
Item 9A. Controls and Procedures . . . . . . . . . . . . . . 86
PART III
Item 10. Directors and Executive Officers
of the Registrant . . . . . . . . . . . . . . . . . 86
Item 11. Executive Compensation. . . . . . . . . . . . . . . 86
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters. . . 86
Item 13. Certain Relationships and Related Transactions. . . 86
Item 14. Principal Accountant Fees and Expenses. . . . . . . 87
PART IV
Item 15. Exhibits, Financial Statement Schedule and
Reports on Form 8-K . . . . . . . . . . . . . . . . 87
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . 88
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This annual report contains statements, including statements that are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, regarding our expectations, beliefs, hopes,
intentions or strategies. Where possible, these forward-looking statements
have been identified by use of words such as "project," "target,"
"forecast," "anticipate," "believe," "will," "expect," and similar
expressions. These forward-looking statements include, without limitation,
statements regarding our expectations of revenue growth, expense growth,
and capital spending. 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, these
forward-looking statements. These risks, uncertainties and other factors
include, without limitation, our ability to secure financing to meet our
long-term capital needs, our ability to protect our patents, trademarks and
proprietary rights, our successful introduction of new services and
features, our ability to add new members, our ability to continue to
attract, assimilate and retain highly skilled personnel, our ability to
secure long-term contracts with existing advertisers and attract new
advertisers, and our ability to compete successfully against current and
future competitors. For a discussion of these and other risks,
uncertainties and factors which could cause actual results to differ
materially from those expressed in, or implied by, the forward-looking
statements, see "Item 1. Business - Risk Factors".
We undertake no obligation to update any of the forward-looking
statements after the date of this report to conform these statements to
actual results or otherwise to reflect new developments or changed
circumstances, unless expressly required by applicable federal securities
laws. You should not place undue reliance on such forward-looking
statements.
* * *
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, 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., REWARDS WHENEVER YOU SHOP, and BUY ANYWHERE. We have also obtained
trademark registrations in Australia, Canada, and the United Kingdom for
COOLSAVINGS and have registration applications pending in Canada.
* * *
ALL DOLLAR AMOUNTS INCLUDED IN THIS REPORT ARE EXPRESSED IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE INDICATED.
PART I
ITEM 1. BUSINESS
OVERVIEW
CoolSavings is an online direct marketing and media company with a
database of 11.5 million active consumers who have taken an action on our
web site in the last twelve months. We help marketers reach their target
consumers by leveraging our broad marketing 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. Using CoolSavings, marketers
drive sales and customer traffic to their stores, web sites, catalogues or
call centers by taking advantage of a wide variety of highly targeted
marketing services, including lead generation, couponing, targeted e-mail,
category newsletters, direct mail, product sampling and banner
advertisements. In addition, our proprietary database technology and
analytical tools track consumer response, shopping preferences and site
behavior at the household and shopper level to provide our clients with a
wide range of sophisticated consumer data which they may use to make
smarter marketing decisions.
Our web site, coolsavings.com, and our marketing network offer
consumers convenient and personalized incentives for goods and services
from a broad range of advertisers, including national retailers, consumer
packaged goods manufacturers, media and publishing companies, and travel
and financial service providers.
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 Landmark having control over our Company. For a
more detailed discussion of Landmark's investment, please see "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Investment by Landmark in CoolSavings, Inc." and Note 2 of our
Financial Statements contained in "Item 8. Financial Statements and
Supplementary Data." 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 retailers, consumer packaged goods manufacturers, media
and publishing companies, and travel and financial service providers. We
offer a wide array of highly targeted promotional services for advertisers
including lead generation, couponing, targeted e-mail, category
newsletters, direct mail, product sampling and banner advertisements.
BENEFITS TO COOLSAVINGS ADVERTISERS
The benefits to advertisers of using CoolSavings include:
. Access to 11.5 million active members who are 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. These
shoppers are willing to provide demographic data about
themselves and others in their households. Advertisers
reach our database of consumers through our web site, email,
and through traditional direct mail programs.
. Cost-effective performance. We believe we provide advertisers
with a cost-effective solution for customer acquisition and
activation. Unlike most other traditional 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 how to make future campaigns more
effective. We can efficiently re-target responding members
with continuity offers to convert new customers into valuable
consumers. 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 media properties have
limited means of tracking their customers' shopping preferences
and behavior. With our members' permission, we acquire
information from the initial member registration, from each
subsequent visit by a member to our web site, or from response
to e-mail offers. As a result, we have data that we can analyze
to provide insight into the interests and preferences of an
advertiser's customers. We can leverage our consolidated
database to develop predictive models 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 full range of promotional incentives that can be
targeted to significant life events a customer may experience,
such as getting married, having a child, buying a first home,
etc. Redeemable both online and in-store, these services
include printable coupons for brick-and-mortar stores,
electronic codes for online purchases, targeted e-mails, lead
generation for trial subscriptions and samples, notices of
ongoing sales where no certificate is necessary, and banner
advertisements.
. Ability to track purchases by the consumer. We can track,
through the use of unique bar codes, the redemption of grocery
coupons by our members. We can also target prospective
customers for our advertisers and track their individual online
purchases. With the cooperation of advertisers and retailers,
we can also track certain offline purchases of our members.
These capabilities result in highly accountable campaigns that
can be improved over time.
. Lower set-up costs and improved time to market. Our
investments in infrastructure, technology and production
systems allow our advertisers to deploy their promotional
campaigns without the upfront expense in production and
technical development associated with any other media,
therefore providing significant cost savings. We enable
our advertisers to deploy their online marketing campaigns
quickly and with a high degree of reliability, thus improving
our advertisers' return on investment.
. Multiple distribution vehicles. Advertisers can reach
millions of consumers via promotions on our web site,
through our marketing network, by direct mail, 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:
. Continue investment in the coolsavings.com web site, its
features, its brand, and its member base. We believe the
service continues to generate high incremental returns.
Maintenance and improvement in the service have a high return
on investment given their low cost. We intend to continue to
promote our brand online, with advertising campaigns on high
traffic web sites designed to drive new and returning consumers
to interact with the service. As this traffic grows, we expect
that our services will be attractive to additional advertisers.
We will therefore continue our investment in features and
services that improve the way our advertisers communicate to
our consumers.
. 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 network marketing relationships. We intend
to continue to pursue relationships to distribute our brand and
offer content to consumers through partnerships with high
quality web-centric partners.
. Rollout new incentive types that take advantage of the growing
infrastructure for electronic transactions to meet advertiser
demands and consumer desires. We intend to make these
investments with a view toward long-term sustainability and
leadership.
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
voluntary 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.
. Lead Generation. We provide advertisers a method of generating
permission-based leads by providing free sample or trial
offers of their products or services to our members. These
offers are targeted to our members by demographic profile and
shopping preferences. Members voluntarily provide the
advertiser with contact information such as name, e-mail and
mailing address, as well as other data about their households
in order to participate in the client's offer.
. Solo Targeted E-Mail. Our members may 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.
. 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 and offers which
they have specifically requested.
. 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 clients
to offer electronic coupons on their web sites, through their
e-mails, or through their electronic advertisements. We
provide the technology, reporting, tracking and production
services to the clients.
. 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 other predictive 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. We also use our sophisticated analytics to
manage and optimize the performance of our collective offer set for our
benefit and the benefit of our consumers.
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 three groups to effectively manage the
breadth and diversity of our key strategic advertisers and advertising
agencies. We intend to continue to build these relationships and expand
our reach into five vertical industry segments: retail, consumer packaged
goods, personal and professional services, media and entertainment, and
financial services.
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.
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 six 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;
. our campaign manager software, SavingsCenter, which we and our
advertisers use to create, target and report on the
effectiveness of our clients' offers; and
. our email system that allows us to deliver Solo Targeted
E-mail, Direct E-mail, Select Response surveys and Category
Newsletters on a highly targeted basis to our consumers who
have specifically requested the contact from our advertisers.
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 Exodus, a Savvis Communications
Corporation data center in suburban Chicago, Illinois. Currently, all site
traffic is directed to the Exodus system, and we maintain a redundant
version of our critical systems at our Chicago headquarters.
INTELLECTUAL PROPERTY
We currently hold all rights, title and interest to two United States
Patents, No. 5,761,648, entitled "Interactive Marketing Network and Process
Using Electronic Certificates" (the "'648 Patent"), and No. 5,855,007,
entitled "Electronic Coupon Communication System" (the "'007 Patent").
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. In connection with one of the lawsuits, our '648
Patent is currently in re-examination with the United States Patent and
Trademark Office. The lawsuits seek, among other things, to prevent us
from using methods that allegedly violate the competitor's patents. See
"Item 3. Legal Proceedings" for further discussion.
In addition, we hold all rights, title and interest to two United
States Patent Applications, including Series Nos. 60/416,981 (filed October
8, 2002) and 10/677,555 (filed October 2, 2003) entitled "Secure
Promotions", and Serial No. 10/760,701 (filed January 20, 2004) entitled
"System and Method of Presenting Offers by Way of a Computer Network."
In addition to our patents and pending application, 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
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 to
protect confidential information about our business plans and technology.
However, 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.
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, analytical capabilities, and 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 other online direct marketers, online publishers, companies
engaged in advertising sales networks, advertising agencies and other
companies that facilitate Internet advertising.
EMPLOYEES
As of March 1, 2004, we had 138 full-time employees. 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 HAVE A HISTORY OF NET LOSSES
We incurred net losses and negative cash flows in all years prior to
2003. We may not be able to sustain profitability in the future. As of
December 31, 2003, our accumulated deficit was $97,211.
WE MAY NOT BE ABLE TO SECURE FINANCING TO MEET OUR LONG TERM CAPITAL
NEEDS
At December 31, 2003, we had $7,347 in 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,
totaling $6,141 at December 31, 2003, is immediately due and payable at the
option of Landmark. Furthermore, Landmark could at any time require us to
redeem any or all of the shares of Series B Preferred Stock held by
Landmark, which had an aggregate redemption value of $24,805 as of
December 31, 2003. 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 to meet our long-term
capital needs, we may be unable to operate our business.
We have received a report from our independent auditors for our
fiscal year ended December 31, 2003 containing an explanatory paragraph
that describes the uncertainty as to our ability to continue as a going
concern because, as of the date they issued their report, we did not have
access to sufficient committed capital or cash flow from operations to meet
our needs in the event Landmark exercised some or all of its rights to
accelerate payment under our obligations to Landmark. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
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 advance 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.
INTELLECTUAL PROPERTY LITIGATION AGAINST US MAY 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 '648 Patent,
which is currently in re-examination with the United States Patent and
Trademark Office, and our '007 Patent. 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 ongoing 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.
WE MAY BE HARMED IF RETAILERS REFUSE TO ACCEPT ELECTRONIC PRINT-AT-
HOME COUPONS OR 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 electronic and
printed coupons, including ours, and upon advertisers reliably delivering
and accurately representing the listed goods and services. Some
traditional retailers may not readily accept computer-generated coupons as
valid, in part because of their cashiers' lack of familiarity with them and
the risk that coupons can be counterfeited. We have occasionally received,
and expect to continue to receive, complaints from our members about
retailers' failure to honor coupons, including ours. If such complaints
become more common and/or costly to our members, 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 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.
During the second half of 2003, we experienced an increase in
advertising rates that have resulted in lower advertising activity. While
this has been offset by subsequent increases in our own rates and by
temporary seasonal fluctuations, we do face a potential long-term risk of
diminished economic opportunity should advertising rates continue to
increase over the long term.
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 currently in use or
those being developed, such as e-mail surcharges (electronic stamps, ISP-
approved white lists, or e-mail sender password verifications), may not
respect the choices made by our members. We, along with others in the
industry that send e-mail, have at various times during 2003 experienced
the failure of an ISP to deliver e-mails to their customers who also are
our members.
Many of our members use e-mail services provided by one of the
relatively small number of large ISPs. If one or more of those ISPs fail
to deliver our e-mail transmissions, our inability to communicate with
those members could harm our business. In addition, if one or more of
those ISP's adopt electronic stamp technology or a white list, our costs
related to e-mail delivery may increase substantially. In any of the prior
examples, 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 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' abilities 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 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.
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 MAY NOT BE ABLE TO COMPETE SUCCESSFULLY AGAINST CURRENT AND FUTURE
COMPETITORS
The market for e-marketing services continues to evolve and is
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.
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. Increased competition may cause us to lose brand recognition
and market share and could otherwise harm our business.
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
specific and affirmative consent of the member. Furthermore, we send our
e-mail notices and newsletters to members who have elected to receive them.
Nevertheless, 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. 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 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 could 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 denial of
service attacks.
A substantial increase in the 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, a Savvis Communications
Corporation data center. Our support arrangement with this provider is for
a term of two years and may be canceled on 30 days' notice in certain
limited 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.
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.
Currently, all site traffic is directed to the Exodus system and we
maintain a redundant version of our critical systems at our Chicago
headquarters. The computer systems at each of our two hosting sites are
vulnerable to damage or interruption from floods, fires, power losses,
telecommunication failures, and other natural disasters or other
unanticipated problems. 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. We maintain business interruption insurance, but it 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.
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 could damage our reputation and harm our business.
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 can be costly, may require significant management resources and may
be inadequate. If the steps we take are not adequate, potential
competitors may be more inclined to offer similar products and services.
PATENTS
Although we have two issued United States patents and have two
pending United States 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 application for a "System and Method of
Generating Sales Leads by Way of a Computer Network" may not
result in the issuance of a patent;
. 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
may 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 may not 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 lawsuits against us that are still pending, and
those lawsuits seek damages against us and further seek to prevent us from
using features of our system or business. The plaintiffs in those lawsuits
and another company we sued in the past 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 '648 Patent will be re-
examined. The re-examination may result in the '648 Patent being narrowed
in scope or declared invalid.
TRADEMARKS, COPYRIGHTS, TRADE SECRETS AND DOMAIN NAMES
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.
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.
WE MAY NOT BE ABLE TO CONTINUE TO ATTRACT, ASSIMILATE AND RETAIN
HIGHLY SKILLED PERSONNEL
Our future success depends on the continued services of our senior
management and other key sales and technical personnel. 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.
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 online 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
the United States' Congress as well as 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 countries, 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. Due to the proliferation of unsolicited e-mail, the
United States' Congress passed the Controlling the Assault of Non-Solicited
Pornography and Marketing Act of 2003 ("CAN-SPAM"). Additionally, 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 expired
November 1, 2003, and the future status of taxes on Internet transactions
is uncertain. There is no federal law preempting state tax laws or 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 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
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 shares
issued for cash, 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.
OUR STOCKHOLDERS COULD SUFFER SUBSTANTIAL DILUTION AS A RESULT OF
OUTSTANDING PREFERRED STOCK, WARRANTS AND STOCK OPTIONS AND NEW ISSUANCES
OF PREFERRED STOCK AND WARRANTS, AND OUR STOCK PRICE MAY DECLINE IF A LARGE
NUMBER OF SHARES ARE SOLD OR THERE IS A PERCEPTION THAT SUCH SALES COULD
OCCUR.
As of March 1, 2004, we had a total of 175,822,331 shares of Series B
and Series C Preferred Stock issued and outstanding. Under the terms and
conditions of the Series B and Series C Preferred Stock, these shares are
convertible into an equal number of shares of our common stock at the
holder's option. In addition, as of March 1, 2004, we had outstanding
warrants exercisable for 11,950,890 shares of our common stock and
outstanding stock options exercisable for 7,806,481 shares of our common
stock. As described under "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources," we continue to issue 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 Senior Secured Note (as
defined in this Form 10-K). Our stockholders may suffer substantial
additional dilution as a result of the issuance of additional shares of
preferred stock and warrants. Furthermore, our stock price may decline as
a result of sales of a large number of the shares of common stock issuable
upon conversion or exercise of the preferred stock, warrants and/or stock
options or the perception that such sales could occur.
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;
. interpretation of the effect of our Series B Preferred Stock
and Series C Preferred Stock on our overall capital structure;
. the expiration, on November 12, 2003, of the covenant
restriction by which Landmark had agreed it would not take
action to cause us to become a privately-held company (such
covenant was contained in an agreement among certain of our
stockholders and Landmark;
. interpretation of the effect of our outstanding stock options
and warrants on our overall capital structure;
. changes in governmental regulation of the Internet or Internet
advertising, including any governmental inquiry of another
Internet company;
. resolution of our pending or future patent litigation or other
changes in the status of our intellectual property rights;
. announcements of technological innovations or new services by
us or our competitors;
. 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 more volatile and subject to wider fluctuations
that may 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.
ITEM 2. PROPERTIES
Our executive and operating offices are currently located in Chicago,
Illinois, in a 48,373 square foot leased facility. We occupy 32,226 square
feet, have sublet 12,173 square feet, and are attempting to sublet the
remaining unoccupied space. The lease expires in 2010. We also lease
3,251 square feet of office space in San Francisco, California, pursuant to
a lease that expires on July 31, 2005. In 2003, due to low utilization, we
terminated our lease agreement for 3,078 square feet of office space in New
York City, New York.
ITEM 3. LEGAL PROCEEDINGS
On October 21, 1998, we instituted a lawsuit in the U.S. District
Court for the Northern District of Illinois (the "Northern District")
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 '648 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. On
February 21, 2003, we settled this lawsuit and agreed to pay Catalina
Marketing $350. The settlement dismissed all claims and counterclaims of
the parties, including claims for attorneys' fees and expenses, with
prejudice. Our payment obligations under this settlement were shared with
a third party, resulting in a net expense to us of $150. 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 alleged that our systems and methods infringed
Catalina Marketing's United States Patent No. 4,674,041 (the "'041
Patent"), and sought to enjoin us from further infringing its '041 patent.
The case was transferred to the Northern District which ruled that we did
not infringe the '041 patent. On May 8, 2002, the United States Court of
Appeals for the Federal Circuit (the "Federal Circuit") affirmed-in-part,
reversed-in-part, and vacated-in-part the non-infringement ruling of the
Northern District. The case was remanded to the Northern District for
further proceedings to determine whether we have any liability for
infringement of the '041 Patent. On June 25, 2003, the Northern District
issued a claim construction ruling construing claim terms in dispute
between the parties. Because Catalina agreed with us that, based on the
Northern District's construction of several claim terms of the '041 Patent,
Catalina Marketing could not establish infringement of the '041 Patent by
us, on July 10, 2003 the parties asked the Northern District to enter a
final judgment of non-infringement in favor of us. On September 4, 2003,
Catalina Marketing appealed the final judgment of the Northern District's
Circuit; that appeal is currently pending. 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. ("Supermarkets
Online"), 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 Supermarket
Online's United States Patent No. 6,014,634 (the "'634 Patent"), and seeks
unspecified damages and injunctive relief. 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. The lawsuit is
currently stayed, except that fact discovery is permitted. This stay may
be lifted at any time, before or after the Patent and Trademark Office
issues its opinion. An unfavorable outcome for us in regards to the
litigation 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.
The two foregoing pending lawsuits, with Catalina Marketing and
Supermarkets Online, while pending for at least three years, are
nevertheless in the pre-trial discovery stage and may not be resolved
favorably to us. For example, 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 a Patent License Agreement with Coupco which was executed on
April 16, 2000 (the "Patent License Agreement"). On July 29, 2003, we
entered into a Restated Patent License Agreement with Coupco which resolved
the dispute under similar terms as the Patent License Agreement.
On August 23, 1999, we instituted a lawsuit in the Northern District
against Brightstreet.com, Inc. ("Brightstreet") for infringement of our
'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 Northern District 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 Northern District.
On May 15, 2003, the Federal Circuit affirmed the Northern District's
decision that the litigation had been settled and dismissed the case with
prejudice.
In March 2003, a customer claimed that we failed to deliver certain
services pursuant to the terms of a 2002 agreement with the customer. We
believe the services were delivered in accordance with the terms of the
agreement. In January 2004, we reached final agreement with the customer
to resolve this matter. The agreement involves our delivery of certain
additional services at no charge, and our receipt from the customer of a
complete release from any future actions related to this matter. We
recorded an expense of $184 and $70 in 2003 and 2002, respectively, in
general and administrative expenses to reflect the cost of these services.
Revenue will be recorded in the period the services are delivered.
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 $256, which was recorded in our 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 $321 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 2003.
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." The following table presents the per share high and low bid
prices of our common stock for the periods indicated as reported by the OTC
Bulletin Board.
High Low
----- -----
Fiscal Year Ended December 31, 2003
First Quarter 2003. . . . . . . . . . . . . . . $0.25 $0.09
Second Quarter 2003 . . . . . . . . . . . . . . 1.15 0.21
Third Quarter 2003. . . . . . . . . . . . . . . 0.90 0.56
Fourth Quarter 2003 . . . . . . . . . . . . . . 0.90 0.51
Fiscal Year Ended December 31, 2002
First Quarter 2002. . . . . . . . . . . . . . . $0.17 $0.08
Second Quarter 2002 . . . . . . . . . . . . . . 0.14 0.05
Third Quarter 2002. . . . . . . . . . . . . . . 0.12 0.03
Fourth Quarter 2002 . . . . . . . . . . . . . . 0.14 0.06
On March 1, 2004, the closing sales price of our common stock was
$0.65, 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 common 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, 2003, 3,192,594
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
In April 2003, we issued 7,976 shares of common stock to one former
employee who exercised his stock options, at an exercise price of $0.20 per
share, prior to our filing of a registration statement on Form S-8 covering
shares issuable under our stock option plan. We issued these shares in
reliance upon the exemption from registration provided by Section 4(2) of
the Securities Act of 1933, as a transaction not involving a public
offering.
RECENT PURCHASES OF OUR EQUITY SECURITIES
We did not purchase any of our equity securities during the fourth
quarter of 2003.
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data set forth below for the years ended
December 31, 2003, 2002 and 2001 and the balance sheet data as of
December 31, 2003 and 2002 have been derived from audited financial
statements included elsewhere within this annual report. The statement of
operations data for the years ended December 31, 2000 and 1999 and the
balance sheet data as of December 31, 2001, 2000 and 1999 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 and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
which are included elsewhere in this report.
Year Ended December 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(in thousands, except share and per share data)
Statement of Operations Data:
Net revenues. . . . . . . . . . . $ 32,392 $ 26,360 $ 22,173 $ 39,866 $ 12,916
Cost of revenues. . . . . . . . . 2,654 3,030 5,739 7,172 1,851
---------- ---------- ---------- ---------- ----------
Gross profit. . . . . . . . . . . 29,738 23,330 16,434 32,694 11,065
---------- ---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing . . . . . . 17,054 14,281 17,814 42,335 17,933
Product development . . . . . . 3,033 4,002 6,092 8,353 4,574
General and administrative. . . 7,962 8,846 18,184 21,384 5,691
Lease exit costs. . . . . . . . 519 2,148 -- -- --
Loss on asset impairment. . . . 81 1,233 -- -- --
---------- ---------- ---------- ---------- ----------
Total operating expenses. . 28,649 30,510 42,090 72,072 28,198
---------- ---------- ---------- ---------- ----------
Income (loss) from operations . 1,089 (7,180) (25,656) (39,378) (17,133)
Interest (expense) income,
net . . . . . . . . . . . . (434) (1,107) (583) 138 265
Amortization of debt discount -- -- (3,096) -- --
Other settlement expense. . . -- -- (219) -- --
Extraordinary gain. . . . . . -- -- 327 -- --
---------- ---------- ---------- ---------- ----------
Net income (loss) . . . . . . . $ 655 $ (8,287) $ (29,227) $ (39,240) $ (16,868)
Deemed dividend representing
the beneficial conversion
feature of Series A Preferred
Stock . . . . . . . . . . . . -- -- -- (19,868) --
Accretion of convertible
redeemable Series B
Preferred Stock to
redemption value. . . . . . . -- -- (1,318) -- --
Cumulative dividend on
Series B Preferred Stock. . . (1,926) (909) (113) -- --
---------- ---------- ---------- ---------- ----------
Year Ended December 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(in thousands)
Loss applicable to common
stockholders. . . . . . . . . $ (1,271) $ (9,196) $ (30,658) $ (59,108) $ (16,868)
Loss per common share,
basic and diluted . . . . . . $ (0.03) $ (0.24) $ (0.78) $ (1.63) $ (0.57)
Weighted average shares used
to compute basic and diluted
loss per common share . . . . 39,107,203 39,093,660 39,093,660 36,313,759 29,804,681
Balance Sheet Data:
Cash and cash equivalents . . . . $ 7,347 $ 4,867 $ 5,144 $ 7,041 $ 17,489
Working capital (deficit) . . . . 112 (1,299) (10,761) (1,623) 15,703
Total assets. . . . . . . . . . . 15,061 14,005 17,964 29,510 29,590
Long-term debt, including
current portion . . . . . . . . 6,059 5,592 14,281 4,389 878
Total convertible redeemable
preferred stock . . . . . . . . 26,755 25,041 12,058 -- --
Total stockholders' (deficit)
equity. . . . . . . . . . . . . (25,317) (24,219) (15,023) 9,743 19,120
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
statements that are not historical facts but may be forward-looking
statements within the meaning of the Private Securities Litigation Reform
Act of 1995 regarding our expectations, beliefs, hopes, intentions or
strategies. Where possible, these forward-looking statements have been
identified by use of words such as "project," "target," "forecast,"
"believe," "will", "expect", "anticipate," and similar expressions. These
forward-looking statements include, without limitation, statements
regarding our expectations of revenue growth, expense growth, and capital
spending. 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, these forward-
looking statements. These risks, uncertainties, and other factors include,
without limitation, our ability to secure financing to meet our long-term
capital needs, our ability to protect our patents, trademarks and
proprietary rights, our successful introduction of new services and
features, our ability to add new members, our ability to continue to
attract, assimilate and retain highly skilled personnel, our ability to
secure long-term contracts with our existing advertisers and attract new
advertisers and our ability to compete successfully against current and
future competitors. For a discussion of these and other risks,
uncertainties and factors which could cause actual results to differ
materially from those expressed in, or implied by, the forward-looking
statements, see "Item 1. Business - Risk Factors".
We undertake no obligation to update any of the forward-looking
statements after the date of this report to conform these statements to
actual results or otherwise to reflect new developments or changed
circumstances, unless expressly required by applicable federal securities
laws. You should not place undue reliance on such forward-looking
statements.
OVERVIEW
For the year ended December 31, 2003, and for the first time in our
history, we recorded positive net income. In addition, the fourth quarter
of 2003 represented our sixth consecutive quarter of positive cash flows
from operations. We expect to generate sufficient cash flow from
operations to meet our ongoing operating obligations for the foreseeable
future, excluding any potential acquisitions that may require large cash
outlays, or any accelerated payments under our obligations to Landmark that
Landmark has the right to demand.
We made important transitions during 2003. We moved from a cash flow
driven approach of cost containment to a longer-term planning and
developing approach whereby we are making investments in additional staff
and product capabilities in our effort to continue the growth of the
business. Although revenue grew 23% for the year, fourth quarter revenue
was down 3% compared to the same quarter of 2002. Despite slower revenue
growth in the fourth quarter, we believe that the positive cash flow over
the last five quarters has given us the resources to address the pressing
issues that currently challenge the growth and profitability of the
business.
During the fourth quarter of 2003, we added 10 new employees to
develop new technology and business relationships to enable us to build a
distribution network of other web properties for lead generation offers.
We expect to have this network operational at the beginning of the second
quarter in 2004. This and future efforts to network-enable our other
products should help to substantially increase our consumer reach.
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 response basis (coupon prints, samples or trial
offers requested);
. 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 emails delivered;
. cost per sale or revenue share; and
. promotion set-up fees.
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 permit either party to terminate the contract upon 30 days'
advance written notice. In 2003, our largest advertiser accounted for
approximately 3.3% of our revenues and our top five advertisers together
accounted for approximately 14.4% 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 have licensed portions of our intellectual property, including our
issued patents, to third parties. Approximately 1% of our revenues were
generated from royalties and license fees and other miscellaneous sources
during the year ended December 31, 2003. We expect to generate
substantially lower licensing revenue in 2004 (see Note 14 "Subsequent
Events" in the Notes to the Financial Statements).
EXPENSES
COST OF REVENUES
Our cost of revenues consists primarily of Internet connection
charges, web site equipment depreciation, salaries and related benefits of
operations personnel, fulfillment costs related to member loyalty
incentives, salaries and related benefits of personnel providing consulting
services to customers, and other operations costs directly related to
revenue generation.
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, occupancy costs, and stock-based compensation
expense.
LEASE EXIT COSTS AND LOSS ON ASSET IMPAIRMENT
Lease exit costs and loss on asset impairment charges reflect costs
associated with our determination that a significant portion of our leased
office space was unnecessary for our future operations. During 2002 and
2003, we recorded lease exit costs representing the present value of
estimated future lease obligations related to the unnecessary leased office
space, and estimated costs associated with subleasing the space, net of
estimated cash flows from future sublease arrangements. These estimates
are revised as market conditions and future outlooks change, and as lease
obligations are terminated.
We also determined that the estimated undiscounted cash flows
expected to be generated by the assets in the unnecessary, unoccupied
office space were less than the net book value of the assets. Therefore, we
recorded losses on asset impairment to write down the assets to their
estimated fair value.
Significant assumptions about the timing of a sale or inclusion of
these assets in a future sublease were required in making the estimate of
fair value for these assets. As provided under Financial Accounting
Standards Board ("FASB") Statement of Accounting Standards ("SFAS")
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets",
we used discounted cash flow analysis to estimate fair values.
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 in accordance with generally accepted accounting principles.
However, certain of our accounting policies, which we refer to as our
"critical accounting policies", are particularly important to the portrayal
of our financial position and results of operations and require application
of management's most difficult, subjective or complex judgments often as a
result of the need to make estimates about matters that are inherently
uncertain and may change in future periods. Management bases its estimates
and judgments on historical experience and various other factors that it
believes to be reasonable under the circumstances. Management considers
the following to be our critical accounting policies:
. 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
. measurement of lease exit liability
. valuation of deferred tax assets
. valuation of stock-based compensation
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
web site, 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 web site, 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 amounts which have been prepaid under 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. During 2003, we estimated this
difference to be approximately 2.1% of sales and therefore have established
a credit memo reserve as a reduction to the recorded revenue and
receivables. The adequacy of this reserve is monitored and adjusted as
customer trends and economic trends develop. The allowance for doubtful
accounts is based on several factors including overall customer credit
quality, historical write-off experience and specific account analysis that
project the ultimate collectibility of the account. As such, these factors
may change over time causing the reserve level to adjust accordingly.
When it is determined that a customer is unlikely to pay, a charge is
recorded to bad debt expense in the income statement and the allowance for
doubtful accounts is increased. When it becomes certain the customer
cannot pay, the receivable is written off by removing the accounts
receivable amount and reducing the allowance for doubtful accounts
accordingly.
CAPITALIZATION OF WEB SITE DEVELOPMENT COSTS
The costs of developing and enhancing the functionality of our web
site are capitalized and amortized over 24 months. Management performs
periodic reviews of the expected 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
would have a 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.
The estimates of future cash flows involve considerable management
judgment and are based upon assumptions about future operating performance.
The actual cash flows could differ from management's estimates due to
changes in business conditions, operating performance, and economic
conditions.
MEASUREMENT OF LEASE EXIT LIABILITY
We continually assess our future leased office space requirements to
determine whether currently leased office space is necessary for our future
operations. We have recorded a liability representing the present value of
the estimated future lease obligations related to the unnecessary leased
office space, and estimated costs associated with subleasing the space, net
of estimated cash flows from future sublease arrangements on this space.
Changes in our estimates of future leased office space requirements, the
cost of subleasing the unnecessary space, or the future cash flows from
subleasing the space result in an adjustment to the liability and an impact
to our earnings.
The estimates of future cash flows involve considerable management
judgment and are based upon assumptions about future events. The actual
cash flows could differ from management's estimates due to changes in
business conditions and economic conditions.
VALUATION OF DEFERRED TAX ASSETS
We assess the probability that we will realize the value of our
deferred tax assets, which result from differences between the carrying
amount of assets and liabilities and their respective tax bases and for tax
carryforward items. Based on our history of net losses through 2002, we
have offset the entire amount of net deferred tax assets with a valuation
allowance due to the uncertainty regarding the realization of the assets.
VALUATION OF STOCK-BASED COMPENSATION
The Company accounts for its stock option plan using Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," which results in no charge to earnings when options are issued
at fair market value. SFAS No. 123, "Accounting for Stock-Based
Compensation," which was issued subsequent to APB No. 25 and amended by
SFAS NO. 148 "Accounting for Stock Based Compensation - Transition and
Disclosure," defines a fair value based method of accounting for employee
stock options but allows companies to continue to measure compensation cost
for employee stock options using the intrinsic value based method described
in APB No. 25.
The Company has no immediate plans at this time to voluntarily change
its accounting policy to the fair value based method; however, the Company
continues to evaluate this alternative. In accordance with SFAS No. 148,
the Company has been disclosing in the notes to its consolidated financial
statements the impact on net income and earnings per share had the fair
value based method been adopted. We used the Black-Scholes option pricing
model to measure stock-based compensation expense under the fair value
based method. The assumptions used in the Black-Scholes option pricing
model include dividend yield, risk free rate of return, expected option
term and expected volatility. If the fair value method had been adopted,
net income (loss) for 2003, 2002, and 2001 would have been $1,397, $2,439,
and $2,249 lower than reported and loss/earnings per share would have been
approximately $.04, $.06 and $.06 per diluted share lower, respectively.
RECENT DEVELOPMENTS
BUSINESS ACQUISITION
On February 6, 2004, the Company acquired certain assets related to
the Targeted Marketing Services ("TMS") business line of Alliance Data
Systems, Inc. ("ADS"). In addition, the Company contracted for certain data
center services, and assumed a short term lease obligation and certain
existing customer contracts and service obligations related to the
operations of the TMS business line. Among the assets acquired were certain
intangible property related to consumer package goods (CPG) contracts,
retail relationships, patent rights, copyrights, trademarks and domain
names and an information technology capability necessary to meet existing
service obligations. The Company made a cash payment of $100 for the
purchase of these assets and a cash payment of $93 for the data center
services to be provided. The funds used for the purchase price were
provided by the Company's existing working capital. In addition, in
connection with the acquisition, the Company released ADS from its
obligations under a license agreement with the Company under which the
Company recorded revenue of $273 in 2003.
INVESTMENT BY LANDMARK IN COOLSAVINGS, INC.
The holders of the Series B Preferred Stock are entitled to receive
8% per annum "in-kind" stock dividends, pursuant to the Securities Purchase
Agreement. In 2003, dividends in the amount of 11,029,635 shares of Series
B Preferred Stock were declared "in-kind" on the outstanding shares of
Series B Preferred Stock. In addition, 3,192,594 shares of Series B
Preferred Stock were accrued as "in-kind" dividends as of December 31,
2003. The Series B Preferred Stock is redeemable at its stated value of
$0.1554 per share plus accrued but unpaid dividends at Landmark's option at
any time. The Series B Preferred Stock also is convertible into common
stock at Landmark's option at any time. As of December 31, 2003, Landmark
held 159,629,737 shares of Series B Preferred Stock (and rights with
respect to accrued dividends thereon) convertible into 159,629,737 shares
of our common stock. Warrants to purchase 11,711,456 shares of our common
stock were held by Landmark as of December 31, 2003.
LEGAL PROCEEDINGS
See "Item 3. Legal Proceedings."
RESULTS OF OPERATIONS
The following table presents statements of operations data as a
percentage of net revenue.
For the Year Ended December 31,
----------------------------------
2003 2002 2001
-------- -------- --------
Net revenues. . . . . . . . . . . 100.0% 100.0% 100.0%
Cost of revenues. . . . . . . . . 8.2% 11.5% 25.9%
-------- -------- --------
Gross profit. . . . . . . . . . . 91.8% 88.5% 74.1%
-------- -------- --------
Operating expenses:
Sales and marketing . . . . . . 52.6% 54.2% 80.3%
Product development . . . . . . 9.4% 15.2% 27.5%
General and administrative. . . 24.6% 33.5% 82.0%
Lease exit costs. . . . . . . 1.6% 8.1% --
Loss on asset impairment. . . . 0.2% 4.7% --
-------- -------- --------
Total operating expenses. . . . . 88.4% 115.7% 189.8%
-------- -------- --------
Income (loss) from operations . . 3.4% (27.2%) (115.7%)
Other income (expense):
Interest and other income . . 0.1% 0.1% 1.2%
Interest expense. . . . . . . . (1.5%) (4.3%) (3.8%)
Other settlement expense. . . . 0.0% 0.0% (1.0%)
Amortization of debt discount . 0.0% 0.0% (14.0%)
-------- -------- --------
Total other income (expense). . . (1.4%) (4.2%) (17.6%)
-------- -------- --------
Income (loss) before income
taxes and extraordinary gain. . 2.0% (31.4%) (133.3%)
Income taxes. . . . . . . . . . . -- -- --
-------- --------- --------
Income (loss) before
extraordinary gain. . . . . . . 2.0% (31.4%) (133.3%)
Extraordinary gain. . . . . . . . 0.0% 0.0% 1.5%
-------- --------- --------
Net income (loss) . . . . . . . . 2.0% (31.4%) (131.8%)
Accretion of convertible
redeemable Series B
Preferred Stock to
redemption value. . . . . . . . -- -- (6.0%)
Cumulative dividends on
Series B Preferred Stock. . . . (5.9%) (3.5%) (0.5%)
-------- --------- ---------
Loss applicable to common
stockholders. . . . . . . . . . (3.9%) (34.9%) (138.3%)
======== ========= =========
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
NET REVENUES
Net revenues increased 23% to $32,392 in 2003 from $26,360 in 2002.
The increase was attributable to an increase in our spending on online
advertising, along with the addition of more well-known brands making
compelling offers as advertisers, and our ability to better apply our data
analytics to more effectively target these offers. These factors drove an
increase in the number of new member registrations and an increase in the
number of revenue producing actions initiated by our members. We currently
expect that our revenues will grow by approximately 20% in 2004, reflecting
anticipated growth associated with the launch of our distribution network
for lead generation offers, scheduled for late first quarter of 2004.
COST OF REVENUES AND GROSS PROFIT
Cost of revenues decreased by 12% to $2,654 in 2003 from $3,030 in
2002. Gross profit increased as a percentage of net revenues to 92% in
2003 from 89% in 2002. The increase in gross profit reflects a $952
decrease in amortization and depreciation expense in 2003 as compared to
2002 caused by a decrease in capital spending since mid-2001 and certain
computer hardware and software assets being fully amortized as of December
31, 2002. Also, we experienced a $337 decrease in the costs of gift
certificates used as member incentives. Partially offsetting these
decreases was a gain of $581 in 2002 associated with a discontinued member
incentive and loyalty program. Also, expenses associated with our direct
mail advertising campaigns increased $191 from 2002 to 2003. We expect
cost of revenues, as a percentage of net revenues, to increase during 2004,
reflecting the costs associated with the development and launch of our
distribution network for lead generation offers.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses increased to
$17,054 in 2003, or 53% of net revenues, from $14,281, or 54% of net
revenues, in 2002. The $2,773 increase was primarily due to a $1,301
increase in personnel and personnel-related costs, a $1,071 increase in
online advertising, a $352 offline advertising credit received in 2002 as
compared to no such credit in 2003, and an increase of $242 in expenditures
for promotions and public relations. Partially offsetting these increases
was a $193 decrease in expenses associated with a decrease in barter
revenue. In addition, we received bonus online advertising at no expense
to us in 2003. We estimate the fair value of this bonus media to be
approximately $443. We may or may not receive bonus online advertising in
the future. We expect sales and marketing costs, as a percentage of net
revenues, to increase during 2004, reflecting higher marketing costs
associated with acquiring new members.
Product Development. Product development expenses decreased to
$3,033 in 2003, or 9% of net revenues, from $4,002 in 2002, or 15% of net
revenues. The $969 decrease was primarily due to a $857 decrease in the
amortization of capitalized web site costs as compared to 2002. A
significant portion of our capitalized web site costs are fully amortized.
Also contributing to this decrease were $11 in write-offs of previously
capitalized web site in 2003 as compared to $177 in 2002. We expect
product development costs in 2004, as a percentage of net revenues, to be
comparable with 2003.
General and Administrative. General and administrative expenses
decreased to $7,962 in 2003, or 25% of net revenues, from $8,846 in 2002,
or 34% of net revenues. In 2003, we incurred $779 in depreciation and
amortization expense as compared to $1,604 in 2002. Also in 2003, office
rent decreased by $709, and we had no legal settlement costs in 2003
compared to $150 in such costs in 2002. We expect general and
administrative expenses, as a percentage of net revenues, to decline
substantially during 2004 due to lower legal fees associated with
intellectual property matters, depreciation and amortization.
Partially offsetting these decreases was $267 in settlement gains
made with vendors in 2002 compared to no such gains in 2003, a $240
increase in personnel and personnel-related expenses, a $242 increase in
legal fees, a $114 increase in expenses related to the resolution of a
customer matter, and a $159 stock option expense in 2003 compared to no
such expense in 2002.
Lease Exit Costs. In accordance with SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities," we recorded an
operating expense of $519 in 2003 and $2,148 in 2002, representing an
adjustment to the estimated future lease obligations related to unnecessary
office space and estimated costs associated with subleasing and disposing
of the space, net of estimated cash flows from future sublease
arrangements. The adjustment in 2003 was recorded to reflect changes in
estimates in current and projected sublease market conditions.
Loss on Asset Impairment. Following ongoing assessments of our
future space requirements, we determined that a significant portion of our
unoccupied leased office space and the assets associated with that office
space were unnecessary for our future operations. In accordance with SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets",
we determined that the estimated undiscounted cash flows expected to be
generated by the assets were less than their net book value. Therefore, we
recorded an operating expense of $81 i