<PAGE>
FILED PURSUANT TO RULE 424(B)(4)
REGISTRATION NO. 333-92301
PROSPECTUS
5,250,000 Shares
[LOGO OF AVENUE A]
COMMON STOCK
---------------
Avenue A, Inc. is offering shares of its common stock. This is our initial
public offering and no public market currently exists for our shares.
---------------
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "AVEA."
---------------
Investing in our common stock involves risks. See "Risk Factors" beginning on
page 8.
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PRICE $24 A SHARE
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<TABLE>
<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public Commissions Avenue A, Inc.
-------- ------------- --------------
<S> <C> <C> <C>
Per Share............................. $24.00 $1.68 $22.32
Total................................. $126,000,000 $8,820,000 $117,180,000
</TABLE>
Avenue A, Inc. has granted the underwriters the right to purchase up to an
additional 787,500 shares to cover over-allotments.
The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities, or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers
on March 3, 2000.
---------------
MORGAN STANLEY DEAN WITTER
SALOMON SMITH BARNEY
THOMAS WEISEL PARTNERS LLC
February 28, 2000
<PAGE>
Inside Front Cover:
Title: Avenue A Focuses on the Needs of Internet Advertisers
Caption 1: Advertisers seeking to take advantage of the Internet's
potential may face numerous challenges, including:
Caption 2: - The scale and complexity of the Internet
Caption 3: - Data analysis and technology requirements
Caption 4: - Operating costs and system requirements
Caption 5: Avenue A Clients
Graphic depicting Avenue A clients connected by a line flowing into the
Avenue A Logo
Caption 6: Avenue A integrates proprietary technology, media planning,
media buying and data analysis to help clients realize the potential
of Internet advertising.
Graphic depicting a line flowing from the Avenue A logo to boxes used to
represent portals, vertical portals, consent sites, ad networks and e-
commerce sites
Title: Avenue A's Systematic Data-Driven Process:
Caption: Avenue A guides its clients through each step of the process.
Graphic depicting the flow of steps leading into and out of a
central box representing "Data Collection" which contains two smaller
boxes representing "Ad Serving & Management Technology" and "Precision
E-mail." The steps leading into the central box (themselves
represented by boxes) are "Strategy", "Media Planning" and "Media
Buying." The steps leading out of the central box (also represented by
boxes) are "Online Campaign Performance Reporting," "Campaign
monitoring & Optimization" and "Data Analysis." Lines from these three
boxes flow into the graphic on right half of page depicting a cylinder
bearing the Avenue A logo and the phrase "The Avenue A Knowledge
Base." A line flows from the cylinder back to the first step of the
flow chart, "Strategy."
Title: The Result
Caption 1: Avenue A integrates Internet media planning and buying, ad
management technology, user profiling and data analysis to help
advertisers increase the effectiveness and return on investment of
their Internet advertising campaigns.
Caption 2: (on left half of page) An Example:
Caption 3: (on left half of page) Ad Management Technology. Our ad serving
systems enable our client service teams to:
Caption 4: (on left half of page) - control the frequency with which ads
are served
Caption 5: (on left half of page) - program the sequence with which ads are
viewed
Caption 6: (on left half of page) 1. Data Collection/Online Reporting:
Caption 7: (on left half of page) Avenue A tracks, stores and measures data
on users' online responses to Internet advertising. Campaign
performance reports are available online throughout the campaign.
Graphic depicting a line from Caption 6 to a graph (on right half of page)
showing response rates. The horizontal axis shows Portal, E-commerce
site 1, Vertical Portal, Content Site, E-Commerce Site 2, Ad Network 1
and Ad Network 2; the vertical axis shows response rates Low, Medium
and High.
Caption 8: (on left half of page) 2. Advertisement Monitoring
Caption 9: (on left half of page) Client service teams eliminate
under-performing advertisements from the campaign.
Graphic depicting a line from Caption 8 to a chart (on right half of page)
showing Advertisements and Response Rates (high, low and medium) in
tabular form.
Caption 10: (on left half of page) 3. Campaign Monitoring
Caption 11: (on left half of page) Client service teams identify under-
performing sites and/or placements within a site. They then adjust the
campaign by:
Caption 12: (on left half of page) - renegotiating with these sites for
lower rates
Caption 13: (on left half of page) - scheduling additional ads on better
performing sites
Caption 14: (on left half of page) - eliminating under-performing sites
from the campaign
Graphic depicting a line from Caption 10 to a graph (on right half of page)
showing the same statistics as under caption 6 with an X through those
columns with "low" response rates.
Caption 15: (on left half of page) 4. Optimization
Caption 16: (on left half of page) By monitoring and optimizing
advertisements, sites and placements within a site, Avenue A helps
advertisers increase campaign performance.
Graphic depicting a line from Caption 15 to a graph (on right half of page)
showing the same statistics as the graph under Caption 6 with the
"low" response rate columns removed.
Caption 17: (on left half of page) Data Analysis
Caption 18: (on left half of page) Once a campaign is concluded, client
service teams provide campaign analysis and recommendations for future
campaigns.
<PAGE>
TABLE OF CONTENTS
<TABLE>
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Page
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<S> <C>
Prospectus Summary....................................................... 4
Risk Factors............................................................. 8
Special Note Regarding Forward-Looking Statements........................ 23
Use of Proceeds.......................................................... 24
Dividend Policy.......................................................... 24
Capitalization........................................................... 25
Dilution................................................................. 26
Selected Consolidated Financial Data..................................... 27
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 28
Business................................................................. 37
Management............................................................... 49
Related-Party Transactions............................................... 62
Principal Shareholders................................................... 65
Description of Capital Stock............................................. 68
Shares Eligible for Future Sale.......................................... 71
Underwriters............................................................. 73
Legal Matters............................................................ 75
Experts.................................................................. 75
Where You Can Find More Information...................................... 75
Index to Consolidated Financial Statements............................... F-1
</TABLE>
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell shares of common stock
and seeking offers to buy shares of common stock only in jurisdictions where
offers and sales are permitted. The information contained in this prospectus
is accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of our common stock.
Until March 24, 2000, 25 days after commencement of the offering, all dealers
that buy, sell or trade shares, whether or not participating in this offering,
may be required to deliver a prospectus. This is in addition to the dealers'
obligation to deliver a prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
3
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PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding Avenue A and the common stock being sold in this offering
and the consolidated financial statements and related notes appearing elsewhere
in this prospectus.
We have a history of significant losses and expect to incur substantial losses
in the future
We have a history of significant losses, including net losses of $3.9
million for the period from our inception on July 1, 1997 through December 31,
1998, and net losses of $11.9 million for the year ended December 31, 1999. As
of December 31, 1999, our accumulated deficit was $15.3 million. We anticipate
incurring substantial losses and negative operating cash flow for the
foreseeable future. For more information regarding these and other risks
involved in investing in our common stock, see "Risk Factors."
Avenue A
Avenue A provides technology-based Internet advertising services to
businesses. We integrate Internet media planning and buying, proprietary ad
management technology, user profiling and data analysis systems to help
advertisers increase the effectiveness and return on investment of their
Internet advertising campaigns. We have developed an extensive knowledge base
of Internet advertising strategies, targeting methods and media placements
which have proven effective. We believe this knowledge base grows richer and
more valuable with each additional campaign we execute and with each additional
client we serve. We focus on serving the needs of Internet advertisers, with
the objective of delivering the most successful advertising campaigns for our
clients. Our top four clients are Gateway, Microsoft, uBid and Uproar, based on
our revenue in the fourth quarter of 1999 and in fiscal year 1999.
The Internet is expected to grow rapidly as a medium for advertising and
commerce. Forrester Research, Inc. projects that online advertising
expenditures in the United States will grow from $2.8 billion in 1999 to
$22.0 billion in 2004. We believe that a number of factors have driven this
growth, including the increasing number of Internet users, the growth of e-
commerce and technological advances. The Internet enables the delivery of
advertisements which can be tailored for individual viewers and quickly
modified based on viewers' responses to the advertisements. Advertisers,
however, often must overcome significant challenges to take full advantage of
the potential of the Internet as an advertising medium. Some of these
challenges include the scale and complexity of the Internet, significant data
analysis and technology requirements and substantial operating costs.
Avenue A helps advertisers overcome these challenges. We have designed our
service offering to meet the needs of buyers of Internet advertising. Our media
planning and ad management services use our database to create and execute
highly targeted advertising campaigns. Our proprietary technology allows us to
simultaneously conduct a large number of advertising campaigns which are
delivered to a broad range of Web sites and advertising networks. Our
technology and data analysis systems measure and analyze our clients'
advertising campaigns based on criteria relevant to their specific business
objectives to help increase the return on their investments. We do not design
the content of advertisements, which is provided by the client or a third party
acting on its behalf.
Our objective is to be the leading provider of Internet and other digital
media advertising services to advertisers. To achieve this goal we plan to:
. aggressively acquire new clients and develop new markets, in particular
through our Growth Markets Division, which tailors our services to
clients with smaller online advertising budgets;
. leverage our extensive database of information from prior Internet
advertising campaigns and our data analysis expertise to improve and
extend our services;
4
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. provide superior client service through a comprehensive, integrated
offering of Internet advertising and marketing services, including our
recently launched Precision E-mail Service;
. continue to build, license and acquire technologies that will enable us
to plan and execute increasingly effective Internet advertising and
marketing campaigns;
. acquire complementary businesses and establish relationships with other
companies, including companies that provide traditional advertising and
media services, to increase our sales penetration, gain access to their
clients and become the preferred or exclusive provider of Internet
advertising and marketing services for these companies;
. extend our technology and capabilities to deliver targeted
advertisements through emerging digital media we choose to exploit,
which may include interactive television, Internet-enabled home
appliances, hand-held computers and cellular telephones; and
. expand our presence internationally in order to capitalize on the global
reach of the Internet.
We began operations in July 1997 and were incorporated in Washington in
February 1998. To expand our presence in the Internet advertising industry and
allow us to serve a broader client base, in September 1999 we acquired iballs
LLC, an Internet media company located in New York City. Our principal
executive offices are located at 506 Second Avenue, Seattle, Washington 98104,
and our telephone number is (206) 521-8800. Our World Wide Web site is
www.avenuea.com. The information contained on our Web site is not part of, or
incorporated by reference into, this prospectus.
"AVENUE A," "AVENUE A MEDIA," "AD CLUB NETWORK," "AXIS," "PRECISION E-MAIL,"
"PRECISION TARGETING" and the Avenue A logo are service marks of Avenue A for
which service mark applications are pending. "IBALLS" and the iballs LLC logo
are service marks of iballs LLC, a wholly owned subsidiary of Avenue A, for
which service mark applications are pending. This prospectus also includes
trademarks, trade names and service marks of other companies. Use or display by
Avenue A of other parties' trademarks, trade names or service marks is not
intended to and does not imply a relationship with, or endorsement or
sponsorship of Avenue A by, these other parties.
Unless the context requires otherwise, in this prospectus the terms "Avenue
A," "we," "us" and "our" refer to Avenue A, Inc. and its subsidiaries, and
references to "iballs LLC" refer to I-Balls LLC, a wholly owned subsidiary of
Avenue A, Inc.
5
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THE OFFERING
<TABLE>
<C> <S>
Common stock offered................................ 5,250,000 shares
Common stock to be outstanding after this offering.. 55,672,992 shares
Use of proceeds..................................... For general corporate
purposes, including
working capital. See "Use
of Proceeds."
Nasdaq National Market symbol....................... AVEA
</TABLE>
The number of shares of our common stock to be outstanding after this
offering is based upon shares outstanding as of December 31, 1999, includes
677,710 shares of common stock to be issued upon exercise of a warrant at an
exercise price of $.55 per share immediately prior to the closing of this
offering, and excludes:
. 7,173,085 shares of common stock subject to outstanding options as of
December 31, 1999, granted under our 1998 stock incentive compensation
plan at a weighted average exercise price of $1.95 per share;
. 1,312,500 shares of common stock subject to outstanding options as of
December 31, 1999, granted outside of our stock incentive compensation
plans at a weighted average exercise price of $1.63 per share;
. 3,837,860 shares of common stock subject to outstanding options granted
after December 31, 1999 under our 1998 stock incentive compensation plan
and 2000 stock incentive compensation plan at a weighted average
exercise price of $7.86 per share; and
. 5,250,000 shares of common stock reserved for issuance under our 1999
stock incentive compensation plan, which includes 3,750,000 shares of
common stock reserved in January 2000, and 750,000 shares of common
stock reserved for issuance under our 1999 employee stock purchase plan.
In addition, except as otherwise noted, all information in this prospectus
is based on the following assumptions:
. the conversion of each outstanding share of preferred stock into 1.5
shares of common stock upon the closing of this offering;
. no exercise of the underwriters' over-allotment option; and
. a 3-for-2 stock split of our common stock in the form of a common stock
dividend which occurred in January 2000.
6
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SUMMARY CONSOLIDATED FINANCIAL DATA
(in thousands, except share and per share data)
The pro forma basic and diluted net loss per share data in the following
table reflects the conversion of all outstanding shares of preferred stock into
24,624,147 shares of common stock effective upon the closing of this offering.
See note 2 of notes to Avenue A's consolidated financial statements contained
elsewhere in this prospectus for an explanation of the determination of the
number of weighted average shares used to compute pro forma basic and diluted
net loss per share amounts.
<TABLE>
<CAPTION>
Period
From Inception
(July 1, 1997) Year Ended December 31,
to December 31, ------------------------
1997 1998 1999
--------------- ----------- -----------
<S> <C> <C> <C>
Consolidated Statements of
Operations Data:
Total revenue..................... $ 18 $ 599 $ 69,695
Loss from operations.............. (284) (3,658) (12,447)
Net loss.......................... (284) (3,646) (11,893)
Basic and diluted net loss per
share............................ $ (.34) $ (.61)
Shares used in computing basic and
diluted net loss per share....... 10,860,682 19,428,034
Pro forma basic and diluted net
loss per share................... $ (.27) $ (.31)
Shares used in computing pro forma
basic and diluted net loss per
share............................ 13,387,488 38,466,488
</TABLE>
The following table presents consolidated balance sheet data as of December
31, 1999:
. on an actual basis; and
. on an as adjusted basis to reflect the sale of 5,250,000 shares of
common stock offered by this prospectus at the initial public offering
price of $24.00 per share, the receipt by Avenue A of the estimated net
proceeds after deducting underwriting discounts and commissions and
estimated offering expenses, and the receipt by Avenue A of the proceeds
from the sale of 677,710 shares upon exercise of a warrant at an
exercise price of $.55 per share immediately prior to the closing of
this offering.
<TABLE>
<CAPTION>
As of December 31,
1999
-------------------
Actual As Adjusted
------- -----------
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents................................. $10,962 $126,715
Working capital........................................... 11,932 127,685
Total assets.............................................. 62,091 177,844
Total liabilities......................................... 40,147 40,147
Total shareholders' equity................................ 21,944 137,697
</TABLE>
7
<PAGE>
RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should carefully consider the following risk factors and the other information
in this prospectus before investing in our common stock. Our business,
financial condition and operating results could be seriously harmed by any of
the following risks. The trading price of our common stock could decline due
to any of these risks, and you may lose all or part of your investment.
Risks Related to Our Company and Business
We are subject to risks frequently encountered by early-stage companies in
the Internet advertising market
Our prospects for financial and operational success must be considered in
light of the risks frequently encountered by early-stage companies in the
Internet advertising industry. These risks include the need to:
. attract new clients and maintain current client relationships;
. achieve effective advertising campaign results for our clients;
. continue to develop and upgrade our technologies to keep pace with the
growth of the Internet advertising market and changes in technology;
. continue to expand the number of services we offer;
. successfully implement our business model, which is unproven and
evolving;
. manage our expanding operations;
. maintain our reputation and build trust with our clients; and
. identify, attract, retain and motivate qualified personnel.
If we do not successfully address these risks, our business could suffer.
We have a history of losses and anticipate continued losses
We incurred net losses of $3.9 million for the period from our inception on
July 1, 1997 through December 31, 1998, and net losses of $11.9 million for
the year ended December 31, 1999. As of December 31, 1999, our accumulated
deficit was $15.3 million. We have not achieved profitability and expect to
continue to incur operating losses for the foreseeable future. We expect to
continue to make significant operating and capital expenditures and, as a
result, we will need to generate significant additional revenue to achieve and
maintain profitability. We cannot assure you that we will generate sufficient
revenue to achieve profitability. Even if we do achieve profitability, we
cannot assure you that we can sustain or increase profitability on a quarterly
or annual basis in the future. If our revenue grows more slowly than we
anticipate, or if our operating expenses exceed our expectations or cannot be
reduced, we will be unable to achieve or maintain profitability.
Our quarterly operating results are subject to fluctuations that may cause
our stock price to decline
Our quarterly operating results have fluctuated in the past and are likely
to continue to do so in the future. It is possible that in the future our
operating results in a particular quarter or quarters will not meet the
expectations of investors. If our operating results fail to meet these
expectations, the market price of our common stock could decline. We believe
that quarter-to-quarter comparisons of our operating results are not a good
indication of our future performance and should not be relied upon to predict
the future performance of our stock price.
Our revenue, expenses and operating results could vary significantly from
quarter to quarter for several reasons, including:
. fluctuating demand for our advertising services and changes in the mix
of advertisements placed and services provided;
8
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. addition of new clients or loss of current clients;
. seasonal fluctuations in advertising spending;
. timing variations on the part of advertisers to implement advertising
campaigns;
. changes in the availability and pricing of advertising space;
. timing and amount of costs relating to the expansion of our operations;
and
. costs related to any possible future acquisitions of technologies or
businesses.
Our current and future expense estimates are based, in large part, on
estimates of future revenue, which is difficult to predict. In particular, we
plan to increase our operating expenses significantly in order to enhance our
proprietary technology, expand our client services, sales and marketing
operations and expand internationally. We may be unable to, or may elect not
to, adjust spending quickly enough to offset any unexpected revenue shortfall.
If our expenses are not accompanied by increased revenue in the same quarter,
our quarterly operating results would be harmed.
Our operating results may fluctuate seasonally, and these fluctuations may
cause our stock price to decline
Our stock price may decline due to seasonal fluctuations. We believe that
our operating results will fluctuate depending on the season because retail
advertisers generally purchase substantially more advertising space during the
fourth calendar quarter of each year than during other quarters, particularly
the first calendar quarter. Given our limited operating history, we cannot be
certain how pronounced these seasonal trends may be or what, if any, other
seasonal trends may emerge that would affect our business.
We rely on a limited number of clients, and the loss of a major client or a
reduction in a major client's Internet advertising budget could
significantly reduce our revenue
Our business would be harmed by the loss of any of our major clients, a
reduction in the Internet advertising budgets of any of these clients or any
significant reduction in revenue generated from these clients. A substantial
amount of our revenue to date has been derived from a limited number of
advertisers that use our services. In 1999, Gateway, Microsoft and uBid each
accounted for over 10% of our total revenue, and together accounted for
approximately 43% of our total revenue. In addition, in 1999 our top ten
clients collectively accounted for over 67% of our total revenue. In the
fourth quarter of 1999, Gateway and uBid each accounted for over 10% of our
total revenue, and together accounted for approximately 29% of our total
revenue. In addition, our top ten clients collectively accounted for
approximately 64% of our total revenue in this same period. Current clients
may decide not to continue purchasing advertising services from us or may
significantly reduce their advertising spending, and we may not be able to
successfully attract additional clients. In addition, the non-payment of
amounts due to us from one or more of our significant clients would harm our
business.
Our client contracts have short terms, and the loss of a significant number
of these contracts in a short period of time could harm our business
We derive substantially all of our revenue from the sale of advertising
services under short-term advertising campaign services contracts, all of
which are cancelable upon 90 days' or less notice. In addition, these
contracts generally do not contain penalty provisions for cancellation before
the end of the contract term. The non-renewal, cancellation or deferral of a
significant number of these contracts in any one period would cause an
immediate and significant decline in our revenue and harm our business.
A portion of our recent increases in revenue was due to a change in the
advertising contracts we use, and these increases should not be relied upon
to predict our future performance
A portion of our increase in revenue since the beginning of 1999 was due to
our change from the use of advertising service fee contracts to advertising
services contracts. Accordingly, this portion of the increase does
9
<PAGE>
not indicate increases in our client base, increases in the level of services
we perform for our clients or increasing demand for our services, and should
not be relied upon to predict our future performance. We estimate that the
increase in our revenue since the beginning of 1999 that was due to changing
from advertising service fee contracts to advertising services contracts was
$7.4 million. In 1998, a majority of our client contracts were advertising
service fee contracts, but during the first quarter of 1999, we replaced a
majority of these contracts with advertising services contracts.
We are substantially dependent on our ability to perform third-party ad
serving and any limitation on this ability could harm our business
We are substantially dependent on our ability to perform advertisement
delivery, or ad serving, on third-party Web sites, and any limitation on this
ability could harm our business. Our technology and advertising services have
been structured around third-party ad serving, and we currently do not plan to
shift our focus or diversify our services to diminish the relative importance
of third-party ad serving. Our business could suffer from a variety of factors
that limit or reduce our ability to perform third-party ad serving, including:
. refusal by Web sites or advertising networks to accept advertisements
served by us;
. technological changes that render our ad serving systems obsolete or
incompatible with the systems of Web sites or advertising networks;
. introduction of more advanced or lower-priced ad serving services by our
competitors;
. lawsuits or injunctions based on claims that our ad serving technologies
violate the proprietary rights of other parties;
. increases in ad serving directly from advertisers to Web sites; and
. interruptions, failures or defects in our ad serving systems.
Some of our competitors have obtained patents and have sued other parties
to enforce their rights under these patents, and we may also be subject to
patent infringement claims, including claims that our ad serving
technologies, processes or methods infringe these or other patents
Other parties may claim that our technologies, processes or methods
infringe their patents. Any such claim may cause us to incur significant
expenses and, if successfully asserted against us, may cause us to pay
substantial damages and prevent us from providing some of our services,
including our core ad serving services, which would substantially harm our
business. A U.S. patent was issued to DoubleClick Inc. in September 1999 which
may cover some of the technologies, processes or methods that we use in our ad
serving systems. DoubleClick recently brought suit against L90, Inc., one of
its competitors, claiming that L90's methods and networks for delivery,
targeting and measuring advertising over the Internet infringe this patent.
DoubleClick also recently filed a suit against Sabela Media, Inc., another of
its competitors, relating to infringement of this same patent. We cannot
assure you that we will be able to distinguish our technologies, processes or
methods from those covered under the DoubleClick patent or that the
DoubleClick patent would be invalidated if challenged. If DoubleClick were to
bring a claim against us based upon this patent and we were unable to
distinguish our technologies, processes or methods or prove that the
DoubleClick patent is invalid, we could incur significant expenses, be
required to pay substantial damages and be enjoined from providing some of our
services, including our core ad serving services.
In addition, DoubleClick and MatchLogic, Inc., a subsidiary of At Home
Corporation, have each filed patent applications that appear to cover
technologies relating to ad serving, and 24/7 Media, Inc. has announced that
it has received a notice of allowance for a U.S. patent application on its ad
delivery technology. If patents are issued pursuant to these applications, we
cannot assure you that we will be able to distinguish our technologies,
processes or methods from those covered under these patents or that the
patents would be invalidated if challenged. The patent field covering
Internet-related technologies is rapidly evolving and surrounded by a great
deal of uncertainty, and other patents or patent applications relating to the
delivery of Internet advertising may exist of which we are unaware.
10
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Any claims that might be brought against us relating to infringement of
patents, including patents that may be issued to DoubleClick, MatchLogic or
24/7 Media, may cause us to incur significant expenses and, if successfully
asserted against us, may cause us to pay substantial damages and limit our
ability to use the intellectual property subject to these claims. Even if we
were to prevail, any litigation could be costly and time-consuming and could
divert the attention of our management and key personnel from our business
operations. Furthermore, as a result of a patent infringement suit, we may be
prevented from providing some of our services, including our core ad serving
services, unless we enter into royalty or license agreements. We may not be
able to obtain royalty or license agreements on terms acceptable to us, if at
all.
In addition to patent infringement claims, third parties may assert other
intellectual property claims, which may cause us to incur significant
expenses, pay substantial damages and be prevented from providing our
services
In addition to patent infringement claims, third parties may claim that we
are infringing or violating their other intellectual property rights,
including their copyrights, trademarks and trade secrets, which may cause us
to incur significant expenses and, if successfully asserted against us, pay
substantial damages and be prevented from providing our services which would
substantially harm our business. Even if we were to prevail, any litigation
regarding our intellectual property could be costly and time-consuming and
divert the attention of our management and key personnel from our business
operations. Furthermore, as a result of an intellectual property infringement
suit, we may be prevented from providing some of our services or using some of
the service marks for which we have sought service mark protection, unless we
enter into royalty or license agreements. We may not be able to obtain royalty
or license agreements on terms acceptable to us, if at all.
Our use of the name "Avenue A" may result in infringement claims and other
legal challenges, which could cause us to incur significant expenses, pay
substantial damages and be prevented from using this name
Our use of the name "Avenue A" may result in infringement claims and other
legal challenges, which could cause us to incur significant expenses, pay
substantial damages and be prevented from using this name. We are aware of
third parties that use the name "Avenue A" or similar names, one of which is a
Canadian advertising agency. We are also aware of a registration in France of
the name "Avenue A" for use in advertising services. There may be other third
parties using names similar to ours of whom we are unaware. We may be subject
to trademark infringement claims by third parties as a result of our use of
the name "Avenue A." In addition, we may not receive approval of our service
mark application for the name "Avenue A," and even if the application is
approved, the service mark may be challenged by third parties or invalidated.
As a result of such infringement claims or challenges, we may incur
significant expenses, pay substantial damages and be prevented from using the
name "Avenue A" unless we enter into royalty or license agreements. We may not
be able to obtain royalty or license agreements on terms acceptable to us, if
at all. Use of the name "Avenue A" or similar names by third parties may also
cause confusion to our clients and confusion in the market, which could
decrease the value of our brand and harm our reputation.
Our intellectual property may be subject to legal challenges, unauthorized
use or infringement, which could diminish the value of our services to
existing and potential clients
If we fail to successfully enforce our intellectual property rights, the
value of our services could be diminished and our business may suffer. Our
success depends in large part on our proprietary technology. We have not been
issued any patents to date and we cannot assure you that any of our patent
applications will be approved, that any future patent issued to us will not be
challenged, invalidated or circumvented, or that the rights granted under any
future patent of ours will provide competitive advantages to us. Our success
also depends on our continuing use of our service marks. We may not receive
approval of our service mark applications, and any service marks we may be
granted may be successfully challenged by others or invalidated. If our
service mark applications are not approved or if our service marks are
invalidated because of prior third-party registrations, our use of these marks
could be restricted unless we entered into arrangements with these third
parties, which might not be available on commercially reasonable terms, if at
all.
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We currently rely on a combination of copyright, trademark and trade secret
laws and confidentiality procedures to establish and protect our proprietary
rights. We may be required to spend significant resources to monitor and
enforce these rights. Third parties may obtain and use our technology without
authorization or independently develop similar technology that may infringe
our proprietary rights. We may not be able to detect such infringements or may
lose competitive position in the market before we do so. In addition,
competitors may design around our technology or develop competing technologies
substantially similar to ours. Also, unauthorized parties may attempt to
disclose, obtain or use our technology. Our precautions may not prevent
misappropriation of our intellectual property, particularly in foreign
countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States.
Third parties may assert claims against us relating to the collection and
use of Internet user information
Third parties may claim that our collection and use of Internet user
information violates federal or state laws, which may cause us to incur
significant expenses, pay substantial damages and be prevented from conducting
targeted advertising and aggregating data from our clients' advertising
campaigns. Several Internet-related companies, including some in the Internet
advertising industry, have recently been sued under federal and state laws, or
had claims brought against them before the Federal Trade Commission, regarding
the collection and use of Internet user information. Any claim by a third
party against us regarding our collection and use of Internet user information
could harm our business.
Any limitation on our ability to conduct targeted advertising could impair
our ability to retain existing clients and attract new clients
Any limitation on our ability to conduct targeted advertising for our
clients could harm our business. Targeted advertising is an essential element
of our business. As more advertisers demand targeted advertising services, we
will need to develop increasingly effective tools and larger databases that
can provide greater precision in targeted advertisement management and
delivery. The development of these tools and databases is technologically
challenging and expensive. We cannot assure you that we can develop any of
these tools or databases in a cost-effective or timely manner, if at all, and
failure to do so could limit our ability to conduct targeted advertising.
Moreover, privacy concerns may result in limitations or prohibitions on the
use of Internet user information, which could also limit our ability to
conduct targeted advertising. Any limitation or prohibition would impair our
ability to retain our existing clients and to attract new clients, which would
harm our business.
Any limitation on our ability to aggregate or use data from our clients'
advertising campaigns could decrease the value of our services, result in
significant expenditures of resources and harm our business
Any limitation on our ability to aggregate data from our clients'
advertising campaigns or to use this data could decrease the value of our
services, result in significant expenditures and harm our business. In
addition to the detailed data we collect and store for individual clients, we
aggregate non-personally identifiable data on the activity of Internet users
from the advertising campaigns of all of our clients. We rely on this data to
build user behavioral models to assist in media planning and in the targeting
of Internet advertising for our clients. Although the data we aggregate from
the campaigns of different clients is, once aggregated, not identifiable by
client, our clients might decide not to allow us to collect some or all of
this anonymous data or limit our use of this data. In addition, although our
advertising campaign services contracts generally permit us to aggregate
anonymous data from advertising campaigns, our clients might nonetheless
request that we discontinue using data from their campaigns that has already
been aggregated with other client campaign data. It would be difficult if not
impossible to comply with these requests, and such requests could result in
significant expenditures of resources. Interruptions, failures or defects in
our data collection and storage systems, as well as privacy concerns regarding
the collection of user data, could also result in limitations on our ability
to aggregate data from our clients' advertising campaigns.
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Our business model is unproven and evolving and may not succeed
Our business model is new and unproven, is continually evolving, and
ultimately may not succeed. We generate revenue by providing technology-based
Internet advertising services to our clients. The Internet has not been in
existence for a sufficient period of time to demonstrate its effectiveness as
an advertising medium. Internet banner advertising, email marketing and other
types of Internet advertising and marketing, as well as technology-based
methods for targeting advertisements and tracking the results of Internet
advertising, may not achieve broad market acceptance. Also, the intense
competition among Internet advertising service providers has led to the
creation of a number of alternative service offerings and pricing structures
for Internet advertisers. Our model for generating revenue may prove
unsuccessful in light of this competition. Our ability to generate revenue
from our clients will depend, in part, on our ability to:
. demonstrate to our clients that Internet advertising and marketing
services will add value and increase advertising or marketing
effectiveness;
. attract and retain clients by differentiating the services we offer; and
. obtain advertising space at competitive prices from a large base of Web
sites and advertising networks sufficient to meet the needs of our
clients.
If we fail to effectively manage our growth, our business could suffer
Failure to manage our growth could harm our business. We have grown
significantly since our inception and expect to grow quickly in the future. We
have increased our number of employees from 46 as of September 30, 1998 to 232
as of December 31, 1999. In addition, we have recently added 27 employees in
New York City in connection with our acquisition of iballs LLC, an Internet
media company. Because many of our executives, including our chief executive
officer, have only recently joined us, our management team has only worked
together for a short time and may not work together effectively.
Future expansion could be expensive and strain our management and other
resources. In order to effectively manage growth, we must:
. continue to develop an effective planning and management process to
implement our business strategy;
. hire, train and integrate new personnel in all areas of our business,
especially in our Client Service teams;
. improve our financial and managerial controls and accounting and
reporting systems and procedures; and
. expand our facilities and increase our capital investments.
We cannot assure you that we will be able to effectively accomplish these
tasks or otherwise effectively manage our growth.
The loss of our chief executive officer or chief financial officer, or any
inability to attract and retain additional personnel, could impair our
ability to maintain or expand our business
The loss of the services of our chief executive officer or chief financial
officer could harm our business. Our future success depends to a significant
extent on the continued service of our key management personnel, particularly
Brian P. McAndrews, our President and Chief Executive Officer, and Robert M.
Littauer, our Chief Financial Officer, Vice President, Finance and
Administration, Secretary and Treasurer. We do not maintain key person life
insurance on any of our executive officers and do not intend to purchase any
in the future. Our business could be harmed if our chief executive officer or
chief financial officer decided to join a competitor or otherwise compete with
us.
Our future success also depends on our ability to attract, retain and
motivate highly skilled personnel. In particular, we will need to hire a
significant number of client service personnel. Competition for qualified
personnel in the Internet and technology industries is intense. If we fail to
hire and retain a sufficient number of client service personnel, as well as
engineering, sales and technical personnel, we will not be able to maintain or
expand our business.
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Many of our clients have limited operating histories, are unprofitable and
may not be able to pay for our services
If any of our current or future clients is unable to pay for our services,
our business could suffer. Many of our principal clients have limited
operating histories and have not achieved profitability. In the past we have
lost clients, or have had difficulty collecting payments from clients, who
could not pay for our services because they were unable to secure ongoing
funding. The ability of many of our clients to meet their payment obligations
is affected by the risks and difficulties encountered by companies with
limited operating histories, particularly in the evolving Internet market.
We are ultimately liable for the cost of advertising space we buy from Web
sites for sale to our clients
We are ultimately responsible for the payment to Web sites for the cost of
advertising space we buy from them for sale to our clients. If our clients
fail to purchase from us advertising space that we buy from Web sites, we
nevertheless will have to pay the Web sites for the cost of the advertising
space and as a result our business could be harmed.
We have many competitors and may not be able to compete successfully in the
market for Internet advertising
The market for Internet advertising is relatively new, yet intensely
competitive. Our competitors include Internet media buyers that integrate ad
serving technology and Internet media buying, interactive advertising
agencies, enabling online advertising technology providers, advertising
networks, targeted email service providers and traditional advertising
agencies that perform Internet advertising and marketing as part of their
services to clients.
In addition, we compete with other traditional advertising agencies that
use traditional advertising media, and in general we compete with television,
radio, cable and print media for a share of advertisers' budgets.
Many of our existing competitors, as well as a number of potential new
competitors, have longer operating histories, greater name recognition, larger
client bases and significantly greater financial, technical and marketing
resources than we have. Also, many of our current and potential competitors
have established or may establish cooperative relationships among themselves
or with third parties. In addition, several of our competitors, including
AdForce, Inc., AdKnowledge, Inc. and Flycast Communications Corporation, have
combined or are in the process of combining with larger companies with greater
resources than ours. These competitors may:
. engage in more extensive research and development;
. undertake more far-reaching marketing campaigns;
. make more attractive offers to existing and potential employees and
clients;
. adopt more aggressive pricing policies and provide services similar to
ours at no additional cost by bundling them with their other product and
service offerings;
. develop services that are equal or superior to our services or that
achieve greater market acceptance than our services; and
. develop databases that are larger than or otherwise superior to our
databases.
Increased competition is likely to result in price reductions, reduced
gross margins and loss of market share. We cannot assure you that we will be
able to compete successfully, and competitive pressures may harm our business.
Consolidation in the Internet industry may impair our ability to retain our
clients
Many of our clients may be affected by rapid consolidation in the Internet
industry. For example, CMGI, Inc. recently announced that it has entered into
an agreement to acquire uBid, Inc., one of our top four clients. Our business
would suffer if we were to lose a substantial number of clients or any of our
significant clients as a
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result of consolidation. These clients may be required to use the advertising
services of the companies that acquire them or of other advertising service
providers.
Consolidation of Internet advertising networks and large Internet portals
may impair our ability to serve advertisements, to acquire advertising
space at favorable rates and to collect campaign data
The consolidation of Internet advertising networks and large Internet
portals could harm our business. This type of consolidation is currently
occurring at a rapid pace and may eventually lead to a concentration of
desirable advertising space on a very small number of networks and large Web
sites. This type of concentration could substantially impair our ability to
serve advertisements if these networks or large Web sites decide not to permit
us to serve advertisements on their Web sites or if they develop ad placement
systems that are not compatible with our ad serving systems. These networks or
Web sites could also use their greater bargaining power to increase their
rates for advertising space or prohibit or limit our aggregation of
advertising campaign data. In addition, concentration of desirable advertising
space in a small number of networks and Web sites could diminish the value of
our advertising campaign databases, as the value of these databases depends on
the continuous aggregation of data from advertising campaigns on a variety of
different Web sites and advertising networks.
We may be unable to adequately protect our data warehouse information
Failure to adequately protect our data warehouse information could harm our
business. Other than typical security features in our systems, we do not take
additional steps to protect our data warehouse information. Our operations may
be susceptible to hacker interception, break-ins and other disruptions. These
disruptions may jeopardize the security of information stored in and
transmitted through our systems. If any of these disruptions were to happen to
our systems, we might be subject to lawsuits by the affected clients or the
users we profile, damage to our reputation among our current and potential
clients and significant expenditures of capital and other resources.
Any failure of our technology to perform satisfactorily could result in
lost revenue, damage to our reputation and expenditure of significant
resources
Any failure of our technology to perform satisfactorily could result in
lost revenue, damage to our reputation and expenditure of significant
resources. Our technology is relatively new and complex and has had, and may
have in the future, errors, defects or performance problems. For example, we
experienced a database outage that lasted for approximately 21 hours, and we
also experienced a defect in our proprietary software that, for approximately
two hours, prevented a portion of the advertisements we serve from appearing
on users' Web pages. In addition, we may encounter problems when we update our
technology to expand and enhance its capabilities. Our technology may
malfunction or suffer from currently unknown design defects that become
apparent only after further use. If our technology malfunctions or contains
such defects, our systems may be rendered incompatible with the systems used
by our clients or by the Web sites and advertising networks where we serve
advertisements. Furthermore, our services could be rendered unreliable, or be
perceived as unreliable by our clients. In such instances, we would need to
expend significant resources to address these problems, and may nonetheless be
unable to adequately remedy these problems. These problems could result in
lost revenue and damage to our reputation.
Sustained or repeated system failures could significantly impair our
operations and lead to client dissatisfaction
Sustained or repeated system failures could significantly impair our
operations and reduce the attractiveness of our services to our current and
potential clients. The continuous and uninterrupted performance of our systems
is critical to our success. Our operations depend on our ability to protect
these systems against damage from fire, power loss, water damage, earthquakes,
telecommunications failures, viruses, vandalism and other malicious
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acts, and similar unexpected adverse events. Clients may become dissatisfied by
any system failure that interrupts our ability to provide our services to them.
In particular, the failure of our ad serving systems, including failures that
delay or prevent the delivery of targeted advertisements to Web sites and
advertising networks, could reduce client satisfaction and damage our
reputation.
Our services are substantially dependent on systems provided by third
parties, over whom we have little control. Interruptions in our services could
result from the failure of telecommunications providers and other third parties
to provide the necessary data communications capacity in the time frame
required. Our ad serving systems and computer hardware are primarily located in
the Seattle, Washington metropolitan area at co-location facilities operated by
Exodus Communications, Inc. and Verio Inc. We depend on these third-party
providers of Internet communication services to provide continuous and
uninterrupted service. We also depend upon Internet service providers that
provide access to our services. In the past, we have occasionally experienced
significant difficulties delivering advertisements to Web sites and advertising
networks due to system failures unrelated to our own systems. For example,
power outages at one of our co-location facilities, including one outage that
lasted for approximately five hours, have prevented us from serving
advertisements, tracking user responses and providing performance reports to
our clients. Any disruption in the Internet access provided by third-party
providers or any failure of third-party providers to handle higher volumes of
user traffic could impair our ability to deliver advertisements and harm our
business.
If we are unable to scale our technology infrastructure, we may experience
capacity constraints that could impair our ability to provide our services
to clients
If we are unable to scale our technology infrastructure, we may experience
significant capacity constraints. Our technology infrastructure may not be able
to support higher volumes of advertisements, additional clients or new types of
Internet and digital media advertising or marketing services. The volume of
advertising delivered through our ad servers has increased from approximately
5.8 million impressions per day in January 1999 to approximately 115.6 million
impressions per day in December 1999. Heightened demand from existing or new
clients for our services will require us to accommodate large increases in the
number of advertisements we serve, the number of campaigns we manage and the
amount of data we store. We will also need to accommodate the introduction of
new and evolving types of Internet and digital media advertising and marketing
that may require greater system resources than current methods of Internet
advertising and marketing. We may not be able to continue to scale our
technology infrastructure in a timely manner or within budget to meet these
demands. Although we believe that we are currently using 50% or less of the
capacity of our ad serving and other systems, any significant increase in the
volume of advertising services provided through our systems could strain the
capacity of our technology infrastructure and ad serving systems. These
capacity constraints could lead to slower response times or system failures.
Such delays or system failures could reduce our ability to place
advertisements, reduce our revenue, damage our reputation and impair our
ability to retain clients or acquire new clients.
Acquisitions or investments may be unsuccessful and may divert our
management's attention and consume significant resources
In September 1999, we acquired iballs LLC, an Internet media company. We may
in the future acquire or make investments in other businesses as well as
products and technologies to complement our current business. Any future
acquisition or investment may require us to use significant amounts of cash,
make potentially dilutive issuances of equity securities and incur debt. In
addition, acquisitions, including the iballs LLC acquisition, involve numerous
risks, any of which could harm our business, including:
. difficulties in integrating the operations, technologies, services and
personnel of acquired businesses;
. diversion of management's attention from other business concerns;
. unavailability of favorable financing for future acquisitions;
. potential loss of key employees of acquired businesses;
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. inability to maintain the key business relationships and the reputations
of acquired businesses;
. responsibility for liabilities of acquired businesses;
. inability to maintain our standards, controls, procedures and policies;
and
. increased fixed costs.
Clients may attempt to prohibit us from providing services to their
competitors, limiting our business opportunities
To use our services more effectively, clients often provide us with
confidential business and marketing information. Many companies are wary of
third parties having access to this information, because access by third
parties increases the risk that confidential business and marketing
information may become known, even if unintentionally, to these companies'
competitors. These confidentiality concerns may prompt our clients to attempt
to contractually prohibit us from managing the Internet advertising campaigns
of their competitors. Limitation of our client base in a particular industry
in this manner could limit the growth of our business.
International expansion could impose substantial burdens on our resources
and divert management's attention from domestic operations
International expansion of our operations could impose substantial burdens
on our resources, divert management's attention from domestic operations, and
otherwise harm our business. This expansion into international markets will
require extensive management attention and resources. In addition, we may need
to rely extensively on third parties in foreign countries to help conduct our
international operations, coordinate with foreign Web sites and conduct sales
and marketing efforts. Our success in international markets will depend to a
large degree on the success of these third parties, over whom we may have
little control, and on their willingness to dedicate sufficient resources to
our relationships. Furthermore, international operations are subject to
several inherent risks, including:
. difficulties and costs of staffing and managing foreign offices;
. the impact of recessions in economies outside the United States;
. changes in regulatory requirements;
. export restrictions, including export controls relating to encryption
technology;
. more stringent rules relating to the collection and use of information
regarding Internet users;
. reduced protection of intellectual property rights;
. adverse tax consequences;
. political and economic instability;
. tariffs and other trade barriers; and
. fluctuations in currency exchange rates.
Our failure to address these risks adequately could harm our business.
Our business does not generate the cash needed to finance our operations,
and we may need additional financing in the future, which we may be unable
to obtain
Our business does not currently generate the cash needed to finance our
operations. We may need additional funds to finance our operations, as well as
to enhance our services, fund our expansion, respond to competitive pressures
or acquire complementary businesses or technologies. We may be unable to
obtain financing on terms favorable to us, if at all. Poor financial results,
unanticipated expenses or unanticipated opportunities that require
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financial commitments could give rise to additional financing requirements
sooner than we expect. If we raise additional funds through the issuance of
equity or convertible debt securities, the percentage ownership of our
existing shareholders would be reduced, and these securities might have
rights, preferences or privileges senior to those of our common stock. If
adequate funds are not available or are not available on acceptable terms, our
ability to enhance our services, fund our expansion, respond to competitive
pressures or take advantage of business opportunities would be significantly
limited, and we might need to significantly restrict our operations.
Potential year 2000 problems with our internal systems or third-party
systems could harm our business
Potential year 2000 problems with our internal systems or third-party
systems could harm our business. Many currently installed computer systems and
software products and systems worldwide are coded to accept only two-digit
entries to identify a year in the date code field. Consequently, after January
1, 2000, many of these systems could fail or malfunction because they are not
able to distinguish between the year 1900 and the year 2000. These system
failures or malfunctions could cause significant disruptions of our
operations.
As a company engaged in Internet advertising services, we rely on computer
programs and systems in connection with our services as well as with our
internal and external communication networks and systems and other business
functions. We have not engaged any third parties to independently verify our
year 2000 readiness, nor have we assessed potential costs associated with year
2000 risks or made any contingency plans to address these risks. Although we
have received assurances from some of the suppliers of our third-party
software, computer equipment and systems that their products are year 2000
compliant, to date we have generally relied on publicly available information
regarding the year 2000 compliance of their products. We also generally do not
have any contractual rights with these providers if their products fail to
function due to year 2000 issues. If these failures do occur, we may incur
unanticipated expenses to remedy any problems, including purchasing
replacement software, computer equipment and systems. Any failures of our
internally developed software or the third-party software, computer equipment
and systems that we use could result in financial loss, damage to our
reputation and legal liability.
We rely on the continued operations of the Web-based computer systems of
our clients and of the vendors whose Web sites or advertising networks host
our clients' advertisements. The successful delivery of our services for our
clients depends on the satisfactory functioning of our clients' and vendors'
computer systems. If these systems fail because they are not year 2000
compliant, we may be unable to fully deliver the services that our clients
have requested, which could harm our quarterly and annual operating results.
We also rely on the satisfactory performance and reliability of the
external communication and computer networks, systems and services integral to
the Internet, such as telecommunications providers and Internet service
providers. In particular, we rely on the satisfactory performance and
reliability of the networks, systems and services of Exodus Communications and
Verio, the Internet service providers that operate our co-location facilities.
Because these external networks, systems and services are maintained or
provided by third parties, the success of our efforts to address the year 2000
problem depends in part on parallel efforts being undertaken by these third
parties. We have initiated communications with most of these third parties to
determine the status of their year 2000 compliance efforts. We cannot,
however, assure you that they have provided accurate or complete information,
or that all of their networks, systems or services will achieve full year 2000
compliance in a timely fashion.
The most reasonably likely worst-case scenario for us resulting from the
year 2000 problem is that disruptions of the external third-party networks,
systems or services on which we depend would reduce or eliminate for a period
of time our ability to provide our Internet advertising services to our
clients. If these disruptions were frequent or long in duration, they could
seriously harm our business. The compliance of third-party networks, systems
and services, including telecommunications providers, Internet service
providers and co-location facilities, is not within our control. Accordingly,
a contingency plan for this worst-case scenario does not exist, and we do not
believe we will be able to develop one.
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Risks Related to Our Industry
Privacy concerns could lead to legislative and other limitations on our
ability to collect personal data from Internet users, including limitations
on our use of cookie technology and user profiling
Privacy concerns could lead to legislative and other limitations on our
ability to conduct targeted advertising campaigns and compile data that we use
to formulate campaign strategies for our clients. Cookies are small files of
information stored on a user's computer which allow us to recognize that
user's browser when we serve advertisements. Cookies are often placed on the
user's computer without the user's knowledge or consent. Our systems use
"cookies" to track Internet users and their online behavior to build user
profiles. We are substantially dependent on cookie technology and user
profiling to target our clients' advertising campaigns and measure their
effectiveness. Any reduction in our ability to use cookies or other means to
build user profiles could harm our business.
Governmental bodies concerned with the privacy of Internet users have
suggested limiting or eliminating the use of cookies or user profiling. United
States legislators in the past have introduced a number of bills aimed at
regulating the collection and use of personal data from Internet users and
additional similar bills may be considered during any congressional session.
Also, the Federal Trade Commission and the Department of Commerce recently
held hearings regarding user profiling, the collection of non-personally
identifiable information and online privacy. In addition, privacy concerns
have led to legal and technical limitations on the use of cookies and user
profiling in some jurisdictions. For example, the European Union recently
adopted a directive addressing data privacy that may result in limitations on
the collection and use of information regarding European Internet users. Also,
Germany has imposed its own laws limiting the use of user profiling, and other
countries may impose similar limitations. In addition, users may limit or
eliminate the placement of cookies on their computers by using third-party
software that blocks cookies, or by disabling the cookie functions of their
Internet browser software. If our ability to use cookies or build user
profiles were substantially restricted by technology, government regulation or
any other means, we would likely have to use other technology or methods that
allow the gathering of user profile data in other ways in order to provide our
services to our clients. This change in technology or methods could require
significant reengineering time and resources, and might not be done in time to
avoid negative consequences to our business. In addition, alternative
technology or methods might not be available at all, or might be prohibitively
expensive.
Legislation or regulations may be adopted that could impair our ability to
provide our services to clients
Legislation or regulations may be adopted that could impair our ability to
provide our services to clients. The legal and regulatory environment
governing the Internet is uncertain and may change. Laws and regulations may
be adopted covering issues such as privacy, pricing, acceptable content,
taxation, consumer protection and quality of products and services on the
Internet. These laws and regulations could dampen the growth in use of the
Internet generally and decrease the acceptance of the Internet as an
advertising medium. In addition, due to the global nature of the Internet, it
is possible that multiple federal, state or foreign jurisdictions might
inconsistently regulate our activities or the activities of advertising
networks or Web sites. Any of these developments could harm our business.
We may not be able to adapt to rapidly changing Internet technology trends
and evolving industry standards
The Internet and Internet advertising markets are characterized by rapidly
changing technologies, evolving industry standards, frequent new product and
service introductions, and changing client demands. The introduction of new
products and services embodying new technologies and the emergence of new
industry standards may render our services obsolete. Our future success will
depend on our ability to adapt to rapidly changing technologies, enhance our
existing Internet advertising services and develop and introduce a variety of
new services to address our clients' changing demands. We may experience
difficulties that could delay or prevent the successful design, development,
introduction or marketing of our services. In addition, any new services or
enhancements must meet the requirements of our current clients and must
achieve significant market
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acceptance. Material delays in introducing new services and enhancements may
cause clients to discontinue use of our services and use the services of our
competitors.
The Internet advertising market may develop more slowly than expected,
which could impair our ability to retain our existing clients and to
attract new clients
If the market for Internet advertising develops more slowly than we expect,
our business could suffer. Our future success is highly dependent on an
increase in the use of the Internet, the commitment of advertisers to the
Internet as an advertising medium, and on the willingness of our potential
clients to outsource their Internet advertising and marketing needs. The
Internet advertising market is new and rapidly evolving, and it cannot yet be
compared with traditional advertising media to gauge its effectiveness. As a
result, demand and market acceptance for Internet advertising services is
uncertain. Many of our current or potential clients have little or no
experience using the Internet for advertising purposes and have allocated only
a limited portion of their advertising budgets to Internet advertising. Also,
we must compete with traditional advertising media, including television,
radio, cable and print, for a share of our clients' total advertising budgets.
Our current and potential clients may find Internet advertising to be less
effective than traditional advertising media for promoting their products and
services. In addition, "filter" software programs are available that limit or
prevent advertising from being delivered to an Internet user's computer. The
widespread adoption of such software could significantly undermine the
commercial viability of Internet advertising.
We recently expanded our service offering to include email advertising and
marketing services. The market for email advertising and marketing in general
is vulnerable to the negative public perception associated with unsolicited
email. Various states have enacted legislation and several bills have been
introduced in Congress that limit or prohibit the use of unsolicited email.
Government action, public perception or press reports related to solicited or
unsolicited email could reduce the overall demand for email advertising and
marketing in general and our email services in particular.
If the Internet infrastructure is unable to effectively support the growth
in demand placed on it, our business could suffer
We depend entirely on Internet advertising services for revenue, and the
increased use of the Internet is essential for our business to grow.
Accordingly, our success will depend, in large part, on the maintenance of the
Internet infrastructure. We cannot assure you that the Internet infrastructure
will continue to effectively support the demands placed on it as the Internet
continues to experience increased numbers of users, frequency of use and
bandwidth requirements. Even if the necessary Internet infrastructure or
technologies are developed, we may have to spend considerable resources to
adapt our services accordingly. Furthermore, the Internet has experienced a
variety of outages and other delays due to damage to portions of its
infrastructure. Outages and delays could impair our ability to serve
advertisements on Web sites and advertising networks. Outages and delays could
also adversely affect our clients' Web sites and online operations and
decrease the level of user traffic on Web sites where our clients advertise.
Such occurrences could result in lost revenue.
Risks Related to This Offering
The trading prices for the stock of Internet-related companies such as ours
have been volatile
The trading prices for the stock of Internet-related companies such as ours
have experienced extreme price and volume fluctuations. These fluctuations
have often been unrelated or disproportionate to the operating performance of
these particular companies. The market price for our common stock will vary
significantly from the initial public offering price after this offering and
may prove to be especially volatile. This volatility could result in
substantial losses for investors. The market price of our common stock may
fluctuate significantly in response to a number of factors, including:
. quarterly variations in our operating results;
. announcements by us or our competitors of new products or services,
significant contracts, acquisitions or business relationships with other
companies;
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. publicity about our company, our services, our competitors, or Internet
advertising in general;
. additions or departures of key personnel;
. any future sales of our common stock or other securities; and
. stock market price and volume fluctuations of other publicly traded
companies and, in particular, those that are Internet-related.
In the past, companies that have experienced volatility in the market price
of their stock have been subject to securities class action litigation. We may
be the target of this type of litigation in the future. Securities litigation
against us could result in substantial costs and divert our management's
attention, which could seriously harm our business.
Future sales of shares by existing shareholders could affect our stock
price
If our shareholders sell substantial amounts of our common stock in the
public market following this offering, the market price of our common stock
could fall, potentially resulting in substantial losses to investors. These
sales also might make it more difficult for us to sell equity or equity-
related securities in the future at a time and price that we deem appropriate.
Based on shares outstanding as of December 31, 1999, upon completion of this
offering and upon the exercise of a warrant to purchase 677,710 shares of
common stock immediately prior to the closing of this offering, we will have
outstanding 55,672,992 shares of common stock, assuming no exercise of options
after December 31, 1999 and the conversion of all shares of outstanding
preferred stock into common stock. Holders of 47,962,890 shares are subject to
agreements with the underwriters that restrict their ability to transfer their
stock for 180 days from the date of this prospectus. Morgan Stanley & Co.
Incorporated, on behalf of the underwriters, may waive the restrictions on
transfer in these agreements during this period. When determining whether or
not to release shareholders from these agreements, Morgan Stanley & Co.
Incorporated may consider, among other factors, the number of shares proposed
to be released or for which the release is being requested, a shareholder's
reasons for requesting the release and any potential impact the release of the
shares would have on the public market and the trading price of our common
stock. After these agreements expire, approximately 27,106,380 shares will be
eligible for sale in the public market assuming no exercise of stock options
after December 31, 1999.
New shareholders will incur substantial dilution as a result of this
offering
The initial public offering price is substantially higher than the book
value per share of our outstanding common stock. As a result, investors
purchasing common stock in this offering will incur immediate and substantial
dilution in net tangible book value per share of the common stock from the
initial public offering price in the amount of $21.62 per share, based upon
the initial public offering price of $24.00 per share. In addition, we have
issued options to acquire common stock at prices significantly below the
initial public offering price. For example, on February 22, 2000, we granted
stock options at an exercise price of $8.00 per share. To the extent these
outstanding options are ultimately exercised, there will be further dilution
to investors in this offering.
Because our directors and executive officers own a large percentage of our
voting stock, your voting power may be limited
Based on the number of shares outstanding as of December 31, 1999, after
this offering, it is anticipated that our executive officers and directors
will beneficially own or control, directly or indirectly, 29,098,730 shares of
common stock, which in the aggregate will represent approximately 48.6% of the
outstanding shares of common stock. As a result, if these persons act
together, they will have the ability to exert significant control over matters
submitted to our shareholders for approval, including the election and removal
of directors and the approval of any business combination. This may delay or
prevent an acquisition or affect the market price of our stock.
21
<PAGE>
Our management has discretion as to the use of the net proceeds from this
offering
Our management has broad discretion as to the use of the net proceeds that
we will receive from this offering. We cannot assure you that management will
apply these funds effectively, nor can we assure you that the net proceeds
from this offering will be invested to yield a favorable return.
We have adopted antitakeover provisions that could make the sale of Avenue
A more difficult
Our articles of incorporation and bylaws contain provisions, such as
undesignated preferred stock, which could make it more difficult for a third
party to acquire us without the consent of our board of directors. In
addition, our board of directors has approved amendments to our articles of
incorporation and bylaws, which, subject to shareholder approval, will provide
for a staggered board, removal of directors only for cause, two-thirds
shareholder approval of some types of business transactions, advance notice of
shareholder proposals and nominations and restrictions on the persons that may
call special shareholder meetings. These provisions may delay or prevent a
change of control of Avenue A even if this change of control would benefit our
shareholders.
This offering will benefit existing shareholders and option holders
This offering will provide substantial benefits to our current shareholders
and substantial potential benefits to our current holders of stock options.
Consummation of this offering is expected to create a public market for the
common stock held by our current shareholders and for common stock that may be
acquired on exercise of stock options held by our current option holders. As
of December 31, 1999, our shareholders had paid approximately $60.8 million,
or an average of $1.22 per share, for an aggregate of 49,745,282 shares of
common stock and our option holders held, in the aggregate, options for
7,173,085 shares of common stock, with a weighted average exercise price of
$1.95 per share. Based upon the initial public offering price of $24.00 per
share, the value of the shares held by our shareholders as of December 31,
1999 would be approximately $1.2 billion, and the unrealized gain to those
shareholders resulting from this offering would be approximately $1.1 billion.
Based upon the initial public offering price of $24.00 per share, the value of
the shares that may be acquired on exercise of options held by our option
holders as of December 31, 1999 would be approximately $172.2 million, and the
in-the-money value of these options resulting from this offering would be
approximately $158.2 million.
We recently sold stock at a substantially lower price and granted options
at a substantially lower exercise price than the initial public offering
price
We recently sold stock at a substantially lower price and granted options
at a substantially lower exercise price than the initial public offering
price. For example, on February 22, 2000, we granted stock options at an
exercise price of $8.00 per share, which is less than the initial public
offering price of $24.00 per share. Accordingly, investors may pay
substantially more for shares of our common stock than the holders of these
shares and stock options. In the first quarter of 2000, we sold an aggregate
of 142,500 shares of common stock to shareholders for approximately $700,000,
or approximately $4.91 per share. Based upon the initial public offering price
of $24.00 per share, the value of these shares would be approximately
$3.4 million and the unrealized gain to these shareholders resulting from this
offering would be approximately $2.7 million. In this same period, we granted
options for an aggregate of 3,837,860 shares of common stock, with a weighted
average exercise price of $7.86 per share. Based upon the initial public
offering price of $24.00 per share, the value of the shares that may be
acquired on exercise of these options would be approximately $92.1 million,
and the in-the-money value of these options resulting from this offering would
be approximately $61.9 million.
22
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. These statements
relate to future events or our future financial performance. In some cases,
you can identify forward-looking statements by terminology such as may, will,
should, expect, plan, intend, anticipate, believe, estimate, predict,
potential or continue, the negative of such terms or other comparable
terminology. These statements are only predictions. Actual events or results
may differ materially. In evaluating these statements, you should specifically
consider various factors, including the risks outlined in the Risk Factors
section above. These factors may cause our actual results to differ materially
from any forward-looking statement.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other
person assumes responsibility for the accuracy and completeness of the
forward-looking statements. We are under no duty to update any of the forward-
looking statements after the date of this prospectus to conform such
statements to actual results or to changes in our expectations.
23
<PAGE>
USE OF PROCEEDS
We estimate that our net proceeds from this offering will be $115.4 million
after deducting underwriting discounts and commissions and estimated offering
expenses. If the underwriters' over-allotment option is exercised in full, we
estimate that our net proceeds will be approximately $133.0 million.
The principal purposes of this offering are to obtain additional working
capital, establish a public market for our common stock and facilitate our
future access to public markets. We have no specific plan for the use of the
net proceeds of this offering. We expect to use the net proceeds for general
corporate purposes, including working capital to fund anticipated operating
losses. We have not, however, designated specific amounts of the anticipated
net proceeds for any particular purpose. We may also use a portion of the net
proceeds to expand our operations internationally, including expansion into
select countries in Europe, but we have made no definitive plans to expand our
operations into any particular country. In addition, we may use a portion of
the net proceeds to acquire complementary businesses or technologies. While
from time to time we evaluate potential acquisitions of businesses or
technologies, we currently have no present understandings, commitments or
agreements with respect to any such transactions. Pending any of these uses,
we intend to invest the net proceeds of this offering in short-term, interest-
bearing, investment-grade securities.
DIVIDEND POLICY
We have never declared or paid cash dividends on our capital stock. We
currently intend to retain all available funds and any future earnings for use
in the operation and expansion of our business and do not anticipate paying
any cash dividends in the foreseeable future.
24
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999:
. on an actual basis;
. on a pro forma basis to reflect the conversion of all outstanding shares
of preferred stock into 24,624,147 shares of common stock effective upon
the closing of this offering and the exercise of a warrant to purchase
677,710 shares of common stock at an exercise price of $.55 per share
immediately prior to the closing of this offering; and
. on a pro forma as adjusted basis to reflect the sale of 5,250,000 shares
of common stock offered by this prospectus at the initial public
offering price of $24.00 per share, and our receipt of the estimated net
proceeds after deducting underwriting discounts and commissions and
estimated offering expenses.
You should read this table in conjunction with our consolidated financial
statements and the notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
December 31, 1999
--------------------------------
Pro Forma
Actual Pro Forma as Adjusted
-------- --------- -----------
(in thousands, except share
and per share data)
<S> <C> <C> <C>
Shareholders' equity:
Convertible preferred stock, $.01 par value
per share; 37,500,000 shares authorized;
16,416,098 shares issued and outstanding,
actual; no shares issued and outstanding, pro
forma and pro forma as adjusted.............. $ 164 $ -- $ --
Common stock, $.01 par value per share;
200,000,000 shares authorized; 25,121,135
shares issued and outstanding, actual;
50,422,992 shares issued and outstanding, pro
forma; 55,672,992 shares issued and
outstanding, pro forma as adjusted........... 251 504 557
Paid-in capital............................... 60,424 60,708 176,035
Deferred stock compensation................... (22,670) (22,670) (22,670)
Subscriptions receivable...................... (965) (965) (965)
Accumulated deficit........................... (15,260) (15,260) (15,260)
-------- -------- --------
Total shareholders' equity................. $ 21,944 $ 22,317 $137,697
-------- -------- --------
Total capitalization..................... $ 21,944 $ 22,317 $137,697
======== ======== ========
</TABLE>
The information in the table above does not include:
. 7,173,085 shares of common stock subject to outstanding options as of
December 31, 1999, granted under our 1998 stock incentive compensation
plan at a weighted average exercise price of $1.95 per share;
. 1,312,500 shares of common stock subject to outstanding options as of
December 31, 1999, granted outside of our stock incentive compensation
plans at a weighted average exercise price of $1.63 per share;
. 3,837,860 shares of common stock subject to outstanding options granted
after December 31, 1999 under our 1998 stock incentive compensation plan
and 2000 stock incentive compensation plan at a weighted average
exercise price of $7.86 per share; and
. 5,250,000 shares of common stock reserved for issuance under our 1999
stock incentive compensation plan, which includes 3,750,000 shares of
common stock reserved in January 2000, and 750,000 shares of common
stock reserved for issuance under our 1999 employee stock purchase plan.
25
<PAGE>
DILUTION
Our pro forma net tangible book value as of December 31, 1999 was
approximately $16.7 million, or $.34 per share of common stock, assuming the
conversion of all outstanding shares of preferred stock into 24,624,147 shares
of common stock. Pro forma net tangible book value per share represents the
amount of our total tangible assets reduced by the amount of our total
liabilities, divided by the pro forma number of outstanding shares of common
stock. After giving effect to the sale of the 5,250,000 shares of common stock
offered by this prospectus at the initial public offering price of $24.00 per
share and the exercise of a warrant to purchase 677,710 shares of common stock
at an exercise price of $.55 per share immediately prior to the closing of
this offering, and after deducting underwriting discounts and commissions and
estimated offering expenses, our pro forma as adjusted net tangible book value
as of December 31, 1999 would have been $132.5 million, or $2.38 per share.
This represents an immediate increase in pro forma net tangible book value of
$2.04 per share to existing shareholders and an immediate dilution of $21.62
per share to investors purchasing shares in this offering. Dilution is
determined by subtracting pro forma net tangible book value per share after
this offering from the initial public offering price per share. The following
table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share.......................... $24.00
Pro forma net tangible book value per share as of December 31,
1999.......................................................... $ .34
Increase per share attributable to new investors............... 2.04
-----
Pro forma as adjusted net tangible book value per share after
this offering................................................... 2.38
------
Dilution per share to new investors.............................. $21.62
======
</TABLE>
The following table sets forth as of December 31, 1999, on the pro forma
basis described above, the difference between the number of shares of common
stock purchased from us, the total consideration paid, and the average price
per share paid by the existing shareholders, by investors purchasing shares in
this offering, based upon the initial public offering price of $24.00 per
share and before deducting underwriting discounts and commissions and
estimated offering expenses, and by a warrant holder exercising a warrant
immediately prior to the closing of this offering:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ -------------------- Price
Number Percent Amount Percent Per Share
---------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders...... 49,745,282 89.4% $ 60,839,000 32.5% $ 1.22
New investors.............. 5,250,000 9.4 126,000,000 67.3 24.00
Warrant holder............. 677,710 1.2 372,741 .2 .55
---------- ---- ------------ ----
Total.................... 55,672,992 100% $187,211,741 100%
========== ==== ============ ====
</TABLE>
As of December 31, 1999, we had outstanding options to purchase 7,173,085
shares of common stock under our 1998 stock incentive compensation plan at a
weighted average exercise price of $1.95 per share, and options to purchase
1,312,500 shares of common stock which were granted outside of our stock
incentive compensation plans at a weighted average exercise price of $1.63 per
share. We granted options after December 31, 1999 to purchase an aggregate of
3,837,860 shares of common stock under our 1998 stock incentive compensation
plan and 2000 stock incentive compensation plan at a weighted average exercise
price of $7.86 per share. In addition, we have reserved 5,250,000 shares of
common stock for issuance under our 1999 stock incentive compensation plan,
which includes 3,750,000 shares of common stock reserved in January 2000, and
750,000 shares of common stock for issuance under our 1999 employee stock
purchase plan. To the extent these options are exercised, and to the extent we
issue new options or rights under our stock plans or issue additional shares
of common stock in the future, new investors will experience further dilution.
26
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes
thereto, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," included elsewhere in this prospectus. The
consolidated statements of operations data for the period from inception on
July 1, 1997 to December 31, 1997 and for the years ended December 31, 1998,
and 1999 and the consolidated balance sheet data as of December 31, 1998 and
1999, have been derived from our audited consolidated financial statements and
related notes thereto included elsewhere in this prospectus. In the opinion of
management, such unaudited consolidated financial statements have been
prepared on the same basis as the audited consolidated financial statements
referred to above and include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of results of
operations for the indicated periods.
<TABLE>
<CAPTION>
Period From
Inception Year Ended December 31,
(July 1, 1997) to ------------------------------------
December 31, 1997 1998 1999
------------------- ----------------- -----------------
(in thousands, except share and per share data)
<S> <C> <C> <C>
Consolidated Statements
of Operations Data:
Revenue:
Advertising services.. $ -- $ -- $ 67,074
Advertising service
fees................. 18 599 2,621
------------ ----------------- -----------------
Total revenue........ 18 599 69,695
Expenses:
Cost of advertising
services............. 20 125 56,979
Client services....... 19 382 4,860
Technology and
operations........... -- 1,493 3,292
Selling, general and
administrative....... 263 2,257 12,330
Amortization of
deferred stock
compensation......... -- -- 4,681
------------ ----------------- -----------------
Total expenses....... 302 4,257 82,142
------------ ----------------- -----------------
Loss from operations.... (284) (3,658) (12,447)
Interest income, net.... -- 12 554
------------ ----------------- -----------------
Net loss................ $ (284) $ (3,646) $ (11,893)
============ ================= =================
Basic and diluted net
loss per share......... $ (.34) $ (.61)
Shares used in computing
basic and diluted net
loss per share......... 10,860,682 19,428,034
Pro forma basic and
diluted net loss per
share(1)............... $ (.27) $ (.31)
Shares used in computing
pro forma basic and
diluted net loss per
share(1)............... 13,387,488 38,466,488
Other Data:
Total billings(2)....... $ 18 $ 3,626 $ 80,671
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
----------------------
1997 1998 1999
----- ------ -------
(in thousands)
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents............................... $ 3 $ 847 $10,962
Working capital (deficit)............................... (338) (30) 11,932
Total assets............................................ 75 3,441 62,091
Total liabilities....................................... 359 2,431 40,147
Total shareholders' equity (deficit).................... (284) 1,010 21,944
</TABLE>
- --------
(1) See note 2 of notes to our consolidated financial statements for an
explanation of the method used to calculate pro forma basic and diluted
net loss per share.
(2) Total billings represents gross billings to customers for advertising
services. Although total billings is not a recognized method of revenue
recognition under generally accepted accounting principles, we believe
that total billings is a standard measure of advertising volume for the
Internet advertising industry that enables a meaningful comparison of
activity from period to period and from one company to another.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and related notes appearing elsewhere in
this prospectus. The following discussion contains forward-looking statements
that involve risks and uncertainties. Our actual results could differ
materially from the results contemplated by these forward-looking statements
as a result of various factors, including those discussed below and elsewhere
in this prospectus.
Overview
Avenue A provides technology-based Internet advertising services to
businesses. We integrate Internet media planning and buying, proprietary ad
management technology, user profiling and data analysis systems to help
advertisers increase the effectiveness and return on investment of their
Internet advertising campaigns. We focus on serving the needs of buyers of
Internet advertising, providing a service that harnesses the complexity,
interactivity and dynamic nature of the Internet with the objective of
delivering the most successful advertising campaigns for our clients.
Revenue
We generate revenue by providing Internet advertising services, which
include the procurement of Internet advertising space for our clients. Due to
a change in the way we structure our advertising contracts, we have changed
from accounting for our revenue primarily as advertising service fee revenue
to accounting for our revenue primarily as advertising services revenue.
Advertising service fee revenue, which is generated under advertising service
fee contracts, consists of commissions earned on services we provide to
clients. Advertising services revenue, which is generated under advertising
services contracts, consists of the gross value of our billings to clients and
includes the price of the advertising space we purchase from Web sites to sell
to clients. By contrast to advertising service fee contracts, under
advertising services contracts we recognize the cost of the advertising we
purchase for our clients as an expense and the payments we receive from our
clients for this advertising as revenue. Consequently, our shift from
advertising service fee contracts to advertising services contracts results in
our recognizing greater revenue and greater expenses for the same level of
client services and advertising.
We began operations in July 1997 and were incorporated in February 1998.
Through December 31, 1998, our primary source of revenue consisted of
advertising service fees. To generate advertising service fee revenue, we
purchase advertising space on behalf of our clients from Web sites that sell
advertising space, also called publisher Web sites. We earn fees based on the
dollar amount of advertising space we purchase. Under advertising service fee
contracts, our clients are ultimately responsible for paying the publisher Web
sites for the cost of the advertising space purchased. Cost of advertising
service fee revenue consists only of the cost of delivering advertisements
over the Internet.
During the first quarter of 1999, we replaced a majority of our advertising
service fee contracts with advertising services contracts. All of the clients
we acquired during 1999 have entered into advertising services contracts, and
substantially all of the contracts with clients acquired in 1997 and 1998 have
been converted to advertising services contracts. To generate advertising
services revenue, we purchase advertising space from publisher Web sites and
sell the purchased space to our clients. Under client relationships based on
advertising services contracts, we are ultimately responsible for paying
publisher Web sites for the cost of advertising space we purchase from them.
Revenue under both advertising service fee contracts and advertising services
contracts is recognized over the period that the related advertising is
delivered. Although the increase in our revenue in recent periods is a result
of an increase in our number of clients and increased total spending by
clients, revenue has increased disproportionately relative to prior periods as
a result of the recognition of gross billings to our clients as revenue in
connection with our use of advertising services contracts.
28
<PAGE>
We changed our contract structure from advertising service fee contracts to
advertising services contracts to account for revenues and expenses relating
to the purchase and sale of Web site advertising space on a basis consistent
with industry practice in the Internet advertising industry. Although we
currently derive some of our revenue from advertising service fee contracts,
we expect that the majority of our future revenue will continue to be derived
from advertising services contracts.
To expand our presence in the Internet advertising industry and allow us to
serve a broader client base, in September 1999 we acquired iballs LLC, an
Internet media company, for a combination of cash and common stock totaling
approximately $6.1 million. We are currently seeking to replace the
advertising service fee contracts between iballs LLC and its clients with
advertising services contracts.
Expenses
Cost of advertising services. Cost of advertising services consists of the
cost of advertising space that we purchase from publisher Web sites, including
inventory purchased by our AdClub, Inc. subsidiary, and the cost of delivering
advertisements over the Internet. AdClub, a reseller of advertising space,
sells advertising only to our clients and its operations are not material to
us as a whole.
Client services expenses. Client services expenses consist primarily of
salaries and related expenses for client service personnel. These employees
are organized into Client Service teams consisting of client strategists,
media buyers, account coordinators and media engineers. Client services
expenses also include the salaries and related expenses for personnel in our
data analysis group.
Technology and operations expenses. Technology and operations expenses
consist of salaries and related costs for information technology and software
development personnel. In addition, these expenses include the cost of housing
our ad servers and other equipment at third-party co-location facilities.
Selling, general and administrative expenses. Selling, general and
administrative expenses consist primarily of salaries and related expenses for
executive, sales, finance, marketing, human resource and administrative
personnel and other general corporate expenses, including amortization of
goodwill and depreciation of property and equipment. In addition, these
expenses include marketing costs such as trade shows and the costs of
advertising our services in trade publications.
Amortization of deferred stock compensation. Amortization of deferred stock
compensation consists of expenses related to employee stock option grants with
option exercise prices below the deemed fair value of our common stock as of
the date of grant. The amount of deferred stock compensation resulting from
these grants is being amortized on an accelerated basis over a four-year
period.
Net Losses
We incurred net losses of $284,000 for the period from our inception on
July 1, 1997 through December 31, 1997, $3.6 million for the year ended
December 31, 1998 and $11.9 million for the year ended December 31, 1999, and
had an accumulated deficit of $15.3 million as of December 31, 1999. We expect
operating losses and negative cash flow to continue for the foreseeable
future. We anticipate our net losses will increase from current levels, since
we expect to incur additional costs and expenses related to brand development,
marketing and other promotional activities, deferred compensation expenses,
amortization of goodwill resulting from the acquisition of iballs LLC, the
expansion of our operations, increasing investment in the systems that we use
to process client orders and payments, and the expansion of our service
offering.
We believe that our operating results will continue to be subject to
seasonal fluctuations because retail advertisers generally purchase
substantially more advertising space during the fourth calendar quarter of
each year than during other quarters, particularly the first calendar quarter.
Due to this seasonal pattern, we expect our revenue in the first quarter of
2000 to be less than those in the fourth quarter of 1999.
29
<PAGE>
Results of Operations
Selected Quarterly Results of Operations
Because we have a limited operating history, we believe that year-to-year
comparisons are less meaningful than an analysis of our recent quarterly
operating results. Accordingly, we are providing a discussion and analysis of
our results of operations for the eight quarters ended December 31, 1999.
During the quarters ended March 31, 1998 and June 30, 1998 we devoted our
resources primarily to developing our business model, which is reflected in
the following discussion and analysis of our quarterly results of operations.
The following tables present, in dollars and as a percentage of revenue,
unaudited statements of operations data for the eight quarters ended December
31, 1999. This information reflects all adjustments, consisting only of normal
recurring adjustments, that we consider necessary for a fair presentation of
such information. The results of any quarter are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1998 1998 1998 1998 1999 1999 1999 1999
--------- --------- ------------- ------------ --------- -------- ------------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statements
of Operations Data:
Revenue:
Advertising
services............. $ -- $ -- $ -- $ -- $ 2,021 $11,369 $20,035 $33,649
Advertising service
fees................. 30 1 245 323 436 121 116 1,948
-------- --------- ------ ------- ------- ------- ------- -------
Total revenue....... 30 1 245 323 2,457 11,490 20,151 35,597
Expenses:
Cost of advertising
services............. 27 35 31 32 1,766 9,498 16,743 28,972
Client services....... 22 31 64 265 460 785 1,340 2,275
Technology and
operations........... 286 252 435 520 498 530 768 1,496
Selling, general and
administrative....... 215 402 572 1,068 1,187 2,064 3,184 5,895
Amortization of
deferred stock
compensation......... -- -- -- -- -- 3 857 3,821
-------- --------- ------ ------- ------- ------- ------- -------
Total expenses...... 550 720 1,102 1,885 3,911 12,880 22,892 42,459
-------- --------- ------ ------- ------- ------- ------- -------
Loss from operations... (520) (719) (857) (1,562) (1,454) (1,390) (2,741) (6,862)
Interest income, net... -- (4) (6) 22 22 112 201 219
-------- --------- ------ ------- ------- ------- ------- -------
Net loss............... $ (520) $ (723) $ (863) $(1,540) $(1,432) $(1,278) $(2,540) $(6,643)
======== ========= ====== ======= ======= ======= ======= =======
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1998 1998 1998 1998 1999 1999 1999 1999
--------- --------- ------------- ------------ --------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
As a Percentage of
Revenue:
Revenue:
Advertising
services............. -- % -- % -- % -- % 82.3 % 98.9 % 99.4 % 94.5 %
Advertising service
fees................. 100.0 100.0 100.0 100.0 17.7 1.1 .6 5.5
-------- --------- ------ ------- ------- ------- ------- -------
Total revenue....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Expenses:
Cost of advertising
services............. 90.0 3,500.0 12.7 9.9 71.9 82.7 83.1 81.4
Client services....... 73.3 3,100.0 26.1 82.0 18.7 6.8 6.6 6.4
Technology and
operations........... 953.3 25,200.0 177.6 161.0 20.3 4.6 3.8 4.2
Selling, general and
administrative....... 716.7 40,200.0 233.4 330.7 48.3 18.0 15.8 16.6
Amortization of
deferred stock
compensation......... -- -- -- -- -- -- 4.3 10.7
-------- --------- ------ ------- ------- ------- ------- -------
Total expenses...... 1,833.3 72,000.0 449.8 583.6 159.2 112.1 113.6 119.3
-------- --------- ------ ------- ------- ------- ------- -------
Loss from operations... (1,733.3) (71,900.0) (349.8) (483.6) (59.2) (12.1) (13.6) (19.3)
Interest income, net... -- (400.0) (2.4) 6.8 .9 1.0 1.0 .6
-------- --------- ------ ------- ------- ------- ------- -------
Net loss............... (1,733.3)% (72,300.0)% (352.2)% (476.8)% (58.3)% (11.1)% (12.6)% (18.7)%
======== ========= ====== ======= ======= ======= ======= =======
</TABLE>
30
<PAGE>
Revenue. Revenue increased in each of the eight quarters ended December 31,
1999, with the exception of a decrease of $29,000 from the first quarter of
1998 to the second quarter of 1998. The increases were primarily due to the
change from the use of advertising service fee contracts to the use of
advertising services contracts and an increase in the number of our clients
from two as of March 31, 1998, to four as of June 30, 1998, 12 as of September
30, 1998, 20 as of December 31, 1998, 27 as of March 31, 1999, 35 as of June
30, 1999, 47 as of September 30, 1999 and 70 as of December 31, 1999.
Cost of advertising services. Cost of advertising services increased in each
of the eight quarters ended December 31, 1999, with the exception of a
decrease of $4,000 from the second quarter of 1998 to the third quarter of
1998. The increases were primarily due to increases in the volume of
advertising space we purchased in each quarter. Cost of advertising services
as a percentage of revenue also increased during this period. The increases
were primarily due to the change from the use of advertising service fee
contracts to the use of advertising services contracts. During the quarters
ended September 30, 1998 and December 31, 1998, revenue consisted of
commissions derived from our advertising service fee contracts with our
clients during those periods. These commissions have no associated cost of
revenue other than the cost of delivering advertisements over the Internet.
Also, under the advertising service fee contracts we did not incur expenses
for advertising space. During the quarter ended March 31, 1999, revenue
consisted of both commissions derived from advertising service fee contracts
and revenue derived from advertising services contracts. During the last three
quarters of 1999, revenue consisted primarily of revenue derived from
advertising services contracts. Cost of advertising services revenue as a
percentage of revenue did not change materially during the last three quarters
of 1999.
Client services. Client services expenses increased in each of the eight
quarters ended December 31, 1999. These increases were primarily due to the
increase in the number of our Client Service teams during this period, which
was in response to the increase in the number of our clients from two as of
March 31, 1998 to 70 as of December 31, 1999. We anticipate continued
increases in our client services expenses to accommodate growth in our client
base.
Technology and operations. Technology and operations expenses increased in
each of the eight quarters ended December 31, 1999, with the exception of a
decrease of $34,000 from the first quarter of 1998 to the second quarter of
1998, and a decrease of $22,000 from the fourth quarter of 1998 to the first
quarter of 1999. The increases were primarily due to increases in the number
of personnel in software development, production systems and information
systems. Due to our increasing volume of advertisements served during this
period, we have increased our capacity for ad serving, in part by adding
computer equipment to the data centers maintained at our co-location
facilities, resulting in increased rental charges. We anticipate continued
increases in our technology and operations expenses in future periods as we
add additional technology-based services to our service offering, supply
additional productivity tools to our Client Service teams and accommodate
additional clients.
Selling, general and administrative. Selling, general and administrative
expenses increased in each of the eight quarters ended December 31, 1999.
These increases were primarily due to increases in the number of personnel in
executive, sales, marketing, finance, accounting and administrative positions,
and the amortization of goodwill resulting from the purchase of iballs LLC in
September 1999. During this period, we added substantially to our management
team, developed an in-house accounting function, created a marketing
department and increased our recruiting efforts. We anticipate continued
growth of our selling, general and administrative expenses as we expand our
administrative and marketing staff, add new marketing programs, incur
additional costs associated with becoming a public company and record
amortization of goodwill in connection with the acquisition of iballs LLC.
Amortization of deferred stock compensation. During the quarters ended
September 30 and December 31, 1999, we recorded deferred stock compensation of
$16.9 million and $10.5 million, respectively. We have recorded aggregate
amortization of deferred stock compensation of $4.7 million through December
31, 1999. Deferred stock compensation is being amortized on an accelerated
basis over the four-year vesting period of the applicable options. The
remaining unamortized balance of $22.7 million will be fully amortized by the
quarter ending December 31, 2003. Since January 1, 2000, we have issued a
total of 3,837,860 options to officers,
31
<PAGE>
directors and employees at a weighted average exercise price of $7.86 per
share. Because these grants were below the deemed fair market value for
financial reporting purposes, we will record deferred compensation in the
first quarter of 2000 of approximately $29.6 million. We will amortize the
deferred compensation over the vesting period of these options.
Interest income, net. Interest income, net consists of earnings on our cash
and cash equivalents. Interest income, net increased during the last three
quarters of 1999. These increases were primarily due to higher cash balances
resulting from our Series B preferred stock financing, which was completed in
February 1999, and our Series C preferred stock financing, which was completed
in May 1999.
Our quarterly and annual revenue, expenses and operating results have
fluctuated in the past and are likely to fluctuate significantly in the future
due to a variety of factors, many of which are beyond our control. Because of
these fluctuations, we believe that period-to-period comparisons are not a
good indication of our future financial performance. We may not be able to
sustain or increase our level of revenue or our rate of revenue growth on a
quarterly or annual basis. Our quarterly or annual operating results may not
meet the expectations of investors. If this happens, the price of our stock
could decline. See "Risk Factors--Our quarterly operating results are subject
to fluctuations that may cause our stock price to decline," "--Our operating
results may fluctuate seasonally, and these fluctuations may cause our stock
price to decline," "--We rely on a limited number of clients, and the loss of
a major client or a reduction in a major client's Internet advertising budget
could significantly reduce our revenue" and "--Our business model is unproven
and evolving and may not succeed."
Comparison of the Years Ended December 31, 1998 and 1999
The following table presents, for the periods indicated, statement of
operations data as a percentage of total revenue.
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------
1998 1999
------ -----
<S> <C> <C>
Revenue:
Advertising services....................................... -- % 96.2 %
Advertising service fees................................... 100.0 3.8
------ -----
Total revenue............................................ 100.0 100.0
Expenses:
Cost of advertising services............................... 20.9 81.8
Client services............................................ 63.8 7.0
Technology and operations.................................. 249.2 4.7
Selling, general and administrative........................ 376.8 17.7
Amortization of deferred stock compensation................ -- 6.7
------ -----
Total expenses........................................... 710.7 117.9
------ -----
Loss from operations......................................... (610.7) (17.9)
Interest income, net......................................... 2.0 .8
------ -----
Net loss..................................................... (608.7)% (17.1)%
====== =====
</TABLE>
Revenue. Revenue increased from $599,000 for the year ended December 31,
1998 to $69.7 million for the year ended December 31, 1999. This increase was
due to the change in the majority of our contracts from advertising service
fee contracts to advertising services contracts and an increase in the number
of our clients from two as of March 31, 1998 to 70 as of December 31, 1999.
Cost of advertising services. Cost of advertising services increased from
$125,000, or 20.9% of revenue, for the year ended December 31, 1998 to $57.0
million, or 81.8% of revenue, for the year ended December 31, 1999. This
increase in cost of advertising services was primarily due to increases in the
volume of advertising space we purchased during this period. The increase in
cost of advertising services as a percentage of revenue
32
<PAGE>
was primarily due to the change from the use of advertising service fee
contracts to the use of advertising services contracts.
Client services. Client services expenses increased from $382,000, or 63.8%
of revenue, for the year ended December 31, 1998 to $4.9 million, or 7.0% of
revenue, for the year ended December 31, 1999. This increase was primarily due
to the increase in the number of our Client Service teams, which was in
response to the increase in the number of our clients from two as of March 31,
1998 to 70 as of December 31, 1999.
Technology and operations. Technology and operations expenses increased from
$1.5 million, or 249.2% of revenue, for the year ended December 31, 1998 to
$3.3 million, or 4.7% of revenue, for the year ended December 31, 1999. This
increase was primarily due to increases in the number of personnel in software
development, production systems and information systems.
Selling, general and administrative. Selling, general and administrative
expenses increased from $2.3 million, or 376.8% of revenue, for the year ended
December 31, 1998 to $12.3 million, or 17.7% of revenue, for the year ended
December 31, 1999. This increase was primarily due to increases in the number
of personnel in executive, sales, marketing, finance, accounting, human
resources and administrative positions. The increase was also due to increases
in the amount of sales commissions and increased marketing expenses.
Amortization of deferred stock compensation. Amortization of deferred stock
compensation began in the quarter ended June 30, 1999. We have recorded
aggregate deferred stock compensation of $27.4 million and recorded aggregate
amortization of deferred stock compensation of $4.7 million through December
31, 1999.
Comparison of Years Ended December 31, 1997 and 1998
We began operations in July 1997, but did not begin to generate significant
revenue until after we were incorporated in February 1998. Our total expenses
increased from $302,000 in 1997 to $4.3 million in 1998. The increase in
expenses was primarily due to increases in client services expenses,
technology and operations expenses, and selling, general and administrative
expenses as our business grew during this period.
Provision for Income Taxes
As of December 31, 1999, we had net operating loss carryforwards for federal
income tax reporting purposes of approximately $9.8 million, and research and
development tax credit carryforwards of approximately $100,000 which begin to
expire in 2001 if not utilized. The Internal Revenue Code contains provisions
that limit the use in any future period of net operating loss and credit
carryforwards upon the occurrence of specified events, including significant
change in ownership interests. We had deferred tax assets, including our net
operating loss carryforwards and tax credits, totaling approximately $5.2
million as of December 31, 1999. We have recorded a valuation allowance for
the entire deferred tax asset as a result of uncertainties regarding the
realization of the asset balance. See note 5 of the notes to our consolidated
financial statements included elsewhere in this prospectus.
Liquidity and Capital Resources
Since inception we have financed our operations primarily through the net
proceeds from private sales of equity securities, which raised approximately
$30.4 million through December 31, 1999.
As of December 31, 1999, we had cash and cash equivalents of $11.0 million.
We have a $1.0 million equipment term loan facility with Silicon Valley Bank
of which $1.0 million was utilized as of December 31, 1999.
Cash used in operating activities was $2.7 million for the year ended
December 31, 1998 and cash provided by operating activities was $2.9 million
for the year ended December 31, 1999.
Cash used in investing activities was $1.1 million for the year ended
December 31, 1998 and $19.0 million for the year ended December 31, 1999. Cash
used in investing activities for the year December 31, 1999 was
33
<PAGE>
primarily related to purchases of marketable securities, the purchase of
iballs LLC and purchases of computer equipment to expand our ad serving
capacity and to equip employees hired during that period.
Cash provided by financing activities was $4.7 million for the year ended
December 31, 1998 and $26.3 million for the year ended December 31, 1999. The
cash provided by financing activities during the year ended December 31, 1999
primarily related to the net proceeds from private sales of equity securities,
which raised approximately $25.7 million through December 31, 1999.
Accounts receivable has grown significantly during 1999 primarily due to
growth in our revenue during the fourth quarter of 1999. Fourth quarter
revenues accounted for approximately 51% of our total revenue for the year
ended December 31, 1999. In addition, through October 1999, we utilized a
billing process that frequently resulted in delayed payments and high levels
of days sales outstanding. Under this process, we billed our clients during a
campaign month based on estimated activity for that month. This process
frequently resulted in the need to reconcile the billing to actual campaign
activity before clients would remit payment. In November 1999, we began
billing clients immediately after the end of the month using actual campaign
activity, thereby greatly reducing these reconciliations. As a result, we
anticipate that our days sales outstanding will decrease in future periods.
Days sales outstanding have decreased from 82 days at September 30, 1999 to 68
days at December 31, 1999.
As of December 31, 1999, we had no material commitments other than
obligations under operating leases for office space and office equipment of
$6.1 million, of which some commitments extend through 2004, and a $1.0
million note payable to a bank which requires monthly payments through 2002.
This note is secured by the equipment purchased with the proceeds from the
note. On October 1, 1999 we entered into a lease for our headquarters facility
in Seattle, Washington. This lease expires in November 2006 with an option to
renew for an additional four-year term, and a further option to renew for an
additional five-year term. Commitments under this lease are $5.4 million for
the next five years. We were also committed at December 31, 1999 to pay rent
of $372,000 under our former facility sublease which ends in June 2001.
However, this commitment is offset by rental income of $357,000 from our
sublease of this facility to another tenant. On February 4, 2000, we entered
into a lease for additional office space. This lease begins in December 2000
and expires in December 2010. Commitments under this lease are approximately
$11.1 million over the ten-year term of the lease. On February 23, 2000, we
entered into a short-term lease for office space. This lease expires on
December 31, 2000. Commitments under this lease are approximately $557,000
over the term of the lease.
Funding our operating losses will consume a material amount of our cash
resources, including a portion of the net proceeds of this offering. We intend
to invest our cash in excess of current operating requirements in short-term,
interest-bearing, investment-grade securities. We believe that our existing
cash and cash equivalents, and available bank borrowings, will be sufficient
to meet our anticipated cash needs for working capital and capital
expenditures for the next twelve months. Thereafter, we may require additional
funds to support our working capital requirements, expand internationally,
acquire complementary businesses and technologies, or for other purposes.
Future capital requirements will depend on many factors, including increases
in the number of employees and the need to expand our ad serving capacity. We
may seek to raise additional funds in the future through public or private
equity financing or from other sources. We may not, however, be able to obtain
adequate or favorable financing. Any financing we obtain may dilute your
ownership interest in us.
Year 2000 Compliance
Many currently installed computer systems and software products and systems
worldwide are coded to accept only two-digit entries to identify a year in the
date code field. Consequently, after January 1, 2000, many of these systems
could fail or malfunction because they are not able to distinguish between the
year 1900 and the year 2000. These system failures or malfunctions could cause
significant disruptions of operations, including
34
<PAGE>
disruptions of our Internet advertising services. As a company engaged in
Internet advertising services, we rely on computer programs and systems in
connection with our services as well as with our internal and external
communication networks and systems and other business functions. Any failure
to provide year 2000 compliant services to our clients could result in
financial loss, damage to our reputation and legal liability.
To date we have not experienced any problems relating to year 2000 issues.
Our internally developed software was designed to be year 2000 compliant and,
based on internal tests we have conducted, we believe that this software is
year 2000 compliant, meaning that the use or occurrence of dates after January
1, 2000 will not materially affect its performance or its ability to correctly
create, store, process and output data involving dates. Substantially all of
our third-party software, computer equipment and internal telecommunications
systems were purchased in the past twelve months. As a result, we believe that
our third-party software, computer equipment and internal telecommunications
systems are also generally year 2000 compliant. However, we cannot assure you
that our internally developed software, and the software, computer equipment
and internal telecommunications systems that we purchased from third parties,
are year 2000 compliant.
We have not, to date, incurred any costs relating to year 2000 issues
separate from the expenditures for acquiring new third-party software,
computer equipment and systems to address year 2000 issues. We do not
anticipate incurring any material costs directly related to addressing year
2000 issues, and we have not deferred any of our ongoing development efforts
to address year 2000 issues.
We have not engaged any third parties to independently verify our year 2000
readiness, nor have we assessed potential costs associated with year 2000
risks or made any contingency plans to address these risks. Although we have
received assurances from some of the suppliers of our third-party software,
computer equipment and systems that their products are year 2000 compliant, to
date we have generally relied on publicly available information regarding the
year 2000 compliance of their products. We also generally do not have any
contractual rights with these providers if their products fail to function due
to year 2000 issues. If these failures do occur, we may incur unanticipated
expenses to remedy any problems, including purchasing replacement software,
computer equipment and systems. Any failures of our internally developed
software or the third-party software, computer equipment and systems that we
use could result in financial loss, damage to our reputation and legal
liability.
We rely on the continued operations of the Web-based computer systems of
our clients and of the vendors whose Web sites or advertising networks host
our clients' advertisements. The successful delivery of our services for our
clients depends on the satisfactory functioning of our clients' and vendors'
computer systems. If these systems fail because they are not year 2000
compliant, we may be unable to fully deliver the services that our clients
have requested, which could harm our quarterly and annual operating results.
We are not aware of any year 2000 problems experienced by our clients or
vendors to date.
We also rely on the satisfactory performance and reliability of the
external communication and computer networks, systems and services integral to
the Internet, such as telecommunications providers and Internet service
providers. In particular, we rely on the satisfactory performance and
reliability of the networks, systems and services of Exodus Communications and
Verio, the Internet service providers that operate our co-location facilities.
Because these external networks, systems and services are maintained or
provided by third parties, the success of our efforts to address the year 2000
problem depends in part on parallel efforts being undertaken by these third
parties. We have initiated communications with most of these third parties to
determine the status of their year 2000 compliance efforts. We cannot,
however, assure you that they have provided accurate or complete information,
or that all of their networks, systems or services have achieved full year
2000 compliance.
The most reasonably likely worst-case scenario for us resulting from the
year 2000 problem is that disruptions of the external third-party networks,
systems or services on which we depend would reduce or eliminate for a period
of time our ability to provide our Internet advertising services to our
clients. If these disruptions were frequent or long in duration, they could
seriously harm our business. The compliance of third-party networks, systems
and services, including telecommunications providers, Internet service
providers and co-location facilities, is not within our control. Accordingly,
a contingency plan for this worst-case scenario does not exist, and we do not
believe we will be able to develop one.
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<PAGE>
Interest Rate Risk
Our exposure to market risk is limited to interest income sensitivity,
which is affected by changes in the general level of U.S. interest rates,
particularly because the majority of our investments are in short-term,
investment-grade debt securities issued by corporations. We place our
investments with high-quality issuers and limit the amount of credit exposure
to any one issuer. Due to the nature of our short-term investments, we believe
that we are not subject to any material market risk exposure. We do not have
any foreign currency or other derivative financial instruments.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 was
effective for financial statements for years beginning after December 15,
1998. SOP 98-1 provides guidance on accounting for computer software developed
or obtained for internal use, including the requirement to capitalize specific
costs and amortization of such costs. We implemented SOP 98-1 and capitalized
approximately $452,000 of internally developed software costs. Accumulated
depreciation related to the capitalized costs was $75,000 as of December 31,
1999.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of
Start-Up Activities." SOP 98-5, which is effective for fiscal years beginning
after December 15, 1998, provides guidance on the financial reporting of
start-up costs and organizational costs. It requires costs of start-up
activities and organizational costs to be expensed as incurred. The
implementation of SOP 98-5 did not have a material impact on our financial
position or operating results.
In December 1999, the Staff of the Securities and Exchange Commission
released Staff Accounting Bulletin Number 101, (SAB, No. 101), "Revenue
Recognition," to provide guidance on the recognition, presentation and
disclosure of revenue in financial statements. We believe our revenue
recognition practices are in conformity with the guidelines in SAB No. 101.
36
<PAGE>
BUSINESS
Overview
Avenue A provides technology-based Internet advertising services to
businesses. We integrate Internet media planning and buying, proprietary ad
management technology, user profiling and data analysis systems to help
advertisers increase the effectiveness and return on investment of their
Internet advertising campaigns. Through this integrated approach we have
developed an extensive knowledge base of Internet advertising strategies,
targeting methods and media placements that perform effectively. We believe
this knowledge base grows richer and more valuable with each additional
campaign we execute and with each additional client we serve. We focus on
serving the needs of buyers of Internet advertising, providing a service that
harnesses the complexity, interactivity and dynamic nature of the Internet
with the objective of delivering the most successful advertising campaigns for
our clients. Our top four clients are Gateway, Microsoft, uBid and Uproar,
based on our revenue in the fourth quarter of 1999 and in fiscal year 1999.
Our services for Internet advertisers include the following key elements:
. Internet media planning and buying. We use our proprietary database and
experience from past advertising campaigns to plan highly targeted
advertising campaigns for our clients. We negotiate and purchase
Internet advertising space for our clients using our status as a large
purchaser of advertising and our historical pricing and performance data
from past campaigns.
. Campaign management. We use our proprietary software and systems in ad
serving, user profiling, performance reporting and data collection and
analysis to manage and increase the effectiveness of our clients'
Internet advertising campaigns.
. Data warehousing and analysis. Our technology enables us to collect,
store and analyze extensive data from our previous and current Internet
advertising campaigns that we use to plan and improve current and future
advertising campaigns for all of our clients.
Our subsidiary, iballs LLC, provides Internet media planning and buying
services to its clients similar to those provided by Avenue A, and uses our ad
serving, user profiling, performance reporting and data collection and
analysis capabilities for some of its clients. We believe that our early entry
advantage in the Internet advertising market, our media planning and buying
expertise, our proprietary technology and our commitment to serving only
advertisers will enable us to continue to strengthen our leadership position
in Internet advertising.
Industry Background
Emergence of the Internet as an Advertising Medium
The Internet is expected to grow rapidly as a medium for advertising and
commerce. Forrester Research, Inc. projects that online advertising
expenditures in the United States will grow from $2.8 billion in 1999 to
$22.0 billion in 2004. We believe this growth is driven by a number of
factors, including the growing number of Internet users, the growth of e-
commerce and advances in online advertising technology. According to
International Data Corporation, the number of Web users worldwide is projected
to grow from approximately 196 million in 1999 to over 500 million by the end
of 2003, and consumer e-commerce spending in the United States is projected to
increase from approximately $71 billion in 1999 to over $200 billion by the
end of 2003.
Historically, the leading Internet advertisers have included technology
companies, Internet portals and e-commerce companies. However, many of the
largest advertisers in traditional media, including mass marketers such as
consumer products companies and automobile manufacturers, have begun
advertising online. Expenditures for online advertising currently represent a
small portion of all media spending, but these expenditures are expected to
grow at a much higher rate than expenditures for traditional advertising.
While traditional advertising spending is expected to increase by
approximately 27% from 1999 through 2004, online advertising spending is
expected to increase by over 690% during that period, based on data from
Forrester Research, Inc.
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Advantages of Internet Advertising
Unlike traditional advertising, Internet advertising involves the delivery
of messages which can be tailored for individual viewers, making the Internet
a revolutionary vehicle for advertisers. Because Internet advertisements are
generally delivered to individual viewers across a digital infrastructure, the
Internet has several advantages as an advertising medium, including:
Measurability. The Internet provides the ability to observe and record a
wide range of online activities, including the delivery of advertisements to a
browser, click-throughs on Internet advertisements, the completion of online
purchases and the downloading of software files. As a result, sophisticated
Internet advertisers can collect and measure data about a broad range of
consumer behaviors associated with a particular advertisement. Using this
data, advertisers can track, monitor and measure the effectiveness of their
Internet advertising campaigns.
Personalization and targeting capabilities. Because each Internet image or
message is generally delivered to one user at a time, specific advertisements
or emails can be tailored with the goal of addressing the interests and needs
of the user to increase the likelihood that the advertisement or email will
elicit the desired response from the user. Using the Internet, advertisers can
target advertising campaigns to specific geographic regions, specific
audiences, and individual consumers with specific demographic or behavioral
profiles. Advertisers can also control the number of times a user's browser
receives an advertisement and rotate sequentially the advertisements that are
delivered to that user's browser. In addition, advertisers can build highly
detailed user profiles for future advertising campaigns through the use of
transaction information, registration procedures and anonymous matching
techniques.
Rapid feedback and response. The Internet enables much more rapid
measurement of and response to the effectiveness of an advertising campaign
than most traditional media. Information on consumer responses to campaigns
can be provided promptly after they occur, allowing an advertiser to respond
quickly to that feedback. For example, an online retailer can assess which
advertisements result in greater numbers of click-throughs or sales, and
respond by eliminating under-performing advertisements from the campaign. In
addition, a traditional mass marketer that does not sell products online but
maintains a Web site to build its brand can determine which online
advertisements are resulting in the most visits to its Web site and eliminate
under-performing advertisements.
Compressed sales cycle. The Internet provides advertisers the opportunity to
accelerate a consumer's progression from awareness of a product to need
recognition to purchase. A consumer can often initiate an online purchase
simply by clicking on an Internet advertisement, and can complete the purchase
with very few intermediate steps. Advertisers therefore can conduct efficient
advertising campaigns with rapid response rates.
Efficient reach. As a medium with no geographic boundaries, the Internet
enables advertisers to reach large audiences throughout the United States and
internationally. Unlike traditional print, outdoor, television or radio
broadcast advertising, which may require advance media purchases in hundreds
of markets to reach an international audience, Internet advertisers can
quickly reach individuals worldwide with a single Internet advertising
campaign.
Challenges of Internet Advertising
Despite the capabilities of the Internet as an advertising medium,
individual advertisers seeking to take advantage of the Internet's potential
may face numerous challenges, including:
Scale and complexity. The proliferation of Web sites and the dispersed
nature of the Internet audience make it difficult for individual advertisers
and ad agencies to target, measure, analyze and optimize Internet advertising
campaigns. An advertiser seeking to conduct a campaign across a large number
of Web sites or advertising networks must be able to identify appropriate Web
sites, understand the technical capabilities of
38
<PAGE>
individual Web sites, determine available inventory of desired advertisement
placements, choose the size and location of advertisements, negotiate
placement pricing and prepare its systems to deliver advertisements and track
results. To determine the overall effectiveness of its advertising, an
advertiser managing campaigns across different Web sites and advertising
networks must reconcile reports from these multiple parties, which are often
based on different measurement methodologies and therefore are not easily
consolidated or compared.
Data analysis and technology requirements. The measurement and recording of
a wide range of online advertising responses, such as click-throughs,
purchases or software downloads, can generate large amounts of data. To
evaluate and optimize their Internet advertising campaigns, advertisers must
analyze this data, which requires access to sophisticated data aggregation,
storage and mining technology and capabilities. Individual advertisers
conducting their own campaigns may not have sufficient in-house data storage
and analysis capabilities, and accordingly the data from their advertising
campaigns may often be underutilized.
Operating costs and requirements. Developing, building and operating an
Internet advertisement management and delivery system to fully exploit the
advantages of Internet advertising is costly and time-consuming. Managing and
tracking numerous advertising campaigns that reach millions of Internet users
on hundreds of Web sites requires complex networking and computing
applications, as well as one or more large, complex data centers with back-up
capabilities. These systems must be continuously maintained to ensure reliable
performance 24 hours a day, seven days a week. For most advertisers and
advertising agencies, the operating costs associated with these systems would
constitute a substantial diversion of resources from their core businesses.
Limited services for advertising buyers. The Internet advertising market is
broadly segmented into two groups: advertisers seeking to conduct the most
effective Internet advertising campaigns at the lowest possible price, and Web
sites and advertising networks seeking to maximize the revenue generated by
their advertising inventory. We believe that while selling power has been
aggregated by large portal sites and advertising networks, there are
relatively few buyers of Internet advertising that match the scale of these
aggregated sellers. In addition, because the interests of large portals and
advertising networks may conflict with those of advertisers, advertisers may
be unwilling to share data with them in order to improve the effectiveness of
their advertising campaigns. As a result, performance reports from portals and
advertising networks are often limited to metrics that may have little value
to purchasers of advertising, such as click-throughs, rather than metrics that
are meaningful to the advertiser's business, such as sales generated, leads
generated, page views and software downloads.
Need for an Outsourced Internet Advertising Service
The rapid growth and complexity of the Internet as an advertising medium
have made the management and delivery of effective advertising extremely
important to advertisers but expensive and difficult to implement. The
technical, operational and resource challenges faced by an advertiser seeking
to independently plan, deliver and optimize its own Internet advertising
campaigns can divert the advertiser's resources and attention away from its
core business. The costs of aggregating and analyzing the large volume of data
necessary to plan, execute and dynamically refine an Internet advertising
campaign can diminish the return on the advertiser's investment. In addition,
individual advertisers may have little power to negotiate lower prices for
their advertising or obtain meaningful data from Web sites on metrics that
measure the effectiveness of their campaigns. We believe advertisers can
benefit from an outsourced advertising service that integrates media planning
expertise, media buying power, ad management technology, user profiling, and
data collection and analysis systems, and that achieves economies of scale, to
enable them to effectively and efficiently conduct Internet advertising
campaigns. By using this outsourced service, advertisers can focus on their
core businesses while realizing the potential benefits of Internet
advertising.
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The Avenue A Advantage
Avenue A integrates proprietary technology and media planning and buying to
help advertisers realize the potential of Internet advertising, providing the
following benefits:
Comprehensive Internet advertising management services. We provide a full
range of services to conduct and increase the effectiveness of Internet
advertising campaigns, including media planning and buying, ad serving, ad
management and data analysis. We have designed our services to enable
advertisers to easily and cost-effectively conduct multiple advertising
campaigns across a broad range of Web sites and advertising networks.
Technology-enabled analysis, monitoring, tracking and optimization. We
collect and analyze data about hundreds of publisher Web sites, numerous
advertising campaigns and tens of millions of Web user profiles, so that our
client strategists can structure targeted advertising campaigns to achieve our
clients' desired business results. To improve campaign performance, we use our
proprietary technology and data analysis capabilities to track, store and
measure data on Web users' online responses to Internet advertisements
promptly after they occur. Based on this data, we generate detailed
performance reports which clients can view over the Internet at any time.
Using these reports, we can refine and improve our clients' advertising
campaigns while they are being conducted to increase their efficiency and
effectiveness.
Proprietary knowledge base. Because we have executed a substantial number
of Internet advertising campaigns for our clients, we have captured a large
quantity of data regarding the efficacy of online advertising campaigns and
techniques. We believe that the more data we accumulate and analyze, the
faster our rate of learning about Internet advertising grows. Our Client
Service teams draw upon our dynamically updated databases to help improve the
results of our clients' advertising campaigns. In particular, these teams use
our proprietary knowledge base to more accurately predict and understand which
techniques are the most effective, what pricing for placements is appropriate
and which targeting efforts are best suited for a particular client's needs.
Focus on Internet advertisers. Because we serve a large number of Internet
advertisers, we are a large and frequent purchaser of Internet advertising
space. We believe that our status as a large purchaser of Internet
advertising, together with our extensive knowledge of historical pricing and
performance information, enables us to negotiate efficient, cost-effective
advertising purchases for Internet advertisers.
Cost savings through economies of scale. Because we serve numerous Internet
advertisers, we are able to spread the substantial costs of developing,
building and operating Internet ad management and delivery systems and
database technologies across a large base of clients. As a result, we are able
to deliver cost-effective services to our clients.
Business Strategy
Our objective is to be the leading provider of Internet and other digital
media advertising services to advertisers. We plan to achieve this goal
through the following key strategies:
Aggressively acquire new clients and develop new markets. We intend to
expand our client base by aggressively pursuing new clients that focus their
advertising efforts on the Internet as well as clients that have historically
relied on traditional media for advertising. Our sales force is dedicated to
acquiring new clients by converting them from traditional advertising to
Internet advertising, and by demonstrating to online advertisers the benefits
of our Internet advertising services. In addition, although we currently
provide a service tailored primarily to the needs of companies with
significant online advertising budgets, we plan to expand our services to new
markets. In particular, we plan to aggressively expand our Growth Markets
Division, which tailors our services to clients with smaller online
advertising budgets.
Leverage our proprietary knowledge base. We seek to build upon and further
leverage our extensive database and our data analysis expertise to attract
additional clients and improve the quality of our services. We
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believe that by increasing the scale and diversity of our client base as well
as the number and type of advertising campaigns we conduct, we will aggregate
more statistically significant data and relevant analysis to improve our
clients' campaigns. We aggregate non-personally identifiable data from our
clients' campaigns on a client anonymous basis for use in conducting media
planning for all of our clients' campaigns. By sharing our expertise with our
clients, we believe we can provide greater value to Internet advertisers than
they would be able to obtain by conducting advertising campaigns
independently. We intend to use our proprietary knowledge base as a platform
to enhance our current services as well as to develop new services for our
clients.
Provide superior client service through a comprehensive service offering. As
part of our goal to provide our clients with superior Internet advertising and
marketing services, we plan to continue to add services that expand our
clients' abilities to advertise and market on the Internet. We recently
launched our Strategic Partnership Program, in which we negotiate and manage
exclusive or complex partnership arrangements between our clients and Web
sites or advertising networks that generally have terms ranging from six
months to a year. As of December 31, 1999, we had entered into 21 Strategic
Partnership Program contracts. In addition, we recently initiated our
Precision E-mail Service. We also intend to add services over time based on
advances in online marketing technology to provide a comprehensive, fully
integrated Internet advertising and marketing service for our clients.
Continue to improve technology. We plan to continue to build, license and
acquire technologies, including enhanced ad serving and media measurement
technologies, that will enable us to plan and execute more effective Internet
advertising and marketing campaigns for our clients. In addition, we intend to
continue to increase our investment in data analysis technology and expertise
in our efforts to realize the full potential of the data that these campaigns
generate.
Acquire complementary businesses and establish relationships with
traditional advertising and media services providers. In September 1999, we
acquired iballs LLC, an Internet media company located in New York City. We
intend to continue to aggressively pursue opportunities to acquire
complementary businesses to expand and enhance our capabilities and services
and increase our number of clients. We also intend to seek to establish
relationships with companies that provide traditional advertising and media
services, which relationships may include joint marketing arrangements and
preferred provider agreements. Through these relationships we intend to
increase our sales penetration, gain access to their clients and become the
preferred or exclusive provider of Internet advertising and marketing services
for these companies.
Exploit emerging digital media opportunities. We believe that in the future,
advertisements may be delivered through a number of digital media in addition
to the Internet, including interactive television, Internet-enabled home
appliances, hand-held computers, cellular telephones, pagers and automobile
personal computers. We plan to extend our technology and capabilities to be
able to deliver targeted advertisements through those emerging digital media
that we determine present the best business opportunities.
Expand internationally. We plan to expand our presence internationally in
order to capitalize on the global reach of the Internet. We believe there is a
significant opportunity to provide our services to companies based outside of
the United States. In addition, we intend to expand our service offering for
our domestic clients to include advertising and marketing on Web sites
operated in foreign markets.
The Avenue A Experience
We have structured our service offering to provide a smooth, efficient,
positive experience for our clients during the entire advertising campaign
process. When a client enlists our services, the client first meets with a
client strategist to discuss the client's campaign objectives. Using our
publisher Web site and user profile databases, the strategist works with the
client to determine target user groups and develop an online media strategy.
Once the client and the strategist have agreed on a media strategy, our media
buyers create a media plan by identifying appropriate placements for the
client's advertisements on a variety of Web sites and advertising networks.
The buyers negotiate placement rates and, upon authorization from the client,
purchase the advertising space. Our media engineers and account coordinators
work with the client to obtain the client's advertisements for delivery by our
ad serving systems.
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When the campaign begins, the Web sites and advertising networks on which
our media buyers have purchased space automatically request advertisements
from our ad servers. Before we serve an advertisement, our ad serving systems
can search the Web user's computer for an Avenue A "cookie," an anonymous
registration file placed by our systems on a computer the first time we serve
an advertisement to that computer. If we find a cookie when we search the Web
user's computer, our ad serving systems query our data warehouse, which might
contain data regarding prior actions conducted on that Web user's computer
that relate to our client, including responses to our client's previous
advertising campaigns and actions taken by that user on our client's Web site.
This query process generally takes less than one second. Using this
information, our systems can serve a specific, targeted advertisement to the
user based on our client's advertising objectives.
As the campaign progresses, our systems can collect data regarding users'
interactions with the advertisements served to them, e.g., banners served,
click-throughs and Web sites visited, and, if the user clicks through and
visits the Web site of the advertiser, the user's behavior on that Web site,
e.g., what sections of the Web site the user visited, whether the user got to
an order page and whether the user bought something. Using the data collected,
our systems generate comprehensive, easy-to-read performance reports that
permit both Avenue A and the client to track the progress of the campaign in
light of the client's campaign objectives. The reports are available online to
the client 24 hours a day, seven days a week, and are updated throughout the
day to provide timely statistics on the performance of the campaign.
The Client Service team reviews the performance reports with the client and,
based on the reports, adjusts the campaign to improve its performance. For
example, if the client's advertisements were initially served to 50 Web sites,
but only 40 Web sites are generating favorable cost per customer acquisition
rates, the Client Service team can take a number of actions to improve the
campaign, including narrowing the scope of the campaign to focus on the 40 Web
sites with favorable performance or negotiating lower rates for continuing
advertisement placements on the other sites. Our ad serving systems enable the
Client Service team to control the frequency with which each advertisement is
displayed, program the sequence with which advertisements are viewed and
target specific advertisements to specific browsers.
Once the campaign is concluded, we provide performance reports to the client
indicating the success of the campaign and recommendations for future
campaigns. Because our systems have automatically stored data collected from
the campaign, we can use this data in additional advertising campaigns for the
client. Using cookie technology, we can anonymously profile Web users so that
future advertisements delivered to those users' browsers in the client's
future advertising campaigns can be customized based on their user profiles.
Avenue A's Services
Core services. Our core services include media planning and buying, ad
serving, campaign analysis, optimization and data collection and aggregation.
. Media planning and buying. Our media planning and buying services are
performed by Client Service teams, which evaluate the client's needs and
objectives, outline a media strategy for the client, develop a media
plan by identifying appropriate media placements, and execute this plan
by negotiating the rates for these placements.
. Ad serving. Our media engineers coordinate and monitor the ad serving
process once an advertising campaign begins. Our ad servers receive
billions of advertisement requests each month, and process a majority of
these requests at sub-millisecond speed. Our ad serving systems allow us
to adjust advertising campaigns quickly and efficiently because changes
required to the advertisements are made on our ad serving systems rather
than on each individual Web site where the advertisements appear.
. Campaign analysis. Our proprietary ad serving systems enable us to
evaluate advertising campaigns along any dimension important to the
client, e.g., sales, leads, registrations, software downloads, etc. We
provide this campaign data to our clients in comprehensive online
performance reports generated by our system, which our client
strategists review with the clients.
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. Optimization. Our Client Service teams can quickly adjust an advertising
campaign in progress to improve its performance. If a Web site is
generating unacceptably low response rates, we can remove that Web site
from the campaign, reduce the number of impressions allocated to that
site, or negotiate a lower rate for advertisement placements on that
site. If a Web site is generating high responses, we can serve more
advertisements to that Web site.
. Data collection and aggregation. As we conduct advertising campaigns, we
collect and store data on these campaigns in our data warehouse. We
aggregate data with the data from all our advertising campaigns as we
continue to expand our data warehouse and build our user profiles.
Precision Targeting Program(TM). Our Precision Targeting Program enables us
to target tailored advertisements to the browsers of users which have
previously visited our clients' Web sites. The program is designed to
strengthen the clients' relationship with the user, improve response rates and
accelerate the sales cycle. This targeting is based on data acquired from
prior interactions conducted through that computer on the client's Web site.
For example, if the information in our data warehouse indicates that the
computer of a particular Web user was previously used to purchase a backpack
from our client, our ad serving systems can serve an advertisement to that
user's computer recommending additional, complementary purchases, such as
hiking boots, tents or fleece jackets.
Strategic Partnership Program(TM). Through our Strategic Partnership
Program, we manage exclusive or complex partnerships between our clients and
Web sites or advertising networks, such as exclusive sponsorships of specific
locations or features of a Web site, or advertising campaigns based on several
complex measurement criteria or methods of advertising. These arrangements
typically have terms ranging from six months to one year. Managers in the
Strategic Partnership Program consult with clients to determine their
objectives and to negotiate the terms of these longer-term, complex
advertising relationships with appropriate Web sites and advertising networks.
We then help manage the partnership by providing participants in the program
with ongoing advertising campaign analysis and optimization services with
respect to exclusive sponsorship links and complex advertising placement
arrangements.
Precision E-mail Service(TM). We recently launched our Precision E-mail
Service through which we deliver targeted emails to specific customer segments
based on their shopping and browsing behavior. We intend to integrate
precision email campaigns with our online advertising campaigns to enhance the
overall effectiveness of our clients' Internet advertising and marketing
campaigns.
Our subsidiary, iballs LLC, provides Internet media planning and buying
services to its clients similar to those provided by Avenue A, and uses our ad
serving, user profiling, performance reporting and data collection and
analysis capabilities for some of its clients. In addition, iballs LLC's
clients can participate in our Precision Targeting Program and Strategic
Partnership Program and use our Precision E-mail Service.
Sales, Marketing and Client Service
We acquire clients primarily through our field sales force, which works in
sales offices in Seattle, New York City and Chicago. As we continue to launch
additional services, including our Precision E-mail Service, we plan to
augment the general sales force with sales specialists that focus on those
particular services. We generate sales leads primarily through field sales,
client referrals, our Web site and responses to our public relations and
marketing efforts.
In addition, we market our services through our Client Service teams as the
services become appropriate for an individual advertiser's evolving needs. For
example, if a client has achieved its initial goal of acquiring customers
through our advertising services, the client might begin using our Precision
Targeting Program to retain these customers or use our Precision E-mail
Service to expand into email marketing.
We use a variety of marketing methods to build awareness of Avenue A and
our service offerings within our target market and to establish credibility
and leadership in the marketplace. These methods include marketing
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materials, advertising, press coverage and other public relations efforts,
direct marketing, trade shows, seminars and conferences, relationships with
recognized industry analysts, and the Avenue A Web site.
Avenue A's client service organization provides all of our primary services
to our clients. As of December 31, 1999, we had 138 employees in our Client
Service teams. Our team-focused approach is designed to encourage an
entrepreneurial spirit and greater accountability to clients' needs.
We have implemented an intensive training program and have built
information systems that are designed to enable employees to draw from our
existing knowledge base. This knowledge base includes both the historical
performance of a given client's campaigns and an aggregated knowledge base of
results from all advertising campaigns. The training program and information
systems are intended to enable new employees to quickly achieve a high
performance level by utilizing institutional knowledge and experience.
Our Clients
The number of our active clients has grown from two as of March 31, 1998 to
70 as of December 31, 1999. In 1999, Gateway, Microsoft and uBid each
accounted for over 10% of our total revenue. Our top 15 currently active
clients, based on revenue in the fourth quarter of 1999 and the fiscal year
1999, are:
. Bolt.com, Inc. . MTV Networks
. The Brodia Group . Onvia.com, Inc.
. Creative Computers, . ProFlowers.com, Inc.
Inc.
. Snowball.com, Inc.
. eBags Inc.
. Ticketmaster Online-City Search,
. Expedia, Inc. Inc.
. Family Wonder, Inc. . uBid, Inc.
. Gateway, Inc. . Uproar Ltd.
. Microsoft Corporation
We provide each of these clients with a number of services, including media
planning and buying, ad serving and campaign analysis. We have historically
sought clients that are large, sophisticated Internet advertisers spending at
least $1 million annually on Internet advertising. We plan to aggressively
expand our Growth Markets Division to provide a service offering designed for
advertisers with smaller Internet advertising budgets.
Technology
Our proprietary technology, which consists of software applications, Web-
based applications, systems and databases, delivers advertisements, tracks
users' responses, aggregates data and provides standardized reporting and data
processing support to the Client Service teams, to the Data Analytics group
and to our clients. Our systems and applications consist of several
independently scalable components: data warehousing, technological
applications for media planning, campaign management and trafficking, and ad
serving. In building these systems and applications, we have developed a
significant amount of proprietary software and techniques, and have also
leveraged leading industry-standard software and hardware.
Data warehousing. Our data warehouse is the foundation of our campaign
management, ad serving, targeting, data collection, data analysis and
performance reporting systems. These systems feed into or utilize the
warehouse for a significant portion of their overall system functionality. We
have developed a number of proprietary technologies for managing and
compressing data that allow us to keep billions of pieces of historical
campaign information online and immediately available to our other systems. We
also utilize industry-standard database technology to aggregate and store
information.
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Media planning. Our client strategists and media buyers use media planning
tools, such as historical cost databases and campaign management software
programs, to keep track of Web sites and select sites and placements during
initial media planning activities. After an advertising campaign is underway,
these tools support ongoing planning and optimization activities.
Campaign management and trafficking. Each month our media buyers make
thousands of advertisement purchases on behalf of our clients and initiate
hundreds of advertising campaigns, which are defined as advertising on one Web
site for one month on behalf of one client. We typically conduct anywhere from
10 to 25 advertising campaigns for a particular client at any given time. We
use our campaign management and trafficking tools to manage the information
from these campaigns and to assist in or automate the process of communicating
with our clients and with the Web sites on which we serve advertisements.
Ad serving. Our ad serving systems are multi-tiered applications that were
built for reliability and scalability. The systems receive billions of
advertisement requests each month and process a majority of these requests at
sub-millisecond speed. Each response to an advertisement request is based on
several factors, which may include the advertising viewing history of a user's
browser. We use standard cookie technology to anonymously track Internet
users' activity on our clients' Web sites, and on each Web site on which the
users' computers receive advertisements served by our systems. The modular
design of our ad serving systems allows us to grow capacity incrementally by
adding a single server at a time, or scale substantially by adding several
servers at a time.
Our ad serving systems are designed to operate 24 hours a day, 7 days a
week. These systems are located in two data centers in Seattle: an Exodus
Communications co-location site and a Verio co-location site. The two data
centers give us redundant capabilities in the event of a hardware failure or
loss of connectivity at one data center. In addition, we use Akamai
Technologies, Inc. in conjunction with our ad serving systems for redirecting
and caching banners to users' browsers in order to reduce load time and
latency.
Competition
The market for Internet advertising is relatively new, yet intensely
competitive. We compete most directly with Internet media buyers that
integrate ad serving technology and Internet media buying, such as AppNet
Inc., through its i33 Communications division, and MediaPlex, Inc. We also
compete with:
. interactive advertising agencies, such as Modem Media . Poppe Tyson
Inc., Ogilvy & Mather Worldwide through its OgilvyOne division, and
Saatchi & Saatchi Advertising, through its Darwin Digital Media Services
division;
. enabling online advertising technology providers, such as At Home
Corporation, through its MatchLogic, Inc. subsidiary, CMGI, Inc.,
through its AdForce, Inc., AdKnowledge, Inc. and Engage Technologies,
Inc. subsidiaries, and DoubleClick Inc.;
. advertising networks, such as DoubleClick Inc., CMGI, Inc., through its
Flycast Communications Corporation subsidiary, L90, Inc. and 24/7 Media,
Inc.;
. targeted email service providers, such as At Home Corporation, through
its MatchLogic, Inc. subsidiary, ClickAction Inc., Digital Impact, Inc.
DoubleClick Inc. and E-Dialog, Inc.; and
. traditional advertising agencies that perform Internet advertising and
marketing as part of their services to clients, such as Ogilvy & Mather
Worldwide and Saatchi & Saatchi Advertising.
In addition, we compete with other traditional advertising agencies that
use traditional advertising media, and in general we compete with television,
radio, cable and print media for a share of advertisers' budgets.
We believe that the principal competitive factors affecting our market are
ad serving technology and functionality, data analysis capabilities, client
service and price. Although we believe we currently compete
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adequately with respect to these factors, our continued ability to compete
depends on a number of circumstances, such as:
. our capability to plan advertising campaigns and serve advertisements
across a broad range of Web sites;
. our ability to respond to rapid technological change and provide feature
enhancements and expanded service offerings;
. the quality and reliability of our operations and client service and
support organizations; and
. the effectiveness of our sales and marketing efforts.
Many of our existing competitors, as well as a number of potential new
competitors, have longer operating histories, greater name recognition, larger
client bases and significantly greater financial, technical and marketing
resources than we have. Also, many of our current and potential competitors
have established or may establish cooperative relationships among themselves
or with third parties. In addition, several of our competitors, including
AdForce, Inc., AdKnowledge, Inc. and Flycast Communications Corporation, have
combined or are in the process of combining with larger companies with greater
resources than ours. These competitors may engage in more extensive research
and development, undertake more far-reaching marketing campaigns and make more
attractive offers to existing and potential employees and clients than we do.
They could also adopt more aggressive pricing policies and may even provide
services similar to ours at no additional cost by bundling them with their
other product and service offerings. They may also develop services that are
equal or superior to our services or that achieve greater market acceptance
than our services. In addition, our competitors may develop databases that are
larger than or otherwise superior to our databases. Increased competition is
likely to result in price reductions, reduced gross margins and loss of market
share. We cannot assure you that we will be able to compete successfully, and
competitive pressures may harm our business.
Intellectual Property
To protect our proprietary rights, we rely generally on copyright,
trademark and trade secret laws, and confidentiality agreements with many of
our employees and consultants. Despite these protections, third parties might
obtain and use our technologies without authorization or develop similar
technologies independently. The steps we have taken may not prevent
misappropriation of our intellectual property, particularly in foreign
countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States.
We have applied for registration of the following service marks: "AVENUE
A," "AVENUE A MEDIA," "AD CLUB NETWORK," "AXIS," "IBALLS," "PRECISION E-MAIL,"
"PRECISION TARGETING," the Avenue A logo and the iballs LLC logo. We cannot
assure you that any of our service mark applications will be approved. Even if
these applications are approved, any service marks may be successfully
challenged by others or invalidated. We are aware of third parties that use
the name "Avenue A" or similar names, one of which is a Canadian advertising
agency. We are also aware of a registration in France of the name "Avenue A"
for use in advertising services. There may be other third parties using names
similar to ours of whom we are unaware. If our service mark applications are
not approved or if our service marks are invalidated because of prior third-
party registrations, our use of these marks could be restricted unless we
enter into arrangements with these third parties, which might not be available
on commercially reasonable terms, if at all.
We recently filed eight provisional patent applications in the United
States for aspects of our technologies, processes and methods, but we have not
been issued any patents to date. We cannot assure you that our provisional
patent applications, or any future patent applications, will be granted, that
any future patent of ours will not be challenged, invalidated or circumvented,
or that the rights granted under any future patent of ours will provide
competitive advantages to us. If a blocking patent has issued or issues in the
future to a third party,
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and we are not able to distinguish our technologies, processes or methods from
those covered under the patent, we may need to either obtain a license or
develop noninfringing technologies, processes or methods with respect to that
patent. We may not be able to obtain a license on commercially reasonable
terms, if at all, or design around the patent, which could impair our ability
to provide our services. We also cannot assure you that any proprietary rights
with respect to our technologies will be viable or of value in the future
since the validity, enforceability and scope of protection of proprietary
rights in Internet-related industries are uncertain and still evolving.
Other persons may claim that our technologies, processes or methods
infringe their patents. Any such claims may cause us to incur significant
expenses and, if successfully asserted against us, may cause us to pay
substantial damages and prevent us from providing some of our services,
including our core ad serving services, which would substantially harm our
business.
A U.S. patent was issued to DoubleClick in September 1999 relating to a
method of delivery, targeting and measuring of advertising over networks. This
patent may cover some of the technologies, processes or methods we use in our
ad serving systems. DoubleClick recently brought suit against L90, one of its
competitors, claiming that L90's methods and networks for delivery, targeting
and measuring advertising over the Internet infringe this patent. DoubleClick
also recently filed a suit against Sabela Media, another of its competitors,
relating to infringement of this same patent. We have purchased advertising
space from DoubleClick in the past and expect to do so in the future. We are
currently evaluating the patent as it pertains to our technologies. We cannot
assure you that we will be able to distinguish our technologies, processes or
methods from those covered under the DoubleClick patent or that the
DoubleClick patent would be invalidated if challenged.
In addition, DoubleClick and MatchLogic, a subsidiary of At Home
Corporation, have each filed U.S. patent applications and related applications
under the Patent Cooperation Treaty that appear to cover technologies relating
to ad serving. In addition, 24/7 Media has announced that it has received a
notice of allowance for a U.S. patent application on its ad delivery
technology that 24/7 Media asserts relates to enabling technology currently in
use by a number of ad serving systems. If patents are issued pursuant to these
applications, we cannot assure you that we will be able to distinguish our
technologies, processes or methods from those covered under these patents or
that the patents would be invalidated if challenged.
Any claims that might be brought against us relating to intellectual
property infringement, including claims of infringement of the DoubleClick
patent and other patents that may be issued to DoubleClick, MatchLogic or 24/7
Media, may cause us to incur significant expenses and, if successfully
asserted against us, may cause us to pay substantial damages and limit our
ability to use the intellectual property subject to these claims. Even if we
were to prevail, such litigation could be costly and time-consuming and could
divert the attention of our management and key personnel from our business
operations. Furthermore, as a result of a patent infringement suit, we may be
prevented from providing some of our services, including our core ad serving
services, unless we enter into royalty or license agreements. We may not be
able to obtain royalty or license agreements on terms acceptable to us, if at
all.
Our technology enables us to collect and use data derived from user
activity on the Internet. Although we believe that we generally have the right
to use this information and to compile it in our databases, we cannot assure
you that any trade secret, copyright or other protection will be available for
this information. In addition, our clients and other parties may claim rights
to this information.
Employees
As of December 31, 1999, we had 232 employees, including 138 in client
services and support, 53 in engineering and technology, 15 in sales and
marketing, and 26 in general and administrative. In addition, as of December
31, 1999, our iballs LLC subsidiary had 27 employees. We believe that we have
good relationships with our employees. We have never had a significant work
stoppage, and none of our employees is represented under a collective
bargaining agreement or by a union. We believe that our future success will
depend in part on our ability to attract, integrate, retain and motivate
highly skilled personnel and upon the continued service of
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our senior management. Competition for qualified personnel in our industry is
intense, and we cannot assure you that we will succeed in attracting,
integrating, retaining and motivating a sufficient number of qualified
personnel to conduct our business in the future.
Facilities
Our principal executive, administrative, engineering, marketing and sales
facility currently occupies approximately 33,000 square feet of office space
in Seattle and will increase to approximately 44,000 square feet in March
2000. The lease for this facility expires in November 2006, with an option to
renew for an additional four-year term and a further option to renew for an
additional five-year term. We leased an additional 23,750 square feet of
office space in Seattle in February 2000. The lease for this facility expires
in December 2000. We expect these facilities will be adequate to meet our
requirements through November 2000. Additionally, we have recently signed a
lease for approximately 30,000 square feet of office space in Seattle. The
lease for this facility begins in December 2000 and expires in December 2010.
We also lease other sales and services office space in offices in New York
City and Chicago. In addition, our iballs LLC subsidiary leases approximately
6,400 square feet of office space in New York City under a lease that expires
in August 2001 with an option to renew for an additional one-year term. We use
network facilities to house our ad servers and other systems at two locations
in Seattle under agreements with Exodus Communications and Verio. Our
agreement with Exodus Communications expires in January 2000 with automatic
renewal for one-year terms. Our agreement with Verio is on a month-to-month
basis.
Legal Proceedings
From time to time, we may become involved in litigation relating to claims
arising in the ordinary course of our business. We believe that there are no
claims or actions pending or threatened against us that, if adversely
determined, would have a material adverse effect on us.
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MANAGEMENT
Executive Officers and Directors
The following table sets forth information with respect to our executive
officers and directors, and an executive officer of our subsidiary, iballs
LLC, as of February 23, 2000:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Brian P. McAndrews....... 41 President, Chief Executive Officer and Director
Nicolas J. Hanauer(1).... 40 Chairman of the Board
Bruce Allenbaugh......... 43 Vice President, Marketing
Anna R. Collins.......... 35 Vice President, Media
Michael T. Galgon........ 32 Chief Strategy Officer
Scott E. Howe............ 31 Vice President and General Manager, Client Services
Clark M. Kokich.......... 48 Senior Vice President, Diversified Services
Scott E. Lipsky.......... 35 Chief Technology Officer and Vice President,
Engineering
Robert M. Littauer....... 51 Chief Financial Officer, Vice President, Finance and
Administration, Secretary and Treasurer
Jamison F. Marra......... 34 Vice President, Information Technology
Jeffrey J. Miller........ 52 Vice President, Corporate Development and Legal
Affairs
J. Drake Pruitt.......... 39 Vice President, Sales
Neve R. Savage........... 55 President, Avenue A International Division
Sumit T. Sen............. 32 Chief Analytics Officer
Thomas M. Sperry......... 48 Vice President and General Manager, Client Services
James A. Warner.......... 46 President, iballs LLC
Jason Green(2)........... 32 Director
Fredric W. Harman(1)(2).. 39 Director
Gregory B. Maffei(1)(2).. 39 Director
Peter M. Neupert......... 43 Director
</TABLE>
- --------
(1) Member of the compensation committee.
(2) Member of the audit committee.
Brian P. McAndrews has served as our Chief Executive Officer and a director
since September 1999, and as our President since January 2000. From July 1990
to September 1999, Mr. McAndrews worked for ABC, Inc., holding executive
positions at ABC Sports, ABC Entertainment and ABC Television Network; most
recently he served as Executive Vice President and General Manager of ABC
Sports. From 1984 to 1989, Mr. McAndrews served as a product manager for
General Mills, Inc., a leading consumer products manufacturer. He holds an
M.B.A. degree from Stanford University and a B.A. degree from Harvard
University.
Nicolas J. Hanauer, a cofounder of Avenue A, has served as our Chairman of
the Board since June 1998 and as a director since Avenue A was incorporated.
He also served as our Chief Executive Officer from June 1998 to September
1999. Since January 1990, Mr. Hanauer has been the Executive Vice President,
Sales and Marketing of Pacific Coast Feather Company, a pillow and bedding
manufacturing company. Mr. Hanauer holds a B.A. degree from the University of
Washington. In addition to serving as a director of Avenue A, Mr. Hanauer
currently serves as a director of Gear.com, Inc., Museum Quality Discount
Framing, Inc. and Pacific Coast Feather Company.
Bruce Allenbaugh has served as our Vice President, Marketing since October
1999. From December 1994 to October 1999, Mr. Allenbaugh served as Vice
President, Marketing Services for NEXTLINK Communications, Inc., a
telecommunications company. From August 1985 to October 1994, he served in
various capacities for The Pepsi Cola Company, most recently as Director, New
Products. Mr. Allenbaugh holds an M.B.A. degree from Northwestern University
and a B.A. degree from the University of Washington.
Anna R. Collins has served as our Vice President, Media since August 1999.
From July 1996 to July 1999, Ms. Collins worked at CVS/Pharmacy, Inc., a
healthcare and pharmacy company, serving as a manager of
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<PAGE>
New Business Development and most recently as Director of New Business
Development. From July 1995 to June 1996, Ms. Collins served as Director of
Business Development & Eastern Operations for Vivra Orthopaedics, Inc., an
orthopedics practice management company. In 1994, she served as a consultant
with APM Incorporated, a healthcare management consulting firm. Ms. Collins
holds an M.B.A. degree from the Harvard Business School and a B.A. degree from
Harvard University.
Michael T. Galgon, a cofounder of Avenue A, has served as our Chief
Strategy Officer since January 2000. From October 1999 to January 2000, he
served as our Senior Vice President, Marketing and Business Development. From
October 1998 to October 1999, he served as our President, and from October
1997 to October 1998, he served as our General Manager. From October 1995 to
October 1997, Mr. Galgon attended the Harvard Business School. From October
1994 to October 1995, he served as a full-time volunteer with Volunteers In
Service To America. From 1990 to 1994, Mr. Galgon served as an officer in the
U.S. Navy. Mr. Galgon holds an M.B.A. degree from the Harvard Business School
and a B.A. degree from Duke University.
Scott E. Howe has served as our Vice President and General Manager, Client
Services since October 1999. From September 1994 to September 1999, Mr. Howe
worked at Boston Consulting Group, a strategy consulting firm, serving as a
consultant from September 1994 to September 1996, Case Leader from September
1996 to February 1998 and most recently as Manager from March 1998 to
September 1999. Mr. Howe holds an M.B.A. degree from the Harvard Business
School and an A.B. from Princeton University.
Clark M. Kokich has served as our Senior Vice President, Diversified
Services since January 2000 and served as Vice President, General Manager,
Growth Markets Division from July 1999 to January 2000. From April 1996 to
October 1998, Mr. Kokich served as President and Chief Executive Officer of
Calla Bay, Inc., an apparel retailer. From January 1992 to April 1996, he
served as the Director, Sales & Marketing for AT&T Wireless Services. Mr.
Kokich holds a B.S. degree from the University of Oregon.
Scott E. Lipsky, a cofounder of Avenue A, has served as our Chief
Technology Officer and Vice President, Engineering since October 1997. From
March 1996 to September 1997, Mr. Lipsky served as Vice President of Business
Expansion for Amazon.com, Inc., an online retailer. From February 1994 to
March 1996, Mr. Lipsky served as Chief Information Officer for Barnes & Noble,
Inc., a national bookstore chain, and Chief Technology Officer for Barnes &
Noble College Bookstores, Inc., a national college bookstore chain. From
September 1991 to January 1994, Mr. Lipsky served as President and Chief
Executive Officer for Omni Information Group, Inc., a software company
providing solutions for retail chains. From September 1987 to September 1991,
Mr. Lipsky served as Vice President of MIS and Chief Technology Officer for
Babbages's, Inc., a retail company.
Robert M. Littauer has served as our Chief Financial Officer and Vice
President, Finance and Administration since August 1998, and as our Secretary
and Treasurer since January 1999. From October 1996 to June 1998, Mr. Littauer
served as Chief Financial Officer and Vice President of Finance and
Administration for Ostex International Inc., a medical diagnostics company.
From June 1987 to September 1996, Mr. Littauer served in various capacities at
NeoRx Corporation, a biotechnology company, including Senior Vice President,
Chief Financial Officer and Treasurer. From June 1982 to May 1987, Mr.
Littauer was Vice President, Finance and Treasurer of Concept, Inc., a
surgical products manufacturer. He holds M.B.A. and B.S. degrees from Cornell
University and is a Certified Public Accountant.
Jamison F. Marra has served as our Vice President, Information Technology
since November 1999. From February 1999 to November 1999, Mr. Marra served as
the Director, Information Technology, for Amazon.com, Inc. From June 1997 to
January 1999, he served as Director, Information Technology, for Laplink.com,
Inc., a provider of electronic file transfer solutions. From November 1991 to
May 1997, he served as Director, Information Technology, for Microsoft
Corporation.
Jeffrey J. Miller, Ph.D., has served as our Vice President, Corporate
Development and Legal Affairs since July 1999. From November 1997 to June
1999, Dr. Miller served as the President and Chief Executive Officer of
Reprogen, Inc., a functional genomics company. From October 1996 to October
1997, he served as Senior Vice President of Corporate Development for Ostex
International Inc. From April 1987 to September 1996,
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<PAGE>
Dr. Miller served in various capacities at NeoRx Corporation, including Senior
Vice President, Business Development and Legal Affairs, Secretary and General
Counsel. From 1985 to April 1987, he was a partner in the Seattle law firm of
Seed and Berry. Dr. Miller holds a Ph.D. degree in biology from the University
of California at Santa Cruz, a J.D. degree from Loyola University of Los
Angeles and a B.A. degree from the University of California at Los Angeles.
J. Drake Pruitt has served as our Vice President, Sales since January 2000.
From February 1996 to April 1999, Mr. Pruitt held the position of General
Manager in the Pacific Northwest region for Nextel Communications, a wireless
telecommunications provider. Prior to that, Mr. Pruitt was a Senior Sales
Manager at Nextel from January 1995 to March 1996 and a Sales Manager for
Nextel from March 1994 to December 1994. From April 1991 to February 1994, Mr.
Pruitt served as Corporate Account Representative for Digital Systems
International, Inc., a telecommunications software company. Mr. Pruitt holds a
B.A. degree from The University of Pennsylvania.
Neve R. Savage has served as our President, Avenue A International Division
since January 2000. From November 1998 to January 2000, Mr. Savage served as
our Vice President, Client Results. From August 1994 to September 1998, Mr.
Savage served as Vice President, Marketing of AT&T Wireless Services. From
October 1988 to July 1994, Mr. Savage served as the Executive Group Director
of Ogilvy & Mather, an advertising company. Mr. Savage holds M.A. and B.A.
degrees from Oxford University.
Sumit T. Sen has served as our Chief Analytics Officer since September
1999. From December 1998 to August 1999, Mr. Sen was a Principal of Proforma
Consulting, a marketing and risk management consulting firm. From December
1997 to November 1998, Mr. Sen served as the Executive Vice President, Risk
Management for The Money Store Inc., a consumer finance company. From October
1994 to October 1997, Mr. Sen served in various capacities at Household
International Inc., a consumer loan and credit card company, including
Director, Risk Management and Director, Scoring and Analysis. Mr. Sen holds a
B.S. degree from Johns Hopkins University.
Thomas M. Sperry has served as our Vice President and General Manager,
Client Services since October 1999. From January 1999 to October 1999, Mr.
Sperry served as Managing Partner of Bozell Worldwide, Inc., a marketing
communications agency. From April 1994 to December 1998, Mr. Sperry was a co-
owner and president of CF2GS Inc., a marketing communications agency which was
acquired by Bozell Worldwide, Inc. in January 1999. Mr. Sperry holds M.A. and
B.A. degrees from the University of San Francisco.
James A. Warner has served as the President of iballs LLC since January
2000. From September 1998 through December 1999, Mr. Warner served as
President of Third Floor Enterprises, a consulting firm which provided
services to online and traditional media companies. From February 1998 to
September 1998, Mr. Warner served as President of the Magazine Division of
Primedia, Inc., a diversified media company. From February 1995 to September
1997, he served as President of the CBS Television Network, a division of CBS,
Inc., a broadcasting and communications company. Mr. Warner holds an M.B.A.
degree from the Harvard Business School and a B.A. degree from Yale
University. He currently serves as a director of LiveWave.com, Inc.
Jason Green has served as one of our directors since May 1999. Since
September 1997, Mr. Green has served as a general partner of U.S. Venture
Partners, a venture capital firm. From September 1995 to August 1997, Mr.
Green was an Ewing Marion Kauffman Fellow with Venrock Associates, a venture
capital firm. From June 1994 to August 1995, Mr. Green served as a Research
Fellow at the Harvard Business School. Mr. Green has served as a vice
president of Muzertechnika, an Eastern European computer and
telecommunications company, and as a consultant with Bain & Company, a
strategy consulting firm. Mr. Green holds an M.B.A. degree from the Harvard
Business School and a B.A. degree from Dartmouth College. He currently serves
as a director of NightFire Software Inc., PerksatWork.com Inc. and
PrintNation.com.
Fredric W. Harman has served as one of our directors since May 1999. Since
1992, Mr. Harman has managed several venture capital funds affiliated with Oak
Investment Partners, a venture capital firm. From 1991 to 1994, he served as a
general partner of Morgan Stanley Venture Capital. Mr. Harman holds an M.B.A.
degree from the Harvard Business School and B.S. and M.S. degrees from
Stanford University. Mr. Harman currently
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<PAGE>
serves as a director of ILOG, S.A., InterNAP Network Services Corporation,
Inktomi Corporation, Primus Knowledge Solutions, Inc., Quintus Corporation and
several privately held companies.
Gregory B. Maffei has served as one of our directors since September 1999.
Since December 1999, Mr. Maffei has served as the Chief Executive Officer of
Worldwide Fiber Inc., a manufacturer of fiber optic communications equipment.
From April 1997 to December 1999, Mr. Maffei served as the Chief Financial
Officer of Microsoft Corporation. From 1993 to 1997, Mr. Maffei served in
various capacities at Microsoft, including Director of Business Development &
Investment; Vice President, Corporate Development; and Treasurer. Mr. Maffei
holds an M.B.A. degree from the Harvard Business School and an A.B. degree
from Dartmouth College. He currently serves as a director of Expedia, Inc.,
Starbucks Corporation, Skytel Communications, Inc., CNET Business Services and
Ragen MacKenzie Group Incorporated.
Peter M. Neupert has served as one of our directors since February 2000.
Since July 1998, Mr. Neupert has served as the President and Chief Executive
Officer of drugstore.com, inc., an online retail store and information site
for health, beauty, wellness, personal care and pharmacy products, and since
July 1999 has served as the chairman of drugstore.com's board of directors.
From March 1987 to July 1998, Mr. Neupert served in various capacities at
Microsoft, most recently as Vice President of News and Publishing for
Microsoft's interactive media group. Mr. Neupert holds an M.B.A. degree from
Dartmouth College and a B.A. degree from Colorado College.
Unless he earlier dies, resigns or is removed, each director serves for a
term expiring at the next annual meeting of shareholders, provided that each
director shall serve until his successor is elected and qualified. Effective
at the first annual meeting of shareholders following this offering, our
amended and restated articles of incorporation will provide for the division
of our board of directors into three classes, with each class serving a three
year term, and one class being elected each year by our shareholders. At the
first election of our directors to the classified board, each class 1 director
will be elected to serve until the next following annual meeting of
shareholders, each class 2 director will be elected to serve until the second
following annual meeting of shareholders and each class 3 director will be
elected to serve until the third following annual meeting of shareholders. At
each annual meeting of shareholders following the meeting at which the board
would be initially classified, the successors to directors whose terms are
expiring will be elected to serve until the third annual meeting of
shareholders following their election.
Board Committees
The board of directors has a compensation committee and an audit committee.
Compensation committee. The compensation committee's duties include
establishing, reviewing and making recommendations to the board regarding
compensation of our officers, considering compensation plans for our
employees, and carrying out other duties under our stock incentive
compensation and other plans approved by us as may be assigned to the
committee by the board. The current members of the compensation committee are
Nicolas J. Hanauer, Fredric W. Harman and Gregory B. Maffei. The current
members of the compensation committee do not meet the definition of "non-
employee" directors for purposes of SEC Rule 16(b)(3). Until the compensation
committee is composed of "non-employee" directors, the full board of directors
will continue to approve stock option grants for our officers in order to
qualify the option grants for an exemption from short-swing trading rules.
Audit committee. The audit committee recommends the selection and retention
of our independent auditors, reviews the scope and results of audits and
submits appropriate recommendations regarding audits, reviews our internal
controls and reviews procedures to ensure compliance with applicable financial
reporting requirements. The current members of the audit committee are Jason
Green, Fredric W. Harman and Gregory B. Maffei.
Compensation Committee Interlocks and Insider Participation
During the year ended December 31, 1998, Mr. Hanauer, our former chief
executive officer, served on the compensation committee of our board of
directors, as did Eric Moen and Roy Clothier, Jr., both former directors
52
<PAGE>
of Avenue A. The compensation committee currently consists of Nicolas J.
Hanauer, Fredric W. Harman and Gregory B. Maffei. None of our executive
officers serves as a member of the compensation committee or board of
directors of any entity that has an executive officer serving as a member of
our compensation committee or board of directors.
Director Compensation
We reimburse our nonemployee directors for reasonable expenses they incur
in attending meetings of the board of directors and its committees. In 1998
and 1999, Mr. Hanauer devoted part of his time to Pacific Coast Feather
Company and part of his time to Avenue A. Under an arrangement with Pacific
Coast Feather Company, we reimbursed Pacific Coast Feather Company for $85,230
of salary paid by that company to Mr. Hanauer in 1999, which reimbursement
represented compensation for Mr. Hanauer's services as an officer and
director of Avenue A in 1999. Except for this transaction, our directors have
not and do not receive salaries for their services.
In August 1999, Mr. Maffei was granted an option to purchase 75,000 shares
of our common stock under our 1998 stock incentive compensation plan at an
exercise price of $1.27 per share. In August 1999, we authorized the sale to
Mr. Maffei of 75,000 shares of our common stock at $1.27 per share under this
plan and in October 1999, we authorized the sale to him of an additional
75,000 shares of our common stock at $2.67 per share under this plan. Both of
these sales were consummated in October 1999. In February 2000, Mr. Neupert
was granted an option to purchase 50,000 shares of our common stock under our
2000 stock incentive compensation plan at an exercise price of $8.00 per
share.
In November 1999, our board of directors adopted our stock option grant
program for nonemployee directors. The program will be administered under our
1999 stock incentive compensation plan. Under this program, each nonemployee
director will automatically receive a nonqualified stock option to purchase
50,000 shares of common stock upon initial election or appointment to the
board following this offering. One-third of this option will vest on each of
the first, second and third anniversaries of the grant date. Thereafter,
beginning with the annual meeting of shareholders in 2000, each nonemployee
director who continues to serve on the board will receive an additional option
to purchase 15,000 shares of common stock upon reelection or reappointment to
the board, which will fully vest on the first anniversary of the grant date.
The exercise price for all options granted under the program will be the fair
market value of the common stock on the grant date. Options will have a ten-
year term, except that options will expire three months after a nonemployee
director ceases service as a director, unless cessation is due to death, in
which case the options will expire one year after date of death.
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<PAGE>
Executive Compensation
The following table sets forth information concerning the compensation
received for services rendered to us in all capacities by named executive
officers for purposes of the summary compensation table, specifically, our
current chief executive officer, our former chief executive officer, our next
four most highly compensated executive officers who earned compensation in
excess of $100,000 during the fiscal year ended December 31, 1999, and one
former executive officer who earned compensation in excess of $100,000 during
the fiscal year ended December 31, 1999. The table also sets forth information
concerning compensation received by our former chief executive officer and an
executive officer who earned compensation in excess of $100,000 during the
year ended December 31, 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
------------
Annual
Compensation Securities
--------------- Underlying All Other
Name and Principal Position Year Salary Bonus Options Compensation
- --------------------------- ---- -------- ------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Brian P. McAndrews(1).......... 1999 $ 88,804 $ -- 1,845,000 $20,179
Chief Executive Officer
Nicolas J. Hanauer(2).......... 1999 85,230 -- -- --
Former Chief Executive Officer 1998 -- -- -- --
Michael T. Galgon.............. 1999 144,350 -- 150,000 --
Chief Strategy Officer
Robert M. Littauer............. 1999 199,850 -- 112,500 --
Chief Financial Officer, Vice
President of Finance and
Administration, Secretary and
Treasurer
Scott E. Lipsky................ 1999 147,475 -- 150,000 --
Chief Technology Officer and 1998
Vice President, 121,599 -- 1,084,500 --
Engineering
Neve R. Savage................. 1999 180,720 -- -- --
President, Avenue A
International Division
R. Michael Leo(3).............. 1999 169,412 70,299 375,000 1,497
Vice President, Sales and
Marketing
</TABLE>
- --------
(1) Based on an annualized salary of $300,000. Mr. McAndrews joined Avenue A
on September 13, 1999. All other compensation represents relocation
expenses.
(2) Under an arrangement with Pacific Coast Feather Company, we reimbursed
Pacific Coast Feather Company for $85,230 of salary paid by that company
to Mr. Hanauer in 1999, which reimbursement represented compensation for
Mr. Hanauer's services as an officer and director of Avenue A in 1999.
The amount shown represents the amount of this reimbursement paid by us
to Pacific Coast Feather Company.
(3) Mr. Leo's employment with us ended on October 9, 1999. Bonus represents
sales commissions paid to Mr. Leo. All other compensation represents
relocation expenses.
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<PAGE>
Option Grants in Last Fiscal Year
The following table sets forth information regarding stock options we
granted to the named executive officers shown in the summary compensation
table during the fiscal year ended December 31, 1999.
<TABLE>
<CAPTION>
Individual Grants Potential Realizable
------------------------------------------------ Value at Assumed
Number of Annual Rates of Stock
Securities Percent of Total Price Appreciation for
Underlying Options Granted Exercise Option Term(2)
Options to Employees in Price Expiration -----------------------
Name Granted Fiscal Year(1) Per Share Date 5% 10%
- ---- ---------- ---------------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Brian P. McAndrews(3)... 1,845,000 18.2% $1.27 09/15/2009 $ 1,469,727 $ 3,724,576
Nicolas J. Hanauer...... -- -- -- -- -- --
Michael T. Galgon(4).... 150,000 1.5 2.67 10/29/2009 251,558 637,497
Robert M. Littauer(4)... 112,500 1.1 2.67 09/30/2009 188,668 478,123
Scott E. Lipsky(4)...... 150,000 1.5 2.67 10/29/2009 251,558 637,497
Neve R. Savage.......... -- -- -- -- -- --
R. Michael Leo(5)....... 375,000 3.7 2.67 01/08/2001 63,125 127,500
</TABLE>
- --------
* Less than 1%.
(1) Based on a total of 10,141,889 options granted to employees during fiscal
1999.
(2) The dollar amounts under these columns result from calculations at the 5%
and 10% rates required by the SEC regulations and are not intended to
forecast possible future appreciation, if any, of the common stock price.
The information in this table assumes that all options are exercised at
the end of each of their terms. Each option has a ten-year term, except
for the option granted to Mr. Leo, which has a fifteen-month term. Actual
gains, if any, on stock option exercises depend on factors such as the
future performance of the common stock and overall stock market
conditions. The amounts shown in this table may not be achieved.
(3) These options are fully exercisable and the shares purchasable upon
exercise of such options are subject to repurchase by Avenue A at the
original exercise price paid per share if Mr. McAndrews terminates his
employment or attempts to transfer the shares before the shares have
vested. In this context, "vested" means that the shares subject to, or
issued on exercise of, options are no longer subject to repurchase by
Avenue A. Shares subject to, or issued upon exercise of, options will
vest at the rate of 20% after one year from his date of hire and 6.66% at
the end of each quarter after one year after his date of hire until fully
vested four years after the hire date.
(4) These options are fully exercisable and the shares purchasable upon
exercise of such options are subject to repurchase by Avenue A at the
original exercise price paid per share if the optionee terminates
employment or attempts to transfer the shares before the shares have
vested. In this context, "vested" means that the shares subject to, or
issued on exercise of, options are no longer subject to repurchase by
Avenue A. Shares subject to, or issued upon exercise of, options vest at
the rate of 20% after one year from the date of the option grant and
6.66% at the end of each quarter after one year after the grant date
until fully vested four years after the grant date.
(5) Mr. Leo's option fully vests and becomes exercisable on October 9, 2000.
The option expires on January 9, 2001.
55
<PAGE>
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
The following table sets forth for the named executive officers shown in
the summary compensation table information regarding the aggregate dollar
value realized upon exercise of stock options in the last fiscal year and the
number and value of securities underlying unexercised stock options held at
December 31, 1999 based on the initial public offering price of $24.00 per
share. The shares purchasable upon exercise of the options may be subject to
repurchase by Avenue A at the original exercise price paid per share if the
optionee terminates employment or attempts to transfer the shares before those
shares have vested.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Options at Fiscal Year-End Fiscal Year-End (1)
Shares Acquired -------------------------------- -------------------------
Name on Exercise Value Realized(1) Exercisable Unexercisable Exercisable Unexercisable
- ---- --------------- ----------------- ---------------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Brian P. McAndrews(2)(3).. 533,683 $12,130,615 1,311,316 -- $29,806,213 $ --
Nicholas J. Hanauer....... -- -- -- -- -- --
Michael T. Galgon(2)(4)... 750,000 17,949,750 304,500 -- 6,857,249 --
Robert M. Littauer(2)(5).. 201,562 4,737,506 98,437 -- 2,099,661 --
Scott E. Lipsky(2)(6)..... 739,500 17,682,494 495,000 -- 11,424,825 --
Neve R. Savage............ 120,000 2,840,040 -- -- -- --
R. Michael Leo(7)......... 529,500 12,632,624 375,000 -- 7,998,750 --
</TABLE>
- --------
(1) Based on the initial public offering price of $24.00 per share, minus the
per share exercise price, multiplied by the number of shares underlying
the option.
(2) These options are fully exercisable and the shares purchasable upon
exercise of such options are subject to repurchase by Avenue A at the
original exercise price paid per share if the optionee terminates his
employment or attempts to transfer the shares before the shares have
vested. In this context, "vested" means that the shares subject to, or
issued on exercise of, options are no longer subject to repurchase by
Avenue A.
(3) Shares subject to, or issued upon exercise of, options will vest at the
rate of 20% after one year from the date of hire and 6.66% at the end of
each quarter beginning one year after the date of hire until fully vested
four years after the date of hire.
(4) Of Mr. Galgon's options granted prior to January 1, 1999 that have not
yet vested, 10% will vest on April 1, 2000 and 5.0% will vest each
quarter thereafter through October 1, 2001, after which date the option
will be fully vested.
(5) Shares subject to, or issued upon exercise of, Mr. Littauer's options
will vest at the rate of 20% after one year from the date of the option
grant and 6.66% at the end of each quarter beginning one year after the
grant date until fully vested four years after the grant date.
(6) Of Mr. Lipsky's options granted prior to January 1, 1999 that have not
yet vested, 8.3% will vest on April 1, 2000 and 4.2% will vest each
quarter thereafter through October 1, 2001, after which date the option
will be fully vested.
(7) Mr. Leo's option fully vests and becomes exercisable on October 9, 2000.
The option expires on January 9, 2001.
Employment Agreements and Change of Control Arrangements
Employment Agreements
Brian P. McAndrews' employment agreement provides for an initial annual
salary of $300,000. The agreement confirms that we have granted Mr. McAndrews
an option, which vests over a four-year period, to purchase 1,845,000 shares
of our common stock. The agreement also provides that, upon the completion of
this offering, Mr. McAndrews will be granted an option, subject to a four-year
vesting period with vesting credit from his hire date, to purchase 264,000
shares of common stock at an exercise price equal to the initial public
56
<PAGE>
offering price per share. Each of the options is exercisable prior to vesting
for unvested shares, which would be subject to a right of repurchase in favor
of us which would lapse according to the vesting schedule applicable to the
option. Mr. McAndrews' employment may be terminated by him or us upon thirty
days' notice. Pursuant to the agreement, if Mr. McAndrews terminates his
employment for "good reason," or he is terminated by us other than for
"cause," Mr. McAndrews' salary will continue at its then-present rate for 12
months. If Mr. McAndrews is terminated without cause, then the vesting
schedule of his unvested stock options and unvested shares will be accelerated
by 12 months. If he terminates his employment for good reason, then 100% of
his unvested options and shares will immediately vest. The agreement also
provides that, if he terminates his employment other than for good reason or
is terminated for cause, his salary will continue for three months. Under the
agreement, "good reason" includes the occurrence after a change of control, as
defined in the agreement, of a demotion or reduction of status or
responsibilities, a reduction in salary, relocation in some circumstances, or
our failure to have the successor company in a change of control assume our
obligations under the employment agreement. Under the agreement, "cause"
includes willful misconduct, dishonesty in the performance of his duties or
other knowing violation of corporate policies which has a material adverse
effect on us, actions or omissions in bad faith that materially impair the
corporate business, goodwill or reputation, conviction of a felony involving
an act of dishonesty, moral turpitude, deceit or fraud, or acts that could
reasonably be expected to result in this kind of conviction, use of illegal
substances, or material violations of his Confidentiality, Inventions
Assignment, Noncompetition and Nonsolicitation Agreement with us.
Brian P. McAndrews' employment agreement states that, upon a change in
control of Avenue A, fifty percent of his unvested stock options and unvested
shares of common stock will immediately vest. Under the agreement, if his
employment with a successor company is terminated without cause within one
year after a change of control of us, his salary will continue at its then
present rate for 12 months and his unvested stock options and unvested shares
will immediately fully vest.
Sumit T. Sen's employment agreement provides for an initial annual salary
of $175,000. The agreement confirms that we have granted Mr. Sen an option, to
vest over a four-year period, to purchase 450,000 shares of our common stock.
The option is immediately exercisable for unvested shares, which are subject
to a right of repurchase in favor of us which lapses in accordance with the
vesting schedule applicable to the option. Mr. Sen's employment may be
terminated by him or us upon thirty-days' notice. Pursuant to his employment
agreement, if he is terminated other than for "cause," or if he terminates his
employment for "good reason," then Mr. Sen's salary will continue at its then-
present rate for 6 months, plus an additional 3 months base salary for each
full calendar year in which he has been employed by us, up to a total possible
amount of 12 months annual base salary. In addition, he will be entitled to
receive severance payments in the amount of his monthly salary for each month
in which he remains unemployed after termination up to a maximum of 12 months.
In addition, if Mr. Sen is terminated other than for cause or if he terminates
his employment for good reason, then the vesting of his unvested stock options
and unvested shares will be accelerated by 12 months. The definitions of "good
reason" and "cause" under Mr. Sen's agreement are similar to those in Mr.
McAndrews' employment agreement. Under Mr. Sen's agreement, upon a change of
control of Avenue A, as defined in the agreement, the vesting schedule of his
unvested stock options and unvested shares will be accelerated by 12 months.
Severance Agreement
On October 8, 1999, we entered into a severance agreement and release with
R. Michael Leo, our former Vice President, Sales and Marketing. Pursuant to
that agreement, Mr. Leo will receive a severance payment of $200,000, payable
in monthly installments over a 12-month period from the date of the agreement.
Pursuant to the agreement, we granted Mr. Leo an option to purchase 375,000
shares of our common stock, which vests one year after date of grant, subject
to Mr. Leo's compliance with the Confidentiality, Inventions Assignment,
Noncompetition and Nonsolicitation Agreement between him and us. In addition,
we provided Mr. Leo with a loan of $75,000, which was applied to the exercise
of previously granted options. Under the agreement, each party agreed to
release the other from any claims arising from Mr. Leo's employment or
termination.
57
<PAGE>
Employee Benefit Plans
1999 Stock Incentive Compensation Plan
In 1999, our board of directors and shareholders approved our 1999 stock
incentive compensation plan. In January 2000, our board increased the shares
available for issuance under the 1999 plan, which increase was approved by our
shareholders in February 2000. The purpose of the plan is to enhance long-term
shareholder value by offering opportunities to selected persons to participate
in our growth and success, and to encourage them to remain in the service of
Avenue A and its related corporations and to acquire and maintain ownership in
our company. The plan permits awards of stock options, shares of common stock
or units denominated in common stock, all of which may be subject to
restrictions. Persons eligible to receive awards under the plan are our
officers, directors, employees, consultants, advisors, agents and independent
contractors and related corporations, but only employees may receive incentive
stock options under the plan.
The number of shares authorized for issuance under the plan is 5,250,000
shares of common stock, plus an automatic annual increase, to be added on the
first day of our fiscal year beginning in 2001, equal to the least of (1)
5,250,000 shares, (2) 8.0% of the adjusted average common shares outstanding
as used to calculate fully diluted earnings per share as reported in our
annual report to shareholders for the preceding year, and (3) a lesser amount
as may be determined by the board. In addition, shares formerly available for
issuance under our 1998 stock incentive compensation plan will become
available for issuance under the 1999 plan, as will shares subject to options
granted under the 1998 stock incentive compensation plan that expire or are
otherwise cancelled without being exercised, up to an aggregate maximum of
13,068,568 shares. The board or a committee appointed by the board will be the
plan administrator for the plan. The plan administrator selects the
individuals to receive awards under the plan. The board also may authorize one
or more senior executive officers to grant awards under the plan, within
limits set by the board. Unless the plan administrator permits otherwise, no
awards may be assigned or transferred by the holder other than by will or by
the applicable laws of descent and distribution, and, during the holder's
lifetime, awards generally may be exercised only by the holder. The board may
suspend or terminate the plan at any time. Unless the board terminates the
plan sooner, the plan will end on November 16, 2009.
Stock option grants. The plan administrator has the authority to specify
the terms and conditions of each option granted, including the vesting
schedule, the term and the exercise price, which, for incentive stock options,
must be at least equal to the fair market value of the common stock on the
grant date and, for nonqualified stock options, must not be less than 85% of
the fair market value of the common stock on the grant date. For purposes of
the plan, fair market value means the closing sales price as reported on the
Nasdaq National Market on the date of grant. Unless the plan administrator
provides otherwise, options granted under the plan will generally expire ten
years from the grant date.
Stock awards. The plan administrator is authorized to award shares of
common stock or awards denominated in units of common stock. These stock
awards may be subject to terms and conditions determined by the plan
administrator, including conditions on how the shares subject to restrictions
must be held while restricted and the circumstances under which a holder will
forfeit the shares if services with us are terminated. Holders of restricted
stock are shareholders of Avenue A and have, subject to some restrictions, all
the rights of shareholders with respect to their shares.
Adjustments. The plan administrator will make proportional adjustments to
the number of shares issuable under the plan and to outstanding awards in the
event of stock splits or other similar capital adjustments.
Corporate transactions. Unless individual letter agreements provide
otherwise, if a corporate transaction specified in the 1999 stock incentive
compensation plan, such as a merger or sale of Avenue A, occurs, each
outstanding option under the plan will be assumed, continued or replaced with
a comparable award by the successor corporation or the parent of the successor
corporation; provided, however, that if a successor corporation refuses to
assume, continue or replace outstanding options, each outstanding option will
automatically accelerate and become 100% vested and exercisable immediately
before the corporate transaction. Any option held by some executive officers
that is assumed, continued or replaced with a comparable award in
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<PAGE>
the corporate transaction, other than in specified related-party transactions,
will accelerate if the officer's employment or services are terminated by the
successor corporation without cause or by the officer voluntarily and with
good reason within two years after the corporate transaction. Acceleration of
option vesting will not occur if the acceleration would prevent pooling-of-
interests accounting treatment in a transaction for which it is available.
Stock Option Grant Program for Nonemployee Directors
In November 1999, our board of directors adopted our stock option grant
program for nonemployee directors. This program will be administered under our
1999 plan.
Under the program, each nonemployee director will automatically receive a
nonqualified stock option to purchase 50,000 shares of common stock upon his
or her initial election or appointment to the board following this offering.
One-third of this option will vest on each of the first, second and third
anniversaries of the grant date. After that, beginning with the annual meeting
of shareholders in 2000, each nonemployee director who continues to serve on
the board will receive an additional option to purchase 15,000 shares of
common stock upon reelection or reappointment to the board, which will fully
vest on the first anniversary of the grant date. The exercise price for all
options granted under the program will be the fair market value of the common
stock on the grant date. Options will have a ten-year term, except that
options will expire three months after a nonemployee director ceases service
as a director, unless cessation is due to death, in which case the options
will expire one year after the date of death.
Unless individual letter agreements provide otherwise, if specified
corporate transactions, such as a merger or sale of Avenue A, occur, each
outstanding option granted to a director under the program will automatically
accelerate and become 100% vested and exercisable immediately before the
corporate transaction. Acceleration of option vesting will not occur if the
corporate transaction is a related-party transaction specified in the plan or
if the acceleration would prevent pooling of interests accounting treatment in
a transaction for which it is available.
1999 Employee Stock Purchase Plan
In 1999, our board of directors and shareholders adopted our 1999 employee
stock purchase plan. We will implement our employee stock purchase plan upon
the effectiveness of this offering to assist employees in acquiring a stock
ownership interest in Avenue A and to encourage employees to remain in our
employ or the employ of our domestic subsidiaries. We intend for the plan to
qualify under Section 423 of the Internal Revenue Code. The plan will be
administered by our board, a committee of the board or an executive officer
appointed to administer the plan.
The board of directors has reserved a total of 750,000 shares of common
stock under the plan plus an automatic annual increase, to be added on the
first day of our fiscal year beginning in 2001, equal to the least of
(1) 1,125,000 shares, (2) 2% of the adjusted average common shares outstanding
as used to calculate fully diluted earnings per share as reported in our
annual report to shareholders for the preceding year and (3) a lesser amount
as may be determined by the board. The plan will expire ten years after it is
adopted by our board of directors, but the board may suspend or terminate the
plan at any time.
Eligibility. Employees generally will be eligible to participate in the
employee stock purchase plan if they are customarily employed by Avenue A for
20 hours or more per week and are not holders of 5% or more of our common
stock or our subsidiaries' common stock. The plan administrator may require
for future offerings that an employee work a minimum of up to five months per
year and have been an employee for some minimum period of time not to exceed
two years. Options granted under the plan are not transferable and are only
exercisable during the employee's lifetime.
Payroll deductions. Our employee stock purchase plan permits our eligible
employees and those of our domestic subsidiaries to purchase common stock
through payroll deductions of up to 20% of their compensation.
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<PAGE>
Under the plan, no employee may purchase common stock with a fair market value
of more than $25,000 in any calendar year or purchase more than 7,500 shares
of common stock in any single purchase period.
Offering and purchase periods. We will implement the employee stock
purchase plan with one-year offering periods. Each offering period will have
two consecutive six-month purchase periods. The first offering period will
commence on the effectiveness of this offering and will end on January 31,
2001. Thereafter offerings will begin on each February 1 and August 1. The
first purchase period under the first offering period will begin on the
effectiveness of this offering and end on July 31, 2000. Subsequent purchase
periods will begin on each February 1 and August 1 and end on the next July 31
and January 31, respectively. Subject to some limitations, the plan
administrator may establish different offering and purchase periods in the
future.
The price of the common stock purchased under the plan will be the lesser
of 85% of the fair market value on the first day of an offering period and 85%
of the fair market value on the last day of the applicable purchase period.
However, the purchase price for the first offering period will be equal to the
lesser of 100% of the initial public offering price of the common stock and
85% of the fair market value on the last day of the applicable purchase
period. For purposes of the plan, fair market value means the closing sales
price as reported on the Nasdaq National Market on the applicable day.
Adjustments. The plan administrator will make proportional adjustments to
the number of shares issuable under the plan and to outstanding options in the
event of stock splits or other similar capital adjustments.
Corporate transactions. In the event of a merger, consolidation or
acquisition by another corporation of all or substantially all of our assets,
each outstanding option to purchase shares under the stock purchase plan will
be assumed or an equivalent option substituted by the successor corporation.
If the successor corporation refuses to assume or substitute for the option,
the offering period during which a participant may purchase stock will be
shortened to a specified date before the proposed transaction. Similarly, in
the event of Avenue A's proposed liquidation or dissolution, the offering
period during which a participant may purchase stock will be shortened to a
specified date before the date of the proposed event.
1998 Stock Incentive Compensation Plan
In 1998, our board of directors and shareholders approved our 1998 stock
incentive compensation plan. The plan permits awards of stock options, shares
of common stock or units denominated in common stock, all of which may be
subject to restrictions. The 1998 plan authorizes the issuance of up to
15,525,000 shares. As of December 31, 1999, options to purchase
7,173,085 shares were outstanding under the plan at exercise prices ranging
from $.07 to $4.33 per share, and options for 5,657,856 shares had been
exercised. In addition, as of December 31, 1999, 83,266 shares had been issued
as stock awards under the plan. After December 31, 1999, we granted options to
purchase 2,610,793 shares of common stock under the 1998 plan. As a result, no
shares of common stock are available for future issuance under the plan.
The plan administrator has the discretion to issue unvested shares of our
common stock upon exercise of a stock option under the plan. Any shares
acquired upon exercise of an unvested portion of an option will be unvested
shares. If an optionee's employment or services at Avenue A are terminated,
all shares issued on exercise of the option that are unvested on the date of
termination may be repurchased by Avenue A at the exercise price paid for the
shares. The terms and conditions of our repurchase right are set forth in an
agreement each optionee signs when the optionee exercises an unvested option.
The plan administrator has the discretionary authority to cancel Avenue A's
repurchase right for unvested shares. Avenue A's repurchase right will also
terminate if the vesting of outstanding options is accelerated in a corporate
transaction.
Corporate transactions. Unless individual letter agreements provide
otherwise, if a corporate transaction specified in the 1998 stock incentive
compensation plan, such as a merger or sale of Avenue A, occurs, each
outstanding option under the plan will automatically accelerate and become
100% vested and exercisable immediately before the corporate transaction,
unless the option is assumed, continued or replaced with a
60
<PAGE>
comparable award by the successor corporation or the parent of the successor
corporation. If option vesting is accelerated, any rights of repurchase held
by us applicable to the stock issued on exercise of the options will lapse.
Any option or stock award held by certain executive officers that is assumed,
continued or replaced with a comparable award in the corporate transaction,
other than in specified related-party transactions, will accelerate if the
holder's employment or services are terminated by the successor corporation
without cause or by the holder voluntarily and with good reason within two
years after the corporate transaction. Acceleration of option vesting will not
occur if the acceleration would prevent pooling of interests accounting
treatment in a transaction for which it is available. In all other material
respects, the terms of the 1998 stock incentive compensation plan are the same
as those in the 1999 stock incentive compensation plan.
2000 Stock Incentive Compensation Plan
In February 2000, our board of directors approved our 2000 stock incentive
compensation plan. The plan permits awards of nonqualified stock options,
shares of common stock or units denominated in common stock, all of which may
be subject to restrictions. The 2000 plan authorizes the issuance of up to
1,261,566 shares of common stock. As of February 22, 2000, options to purchase
1,261,566 shares were outstanding under the plan at an exercise price of $8.00
per share. In all other material respects, the terms of the 2000 plan are the
same as those in the 1998 stock incentive compensation plan.
401(k) Plan
We maintain a 401(k) plan that covers all our employees over the age of 18.
We may make an annual contribution for the benefit of eligible employees in an
amount determined by our board of directors. We have not made any contribution
to date and have no current plans to do so. Eligible employees may make pre-
tax elective contributions of up to 25% of their compensation, subject to
maximum limits on contributions prescribed by law.
Limitations on Director and Officer Liability and Indemnification
Our articles of incorporation limit the liability of directors to the
fullest extent permitted by the Washington Business Corporation Act as it
currently exists or as it may be amended in the future. Consequently, subject
to the Washington Business Corporation Act, no director will be personally
liable to us or our shareholders for monetary damages resulting from his or
her conduct as one of our directors, except liability for:
. acts or omissions involving intentional misconduct or knowing violations
of law or unlawful distributions; or
. transactions from which the director personally receives a benefit in
money, property or services to which the director is not legally
entitled.
Our bylaws also provide that we will indemnify any individual made a party
to a proceeding because that individual is or was a director or officer or, in
some circumstances, an employee of Avenue A, and will reimburse reasonable
expenses incurred by such individual in advance of the final disposition of
the proceeding to the fullest extent permitted by applicable law. Any repeal
of or modification to our articles of incorporation or bylaws may not
adversely affect any right of indemnification under the articles or bylaws of
a director or officer of Avenue A who is or was a director or officer at the
time of such repeal or modification. To the extent the provisions of our
articles of incorporation or bylaws provide for indemnification of directors
or officers for liabilities arising under the Securities Act, those provisions
are, in the opinion of the SEC, against public policy as expressed in the
Securities Act and they are unenforceable.
In addition, we intend to purchase and maintain a liability insurance
policy pursuant to which our directors and officers may be indemnified against
liability they may incur for serving in their capacities as our directors and
officers.
We believe that the limitation of liability provision in our articles of
incorporation, the indemnification provisions in our bylaws and the liability
insurance policy will help us continue to attract and retain qualified
individuals to serve as our directors and officers.
61
<PAGE>
RELATED-PARTY TRANSACTIONS
Nicolas J. Hanauer, the current chairman of our board of directors, is, and
was during 1997 through 1999, a director, officer and significant shareholder
of Pacific Coast Feather Company. During the period from our inception through
1998, Pacific Coast Feather Company paid for a portion of our operating
expenses and asset purchases, including some payroll expenses, totalling
$3,082,000. We repaid $1,494,000 of this amount in cash directly to Pacific
Coast Feather Company. We repaid $1,588,000 of this amount through the
proceeds of our sale of shares of our common stock in 1998 to Pacific Coast
Feather Company and affiliates of Pacific Coast Feather Company, including:
Nicolas J. Hanauer; Gerard Hanauer, the father of Nicolas J. Hanauer; Roy
Clothier, Jr.; Eric Moen; Lenore Hanauer, the mother of Nicolas J. Hanauer;
and Adrian Hanauer, the brother of Nicolas J. Hanauer. Each of Gerard Hanauer,
Roy Clothier, Jr., Lenore Hanauer and Adrian Hanauer is and was during 1997
through 1999 an officer, director and significant shareholder of Pacific Coast
Feather Company. Mr. Moen is and was during 1997 through 1999 an officer and
shareholder of Pacific Coast Feather Company. Gerard Hanauer, Roy Clothier,
Jr. and Eric Moen served as directors of Avenue A during 1998 and part of
1999. Sales of our common stock to Pacific Coast Feather Company and its
affiliates with an aggregate purchase price in excess of $60,000 are set forth
in the table below.
Since our inception we have sold shares of our common and preferred stock
to some of our executive officers and directors and some of their affiliates.
Sales of our stock to our executive officers and directors and their
affiliates with an aggregate purchase price in excess of $60,000 are also set
forth in the table below.
<TABLE>
<CAPTION>
Total Value of
Shares at the
Initial Public
Number of Price Aggregate Offering
Shares per Purchase Price of $24.00
Date of Purchase Purchaser Purchased Share(1) Price(1) Per Share
---------------- --------- --------- -------- ---------- ---------------
<C> <S> <C> <C> <C> <C>
May 26, 1998 Roy Clothier, Jr.(2).... 1,650,000 $ .10 $ 161,000 $ 39,600,000
Adrian Hanauer(3)....... 1,650,000 .10 161,000 39,600,000
Gerard Hanauer(4)....... 1,650,000 .10 161,000 39,600,000
Nicolas J. Hanauer,
Chairman of the Board.. 4,950,000 .10 483,000 118,800,000
May 29, 1998 Lenore Hanauer(5)....... 1,650,000 .10 161,000 39,600,000
June 10, 1998 Pacific Coast Feather
Company................ 1,421,850 .10 138,738 34,124,400
July 2, 1998 Nicolas Hanauer......... 3,000,000 .10 300,000 72,000,000
August 5, 1998 John P. Galgon(6)....... 117,469 .55 65,000 2,819,256
March 15, 1999 R. Michael Leo(7)....... 92,142 .75 68,800 2,211,408
May 4, 1999 Entities affiliated with
U.S. Venture
Partners(8)(10)........ 4,639,174 1.29 6,000,000 111,340,176
Entities affiliated with
Oak Investment
Partners(9)(10)........ 7,731,958 1.29 9,990,000 185,566,992
October 8, 1999 Brian P. McAndrews,
President, Chief
Executive Officer and
Director............... 37,500 2.67 100,000 900,000
Robert M Littauer, Chief
Financial Officer, Vice
President, Finance and
Administration,
Secretary and
Treasurer.............. 37,500 2.67 100,000 900,000
Neve R. Savage,
President, Avenue A
International
Division............... 37,500 2.67 100,000 900,000
Jeffrey J. Miller, Vice
President, Corporate
Development and Legal
Affairs................ 37,500 2.67 100,000 900,000
Michael T. Galgon, Chief
Strategy Officer....... 37,500 2.67 100,000 900,000
Scott E. Lipsky, Chief
Technology Officer and
Vice President,
Engineering............ 37,500 2.67 100,000 900,000
October 25, 1999 Sumit T. Sen, Chief
Analytics Officer...... 187,500 2.67 500,000 4,500,000
October 26, 1999 Gregory B. Maffei,
Director............... 75,000 2.67 200,000 1,800,000
Gregory B. Maffei....... 75,000 1.27 95,000 1,800,000
December 15, 1999 Bruce Allenbaugh, Vice
President, Marketing... 37,500 4.33 162,500 900,000
February 4, 2000 James A. Warner,
President, iballs LLC.. 75,000 8.00 600,000 1,800,000
</TABLE>
- --------
(1) Price per share is rounded to the nearest cent and aggregate purchase
price is rounded to the nearest dollar. Aggregate purchase price may not
equal the number of shares purchased multiplied by the price per share
due to rounding.
62
<PAGE>
(2) Mr. Clothier was one of our directors in 1998 and part of 1999.
(3) Adrian Hanauer is the brother of Nicolas J. Hanauer, who has been a
director of Avenue A since its incorporation.
(4) Gerard Hanauer is the father of Nicolas J. Hanauer.
(5) Lenore Hanauer is the mother of Nicolas J. Hanauer.
(6) Mr. Galgon is the father of Michael T. Galgon, our Chief Strategy
Officer. Michael T. Galgon served as our General Manager at the time of
his father's purchase of shares of our Series A preferred stock. Number
of shares and price per share have been adjusted to give effect to the
conversion of each share of preferred stock into 1.5 shares of common
stock upon the closing of this offering.
(7) Mr. Leo was a Vice President of Avenue A at the time of this sale.
Number of shares and price per share have been adjusted to give effect
to the conversion of each share of preferred stock into 1.5 shares of
common stock upon the closing of this offering.
(8) Mr. Green, one of our directors, is a managing member of Presidio
Management Group VI, L.L.C. Presidio Management Group VI is the general
partner of each of U.S. Venture Partners VI, L.P., USVP VI Affiliates
Fund, L.P., 2180 Associates Fund VI, L.P. and USVP VI Entrepreneur
Partners, L.P., collectively the "USVP Entities." On May 4, 1999, the
USVP Entities purchased 3,092,783 shares of our Series C preferred stock
for $6 million. Presidio Management Group VI disclaims beneficial
interest in such shares, except as to its pecuniary interest arising as
a result of its interest in each of the USVP Entities. Mr. Green
disclaims beneficial ownership of such shares, except to the extent of
his pecuniary interest arising as a result of his interest in Presidio
Management Group VI. Number of shares and price per share have been
adjusted to give effect to the conversion of each share of preferred
stock into 1.5 shares of common stock upon the closing of this offering.
(9) Mr. Harman, one of our directors, is a managing member of Oak Associates
VIII, LLC, the general partner of Oak Investment Partners VIII, Limited
Partnership and a managing member of Oak VIII Affiliates, LLC, the
general partner of Oak VIII Affiliates Fund, Limited Partnership. On May
4, 1999, Oak Investment Partners VIII, Limited Partnership purchased
5,056,701 shares of our Series C preferred stock for $9.8 million and
Oak VIII Affiliates Fund, Limited Partnership purchased 97,938 shares of
our Series C preferred stock for $190,000. Mr. Harman disclaims
beneficial ownership of such shares, except to the extent of his
pecuniary interest arising as a result of his interest in Oak Associates
VIII, LLC and Oak VIII Affiliates, LLC. Number of shares and price per
share have been adjusted to give effect to the conversion of each share
of preferred stock into 1.5 shares of common stock upon the closing of
this offering.
(10) U.S. Venture Partners VI, L.P., Oak Investment Partners VIII, Limited
Partnership and Oak VIII Affiliates Fund, Limited Partnership are
parties to an investors rights agreement with us. Pursuant to the terms
of that agreement, the holders of our Series C preferred stock have
registration rights that obligate us, under circumstances specified in
the investor rights agreement, to register shares of common stock under
the Securities Act. Number of shares and price per share have been
adjusted to give effect to the conversion of each share of preferred
stock into 1.5 shares of common stock upon the closing of this offering.
Pacific Coast Feather Company incurred obligations of approximately $13,333
in 1998 and $67,473 in 1999 for advertising services we provided, of which
$38,085 was uncollected as of December 31, 1999. In 1998 and 1999, Nicolas J.
Hanauer devoted part of his time to Pacific Coast Feather Company and part of
his time to Avenue A. Under an arrangement with Pacific Coast Feather Company,
we reimbursed Pacific Coast Feather Company for $85,230 of salary paid by it
to Mr. Hanauer in 1999, which reimbursement represented compensation for
Mr. Hanauer's services as an officer and director of Avenue A in 1999.
Nicolas J. Hanauer is also a director of Gear.com, Inc. Gear.com incurred
obligations to us of approximately $7,733 in 1998 and $641,463 in 1999 for
advertising services, of which $108,436 was uncollected as of December 31,
1999.
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<PAGE>
Gregory B. Maffei, one of our directors, was an executive officer of
Microsoft Corporation in 1998 and 1999. Microsoft incurred obligations to us
of approximately $3,750 in 1998 and $7,610,934 in 1999 for advertising
services, of which $1,331,759 was uncollected as of December 31, 1999.
On October 8, 1999, we made loans of $100,000 to Robert M. Littauer, our
chief financial officer, vice president, finance and administration, secretary
and treasurer, and $676,000 to Brian P. McAndrews, our chief executive officer
and one of our directors, pursuant to promissory notes in connection with the
purchase of shares of common stock and the exercise of stock options by Mr.
Littauer and Mr. McAndrews, respectively. The notes bear interest at a rate
equal to the greater of (1) the applicable federal rate for a demand note as
of October 8, 1999 and as redetermined each year on the anniversary date of
the notes and (2) the lowest rate necessary to avoid the imputation of
interest under the Internal Revenue Code.
On October 8, 1999, we entered into a severance agreement and release with
R. Michael Leo. Pursuant to that agreement, Mr. Leo will receive a severance
payment of $200,000, payable in monthly installments over a 12-month period
from the date of the agreement. Pursuant to the agreement, we granted Mr. Leo
an option to purchase 375,000 shares of our common stock, subject to Mr. Leo's
compliance with the Confidentiality, Inventions Assignment, Noncompetition and
Nonsolicitation Agreement between us and him. The option has an exercise price
of $2.67 per share. In addition, we provided Mr. Leo with a loan of $75,000
which was applied to the exercise of previously granted options. Under the
agreement, each party agreed to release the other from any claims arising from
Mr. Leo's employment or termination.
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<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth information regarding beneficial ownership
of our common stock as of December 31, 1999 by
. each person or group known by us to own beneficially more than 5% of
our common stock;
. each of our directors;
. our named executive officers shown in the summary compensation
table; and
. our current directors and executive officers as a group.
As of December 31, 1999, assuming conversion of all outstanding shares of
preferred stock, there were 49,745,282 shares of common stock outstanding and
354 shareholders of record of Avenue A. The number of shares outstanding after
this offering assumes the sale of the 5,250,000 shares offered by this
prospectus and the exercise of an outstanding warrant to purchase 677,710
shares of common stock immediately prior to the closing of this offering.
Beneficial ownership is determined in accordance with SEC rules. In computing
the number of shares beneficially owned by a person or a group and the
percentage ownership of that person or group, shares of our common stock
subject to options currently exercisable or exercisable within 60 days after
December 31, 1999 are deemed outstanding but are not deemed outstanding for
computing the percentage ownership of any other person. Except as otherwise
indicated in the footnotes below, we believe the beneficial owners of the
common stock listed below, based on information furnished by them, have sole
voting and investment power with respect to the number of shares listed
opposite their names, subject to community property laws where applicable.
<TABLE>
<CAPTION>
Percentage of
Shares
Number of Number of Beneficially
Shares Shares Owned
Beneficially Beneficially -----------------
Owned Prior Owned After Prior to After
Name of Beneficial Owner to Offering Offering Offering Offering
- ------------------------ ------------ ------------ -------- --------
<S> <C> <C> <C> <C>
Entities affiliated with Oak
Investment Partners(1)........... 7,654,639 8,109,117 15.4% 14.6%
525 University Avenue, Ste. 1300
Palo Alto, CA 94301
Entities affiliated with U.S.
Venture Partners(2).............. 4,639,174 4,861,860 9.3 8.7
2180 Sand Hill Road, Ste. 300
Menlo Park, CA 94025
Jason Green(2).................... 4,639,174 4,861,860 9.3 8.7
2180 Sand Hill Road, Ste. 300
Menlo Park, CA 94025
Nicolas J. Hanauer................ 6,490,651 6,490,651 13.0 11.7
506 Second Avenue, 9th Floor
Seattle, WA 98104
Fredric W. Harman(1).............. 7,654,639 8,109,117 15.4 14.6
525 University Avenue, Ste. 1300
Palo Alto, CA 94301
Gregory B. Maffei(3).............. 225,000 225,000 * *
Brian P. McAndrews(4)............. 2,141,999 2,141,999 4.2 3.7
Peter M. Neupert(5)............... 50,000 50,000 * *
Michael T. Galgon(6).............. 1,087,750 1,087,750 2.2 1.9
Robert M. Littauer(7)............. 629,999 629,999 1.3 1.1
Neve R. Savage(8)................. 547,500 547,500 1.1 1.0
Scott E. Lipsky(9)................ 1,534,500 1,534,500 3.1 2.7
R. Michael Leo(10)................ 934,779 934,779 1.9 1.7
Directors and executive officers
as a group (21 persons)(11).... 28,304,066 29,098,730 52.4 48.6
</TABLE>
- --------
*Less than 1%.
65
<PAGE>
(1) Number of shares beneficially owned prior to offering represents
7,509,201 shares held by Oak Investment Partners VIII, Limited
Partnership and 145,438 shares held by Oak VIII Affiliates Fund, Limited
Partnership. Number of shares beneficially owned after the offering
includes the number of shares beneficially owned prior to the offering
and also includes 159,229 shares which Oak Investment Partners VIII,
Limited Partnership and 3,084 shares which Oak VIII Affiliates Fund,
Limited Partnership each will acquire from each of Roy Clothier, Jr. and
Gerard Hanauer, as well as 63,692 shares which Oak Investment Partners
VIII, Limited Partnership and 1,234 shares which Oak VIII Affiliates
Fund, Limited Partnership each will acquire from each of Lenore Hanauer
and Adrian Hanauer, immediately after the closing of this offering for a
purchase price per share equal to the initial public offering price,
pursuant to stock purchase agreements. Fredric W. Harman, a director of
Avenue A, is a managing member of Oak Associates VIII, LLC, the general
partner of Oak Investment Partners VIII, Limited Partnership, and a
managing member of Oak VIII Affiliates, LLC, the general partner of Oak
VIII Affiliates Fund, Limited Partnership and thus may be deemed to
share voting and dispository power with each of the above entities. Mr.
Harman disclaims beneficial ownership of shares held by these entities,
except to the extent of his pecuniary interest in Oak Associates VIII,
LLC and Oak VIII Affiliates, LLC.
(2) Number of shares beneficially owned prior to offering represents
4,314,432 shares held by U.S. Venture Partners VI, LP, 120,618 shares
held by USVP VI Affiliates Fund, LP, 134,536 shares held by USVP VI
Entrepreneur Partners, L.P., and 69,588 shares held by 2180 Associates
Fund VI, L.P. Number of shares beneficially owned after the offering
includes the number of shares beneficially owned prior to the offering
and also includes 73,964 shares which U.S. Venture Partners VI, LP,
1,193 shares which 2180 Associates Fund VI, LP, 2,306 shares which USVP
VI Entrepreneur Partners, LP and 2,068 shares which USVP VI Affiliates
Fund, LP each will acquire from each of Roy Clothier, Jr. and Gerard
Hanauer, as well as 29,585 shares which U.S. Venture Partners VI, LP,
477 shares which 2180 Associates Fund VI, LP, 923 shares which USVP VI
Entrepreneur Partners, LP and 827 shares which USVP VI Affiliates Fund,
L.P. each will acquire from each of Lenore Hanauer and Adrian Hanauer,
immediately after the closing of this offering for a purchase price per
share equal to the initial public offering price, pursuant to stock
purchase agreements. Jason Green, a director of Avenue A, is a managing
member of Presidio Management Group VI, LLC, the general partner of each
of the above entities and thus may be deemed to share voting and
dispository power with each of the above entities. Mr. Green disclaims
beneficial ownership of shares held by these entities, except to the
extent of his pecuniary interest in Presidio Management Group VI LLC.
(3) Represents 225,000 shares, of which 75,000 shares are subject to
repurchase by Avenue A at the original exercise price in the event of
termination of services of holder, which right lapses over time in
accordance with a vesting schedule.
(4) Represents (a) 6,000 shares, (b) 533,683 shares that are subject to
repurchase by Avenue A at the original exercise price paid for such
shares in the event of termination of services of holder, which right
lapses over time in accordance with a vesting schedule, and (c)
1,602,317 shares subject to options exercisable within 60 days of
December 31, 1999, including options granted after December 31, 1999,
which shares are subject to repurchase by Avenue A at the original
exercise price in the event of termination of services of holder, which
right lapses over time in accordance with vesting schedules.
(5) Represents 50,000 shares subject to options granted after December 31,
1999 and exercisable within 60 days of December 31, 1999, which shares
are subject to repurchase by Avenue A at the original exercise price in
the event of termination of services of holder, which right lapses over
time in accordance with a vesting schedule.
(6) Represents (a) 458,250 shares, (b) 300,000 shares that are subject to
repurchase by Avenue A at the original exercise price paid for such
shares in the event of termination of services of holder, which right
lapses over time in accordance with a vesting schedule, and (c) 329,500
shares subject to options exercisable within 60 days of December 31,
1999, including options granted after December 31, 1999, which shares
are subject to repurchase by Avenue A at the original exercise price in
the event of termination of services of holder, which right lapses over
time in accordance with vesting schedules.
(7) Represents (a) 364,999 shares, (b) 151,563 shares that are subject to
repurchase by Avenue A at the original exercise price paid for such
shares in the event of termination of services of holder, which right
lapses over
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<PAGE>
time in accordance with a vesting schedule, and (c) 113,438 shares subject
to options exercisable within 60 days of December 31, 1999, including
options granted after December 31, 1999, which shares are subject to
repurchase by Avenue A at the original exercise price in the event of
termination of services of holder, which right lapses over time in
accordance with vesting schedules.
(8) Represents (a) 339,000 shares, (b) 96,000 shares that are subject to
repurchase by Avenue A at the original exercise price paid for such
shares in the event of termination of services of holder, which right
lapses over time in accordance with a vesting schedule and (c) 112,500
shares subject to options exercisable within 60 days of December 31,
1999, including options granted after December 31, 1999, which shares
are subject to repurchase by Avenue A at the original exercise price in
the event of termination of services of holder and which right lapses
over time in accordance with vesting schedules.
(9) Represents (a) 877,500 shares, (b) 232,875 shares that are subject to
repurchase by Avenue A at the original exercise price paid for such
shares in the event of termination of services of holder, which right
lapses over time in accordance with a vesting schedule, and (c) 424,125
shares subject to options exercisable within 60 days of December 31,
1999, which shares are subject to repurchase by Avenue A at the original
exercise price in the event of termination of services of holder, which
right lapses over time in accordance with vesting schedules.
(10) Mr. Leo's employment with the Company ended on October 9, 1999.
(11) Number of shares beneficially owned after the offering includes
1,907,790 shares subject to repurchase by Avenue A at the original
exercise price paid for such shares, which right lapses over time in
accordance with a vesting schedule. Also includes 4,220,710 shares
subject to options exercisable within 60 days of December 31, 1999,
including options granted after December 31, 1999, 4,066,210 shares of
which are subject to repurchase by Avenue A at the original exercise
price in the event of termination of services of holder, which right
lapses over time in accordance with vesting schedules. Two of our
current officers whose shares and options are included in those of
directors and executive officers as a group were not officers at
December 31, 1999.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue up to 200,000,000 shares of common stock, $.01
par value per share, and 37,500,000 shares of preferred stock, $.01 par value
per share. The following summary of provisions of the common stock and
preferred stock is not complete and may not contain all the information you
should consider before investing in the common stock. You should read
carefully our articles of incorporation, which are included as an exhibit to
the Registration Statement, of which this prospectus is a part.
Common Stock
As of December 31, 1999, assuming conversion of all outstanding shares of
preferred stock, there were 49,745,282 shares of common stock outstanding held
of record by 354 shareholders. Following this offering, there will be
55,672,992 shares of common stock outstanding, assuming exercise of an
outstanding warrant, assuming no exercise of the underwriters' over-allotment
option and no exercise of outstanding options. The holders of common stock are
entitled to one vote per share on all matters to be voted on by the
shareholders. Our amended and restated articles of incorporation do not
authorize cumulative voting. Effective at the first annual meeting of
shareholders following this offering, our board will be classified. See "--
Antitakeover Effects of Provisions of Articles of Incorporation, Bylaws and
Washington Law--Election and removal of directors." Subject to preferences of
any outstanding shares of preferred stock, the holders of common stock are
entitled to receive ratably any dividends the board of directors declares out
of funds legally available for the payment of dividends. If Avenue A is
liquidated, dissolved or wound up, the holders of common stock are entitled to
share pro rata all assets remaining after paying liabilities and liquidation
preferences of any outstanding shares of preferred stock. Holders of common
stock have no preemptive rights or rights to convert their common stock into
any other securities. There are no redemption or sinking fund provisions
applicable to the common stock. All outstanding shares of common stock are
fully paid and nonassessable, and the shares of common stock to be issued
following this offering will be fully paid and nonassessable.
Preferred Stock
Upon the closing of this offering, each outstanding share of Series A,
Series B and Series C preferred stock automatically will be converted into 1.5
shares of common stock. After that, pursuant to our articles of incorporation,
the board of directors will have the authority, without further action by the
shareholders, to issue up to 21,083,902 shares of preferred stock in one or
more series. The board also has the authority to fix the designations, powers,
preferences, privileges and relative, participating, optional or special
rights and the qualifications, limitations or restrictions of any preferred
stock, including dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may be greater
than the rights of the common stock. The board of directors, without
shareholder approval, can issue preferred stock with voting, conversion or
other rights that could adversely affect the voting power and other rights of
the holders of common stock. Preferred stock could thus be issued quickly with
terms that could delay or prevent a change in control of Avenue A or make
removal of management more difficult. Additionally, the issuance of preferred
stock may decrease the market price of the common stock and may adversely
affect the voting and other rights of the holders of common stock. We have no
plans at this time to issue any preferred stock.
Warrant
At December 31, 1999, we had one warrant outstanding to purchase 677,710
shares of common stock at $.55 per share, which is held by Jeffrey P. Bezos.
The warrant expires in August 2003. The warrant will be exercised in full
immediately prior to the closing of this offering.
Registration Rights
After this offering, the holders of 15,506,436 shares of common stock will
be entitled to rights with respect to the registration of such shares under
the Securities Act, pursuant to the terms of an investors rights agreement
between Avenue A and the holders of Avenue A's Series C preferred stock and a
registration rights agreement
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<PAGE>
between Avenue A and the members of iballs LLC, a New York limited liability
company acquired by Avenue A in September 1999.
Antitakeover Effects of Provisions of Articles of Incorporation, Bylaws and
Washington Law
Issuance of preferred stock. As noted above, our board of directors,
without shareholder approval, has the authority under our articles of
incorporation to issue preferred stock with rights superior to the rights of
the holders of common stock. As a result, preferred stock could be issued
quickly and easily, could adversely affect the rights of holders of common
stock and could be issued with terms calculated to delay or prevent a change
in control of Avenue A or make removal of management more difficult.
Election and removal of directors. Upon the closing of this offering and
effective at the first annual meeting of shareholders following this offering,
our amended and restated articles of incorporation will provide for the
division of our board of directors into three classes, as nearly as equal in
number as possible. At the first election of our directors to the classified
board, each class 1 director will be elected to serve until the next following
annual meeting of shareholders, each class 2 director will be elected to serve
until the second following annual meeting of shareholders and each class 3
director will be elected to serve until the third following annual meeting of
shareholders. At each annual meeting of shareholders following the meeting at
which the board would be initially classified, the successors to directors
whose terms are expiring will be elected to serve until the third annual
meeting of shareholders following their election. Directors serve until their
successors are elected and qualified or until their death, resignation or
removal from office. Our directors can be removed from office only for cause
and only by a two-thirds vote of the shareholders. Because this system of
electing and removing directors generally makes it more difficult for
shareholders to replace a majority of the board of directors, it may
discourage a third party from making a tender offer or otherwise attempting to
gain control of Avenue A and may maintain the incumbency of the board.
Approval for business combinations. Upon the closing of this offering, our
articles will require that specified business combinations, including a
merger, share exchange and the sale, lease, exchange, mortgage, pledge,
transfer or other disposition or encumbrance of a substantial part of assets
other than in the usual and regular course of business, be approved by the
holders of not less than two-thirds of the outstanding shares, unless such a
business combination has been approved by the board of directors, in which
case the affirmative vote required shall be a majority of the outstanding
shares.
Shareholder meetings. Upon the closing of this offering, our articles and
bylaws will provide that our shareholders may call a special meeting only upon
the written request of holders of at least 25% of the outstanding shares
delivered to us at least 20 days prior to the date of the meeting.
Additionally, the board of directors, the chairman of the board, the chief
executive officer and the president may call special meetings of shareholders.
Requirements for advance notification of shareholder nominations and
proposals. Upon the closing of this offering, our bylaws will establish
advance notice procedures with respect to shareholder proposals and the
nomination of candidates for election as directors, other than nominations
made by or at the direction of the board of directors or a committee thereof.
Washington law. Washington law imposes restrictions on some transactions
between a corporation and significant shareholders. With some exceptions,
Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target
corporation" from engaging in specified "significant business transactions"
with an "acquiring person." An acquiring person is defined as a person or
group of persons that beneficially owns 10% or more of the voting securities
of the target corporation. "Significant business transactions," as defined in
Chapter 23B.19, may not occur for a period of five years after the acquiring
person acquires the securities, unless the transaction or acquisition of
shares is approved by a majority of the members of the target corporation's
board of directors prior to the time of acquisition. "Significant business
transactions" include, among other things,
. a merger or consolidation with, disposition of assets to, or issuance or
redemption of stock to or from, the acquiring person;
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<PAGE>
. termination of 5% or more of the employees of the target corporation as
a result of the acquiring person's acquisition of 10% or more of the
shares; or
. allowing the acquiring person to receive any disproportionate benefit as
a shareholder.
After the five-year period, a "significant business transaction" may occur,
as long as it complies with "fair price" provisions specified in the statute. A
corporation may not "opt out" of this statute. This provision may have the
effect of delaying, deterring or preventing a change in control of Avenue A.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services, L.L.C.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for Avenue A common stock.
Future sales of substantial amounts of common stock in the public market could
adversely affect prevailing market prices. Furthermore, since only a limited
number of shares will be available for sale shortly after this offering
because of contractual and legal restrictions on resale, sales of substantial
amounts of our common stock in the public market after the restrictions lapse
could adversely affect prevailing market prices and our ability to raise
equity capital in the future.
Upon completion of this offering, we will have 55,672,992 shares of common
stock outstanding, assuming no exercise of options after December 31, 1999,
assuming exercise of an outstanding warrant and assuming the conversion of all
shares of outstanding preferred stock into common stock, based on shares
outstanding as of December 31, 1999. Of these shares, the 5,250,000 shares
sold in this offering, plus any shares issued upon exercise of the
underwriters' over-allotment option, will be freely transferable without
restriction or registration under the Securities Act, except for shares
purchased by any of our existing "affiliates," which generally includes
officers, directors or 10% shareholders, as that term is defined in Rule 144
under the Securities Act. The remaining 50,422,992 shares of common stock
outstanding upon completion of this offering are "restricted securities"
within the meaning of Rule 144 under the Securities Act. These shares may be
sold in the public market only if registered, or if they qualify for an
exemption from registration under Rule 144, 144(k) or 701 promulgated under
the Securities Act, which are summarized below.
Including our directors and officers, holders of a total of approximately
47,962,890 shares of common stock, including shares issuable upon automatic
conversion of the outstanding preferred stock and shares issuable upon
exercise of an outstanding warrant, have entered into lock-up agreements
generally providing that they will not, without the prior written consent of
Morgan Stanley & Co. Incorporated, offer, pledge, sell, contract to sell, sell
any option or contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, lend or otherwise transfer or
dispose of, directly or indirectly, any shares of common stock or any
securities convertible into or exercisable or exchangeable for common stock
for a period of 180 days after the date of this prospectus. Avenue A has
entered into a similar agreement with Morgan Stanley. As a result of
these contractual restrictions, notwithstanding possible earlier eligibility
for sale under the provisions of Rules 144, 144(k) and 701, shares subject to
lock-up agreements will not be eligible for sale until these agreements expire
or are waived by Morgan Stanley. Taking into account the lock-up agreements,
and assuming Morgan Stanley does not release the parties from these
agreements, the following shares will be eligible for sale in the public
market at the following times:
. Beginning on the effective date of this offering, only the shares sold
in this offering will be immediately available for sale in the public
market.
. Beginning 180 days after the date of this prospectus, the expiration
date of the lock-up agreements, approximately 27,106,380 shares will be
eligible for sale pursuant to Rules 144, 144(k) and 701.
. An additional 20,990,224 shares will become eligible for sale pursuant
to Rule 144 beginning approximately one year after the date of this
prospectus. Shares eligible to be sold by affiliates pursuant to Rule
144 are subject to the volume restrictions described below.
In general, under Rule 144 as currently in effect, a person, or persons
whose shares are aggregated, who has beneficially owned restricted securities
for at least one year is entitled to sell within any three-month period a
number of shares that does not exceed the greater of: (1) 1% of our then
outstanding shares of common stock, approximately 556,729 shares immediately
after this offering, or (2) the average weekly trading volume of our common
stock on the Nasdaq Stock Market during the four calendar weeks preceding the
date on which notice of the sale is filed with the SEC. Sales under Rule 144
also are subject to manner of sale provisions, notice requirements and the
availability of current public information about us. Under Rule 144(k), a
person who is not deemed to have been one of our affiliates at any time during
the three months preceding a sale, and who has
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<PAGE>
beneficially owned the shares proposed to be sold for at least two years, may
sell such shares without complying with the manner of sale, public
information, volume limitation, or notice provisions of Rule 144.
The holders of approximately 15,506,436 shares of common stock or their
transferees are also entitled to various rights with respect to the
registration of their shares of common stock for offer or sale to the public.
If these holders, by exercising their registration rights, cause a large
number of shares to be registered and freely transferable in the public
market, the sales could have a material adverse effect on the market price of
our common stock.
Beginning 90 days after the effective date of this prospectus, subject to
contractual restrictions, any of our employees, consultants or advisors who
purchased shares from us prior to the closing of this offering pursuant to a
written compensatory plan or contract may be entitled to rely on the resale
provisions of Rule 701. Rule 701 permits affiliates to sell their Rule 701
shares under Rule 144 without complying with the holding period requirements
of Rule 144. Rule 701 further provides that persons other than affiliates may
sell shares in reliance on Rule 144 without having to comply with the holding
period, public information, volume limitation, or notice provisions of Rule
144.
As of December 31, 1999, options to purchase 7,173,085 shares of common
stock pursuant to our 1998 stock incentive compensation plan were outstanding
and exercisable, and options to purchase 1,312,500 shares of common stock
outside of our 1998 stock incentive compensation plan were outstanding and
exercisable. After December 31, 1999, we granted options to purchase an
additional 2,610,793 shares under the 1998 stock incentive compensation plan
and therefore there are no shares reserved for future issuance under that
plan. In addition, on February 22, 2000, the board of directors adopted our
2000 stock incentive compensation plan with respect to 1,261,566 shares of
common stock, all of which are subject to issuance pursuant to grants made on
that date under that plan. In addition, we have reserved 5,250,000 shares of
common stock for future issuance under our 1999 stock incentive compensation
plan and 750,000 shares of common stock for future issuance under our 1999
employee stock purchase plan. No shares have been issued to date under this
plan.
After the closing of this offering, we intend to file registration
statements under the Securities Act to register shares to be issued pursuant
to our stock plans. Such registration statements are expected to become
effective immediately upon filing, and shares covered by such registration
statements will then become eligible for sale in the public market. As a
result, shares issued pursuant to our 1998 stock incentive compensation plan,
our 1999 stock incentive compensation plan, our 1999 employee stock purchase
plan and our 2000 stock incentive compensation plan, after the effectiveness
of such registration statements, also will be freely transferable in the
public market, subject to Rule 144 limitations applicable to affiliates,
vesting restrictions and expiration of lock-up agreements.
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<PAGE>
UNDERWRITERS
Under the terms and subject to the conditions contained in the underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Salomon Smith Barney Inc. and Thomas
Weisel Partners LLC are acting as representatives, have severally agreed to
purchase, and we have agreed to sell to them, the respective number of shares
of common stock set forth opposite the names of the underwriters below:
<TABLE>
<CAPTION>
Number of
Name Shares
---- ---------
<S> <C>
Morgan Stanley & Co. Incorporated................................. 2,225,000
Salomon Smith Barney Inc.......................................... 1,112,500
Thomas Weisel Partners LLC........................................ 1,112,500
Dain Rauscher Wessels, a division of Dain Rauscher Incorporated... 80,000
First Union Securities, Inc. ..................................... 80,000
Janney Montgomery Scott LLC....................................... 80,000
Edward D. Jones & Co., L.P. ...................................... 80,000
McAdams Wright Ragen, Inc. ....................................... 80,000
Pacific Crest Securities, Inc. ................................... 80,000
Raymond James & Associates, Inc. ................................. 80,000
SoundView Technology Group, Inc. ................................. 80,000
U.S. Bancorp Piper Jaffray Inc. .................................. 80,000
C. E. Unterberg, Towbin........................................... 80,000
---------
Total........................................................... 5,250,000
=========
</TABLE>
The underwriters are offering the shares subject to their acceptance of the
shares from us and subject to prior sale. The underwriting agreement provides
that the obligations of the several underwriters to pay for and accept
delivery of the shares of common stock offered by us in this offering are
subject to the approval of legal matters by their counsel and to other
conditions.
The underwriters are obligated to take and pay for all of the shares of
common stock offered by this prospectus, other than those covered by the over-
allotment option described below, if any of these shares are taken. Morgan
Stanley Dean Witter Online, an affiliate of Morgan Stanley & Co. Incorporated,
is acting as a selected dealer in connection with this offering and will be a
distributor of shares of common stock over the Internet to its eligible
account holders.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the public offering price set forth on the
cover page of this prospectus and part to some dealers at a price that
represents a concession not in excess of $1.09 share under the public offering
price. Any underwriters may allow, and any of these dealers may reallow, a
concession not in excess of $.00 per share to other underwriters or to some
other dealers. After the initial offering of the shares of common stock, the
offering price and other selling terms may from time to time be varied by the
representatives of the underwriters.
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to an aggregate of 787,500
additional shares of common stock at the public offering price set forth on
the cover page of this prospectus, less underwriting discounts and
commissions. The underwriters may exercise this option solely for the purpose
of covering over-allotments, if any, made in connection with this offering of
common stock. To the extent this over-allotment option is exercised, each
underwriter will become obligated, subject to specified conditions, to
purchase approximately the same percentage of additional shares of common
stock as the number set forth next to that underwriter's name in the preceding
table bears to the total number of shares of common stock set forth next to
the names of all underwriters in the preceding table.
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<PAGE>
The following table shows the per share and total underwriting discounts
and commissions to be paid to the underwriters by us and the estimated per
share and total other expenses of issuance and distribution which are payable
by us. These amounts are shown assuming both no exercise and full exercise of
the underwriters' over-allotment option. The total underwriting discounts and
commissions to be paid to the underwriters by us is a percentage of the
initial public offering price.
<TABLE>
<CAPTION>
Per Share Total
---------------------- --------------------------
No
Exercise Full Exercise No Exercise Full Exercise
-------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Underwriting discounts
and commissions paid by
us..................... $1.68 $1.68 $8,820,000 $10,143,000
Estimated expenses
payable by us.......... .34 .30 1,800,000 1,800,000
</TABLE>
At our request, the underwriters have reserved up to 385,000 shares of
common stock to be issued by us and offered hereby for sale, at the initial
public offering price, to employees, business associates and related persons
of us. The number of shares of common stock available for sale to the general
public will be reduced to the extent these individuals purchase such reserved
shares. Any reserved shares not so purchased will be offered by the
underwriters to the general public on the same basis as the other shares
offered by this prospectus.
Avenue A, our directors and officers, and a substantial majority of the
shareholders of Avenue A have agreed that, without the prior written consent
of Morgan Stanley & Co. Incorporated on behalf of the underwriters, during the
period ending 180 days after the date of this prospectus, they will not:
. offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend or otherwise transfer or dispose of
any shares of common stock or any securities convertible into or
exercisable or exchangeable for common stock, or
. enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of
common stock.
The restrictions described above do not apply to:
. the sale to the underwriters of the shares of common stock under the
underwriting agreement;
. the issuance by Avenue A of shares of common stock upon exercise of any
options or warrants or the conversion of any securities outstanding on
the date of this prospectus which is described in this prospectus;
. transactions by any person other than Avenue A relating to shares of
common stock or other securities acquired in open market transactions
after the completion of this offering;
. issuances of shares of common stock or options to purchase shares of
common stock pursuant to our employee benefit plans as in existence on
the date of this prospectus; or
. some issuances by us of shares of common stock in connection with
mergers or acquisitions, provided, among other things, the holder of
such shares agrees to be bound by the restrictions contained in the
previous paragraph.
The underwriters have informed us that they do not intend sales to
discretionary accounts to exceed 5% of the total number of shares of common
stock offered by them.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with this offering, creating a short position in the common stock
for their own account. In addition, to cover over-allotments or to stabilize
the price of the common stock, the underwriters may bid for, and purchase,
shares of common stock in the open market. Finally, the underwriting syndicate
may reclaim selling concessions allowed to an underwriter or a dealer for
distributing the common stock in this offering if the syndicate repurchases
previously distributed shares of common stock in transactions to cover
syndicate short positions, in stabilization transactions or otherwise. Any of
these activities may stabilize or maintain the market price of the common
stock above independent market levels. The underwriters are not required to
engage in these activities and may end any of these activities at any time.
74
<PAGE>
We estimate that the total expenses of the offering, excluding underwriting
discounts and commissions, will be approximately $1,800,000.
We and the underwriters have agreed to indemnify each other against some
liabilities, including liabilities under the Securities Act.
Due to the fact that one of the representatives of the underwriters was
organized within the last three years, we are providing the following
information. Thomas Weisel Partners LLC, one of the representatives of the
underwriters, was organized and registered as a broker-dealer in December
1998. Since December 1998, Thomas Weisel Partners LLC has been named as a lead
or co-manager of, or as a syndicate member in, numerous public offerings of
equity securities. Thomas Weisel Partners LLC does not have any material
relationship with us or any of our officers, directors or other controlling
persons.
Pricing of the Offering
Prior to this offering, there has been no public market for the shares of
common stock. The initial public offering price was determined by negotiations
between us and the representatives. Among the factors considered in
determining the initial public offering price were:
. our future prospects and those of our industry in general;
. our sales, earnings and other financial and operating information in
recent periods; and
. the price-earnings ratios, price-sales ratios, market prices of
securities and financial and operating information of companies engaged
in activities similar to ours.
LEGAL MATTERS
Avenue A is being represented by Perkins Coie LLP, Seattle, Washington. An
attorney at Perkins Coie LLP beneficially owns 13,393 shares of our series A
preferred stock. The underwriters are being represented by Wilson Sonsini
Goodrich & Rosati, Professional Corporation, Kirkland, Washington.
EXPERTS
The consolidated financial statements and schedules of Avenue A, Inc. and
its subsidiaries included in this prospectus and elsewhere in the registration
statement, to the extent and for the periods indicated in their reports, have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their reports with respect thereto, and are included herein in
reliance upon the authority of Arthur Andersen LLP as experts in accounting
and auditing in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act with respect to the shares of common stock offered in this
prospectus. This prospectus, which forms a part of the registration statement,
does not contain all of the information included in the registration
statement. Some information is omitted and you should refer to the
registration statement and its exhibits for that information. With respect to
references made in this prospectus to any contract or other document of Avenue
A, such references are not necessarily complete and you should refer to the
exhibits attached to the registration statement for copies of the actual
contract or document. You may review a copy of the registration statement,
including exhibits and the schedule filed with it, at the SEC's public
reference facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the regional offices of the SEC located at 7
World Trade Center, Suite 1300, New York, New York 10048, and Citicorp Center,
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may also
obtain copies of such materials from the Public Reference Room of the SEC,
Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. You may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a Web
site at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding registrants, such as Avenue A, that
file electronically with the SEC.
75
<PAGE>
AVENUE A, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
AVENUE A, INC.
Report of Independent Public Accountants................................. F-2
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Operations.................................... F-4
Consolidated Statements of Shareholders' Equity (Deficit)................ F-5
Consolidated Statements of Cash Flows.................................... F-6
Notes to Consolidated Financial Statements............................... F-7
I-BALLS L.L.C.
Report of Independent Public Accountants................................. F-20
Balance Sheets........................................................... F-21
Statements of Operations................................................. F-22
Statements of Members' Equity............................................ F-23
Statements of Cash Flows................................................. F-24
Notes to Financial Statements............................................ F-25
Unaudited Pro Forma Combined Financial Statements of Avenue A, Inc. and
I-Balls L.L.C. ......................................................... F-28
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of Avenue A, Inc.:
We have audited the accompanying consolidated balance sheets of Avenue A, Inc.
and subsidiaries as of December 31, 1998 and 1999, and the related
consolidated statements of operations, shareholders' equity (deficit) and cash
flows for the period from inception (July 1, 1997) to December 31, 1997 and
for each of the two years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Avenue A, Inc. and its
subsidiaries as of December 31, 1998 and 1999, and the results of their
operations and their cash flows for the period from inception to December 31,
1997 and for each of the two years in the period ended December 31, 1999, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Seattle, Washington,
February 6, 2000
F-2
<PAGE>
AVENUE A, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Pro Forma
Shareholders'
December 31, Equity at
----------------- December 31,
1998 1999 1999
------- -------- -------------
(unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents.................... $ 847 $ 10,962
Short-term investments....................... -- 11,803
Accounts receivable, net of allowance of $70
and $1,594 in 1998 and 1999, respectively... 1,545 28,295
Other receivable............................. -- 183
Prepaid expenses and other current assets.... 9 153
------- --------
Total current assets........................... 2,401 51,396
------- --------
Property and equipment, net.................... 1,027 4,625
Intangible assets, net......................... -- 5,221
Other assets................................... 13 849
------- --------
Total assets................................... $ 3,441 $ 62,091
======= ========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable............................. $ 2,078 $ 36,075
Accrued expenses............................. 187 3,066
Due to affiliates............................ 75 --
Deferred revenue............................. 91 20
Note payable, current portion................ -- 303
------- --------
Total current liabilities...................... 2,431 39,464
------- --------
Long-term note payable......................... -- 683
------- --------
Total liabilities.............................. 2,431 40,147
------- --------
Commitments and contingencies (Note 7)
Shareholders' equity:
Convertible preferred stock, $0.01 par value,
aggregate liquidation preferences of $25,293
at December 31, 1999
Authorized 37,500,000
Outstanding 3,998,474 and 16,416,098 at
December 31,1998 and 1999.................. 40 164 $ --
Common stock, $0.01 par value
Authorized 200,000,000
Outstanding 18,059,700 and 25,121,135 at
December 31,1998 and 1999; 49,745,282
shares outstanding pro forma............... 181 251 497
Paid-in-capital............................... 4,156 60,424 60,342
Deferred stock compensation................... -- (22,670) (22,670)
Subscriptions receivable...................... -- (965) (965)
Accumulated deficit........................... (3,367) (15,260) (15,260)
------- -------- -------
Total shareholders' equity..................... 1,010 21,944 $21,944
------- -------- =======
Total liabilities and shareholders' equity..... $ 3,441 $ 62,091
======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
AVENUE A, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
Period from Year Ended
Inception December 31,
(July 1, 1997) to ----------------------
December 31, 1997 1998 1999
----------------- ---------- ----------
<S> <C> <C> <C>
Revenue:
Advertising services.............. $ -- $ -- $ 67,074
Advertising service fees.......... 18 599 2,621
------ ---------- ----------
Total revenue................... 18 599 69,695
------ ---------- ----------
Expenses:
Cost of advertising services...... 20 125 56,979
Client services................... 19 382 4,860
Technology and operations......... -- 1,493 3,292
Selling, general and
administrative................... 263 2,257 12,330
Amortization of deferred stock
compensation..................... -- -- 4,681
------ ---------- ----------
Total expenses.................. 302 4,257 82,142
------ ---------- ----------
Loss from operations................ (284) (3,658) (12,447)
Interest income, net................ -- 12 554
------ ---------- ----------
Loss before provision for income
taxes.............................. (284) (3,646) (11,893)
Provision for income taxes.......... -- -- --
------ ---------- ----------
Net loss............................ $ (284) $ (3,646) $ (11,893)
====== ========== ==========
Basic and diluted net loss per
share.............................. $ (.34) $ (.61)
========== ==========
Shares used in computing basic and
diluted net loss per share......... 10,860,682 19,428,034
========== ==========
Pro forma basic and diluted net loss
per share.......................... $ (.31)
==========
Shares used in computing pro forma
basic and diluted net loss
per share.......................... 38,466,488
==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
AVENUE A, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
<TABLE>
<CAPTION>
Convertible Accumulated
Preferred Stock Common Stock Deficit
----------------- ----------------- Paid-In Deferred Stock Subscriptions Prior to Accumulated
Shares Amount Shares Amount Capital Compensation Receivable Incorporation Deficit
---------- ------ ---------- ------ ------- -------------- ------------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES, July 1,
1997............. -- $ -- -- $ -- $ -- $ -- $ -- $ -- $ --
Net loss........ -- -- -- -- -- -- -- (284) --
---------- ----- ---------- ----- ------- -------- ----- ----- --------
BALANCES,
December 31,
1997............. -- -- -- -- -- -- -- (284) --
Net loss prior
to incorporation
on February 27,
1998............ -- -- -- -- -- -- -- (279) --
Issuance of
common stock to
affiliates for
cash, conversion
of payable and
satisfaction of
payable......... -- -- 18,000,000 180 857 -- -- 563 --
Exercise of
common stock
options......... -- -- 59,700 1 3 -- -- -- --
Issuance of
convertible
preferred stock
and issuance of
common stock
warrants for
cash, net of
offering costs
of approximately
$165............ 3,998,474 40 -- -- 3,271 -- -- -- --
Compensation
expense
associated with
stock option
grants.......... -- -- -- -- 25 -- -- -- --
Net loss from
February 27,
1998 to December
31, 1998........ -- -- -- -- -- -- -- -- (3,367)
---------- ----- ---------- ----- ------- -------- ----- ----- --------
BALANCES,
December 31,
1998............. 3,998,474 40 18,059,700 181 4,156 -- -- -- (3,367)
Issuance of
preferred stock,
net of offering
costs of
approximately
$170............ 12,417,624 124 -- -- 21,755 -- -- -- --
Deferred stock
compensation
related to stock
options......... -- -- -- -- 27,351 (27,351) -- -- --
Amortization of
deferred stock
compensation.... -- -- -- -- -- 4,681 -- -- --
Issuance of
common stock in
connection with
the I-Balls
acquisition..... -- -- 750,000 8 2,492 -- -- -- --
Issuance of
common stock for
services........ -- -- 83,266 1 166 -- -- -- --
Issuance of
common stock
options to
consultants..... -- -- -- -- 153 -- -- -- --
Exercise of
common stock
options and sale
of restricted
stock........... -- -- 6,228,169 61 4,374 -- (965) -- --
Unrealized loss
on investment... -- -- -- -- (23) -- -- -- --
Net loss........ -- -- -- -- -- -- -- -- (11,893)
---------- ----- ---------- ----- ------- -------- ----- ----- --------
BALANCES,
December 31,
1999............. 16,416,098 $ 164 25,121,135 $ 251 $60,424 $(22,670) $(965) $ -- $(15,260)
========== ===== ========== ===== ======= ======== ===== ===== ========
<CAPTION>
Total
Shareholders'
Equity
(Deficit)
-------------
<S> <C>
BALANCES, July 1,
1997............. $ --
Net loss........ (284)
-------------
BALANCES,
December 31,
1997............. (284)
Net loss prior
to incorporation
on February 27,
1998............ (279)
Issuance of
common stock to
affiliates for
cash, conversion
of payable and
satisfaction of
payable......... 1,600
Exercise of
common stock
options......... 4
Issuance of
convertible
preferred stock
and issuance of
common stock
warrants for
cash, net of
offering costs
of approximately
$165............ 3,311
Compensation
expense
associated with
stock option
grants.......... 25
Net loss from
February 27,
1998 to December
31, 1998........ (3,367)
-------------
BALANCES,
December 31,
1998............. 1,010
Issuance of
preferred stock,
net of offering
costs of
approximately
$170............ 21,879
Deferred stock
compensation
related to stock
options......... --
Amortization of
deferred stock
compensation.... 4,681
Issuance of
common stock in
connection with
the I-Balls
acquisition..... 2,500
Issuance of
common stock for
services........ 167
Issuance of
common stock
options to
consultants..... 153
Exercise of
common stock
options and sale
of restricted
stock........... 3,470
Unrealized loss
on investment... (23)
Net loss........ (11,893)
-------------
BALANCES,
December 31,
1999............. $ 21,944
=============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
AVENUE A, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Period from
Inception
(July 1, 1997) Year Ended
to December 31,
December 31, -----------------
1997 1998 1999
-------------- ------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................... $(284) $(3,646) $(11,893)
Adjustments to reconcile net loss to net
cash used in operating activities--
Depreciation and amortization............. 2 155 1,504
Amortization of deferred stock
compensation............................. -- -- 4,681
Noncash compensation expense.............. -- 25 320
Changes in assets and liabilities, net of
acquisition:
Accounts receivable..................... (8) (1,537) (25,368)
Other receivables and other current
assets................................. (10) 1 (326)
Other assets............................ (4) (9) (799)
Accounts payable........................ 5 2,073 32,126
Accrued expenses........................ 19 168 2,848
Deferred revenue........................ -- 91 (208)
----- ------- --------
Net cash (used in) provided by operating
activities................................. (280) (2,679) 2,885
----- ------- --------
Cash flows from investing activities:
Purchases of property and equipment......... (52) (1,132) (4,439)
Purchase of I-Balls, LLC.................... -- -- (3,601)
Proceeds from sale of marketable
securities................................. -- -- 2,084
Purchase of marketable securities........... -- -- (13,887)
Cash acquired in I-Balls acquisition........ -- -- 812
----- ------- --------
Net cash used in investing activities....... (52) (1,132) (19,031)
----- ------- --------
Cash flows from financing activities:
Borrowings on note payable.................. -- -- 1,000
Payments on note payable.................... -- -- (14)
Proceeds from issuance of common stock,
net........................................ -- 1,471 1,643
Proceeds from issuance of convertible
preferred stock............................ -- 3,311 21,879
Proceeds from the exercise of common stock
options.................................... -- 4 1,829
Advances from (payments to) affiliate, net.. 335 (131) (76)
----- ------- --------
Net cash provided by financing activities... 335 4,655 26,261
----- ------- --------
Net increase in cash and cash equivalents... 3 844 10,115
Cash and cash equivalents, beginning of
period..................................... -- 3 847
----- ------- --------
Cash and cash equivalents, end of period.... $ 3 $ 847 $ 10,962
===== ======= ========
Supplemental disclosure of noncash
activities:
Affiliate payable converted to common
stock...................................... $ -- $ 139 $ --
===== ======= ========
Conversion of accumulated deficit prior to
incorporation to contributed capital....... $ -- $ (563) $ --
===== ======= ========
Common stock issued in I-Balls acquisition.. $ -- $ -- $ 2,500
===== ======= ========
Subscriptions receivable.................... $ -- $ -- $ 965
===== ======= ========
Deferred stock compensation................. $ -- $ -- $ 27,351
===== ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(in thousands except share and per share data)
1. Organization and Operations of the Company
Avenue A, Inc. (the Company) is an Internet advertising services company
that was founded on July 1, 1997. During the early stages of the Company,
Pacific Coast Feather Company (PCF) provided loans to fund operations and
provided certain accounting services. As of December 31, 1999, all of the
loans were either repaid or converted to common stock in the Company and all
services provided by PCF were paid for. On February 27, 1998, the Company was
incorporated.
On September 2, 1999, the Company completed the acquisition of I-Balls LLC
(I-Balls) a full service interactive media planner and buyer. The acquisition
was recorded under the purchase method of accounting and, therefore, the
results of operations of I-Balls and the fair value of the acquired assets and
liabilities were included in the Company's consolidated financial statements
beginning on the acquisition date (Note 3).
The Company is subject to a number of risks similar to other companies in a
comparable stage of development including reliance on key personnel,
competition from other companies with greater financial, technical and
marketing resources, and the risk relating to the ability to secure adequate
financing.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include demand deposits, money market accounts
and all highly liquid debt instruments with an original maturity date of three
months or less.
Stock Split
In January 2000, the Board of Directors approved a 3-for-2 stock split in
the form of a common stock dividend of the Company's common stock. The related
common stock, per-share data and preferred stock conversion ratios in the
accompanying financial statements have been retroactively adjusted to reflect
the stock split.
Short-Term Investments
The Company's short-term investments consist primarily of investment-grade
marketable securities, which are classified as available for sale and recorded
at fair value.
At December 31, 1998, all short-term investments had a contractual maturity
of one year or less.
F-7
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
Financial Instruments and Concentrations of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist of cash and cash equivalents, short-term
investments, accounts receivable and accounts payable. Fair values of cash and
cash equivalents and short-term investments approximate cost due to the short
period of time to maturity. The fair values of financial instruments that are
short-term and/or that have little or no market risk are considered to have a
fair value equal to book value. Assets and liabilities that are included in
this category are accounts receivable and accounts payable.
The Company performs initial and ongoing evaluations of its customers'
financial position, and generally extends credit on open account, requiring
collateral as deemed necessary. The Company maintains allowances for potential
credit losses.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets, of
three to five years. Leasehold improvements are amortized over the shorter of
the remaining lease term or the estimated useful lives of the improvements
using the straight-line method.
Intangible Assets
As of December 31, 1999, intangible assets consisted of the following:
<TABLE>
<S> <C>
Customer Base...................................................... $5,745
Skilled workforce.................................................. 127
------
5,872
Less: Accumulated Amortization..................................... (651)
------
$5,221
======
</TABLE>
The Company identifies and records impairment losses on intangible and
other assets when events and circumstances indicate that such assets might be
impaired. The Company considers factors such as significant changes in the
regulatory or business climate and projected future cash flows from the
respective asset. Impairment losses are measured as the amount by which the
carrying amount of the asset exceeds the fair value of the asset.
Subscriptions Receivable
In conjunction with the exercise of certain stock options by several
executives of the Company, the Company received full recourse promissory notes
in the amount of approximately $965. The notes are due on demand and bear
interest at a rate equal to the greater of the applicable federal rate for a
demand note or the lowest rate allowable by the Internal Revenue Code of 1986.
Revenue Recognition
Revenue consists of both advertising services revenue and advertising
service fee revenue. Advertising services revenue consists of the gross value
of the Company's billings to the Company's clients, which includes the price
of the advertising space that the Company purchases from Web sites to resell
to its clients. Under
F-8
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
advertising services contracts, the Company purchases advertising space from
publisher Web sites and sells the purchased space to the Company's clients.
Under advertising services arrangements, the Company is ultimately responsible
for payment to Web sites for the cost of space the Company purchases.
Advertising service fees revenue consists of commissions earned on services
the Company provides to its clients. To generate revenue from advertising
service fees, the Company buys advertising space from publisher Web sites on
behalf of its clients and earns fees based on the dollar amount of advertising
space the Company purchases. Under the advertising service fee arrangements,
the Company's clients are ultimately responsible for payment to the publisher
Web sites for the cost of the advertising space purchased. Revenue under both
advertising services and advertising service fees is recognized over the
period that the related advertising is delivered.
Revenue is deferred in cases where the Company has not yet earned
advertising revenue due to billing the customer or receiving payment from the
customer prior to providing the services.
The percentage of sales to customers representing more than 10% of
consolidated revenues is as follows:
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Customer A................................................. * * 17%
Customer B................................................. * * 15%
Customer C................................................. * * 11%
Customer D................................................. * 19% *
Customer E................................................. * 17% *
Customer F................................................. * 14% *
Customer G................................................. * 10% *
Customer H................................................. 100% * *
</TABLE>
- --------
* Less than 10%
Computation of Basic and Diluted Net Loss Per Share and Pro Forma Basic and
Diluted Net Loss Per Share
Historical net loss per share has been calculated under Statement of
Financial Accounting Standards No. 128 "Earnings per Share." Basic net loss
per share on a historical basis is computed using the weighted average number
of shares of common stock outstanding. Unvested outstanding shares subject to
repurchase rights are excluded from the calculation. No diluted loss per share
information has been presented in the accompanying consolidated statements of
operations since potential common shares from conversion of preferred stock,
stock options, and warrants are antidilutive.
Pro forma basic and diluted net loss per share has been calculated assuming
the conversion of preferred stock into 1.5 shares of common stock as if the
shares had converted on the dates of their issuance.
Income Taxes
The Company recognizes deferred income tax assets and liabilities for the
expected future income tax consequences of temporary differences between the
financial reporting and tax bases of assets, liabilities and tax
carryforwards. Deferred tax assets are then reduced, if deemed necessary, by a
valuation allowance for the amount of any tax benefits which, more likely than
not based on current circumstances, are not expected to be realized (see Note
5).
F-9
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
Costs of Advertising Services, Costs of Advertising Service Fees, Client
Services, and Technology and Operations
Cost of advertising services consist of the costs of advertising space that
the Company purchases from publisher's Web sites and the costs of delivering
the advertisements over the Internet.
Cost of advertising service fees revenue consists only of the costs of
delivering advertisements over the Internet.
Client services expenses consist primarily of salaries and related expenses
for client service personnel. Also included in client services costs are the
salaries and related expenses of personnel in the Company's data analysis
group.
Technology and operations expenses consist of salaries and related costs
for information technology and software development personnel. In addition,
these expenses include the cost of housing the Company's ad serving equipment
at third-party co-location facilities.
Stock-Based Compensation
The Company has elected to apply the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation" (SFAS 123). In accordance with the provisions of SFAS 123,
the Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25), and related interpretations in
accounting for its stock option plan.
Unaudited Pro Forma Shareholders' Equity
If the offering contemplated by this prospectus is consummated, all of the
preferred stock outstanding as of the closing date will automatically be
converted into 1.5 shares of common stock. Unaudited pro forma shareholders'
equity at December 31, 1999, as adjusted for the conversion of preferred
stock, is presented in the accompanying consolidated balance sheet.
Comprehensive Income
In 1999, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income (SFAS 130)." SFAS 130 requires
companies to report a new, additional measure of income on the income
statement or to create a new financial statement that shows the new measure of
income. Comprehensive income includes foreign currency translation gains and
losses and unrealized gains and losses on equity securities that have been
previously excluded from net income and reflected instead in equity. A
separate statement was not included as SFAS 130 did not have a material impact
on the Company's results of operations.
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131). SFAS 131 changes the way
companies report selected segment information in annual financial statements
and requires companies to report selected segment information in interim
financial reports to shareholders. SFAS 131 is effective for Avenue A's year
ending December 31, 1999. Avenue A operates solely in one segment, providing
Internet advertising services. As of December 31, 1998, and 1999, the
Company's assets are located solely in
F-10
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
the United States. The Company has no sales to international customers and
therefore the Company has no international revenue.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 was
effective for financial statements for years beginning after December 15,
1998. SOP 98-1 provides guidance over accounting for computer software
developed or obtained for internal use including the requirement to capitalize
specific costs and amortization of such costs. The Company implemented SOP 98-
1 and capitalized approximately $452 of internally developed software costs.
Accumulated depreciation related to the capitalized costs was approximately
$75 at December 31, 1999.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of
Start-Up Activities." SOP 98-5, which is effective for fiscal years beginning
after December 15, 1998, provides guidance on the financial reporting of
start-up costs and organization costs. It requires costs of start-up
activities and organization costs to be expensed as incurred. The
implementation of SOP 98-5 did not have a material impact on the Company's
financial position or results of operations.
In December 1999, the Staff of the Securities and Exchange Commission
released Staff Accounting Bulletin 101 (SAB 101), "Revenue Recognition" to
provide guidance on the recognition, presentation and disclosure of revenue in
financial statements. The Company believes their revenue recognition practices
are in conformity with the guidelines in SAB 101.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
3. Acquisitions
Effective September 2, 1999, the Company acquired I-Balls, a New York
based, full service interactive media planning and buying company. In
connection with the acquisition, the Company issued 750,000 shares of common
stock and paid $3.5 million in cash in exchange for all of the outstanding
members' equity. The deemed fair value of the common stock issued in the
acquisition, for accounting purposes, was approximately $2.5 million. The
Company also incurred $101 in acquisition costs, for a total purchase price of
$6,101. At the date of closing, $500 of the cash payment was deposited in an
escrow account. The acquisition was accounted for as a purchase and,
accordingly, the results of operations of I-Balls have been included in the
consolidated financial statements commencing on the date of acquisition. The
excess of the purchase price over the value of the net assets acquired of
approximately $5,872 was allocated to customer base and skilled workforce,
which is being amortized on a straight-line basis over a useful life of three
years. Accumulated amortization was approximately $651 at December 31, 1999.
In connection with the acquisition, net assets acquired were as follows:
<TABLE>
<S> <C>
Cash, receivables and other current assets........................ $2,194
Property and equipment, and other noncurrent assets............... 74
Current liabilities............................................... (2,039)
------
$ 229
======
</TABLE>
F-11
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
The following table presents the unaudited pro forma results assuming that
the Company had acquired I-Balls at the beginning of fiscal year 1998. This
information may not necessarily be indicative of the future combined results
of operations of the Company.
<TABLE>
<CAPTION>
Year Ended
December 31,
-----------------
1998 1999
------- --------
<S> <C> <C>
Total revenue............................................ $ 1,607 $ 71,197
Net loss................................................. $(5,244) $(12,455)
Basic net loss per share................................. $ (.68) $ (.62)
</TABLE>
4. Property and Equipment
<TABLE>
<CAPTION>
December 31,
--------------
1998 1999
------ ------
<S> <C> <C>
Computer equipment........................................... $1,161 $4,368
Furniture and fixtures....................................... 23 355
Software costs............................................... -- 452
Leasehold improvements....................................... -- 427
------ ------
1,184 5,602
Less: Accumulated depreciation and amortization.............. (157) (977)
------ ------
$1,027 $4,625
====== ======
</TABLE>
5. Federal Income Taxes
The Company did not provide any current or deferred U.S. federal or state
income tax provision or benefit for any of the periods presented because it
has experienced operating losses since inception, and has provided full
valuation allowances on deferred tax assets because of uncertainty regarding
their realizability.
The difference between the statutory federal tax rate of 34% and the tax
provision of zero recorded by the Company is primarily due to the Company's
full valuation allowance against its deferred tax assets.
At December 31, 1999, the Company had net operating loss carryforwards of
approximately $9.8 million related to U.S federal and state jurisdictions.
Utilization of net operating loss carryforwards are subject to certain
limitations under Section 382 of the Internal Revenue Code of 1986, as
amended, as a result of the Series C preferred financing transaction in 1999.
The Company's use of losses is limited to approximately $1.8 million per year
on net operating losses incurred prior to May 1999. These carryforwards will
begin to expire at various times commencing in 2018.
F-12
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred taxes were as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------
1998 1999
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $ 1,032 $ 3,322
Other..................................................... 46 296
------- -------
Total deferred assets................................... 1,078 3,618
Deferred tax liabilities:
Property and equipment.................................... (30) (156)
Intangible assets......................................... -- (1,775)
Valuation allowance for deferred tax assets............... (1,048) (1,687)
------- -------
Net deferred taxes...................................... $ -- $ --
======= =======
</TABLE>
6. Shareholders' Equity
Convertible Preferred Stock
As of December 31, 1999, the Company was authorized to issue 37.5 million
shares of preferred stock. Shares of preferred stock may be issued from time
to time in one or more series, with designations, rights, preferences and
limitations established by the Company's Board of Directors.
As of December 31, 1999, the Company had designated three series of
convertible preferred stock (Series A through C).
The rights and privileges of the Preferred Stock are as follows:
Dividends--Holders of Series A, B and C are entitled to receive
dividends of $0.05, $0.05 and $0.10, respectively, per share per annum,
when and if declared by the Board of Directors. Such dividends are not
cumulative. As of December 31, 1999, no dividends have been declared.
Conversion--Each share of Series A and B is convertible, at the option
of the holders or upon the vote of two-thirds of the Series A and B
shareholders, respectively, into 1.5 shares of common stock. Each share of
Series C is convertible at the option of the shareholders into 1.5 shares
of common stock. Each share of Series A and B automatically converts into
common stock upon the closing of a public offering that meets certain
conditions. Each share of Series C automatically converts into common stock
upon the closing of a public offering with an aggregate offering price of
not less than $20 million (the "Proceeds Target"). In the event the Company
closes a public offering which meets the Proceeds Target but is at a per
share price to the public which is less than $2.59, each share of Series C
preferred stock shall, upon the closing of such offering, be converted into
the number of shares of common stock which equals $2.59 divided by the per
share price to the public in such offering.
Liquidation Preferences--The Series A, B and C shares have liquidation
preferences of $.83, $1.12 and $1.94 per share, respectively, plus all
declared but unpaid dividends.
F-13
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
If the value of the Company on liquidation is insufficient to pay the
entire preferential amount, distribution shall be made pro rata to all
preferred shareholders in proportion to the preferential amount the
preferred shareholder is otherwise entitled to receive.
Any assets remaining after the preferential distribution will be paid to
holders of common stock in proportion to shares held by each.
Voting Rights--The holders of each share of preferred stock shall be
entitled to the number of votes equal to the number of shares of common
stock into which such shares could be converted, and have voting rights
equal to holders of common stock.
Stock Option Plan
As of December 31, 1999, the Company has reserved 15,525,000 shares of
common stock for issuance under its 1998 Stock Incentive Compensation Plan
(the Plan) to employees and consultants of the Company. Under the Plan, either
incentive or nonqualified options to purchase the Company's common stock may
be granted to full-time employees and consultants at prices determined by the
Board of Directors. Options granted under the Plan are exercisable at such
times and under such conditions as determined by the Board of Directors, but
the term of the options and the right of exercise may not exceed 10 years from
the date of grant. The stock options typically vest 20% in the first year and
ratably over the following twelve quarters. The Plan permits the exercise of
unvested options. Unvested common stock purchased under the Plan may be
subject to repurchase by the Company at the option exercise price in the event
of termination of employment. At December 31, 1999, 3,147,285 of the shares
acquired under the Plan were subject to the Company's repurchase rights. The
Company accounts for the Plan under APB 25 for which approximately $25 and
$4,681 has been recognized as compensation expense for the issuance of non-
qualified stock options for the years ending December 31, 1998 and 1999,
respectively. Had compensation expense for the Plan been determined consistent
with SFAS 123, the Company's net loss would have been increased as follows:
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1998 1999
----- ------- --------
<S> <C> <C> <C>
Net Loss:
As reported..................................... $(284) $(3,646) $(11,893)
Pro forma....................................... $(3,649) $(12,011)
Basic and Diluted Net Loss Per Share:
As reported..................................... $ (.34) $ (.61)
Pro forma....................................... $ (.34) $ (.62)
</TABLE>
To determine compensation expense under SFAS 123, the Company used the
following assumptions:
<TABLE>
<CAPTION>
December 31,
----------------
1998 1999
------ ---------
<S> <C> <C>
. Weighted average risk-free interest rate.................. 5.26 5.62
. Expected lives............................................ 1 year 1-4 years
. Expected dividend yields.................................. -- --
. Expected volatility....................................... -- --
</TABLE>
F-14
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
Option activity under the Plan was as follows:
<TABLE>
<CAPTION>
Weighted Weighted
Options Average Average
Available Options Exercise Grant Date
for Grant Outstanding Price Fair Value
---------- ----------- -------- ----------
<S> <C> <C> <C> <C>
Balances, December 31, 1997... -- -- --
Authorized.................. 5,250,000 -- --
Granted..................... (4,774,575) (4,774,575) $ .14 $ .03
Exercised................... -- (59,700) .07
Cancelled................... 36,000 (36,000) .13
---------- ----------
Balances, December 31, 1998... 511,425 4,678,875 $ .14
Authorized.................. 10,275,000 --
Granted..................... (8,829,389) 8,829,389 $1.87 $1.87
Exercised................... -- (5,681,422) .52
Cancelled................... 653,757 (653,757) .29
---------- ----------
Balances, December 31, 1999... 2,610,793 7,173,085 $1.95
========== ==========
</TABLE>
The following information is provided for options outstanding and
exercisable at December 31, 1999:
<TABLE>
<CAPTION>
Outstanding Exercisable
-------------------------- -----------
Weighted Average
Remaining
Exercise Number of Contractual Life Number of
Price Options (Years) Options
-------- --------- ---------------- -----------
<S> <C> <C> <C>
$ .07 359,675 8.48 359,675
.33 402,429 8.74 402,429
.52 475,132 9.15 475,132
1.03 189,000 9.47 189,000
1.27 2,176,147 9.68 2,176,147
2.67 2,640,901 8.55 2,640,901
3.33 426,551 9.92 426,551
4.33 503,250 9.96 503,250
</TABLE>
The options outstanding at December 31, 1999 have a weighted average
remaining contractual life of approximately 9.14 years. Of these options,
2,593,837 are fully vested and 7,173,085 are exercisable as of December 31,
1999 with exercise prices ranging from $.07 to $4.33. In addition to the
shares noted above, the Company has granted 1,312,500 options outside of the
Plan at exercise prices ranging from $1.27 to $1.67 to employees of I-Balls.
In November 1999, the Board of Directors and shareholders approved the
adoption of the Company's 1999 Stock Incentive Compensation Plan (the 1999
Plan). In January 2000, the Board of Directors increased the shares available
for issuance under the 1999 Plan, subject to shareholder approval. The Company
has reserved 1.5 million shares of common stock for issuance under the 1999
Plan with a proposed increase to 5,250,000 shares. No issuances have been made
under the 1999 Plan as of December 31, 1999. The shares under the 1999 Plan
will increase annually on the first day of the Company's fiscal year beginning
in 2001 by an
F-15
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
amount equal to the lesser of (i) 5,250,000 shares, (ii) 8% of the adjusted
average common shares outstanding of the Company used to calculate fully
diluted earnings per share for the preceding year or (iii) a lesser amount
determined by the Board of Directors. Any shares not yet issued under the
Company's 1998 Stock Incentive Compensation Plan as of the date of the
Company's proposed initial public offering, as well as shares subject to
options under the 1998 Plan that expire or are cancelled without being
exercised, will be available for grant under the 1999 Plan. The exercise price
for incentive stock options may not be less than 100% of the fair value of the
Company's common stock on the date of grant (85% for nonstatutory options).
The 1999 Plan terms and conditions are substantially the same as the 1998
Stock Incentive Compensation Plan.
Employee Stock Purchase Plan
On November 16, 1999, the Board of Directors approved the adoption of the
Company's 1999 Employee Stock Purchase Plan (the 1999 Purchase Plan), subject
to shareholder approval. A total of 750,000 shares of common stock has been
reserved for issuance under the 1999 Purchase Plan. The shares under the 1999
Purchase Plan will increase annually on the first day of the Company's fiscal
year beginning in 2001 by an amount equal to the lessor of (i) 1,125,000
shares of common stock, (ii) 2% of the adjusted average common shares
outstanding of the Company used to calculate fully diluted earnings per share
for the preceding year, or (iii) a lesser amount determined by the Board of
Directors. The 1999 Purchase Plan permits eligible employees to acquire shares
of the Company's common stock through periodic payroll deductions of up to 20%
of base cash compensation. Each offering period will have a maximum duration
of 12 months. The price at which the common stock may be purchased is 85% of
the lesser of the fair market value of the Company's common stock on the first
day of the applicable offering period or on the last day of the respective
purchase period. The initial offering period will commence on the
effectiveness of the initial public offering and will end on January 31, 2001.
Deferred Stock Compensation
In connection with the grant of certain stock options to employees and
consultants during the year ended December 31, 1999, the Company recorded
deferred stock compensation of approximately $27.4 million representing the
difference between the deemed fair value of the common stock for accounting
purposes and the option exercise price of such options at the date of grant.
Such amount is presented as a reduction of shareholders' equity and amortized,
in accordance with Financial Accounting Standards Board Interpretation No. 28,
on an accelerated basis over the vesting period of the applicable options
(generally 4 years). Under this method, approximately 52% of the Deferred
Stock Compensation is recognized in the first twelve months, 27% in the second
twelve months, 15% in the third twelve months and 6% in the fourth twelve
months.
During 1999, the Company amortized approximately $4,681. Compensation
expense is decreased in the period of forfeiture for any accrued but unvested
compensation arising from the early termination of an option holder's
services.
Equity Instruments Issued to Non-employees
In connection with the sale of Series A preferred stock, the Company issued
a warrant to purchase 677,710 shares of common stock at an exercise price of
$.55 per share. The warrant had a grant date fair value of $.23 per share and
expires in August 2003. To determine the grant date fair value, the Company
used a risk free interest rate of 5.6%, expected life of five years, expected
dividend yields of 0%, and expected volatility of 105%. The Company recorded
expense of $157 during the year ended December 31, 1998 related to the
warrant.
F-16
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
During 1999, the Company granted options to purchase 257,025 shares of the
Common Stock at exercise prices ranging from $.52 to $1.27 per share to
consultants for past services. The two option grants had grant date fair
values of $.23 and $.74 per share, respectively, and expire in 2009. To
determine the grant date fair value, the Company used a risk free interest
rate of 4.4% and 4.8%, respectively, expected life of two years, expected
dividend yields of 0%, and expected volatility of 111%. The Company expensed
approximately $153 during the year ended December 31, 1999 related to the
options.
Reserved for Future Issuance
The following shares of common stock have been reserved for future issuance
as of December 31, 1999:
<TABLE>
<S> <C>
Employee stock options........................................ 7,173,085
Stock options issued outside of the Plan...................... 1,312,500
Convertible Preferred Stock................................... 24,624,147
Warrants...................................................... 677,710
----------
33,787,442
==========
</TABLE>
7. Commitments and Contingencies
Operating Leases
The Company has various operating leases, including building and equipment,
that expire at various times through 2010. Future minimum lease payments as of
December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000.............................................................. $1,456
2001.............................................................. 1,383
2002.............................................................. 1,180
2003.............................................................. 1,195
2004.............................................................. 915
------
$6,129
======
</TABLE>
Rent expense under operating leases totaled approximately $0, $182 and $601
for the years ended December 31, 1997, 1998 and 1999 respectively.
The above future minimum lease payments include a commitment of
approximately $21 per month expiring on June 30, 2001, which has been
subleased at a loss. The loss of approximately $54 has been recognized in the
statement of operations.
The Company has multiple agreements with third-parties to house the
Company's ad serving equipment. One of the agreements is on a month-to-month
basis and the other agreement is on a year-to-year basis. For the year ended
December 31, 1999, total expense under these agreements approximated $240.
F-17
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
8. Related Party Transactions
Prior to incorporation on February 27, 1998, the Company relied on non-
interest bearing loans from PCF to fund operations. During 1998, PCF converted
approximately $139 of the debt to 1,421,850 shares of the Company's common
stock. Subsequent to year-end, the Company repaid all loans to PCF. The
accompanying statement of operations includes allocations from PCF for certain
accounting services. These allocations totaled approximately $32 and $1 in
1997 and 1998, respectively, and were based on estimates of time and effort
spent by PCF personnel on behalf of the Company. Additionally, PCF paid the
Company approximately $36 and $33 during 1998 and 1999, respectively, for
advertising services. At December 31, 1997 and 1998, amounts due to PCF were
approximately $335 and $75, respectively.
9. Earnings Per Share
The following is a reconciliation of the numerators and denominators used
in computing basic and diluted earnings per share:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1997 1998 1999
----- ---------- ----------
<S> <C> <C> <C>
Net Loss (numerator for basic and diluted)... $(284) $ (3,646) $ (11,893)
===== ========== ==========
Shares (denominator for basic and diluted):
Gross weighted average common shares
outstanding............................... 10,860,682 20,536,376
Less:
Weighted average common shares subject to
repurchase............................... -- 1,108,342
---------- ----------
Shares used in computation................... 10,860,682 19,428,034
========== ==========
Basic and diluted net loss per share......... $ (.34) $ (.61)
========== ==========
</TABLE>
The following is a reconciliation between historical and pro forma shares
used in computing basic and diluted net loss per share:
<TABLE>
<CAPTION>
Year Ended
December 31,
---------------------
1998 1999
---------- ----------
<S> <C> <C>
Historical weighted average shares used in computing
basic and diluted net loss per share................. 10,860,682 19,428,034
Add:
Weighted average preferred stock that will convert
upon the closing of a public offering.............. 2,526,806 19,038,454
---------- ----------
Pro forma shares used in computing basic and diluted
net loss per share................................... 13,387,488 38,466,488
========== ==========
</TABLE>
At December 31, 1999, options to purchase 7,173,085 shares of common stock,
warrants to purchase 677,710 shares of common stock, 16,416,098 shares of
convertible preferred stock to purchase 24,624,147 shares of common stock and
3,147,285 shares of common stock subject to repurchase rights were outstanding
but were not included in the computation of diluted earnings per share as
their inclusion would be antidilutive.
F-18
<PAGE>
AVENUE A, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
DECEMBER 31, 1999
(in thousands except share and per share data)
10. Note Payable
During November and December 1999, the Company borrowed a total of
$1,000,000 under an equipment term loan facility. The loan is secured by the
equipment and is payable in monthly installments of principal and interest of
approximately $32. Interest is accrued on the outstanding balance at a per
annum rate of one percentage point above the Prime Rate. As of December 31,
1999, the interest rate was 9.5%.
Minimum principal payments are as follows:
<TABLE>
<S> <C>
2000.................................................................... $303
2001.................................................................... 333
2002.................................................................... 350
----
$986
====
</TABLE>
11. Subsequent Event
On February 4, 2000, the Company entered into a ten-year facilities lease
to commence on December 1, 2000. The payments under the lease commitment total
approximately $11,060,000.
F-19
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Members of I-Balls L.L.C.:
We have audited the accompanying balance sheets of I-Balls L.L.C. as of
December 31, 1997 and 1998, and the related statements of operations, members'
equity and cash flows for the period January 28, 1997 to December 31, 1997 and
the year ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of I-Balls L.L.C. as of
December 31, 1997 and 1998, and the results of its operations and its cash
flows for the period January 28, 1997 to December 31, 1997 and the year ended
December 31, 1998, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
New York, New York
October 29, 1999
F-20
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------- September 2,
1997 1998 1999
-------- ---------- ------------
(Unaudited)
<S> <C> <C> <C>
Assets
Current Assets:
Cash and cash equivalents................... $ 49,730 $ 494,505 $ 811,610
Accounts receivable, net of allowance for
doubtful accounts of $4,100, $59,900 and
$123,600, respectively..................... 438,395 992,172 1,151,264
Unbilled receivables........................ -- 181,572 230,087
Prepaids and other current assets........... 4,070 8,054 1,000
-------- ---------- ----------
Total current assets.......................... 492,195 1,676,303 2,193,961
Equipment and leasehold improvements, net..... 14,607 16,958 36,672
Other assets.................................. 6,208 6,167 37,500
-------- ---------- ----------
Total assets.................................. $513,010 $1,699,428 $2,268,133
======== ========== ==========
Liabilities and Members' Equity
Current liabilities:
Accounts payable and accrued expenses....... $412,098 $1,276,354 $1,886,149
Capital lease obligation current portion.... 6,365 9,436 9,136
Employee loan............................... 38,345 -- --
Deferred revenue............................ 38,228 54,992 137,723
-------- ---------- ----------
Total current liabilities..................... 495,036 1,340,782 2,033,008
-------- ---------- ----------
Long-term debt:
Capital lease obligation long-term portion.. 7,997 1,715 5,625
-------- ---------- ----------
Commitments and contingencies (Note 5)
Members' equity:
Members' interest........................... 1,000 1,000 1,000
Retained earnings........................... 8,977 355,931 228,500
-------- ---------- ----------
Total members' equity......................... 9,977 356,931 229,500
-------- ---------- ----------
Total liabilities and members' equity......... $513,010 $1,699,428 $2,268,133
======== ========== ==========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-21
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Periods Ended
-------------------------
January 28, Year January 1
Through Ended Through
December 31, December 31, September 2,
1997 1998 1999
------------ ------------ ------------
(unaudited)
<S> <C> <C> <C>
Advertising service fees................. $115,854 $1,008,022 $1,501,943
Expenses:
Sales and marketing.................... 66,687 409,100 581,586
General and administrative............. 40,190 256,137 162,575
-------- ---------- ----------
Total expenses....................... 106,877 665,237 744,161
-------- ---------- ----------
Income from operations................... 8,977 342,785 757,782
Interest income.......................... -- 10,435 19,693
Income taxes............................. -- -- 35,062
-------- ---------- ----------
Net income............................... $ 8,977 $ 353,220 $ 742,413
======== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
STATEMENTS OF MEMBERS' EQUITY
<TABLE>
<CAPTION>
Total
Members' Retained Members'
Interest Earnings Equity
-------- -------- --------
<S> <C> <C> <C>
Initial Capital Contribution, January 28, 1997.... $1,000 $ -- $ 1,000
Net income........................................ -- 8,977 8,977
------ -------- --------
Balance, December 31, 1997........................ 1,000 8,977 9,977
Distributions..................................... -- (6,266) (6,266)
Net income........................................ -- 353,220 353,220
------ -------- --------
Balance, December 31, 1998........................ 1,000 355,931 356,931
Distributions (unaudited)......................... -- 869,844 869,844
Net income (unaudited)............................ -- 742,413 742,413
------ -------- --------
Balance, September 2, 1999 (unaudited)............ $1,000 $228,500 $229,500
====== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
January 28, January 1,
Through Year Ended Through
December 31, 1997 December 31, 1998 September 2, 1999
----------------- ----------------- -----------------
(unaudited)
<S> <C> <C> <C>
Cash flows from
operating activities:
Net income.............. $ 8,977 $ 353,220 $ 742,413
Adjustments to reconcile
net income to net cash
provided by operating
activities-
Depreciation.......... 3,652 6,979 6,720
Amortization of
intangible assets.... 292 541 1,667
Changes in assets and
liabilities-
Accounts
receivable......... (438,395) (553,777) (159,092)
Unbilled
receivables........ -- (181,572) (48,515)
Prepaid expenses and
other current
assets............. (2,070) (4,984) 8,054
Other assets........ (6,500) (500) (33,000)
Accounts payable and
accrued expenses... 412,098 864,256 609,795
Deferred revenue.... 38,228 16,764 82,731
--------- --------- ----------
Net cash provided by
operating activities... 16,282 500,927 1,210,773
--------- --------- ----------
Cash flows from
investing activities:
Capital expenditures.... -- (2,572) (22,824)
Cash flows from
financing activities:
Proceeds (repayment) of
member loans........... 38,345 (38,345) --
Repayment of capital
lease obligation....... (3,897) (9,969) --
Employee (loan)
receivable/payment..... (1,000) 1,000 (1,000)
Member distributions.... -- (6,266) (869,844)
--------- --------- ----------
Net cash provided by
(used in) financing
activities............. 33,448 (53,580) (870,844)
--------- --------- ----------
Net increase in cash and
cash equivalents....... 49,730 444,775 317,105
Cash and cash
equivalents, beginning
of period.............. -- 49,730 494,505
--------- --------- ----------
Cash and cash
equivalents, end of
period................. $ 49,730 $ 494,505 $ 811,610
========= ========= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-24
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
NOTES TO FINANCIAL STATEMENTS
1. Business and Summary of Significant Accounting Policies
Business
I-Balls L.L.C. (the "Company"), a New York limited liability company, was
incorporated on January 28, 1997. The Company is a full-service interactive
media planner and buyer.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
Revenue consists of fees charged to customers. The Company acts as an agent
for clients and purchases space from publisher websites on their behalf.
Advertising service fees earned under fee based contracts reflect the amount
of the commission earned. Revenue is recognized over the period the
advertising is delivered. Deferred revenue represents billings issued in
advance of the service period. Unbilled receivables represents fees earned but
not billed. All contracts in process are expected to be billed and collected
within one year.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity from the date of purchase of three months or less to be cash
equivalents.
Equipment and Leasehold Improvements
Equipment and leasehold improvements are stated at cost, net of accumulated
depreciation and amortization. Equipment is depreciated on the double-
declining method over estimated useful lives ranging from five to seven years.
Leasehold improvements are amortized over the life of the current office
lease. The lease expires on August 14, 2001.
Income Taxes
The Company is a limited liability company taxed as a partnership for
federal and state income tax purposes and, as a result, the earnings of the
Company are taxable directly to the members. The Company remains liable for
the New York City Unincorporated Business Tax.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable, due
from members, due to members, and accounts payable approximate fair value due
to the short-term maturity of these instruments.
New Accounting Pronouncements
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"),
F-25
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
which provides guidance for determining whether computer software is internal-
use software and on accounting for the proceeds of computer software
originally developed or obtained for internal use and then subsequently sold
to the public. It also provides guidance on capitalization of the costs
incurred for computer software developed or obtained for internal use. SOP 98-
1 is effective for fiscal years beginning after December 31, 1998. The Company
does not expect the adoption of SOP 98-1 to have a material effect on its
financial statements.
2. Equipment and Leasehold Improvements
Equipment consisted of the following:
<TABLE>
<CAPTION>
December 31,
--------------- September 2,
1997 1998 1999
------- ------- ------------
(Unaudited)
<S> <C> <C> <C>
Computer equipment.............................. $18,259 $27,589 $44,073
Leasehold improvements.......................... -- -- 9,950
------- ------- -------
Total equipment............................... 18,259 27,589 54,023
Less--Accumulated depreciation.................. 3,652 10,631 17,351
------- ------- -------
Equipment and leaseholds, net................. $14,607 $16,958 $36,672
======= ======= =======
</TABLE>
Depreciation expense aggregated $3,652, $6,979 and $6,720 (unaudited) for
the period January 28, 1997 to December 31, 1997 and the year ended December
31, 1998 and for the period from January 1, 1999 through September 2, 1999,
respectively.
3. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31,
------------------- September 2,
1997 1998 1999
-------- ---------- ------------
(Unaudited)
<S> <C> <C> <C>
Accounts payable.......................... $393,906 $1,269,930 $1,643,805
Accrued bonuses........................... 11,500 -- 211,838
Accrued payroll........................... 6,692 6,424 --
Accrued tax payable....................... -- -- 30,506
-------- ---------- ----------
Total accounts payable and accrued
expenses............................... $412,098 $1,276,354 $1,886,149
======== ========== ==========
</TABLE>
4. Members' Equity
Initial Capital Contribution
On June 1, 1997, the founding members entered into a Limited Liability
Company Operating Agreement by which they pledged a total capital contribution
of $1,000.
Distributions
The Company distributes earnings to its members based upon a formula in the
members' agreement, which takes into consideration, among other things,
ownership percentages, and other subjective allocations.
F-26
<PAGE>
I-BALLS L.L.C.
(a limited liability company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
5. Commitments and Contingencies
Leases
The Company is committed under operating leases for office space and fixed
assets. Rent expense was $10,325, $27,275 and $24,750 (unaudited) for the
period January 28, 1997 to December 31, 1997 and the year ended December 31,
1998 and for the period from January 1, 1999 through September 2, 1999,
respectively. Operating lease expense related to fixed assets was $3,010,
$8,408 and $6,870 (unaudited) for the period January 28, 1997 to December 31,
1997 and the year ended December 31, 1998 and for the period from January 1,
1999 through September 2, 1999, respectively. Future minimum lease payments
under the terms of noncancelable operating lease are as follows:
<TABLE>
<CAPTION>
Lease
Payments
--------
<S> <C>
Years ending December 31:
1999............................................................. $ 81,377
2000............................................................. 161,867
2001............................................................. 82,290
2002............................................................. 1,180
--------
$326,714
========
</TABLE>
6. Business Concentrations and Credit Risk
Financial instruments, which subject the Company to concentrations of
credit risk, consisted primarily of cash and cash equivalents and trade
accounts receivable. The Company maintains cash and cash equivalents with
various financial institutions. The Company performs periodic evaluations of
the relative credit standing of these institutions. The Company's clients are
primarily concentrated in the United States. The Company performs ongoing
credit evaluations, generally does not require collateral, and establishes an
allowance for doubtful accounts based upon factors surrounding the credit risk
of customers, historical trends and other information. To date, such losses
have been within management's expectations.
For the period January 28, 1997 to December 31, 1997, three clients
accounted for 52%, 23% and 16%, respectively, of total revenue.
For the year ended December 31, 1998, three clients accounted for 28%, 20%
and 18%, respectively, of total revenue.
For the period from January 1, 1999 through September 2, 1999 (unaudited),
three clients accounted for 34%, 17% and 11%, respectively, of total revenue.
As of December 31 1997 four clients accounted for 37%, 26%, 17% and 11%,
respectively, of total accounts receivable.
As of December 31, 1998, two clients accounted for 49% and 15%,
respectively, of total accounts receivable.
As of September 2, 1999 (unaudited), one client accounted for 53% of total
accounts receivable.
7. Sale of Members' Interest
On September 2, 1999, the members of the Company sold 100% of their
interest in the Company to Avenue A, Inc. ("Avenue A"). As a result of this
transaction, the Company became a wholly owned subsidiary of Avenue A.
F-27
<PAGE>
AVENUE A, INC.
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
On September 2, 1999, Avenue A, Inc. (the "Company" or "Avenue A")
completed the acquisition of I-Balls L.L.C. ("I-Balls"), a full service
interactive media planner and buyer. The acquisition of I-Balls has been
accounted for as a purchase. Accordingly, the results of operations of I-Balls
have been included in the consolidated statement of operations of Avenue A
commencing on the date of acquisition.
The accompanying unaudited pro forma combined statement of operations of
Avenue A, Inc. for the year ended December 31, 1999 assumes that the
acquisition took place as of January 1, 1999.
The unaudited pro forma combined statements of operations are presented for
informational purposes only and do not purport to represent what the Company's
results of operations for the year ended December 31, 1999 would actually have
been had the acquisitions, in fact, occurred on January 1, 1999, or the
Company's results of operations for any future period. The unaudited pro forma
combined statements of operations should be read in conjunction with the
financial statements and related notes thereto included elsewhere in this
prospectus and the information set forth in "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
F-28
<PAGE>
AVENUE A, INC.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
January 1-
December 31, September 2, Pro
1999 1999 Forma Pro Forma
Avenue A I-Balls Adjustments Combined
------------ ------------ ----------- ----------
<S> <C> <C> <C> <C>
Revenue:
Advertising services.. $ 67,074 $ -- $ -- $ 67,074
Advertising service
fees................. 2,621 1,502 -- 4,123
---------- ------ ------- ----------
Total revenue....... 69,695 1,502 -- 71,197
---------- ------ ------- ----------
Expenses:
Cost of advertising
services revenue..... 56,979 -- -- 56,979
Client services....... 4,860 -- -- 4,860
Technology and
operations........... 3,292 -- -- 3,292
Selling, general and
administrative....... 11,680 745 -- 12,425
Amortization of
intangible assets.... 650 -- 1,304 (a) 1,954
Amortization of
deferred stock
compensation......... 4,681 -- -- 4,681
---------- ------ ------- ----------
Total expenses...... 82,142 745 1,304 84,191
---------- ------ ------- ----------
Income (loss) from
operations......... (12,447) 757 (1,304) (12,994)
Interest income......... 554 20 -- 574
---------- ------ ------- ----------
Income (loss) before
provision for income
taxes.................. (11,893) 777 (1,304) 12,420
Provision for income
tax.................... -- 35 -- 35
---------- ------ ------- ----------
Net income (loss)....... $ (11,893) $ 742 $(1,304) $ (12,455)
========== ====== ======= ==========
Basic and diluted net
loss per share......... $ (.61) $ (.62)(b)
========== ==========
Shares used in computing
basic and diluted net
loss per share......... 19,428,034 19,931,459 (b)
========== ==========
Pro forma basic and
diluted net loss per
share.................. $ (.31) $ (.32)(b)
========== ==========
Shares used in computing
pro forma basic and
diluted net loss per
share.................. 38,466,488 38,969,913 (b)
========== ==========
</TABLE>
The accompanying notes are an integral part of this combined financial
statement.
F-29
<PAGE>
AVENUE A, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
1. Basis of Presentation
The unaudited pro forma combined statement of operations for the year ended
December 31, 1999 gives effect to the acquisition of I-BALLS, LLC as if this
transaction had occurred January 1, 1999.
The pro forma combined financial statements are presented for illustrative
purposes only and should not be construed to be indicative of the actual
combined results of operations as may exist in the future. The pro forma
adjustments are based on the cash and common stock consideration exchanged by
Avenue A for the fair value of the assets acquired and liabilities assumed.
2. Pro Forma Adjustments
Certain pro forma adjustments have been made to the accompanying unaudited
pro forma combined statements of operations as described below:
(a) Reflects eight months amortization of the excess of the purchase price
over the fair value of net assets acquired, which is being amortized
over three years.
(b) Basic and diluted net loss per share is computed by dividing net loss
by the weighted average number of shares outstanding during the period
assuming that shares issued for the acquisition were outstanding for
the entire period. Pro forma basic and diluted net loss per share has
been computed assuming the conversion of preferred stock into an
equivalent number of common shares, as if the shares had converted on
the dates of their issuance, and based on the weighted average number
of shares outstanding giving effect to shares issued in the acquisition
as if they were outstanding for the entire period.
3. Purchase Price Allocation
In connection with the acquisition, the Company issued 750,000 shares of
common stock and paid $3.5 million in cash in exchange for all of the
outstanding member's equity for a total purchase price of $6.1 million. The
acquisition was accounted for as a purchase and, accordingly, the results of
operations of I-Balls have been included in the consolidated financial
statements commencing on the date of acquisition. The excess purchase price of
approximately $5.9 million was allocated to customer base and skilled
workforce and is being amortized on a straight-line basis over a useful life
of three years.
F-30
<PAGE>
Back Cover:
Graphic in center of page depicting a large Avenue A logo
Graphic in lower-left corner of page depicting a small Avenue A logo