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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-81151
FREESHOP LOGO
3,200,000 SHARES
COMMON STOCK
This is the initial public offering of FreeShop.com, Inc. and we are offering
3,200,000 shares of our common stock. The initial public offering price is
$12.00 per share.
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "FSHP."
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE RISK FACTORS BEGINNING ON PAGE
8.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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UNDERWRITING
PUBLIC OFFERING DISCOUNTS AND PROCEEDS TO
PRICE COMMISSIONS FREESHOP
<S> <C> <C> <C>
Per Share $12.00 $0.84 $11.16
Total $38,400,000 $2,688,000 $35,712,000
</TABLE>
We have granted the underwriters the right to purchase up to 480,000 additional
shares to cover any over-allotments.
DEUTSCHE BANC ALEX. BROWN
DAIN RAUSCHER WESSELS
a division of Dain Rauscher Incorporated
VOLPE BROWN WHELAN & COMPANY
E*OFFERING
The date of this prospectus is September 27, 1999
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[ON INSIDE COVER]
[At the top center of the page is the FreeShop logo with the phrase "PUTTING
CONSUMERS IN CONTROL OF THE DIRECT MARKETING PROCESS" set forth underneath the
logo. In the middle of the page is a color depiction of the home page from the
FreeShop.com Web site. Beneath the picture of the home page is the following
text: "The traditional world of direct marketing is based on contacting a broad
range of consumers through mail, telephone, and other solicitations in the hope
of generating responses from a small percentage of those consumers. Unlike the
traditional direct marketing process, FreeShop aggregates over a thousand free,
trial, and promotional offers from marketers in a single place where consumers
can easily choose the offers that meet their specific needs."]
[ON FOLD OUT FLAP INSIDE THE FRONT COVER]
[The phrase "Putting consumers in control of the direct marketing process"
appears across the top of the two pages. Underneath the heading, three blocks of
text appear across the page. The left block states "OVER SIX MILLION ORDERS TO
DATE FreeShop connects millions of consumers with over a thousand offers
covering major consumer interest areas. To date, FreeShop has generated more
than six million orders." The center block states "OUR BUSINESS MODEL FreeShop
generates revenue in multiple ways. Our core business is lead generation, where
marketers pay us a fee per lead, or customer request for an offer. In addition,
we generate revenue through advertising on our site and in our Club FreeShop
newsletters." The right block states "CLUB FREESHOP: OVER 1.5 MILLION EMAIL
MEMBERS Club FreeShop is a free membership program through which we communicate
with our most valued customers. Members regularly receive email newsletters
informing them of special offers, exclusive contests and other promotional
opportunities." In the middle of the page is a picture of the FreeShop logo with
rectangle banners labeled "SHOPPERS" and "MARKETERS" on either side of the logo,
with arrows pointing from the banners toward the FreeShop logo. At the bottom
left of the page, three color pictures of category screens from the FreeShop.com
Web site appear descending diagonally from left to right. A fourth category
screen appears to the right of the top category screen. The caption next to the
screens reads "FreeShop is organized by category to make the site easy for
customers to find what they want." centered on the bottom of the page are three
graphics from the FreeShop.com Web site arranged vertically depicting graphics
representing the themes of "Got kids?" "Live Longer" and "Back to School!" The
"Got Kids?" graphic includes the text "100% free laughs, puzzles, pets, advice .
. . and more!" The "Live Longer" graphic includes the text "100% free for a
healthier glow, super wellness, tips and secrets . . . and more!" The "Back to
School" graphic includes the text "100% free for high school, college, grad
students . . . and more!" The caption next to the graphics reads "Offers are
also organized using seasonal and interest-oriented themes." On the bottom right
side of the page, three color pictures of screens from the FreeShop.com Web site
appear descending diagonally from left to right, including the home page,
magazine category page and Join Club FreeShop page. FreeShop's Privacy Pledge
screen appears to the right of the home page screen. The caption next to the
screens reads "The FreeShop site is designed to make it easy for customers to
get comfortable shopping on the Internet."]
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PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information and financial statements and accompanying notes appearing in this
prospectus.
FREESHOP.COM, INC.
FreeShop provides online direct marketing services, giving consumers access
to over 1,000 free, trial and promotional offers through our Web site and email
newsletters. Consumers seeking to discover, learn about or try new products can
choose from a collection of offers from over 100 companies. FreeShop enables
consumers to seek out new products of specific interest to them, unlike the
traditional direct marketing model, in which marketers communicate to broad
audiences in search of new customers.
FreeShop currently has more than 1,000 offers from over 100 companies for
items such as catalogs, magazines, product samples, software, coupons and
consumer goods. To assist consumers in locating offers that interest them most,
we arrange offers by category, such as travel, personal finance, entertainment
and sports. Our primary source of revenue is lead generation, for which
marketers pay us fees based on the number of customer requests for the
marketers' offers. We also receive revenue from advertisements placed on our Web
site and in our Club FreeShop email newsletters. We believe our Internet-based,
consumer-directed process creates a highly effective method of direct marketing
in terms of cost, targeting, efficiency and consumer satisfaction.
We have received and transmitted to marketer clients more than 6.0 million
orders, which are requests by consumers for various offers. According to Media
Metrix, Inc., in July 1999, FreeShop was among the top ten online shopping sites
based on the estimated number of different visitors to our Web site that month.
Our customer database has grown from approximately 850,000 customers in January
1998 to more than 2.0 million customers as of August 1999. In addition, our
email newsletters are regularly received by the over 1.5 million members of Club
FreeShop, informing them of special offers, exclusive contests and other
opportunities.
In December 1998, Fingerhut Companies, Inc. became a FreeShop shareholder
and currently holds 34.6% of our capital stock. Fingerhut is the eighth largest
cataloger and the second largest general merchandise cataloger in the United
States. We have recently initiated a noncontractual direct marketing
relationship with Fingerhut under which we have established Web site links and
are advertising and including inserts in some of Fingerhut's catalogs and order
delivery packages.
As part of our strategy to increase the number and types of offers on our
Web site and increase our visitor and client bases, in May 1999, we acquired the
Catalog Site and the Worldwide Brochures Web sites, which greatly expanded our
catalog and travel-related offerings.
OUR OBJECTIVE
Our objective is to be the dominant provider of online direct marketing
services. We intend to achieve this objective through the following key
strategies:
- increase visitor traffic and transactions through both online and
traditional marketing programs;
- increase our client base by expanding our sales staff and the services we
offer and by broadening our relationships with advertising agencies and
companies with national consumer brands;
- enhance FreeShop's brand name recognition through aggressive marketing;
- expand the number of categories and increase the number of offers within
each category;
- continue to develop and use technology to serve our marketer clients and
to make our Web site faster, easier to use and more personalized; and
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- further develop our marketing relationship with Fingerhut and initiate a
similar relationship with Federated Department Stores, Inc., Fingerhut's
parent.
RISK FACTORS
We have a history of significant losses and have accumulated losses of over
$9.6 million since we began operations. The online direct marketing industry is
highly competitive and we anticipate incurring substantial losses in the
foreseeable future.
OUR HISTORY
FreeShop began as a division of Online Interactive, Inc., a Washington
corporation that was incorporated in June 1994. On June 30, 1997, Online
Interactive contributed the FreeShop division to its wholly owned subsidiary,
FreeShop International, Inc., a Washington corporation incorporated on June 23,
1997, which then began operating as a separate entity. On February 19, 1999,
FreeShop International, Inc. changed its name to FreeShop.com, Inc. Our offices
are located at 95 South Jackson Street, Suite 300, Seattle, Washington 98104.
Our telephone number is (206) 441-9100.
THE OFFERING
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<S> <C>
Common stock offered by FreeShop............................ 3,200,000 shares
Common stock to be outstanding after the offering........... 14,955,155 shares
Use of proceeds............................................. For marketing, working capital
and general corporate
purposes. See "Use of
Proceeds."
Proposed Nasdaq National Market symbol...................... FSHP
</TABLE>
The number of shares of common stock to be outstanding after the offering
as set forth above is based on the number of shares actually outstanding as of
July 31, 1999 and includes:
- 1,890,432 shares of common stock issuable upon conversion of 472,608
shares of series B convertible preferred stock, which conversion will
occur not later than the completion of this offering;
- 1,586,156 shares of common stock issuable upon conversion of 396,539
shares of series B convertible preferred stock, which stock will be
acquired pursuant to the exercise of warrants and converted not later
than the completion of this offering; and
- 35,280 shares of common stock issuable upon conversion of 8,820 shares of
series B convertible preferred stock, which stock will be issued and
converted not later than the completion of this offering.
The number excludes, as of July 31, 1999, a total of 953,289 shares of
common stock issuable upon exercise of outstanding stock options at a weighted
average exercise price of $1.50 per share, and 27,700 shares of common stock
issuable upon exercise of warrants at a weighted average exercise price of $1.19
per share.
---------------
The terms "FreeShop," "we," "us" and "our" as used in this prospectus refer
to FreeShop.com, Inc. Information throughout this prospectus reflects a
1-for-2.5 reverse split of the outstanding shares of common stock effected on
September 15, 1999. Unless otherwise specifically stated, information throughout
this prospectus also assumes that:
- the underwriters' over-allotment option is not exercised; and
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- Fingerhut will exercise warrants to purchase 396,539 shares of series B
convertible preferred stock and will purchase an additional 8,820 shares
of series B convertible preferred stock prior to the completion of this
offering, and all shares of series B convertible preferred stock will
convert into 3,511,868 shares of common stock not later than the
completion of this offering.
"Free Shop" is a registered trademark of FreeShop.com, Inc. "Find It! Try
It! Buy It!," "The starting point for smart online shopping," "Powered by
FreeShop" and "FreeShop by Email" are service marks of FreeShop. We may apply
for certain other trademarks and service marks, including Club FreeShop,
FreeShop Savings Club, Savings Central, FreeShop shopping assistant, Catalog
Site, Catalog Channel, The Catalog Site and Worldwide Brochures. All other
trademarks and service marks that we refer to in this prospectus are the
property of their respective owners. The information on our Web sites is not a
part of this prospectus.
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SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Set forth below is our actual statement of operations data. See Note 2 to
FreeShop's audited financial statements for a description of how we calculated
the number of shares used to compute basic and diluted net loss per share of
common stock.
The following unaudited pro forma statement of operations data gives effect
to the acquisitions of the Catalog Site and Worldwide Brochures Web sites and
related assets as if they had occurred on January 1, 1998, but does not reflect
the issuance and conversion of the series B convertible preferred stock, which
will have occurred not later than the completion of this offering. See Note 7 to
our unaudited pro forma combined financial information for a description of the
method we used to compute basic and diluted net loss per share of common stock
and the number of shares used in that computation.
The following balance sheet data provides a summary at June 30, 1999,
- on an actual basis;
- on a pro forma basis to reflect
(1) the issuance of series B convertible preferred stock upon the
exercise of warrants,
(2) the sale of 8,820 additional shares of series B convertible
preferred stock, and
(3) the conversion of all series B convertible preferred stock into
shares of common stock not later than the completion of this
offering; and
- on a pro forma as-adjusted basis to reflect the estimated net proceeds
from the sale of 3,200,000 shares of common stock in this offering at an
initial offering price of $12.00 per share, after deducting underwriting
discounts and commissions and estimated offering expenses.
See "Selected Unaudited Pro Forma Financial Data," "Selected Actual Financial
Data" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
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THREE MONTHS ENDED
(UNAUDITED)
YEAR ENDED ------------------------------------------------------------------
DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1998 1998 1998 1998 1998 1999 1999
---------- --------- -------- --------- -------- --------- --------
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STATEMENT OF OPERATIONS DATA:
ACTUAL
Revenues....................... $ 1,251 $ 220 $ 209 $ 321 $ 501 $ 667 $ 1,480
Gross profit................... 1,034 181 172 256 425 584 1,373
Operating loss................. (3,136) (573) (641) (970) (952) (1,378) (2,472)
Net loss....................... $ (3,199) $ (585) $ (658) $ (992) $ (964) $(1,366) $(2,420)
Basic and diluted net loss per
common share................. $ (0.51) $ (0.10) $ (0.11) $ (0.16) $ (0.14) $ (0.17) $ (0.29)
Shares used to compute basic
and diluted net loss per
common share................. 6,224 5,688 5,955 6,367 6,871 8,151 8,214
</TABLE>
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SIX MONTHS
YEAR ENDED ENDED
DEC. 31, JUNE 30,
1998 1999
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PRO FORMA (UNAUDITED)
Revenues.................................................. $ 1,893 $ 2,381
Gross profit.............................................. 1,455 2,135
Operating loss............................................ (4,233) (4,155)
Net loss.................................................. $ (4,296) $(4,092)
Basic and diluted net loss per common share............... (0.68) (0.46)
Shares used to compute pro forma basic and diluted net
loss per common share................................... 6,277 8,858
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AS OF JUNE 30, 1999
(UNAUDITED)
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
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BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 4,330 $13,209 $48,171
Working capital........................................... 5,190 14,069 49,031
Total assets.............................................. 10,613 19,492 54,454
Long-term obligations, less current portion............... 81 81 81
Total shareholders' equity................................ 8,507 17,386 52,348
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RISK FACTORS
This offering involves a high degree of risk. You should carefully consider
the risks described below and the other information in this prospectus before
deciding to invest in shares of our common stock. Any of these risk factors
could materially and adversely affect our business, financial condition or
operating results. In that case, the trading price of our common stock could
decline, and you could lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO PREDICT OUR
FUTURE PERFORMANCE.
Our limited operating history makes predicting our future performance
difficult and does not provide investors with a meaningful basis for evaluating
an investment in our common stock. From our inception in June 1994 through June
1997, we existed as a division of Online Interactive, Inc. We began operations
as an independent company in June 1997. In the first half of 1998, we began
offering advertising opportunities on our Web site and in our email newsletters,
in addition to our primary business of lead generation. As a result, our
performance since the end of the first quarter of 1998 is not comparable to
prior periods. Moreover, we have never operated during a general economic
downturn in the United States, which typically adversely affects advertising and
marketing expenditures.
WE WILL FACE RISKS ENCOUNTERED BY EARLY-STAGE COMPANIES IN INTERNET-RELATED
BUSINESSES AND MAY BE UNSUCCESSFUL IN ADDRESSING THESE RISKS.
We face risks frequently encountered by early-stage companies in new and
rapidly evolving markets, including the market for online direct marketing. We
may not succeed in addressing these risks, and our business strategy may not be
successful. These risks include uncertainties about our ability to:
- attract a larger number of consumers to our Web site;
- sign up new marketing clients and add new and compelling content to our
Web site;
- manage our expanding operations;
- adapt to potential decreases in online advertising rates;
- successfully introduce new products and services;
- continue to develop and upgrade our technology and to minimize technical
difficulties and system downtime;
- create and maintain the loyalty of our customers and clients;
- maintain our current, and develop new, strategic relationships and
alliances; and
- attract, retain and motivate qualified personnel.
WE HAVE A HISTORY OF LOSSES, EXPECT FUTURE LOSSES AND MAY NEVER ACHIEVE
PROFITABILITY.
We have not achieved profitability and expect to continue to incur
operating losses for the foreseeable future. We incurred net losses of $3.2
million, or more than 2.5 times the amount of our revenues, for the year ended
December 31, 1998, and $3.8 million, or more than 1.75 times the amount of our
revenues, for the six months ended June 30, 1999. As of June 30, 1999, our
accumulated losses were $9.6 million, which represents our losses since we began
our operations. We have recently increased our operating expenses and capital
expenditures in order to accelerate our growth. We expect further increases in
operating expenses, including at least $20.0 million of the proceeds of this
offering, to significantly expand marketing and brand name promotion over the
next
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twelve months. Although our revenues have grown in recent quarters, we will need
to significantly increase revenues to achieve profitability. Even if we do
achieve profitability, we may be unable to sustain profitability on a quarterly
or annual basis in the future. It is possible that our revenues will grow more
slowly than we anticipate or that operating expenses will exceed our
expectations.
OUR QUARTERLY OPERATING RESULTS ARE UNCERTAIN AND MAY FLUCTUATE SIGNIFICANTLY,
WHICH COULD NEGATIVELY AFFECT THE VALUE OF YOUR INVESTMENT.
Our operating results have varied significantly from quarter to quarter in
the past and may continue to fluctuate. As a result, we believe period-to-period
comparisons of our operating results are not meaningful. For example, during the
year ended December 31, 1998, the percentage of annual sales attributable to the
first, second, third and fourth quarters were 17.6%, 16.7%, 25.7% and 40.0%,
respectively. Our operating results for a particular quarter or year may fall
below the expectations of securities analysts and investors, which could result
in a decrease in our stock price.
Our limited operating history and the new and rapidly evolving Internet
markets make it difficult to ascertain the effects of seasonality on our
business. We believe, however, that our revenue may be subject to seasonal
fluctuations because advertisers generally place fewer advertisements during the
first and third calendar quarters of each year. In addition, expenditures by
advertisers tend to be cyclical, reflecting overall economic conditions as well
as budgeting and buying patterns. A decline in the economic prospects of
advertisers could alter current or prospective advertisers' spending priorities,
or the time periods in which they determine their budgets, or increase the time
it takes to close a sale with our advertisers.
During the three months ended June 30, 1999, approximately 90% of our
contracts were month-to-month with automatic renewal unless terminated by either
party with 10 days' notice. The loss of a significant number of these contracts
in any one period might result in a significant decline in our quarterly
operating results.
WE HAVE EXPERIENCED RAPID GROWTH WHICH HAS PLACED A STRAIN ON OUR RESOURCES, AND
ANY FAILURE TO MANAGE OUR GROWTH EFFECTIVELY COULD CAUSE OUR BUSINESS TO SUFFER.
We do not have a proven record in managing our growth and may not be
successful in doing so. We have grown from 29 employees on July 1, 1997 to 102
employees on July 31, 1999. We have recently hired key management personnel,
acquired two businesses and added personnel in connection with these
acquisitions. Due to our recent rapid growth and our inexperience in integrating
newly acquired businesses, we may not be successful in integrating new personnel
and acquired businesses into our existing operations. In addition, we plan to
continue expanding our sales and marketing, customer support and research and
development organizations. Past growth in these areas has placed, and any future
growth will continue to place, a significant strain on our management systems
and resources.
IF WE ARE UNABLE TO STRENGTHEN THE FREESHOP BRAND NAME, WE MAY BE UNABLE TO
COMPETE EFFECTIVELY AGAINST COMPETITORS WITH GREATER BRAND NAME RECOGNITION.
We may be unsuccessful in strengthening our brand name. As competitive
pressures in the online direct marketing industry increase, we expect that brand
name strength will become increasingly important. If we cannot strengthen our
brand name, we may be unable to maintain or increase traffic to our Web site,
which would lead to decreased revenues from clients. We intend to devote
substantial resources to promote the FreeShop brand name. The reputation of our
brand name will depend on our ability to provide a high-quality online
experience for consumers visiting our Web site or receiving our Club FreeShop
email newsletters. Negative experiences of consumers or marketers with FreeShop
might result in publicity that could damage our reputation and diminish the
strength of our brand name.
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IF WE CANNOT SECURE SUFFICIENT PROMOTIONAL OFFERS FROM OUR MARKETER CLIENTS, OUR
BUSINESS WILL SUFFER.
If we are unsuccessful in acquiring and renewing a continuing array of
free, trial and promotional offers for our Web site, traffic on our site will
likely decrease. The attractiveness of our Web site to consumers is based in
part on our ability to provide a broad variety of offers of interest to
consumers. In addition, a number of other Web sites give consumers access to
similar offers. We face competition for free, trial and promotional offers from
these Web sites as well as a variety of other online and traditional
competitors. Without sufficient variety and quality of offers, our Web site will
become less attractive to marketers, and our ability to generate revenue from
marketer clients will be adversely affected.
THE MAJORITY OF OUR CONTRACTS HAVE MONTH-TO-MONTH TERMS, AND THE LOSS OF A
SIGNIFICANT NUMBER OF THESE CONTRACTS IN A SHORT PERIOD OF TIME COULD HARM OUR
BUSINESS.
During the three months ended June 30, 1999, approximately 90% of our
contracts had month-to-month terms with automatic renewal unless terminated by
either party with 10 days' notice. The loss of a significant number of these
contracts in any one period could result in decreased traffic to our Web site,
cause an immediate and significant decline in our revenues and cause our
business to suffer.
THE LOSS OF THE SERVICES OF ANY OF OUR EXECUTIVE OFFICERS OR KEY PERSONNEL WOULD
LIKELY CAUSE OUR BUSINESS TO SUFFER.
Our future success depends to a significant extent on the efforts and
abilities of our senior management, particularly Timothy C. Choate, our
Chairman, President and Chief Executive Officer, and other key employees,
including our technical and sales personnel. The loss of the services of any of
these individuals could harm our business. We may be unable to attract, motivate
and retain other key employees in the future. Competition for employees in our
industry is intense, and in the past we have experienced difficulty in hiring
qualified personnel. We do not have employment agreements with any of our key
personnel, nor do we have key-person insurance for any of our employees.
IF WE ARE UNABLE TO INTEGRATE THE OPERATIONS FROM OUR ACQUISITIONS OF THE
CATALOG SITE AND WORLDWIDE BROCHURES WEB SITES OR FROM ANY FUTURE ACQUISITIONS,
OUR BUSINESS WILL SUFFER.
We may be unsuccessful in integrating the operations from our two recent
acquisitions or from any future acquisitions. In May 1999, we acquired the
Catalog Site and Worldwide Brochures Web sites and related assets. These are our
first acquisitions, and we have limited experience with completing and
integrating acquisitions. We may be unable to integrate their offers into our
Web site and their operations into our existing business. Both of these Web
sites have earned their revenues from advertising contracts that require a flat
fee for the period of the contract. We intend to seek to transition these flat
fee contracts into contracts that require the clients to pay us for leads
generated through our Web site. We cannot be certain that the acquired sites'
advertisers will agree to enter into lead generation contracts or that we will
be able to keep their business.
Our business strategy includes growth through acquisitions, so we expect to
pursue other acquisitions in the future. Our recent acquisitions and any future
acquisitions present many risks and uncertainties generally associated with
acquisitions, including:
- difficulties integrating operations, personnel, technologies, products
and information systems of acquired businesses;
- potential loss of key employees of acquired businesses;
- adverse effects on our results of operations from acquisition-related
charges and amortization of goodwill and purchased technology;
- increased fixed costs, which could delay profitability;
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- inability to maintain the key business relationships and the reputations
of acquired businesses;
- potential dilution to current shareholders from the issuance of
additional equity securities;
- inability to maintain our standards, controls, procedures and policies;
- responsibility for liabilities of companies we acquire; and
- diversion of management's attention from other business concerns.
IF WE ARE UNABLE TO DEVELOP AND MAINTAIN A POSITIVE BUSINESS RELATIONSHIP WITH
FINGERHUT OR INITIATE A RELATIONSHIP WITH FEDERATED, OUR BUSINESS COULD SUFFER.
Our business could be adversely affected if we fail to develop and maintain
a positive relationship with Fingerhut or to initiate a relationship with
Federated. We recently initiated a noncontractual direct marketing relationship
with Fingerhut that will include Web site links, advertising and package and
catalog inserts. Because Fingerhut only recently invested in us, and because
Federated only recently acquired Fingerhut, we do not know what benefits, if
any, we will receive from our relationship with Fingerhut or any future
relationship we may initiate with Federated, or the degree to which, if any,
these relationships may impact our business. Both Fingerhut and Federated
operate independently of FreeShop and, subject to future contractual
obligations, each remains free to act in its own interest regardless of the
effect of its actions on us. In addition, although Fingerhut will retain a
substantial equity interest in us immediately following this offering, apart
from the exercise of its warrants, neither Fingerhut nor Federated has any
obligation to make equity or other capital resources available to us in the
future. Because no contractual relationship with Fingerhut currently exists,
should Fingerhut become dissatisfied with its relationship with us or decide to
change its general business strategy relating to the Internet, our relationship
with Fingerhut, and our ability to develop a relationship with Federated, could
be adversely affected. If Fingerhut were to decide to discontinue or curtail its
relationship with us, our reputation and our stock price could be adversely
affected.
AN INCREASE IN THE NUMBER OF VISITORS TO OUR WEB SITE MAY STRAIN OUR SYSTEMS,
AND WE ARE VULNERABLE TO SYSTEM MALFUNCTIONS.
Any serious or repeated problems with the performance of our Web site could
lead to the dissatisfaction of consumers or our marketer clients. The amount of
traffic on our Web site has increased over time to approximately 2.7 million
visitors in July 1999, and we are seeking to further increase traffic. The
systems that support our Web site must be able to accommodate an increased
volume of traffic. Although we believe our systems can currently accommodate
approximately 10 million visitors monthly, in the past, our Web site and the
Worldwide Brochures Web site have experienced slow response times and other
systems problems for a variety of reasons, including failure of our Internet
service providers, hardware failures and failure of software applications. In
these instances, our Web site was typically unavailable or slow for
approximately one and one-half to two hours. Although these failures did not
have a material adverse effect on our business, we may experience similar
problems in the future that could have a material adverse effect on our
business. See "Business -- Operations and Technology."
WE MAY FACE SYSTEM FAILURES RESULTING FROM YEAR 2000 RISKS.
Because many computer applications have been written using two digits
rather than four to define the applicable year, some date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
year 2000 problem could result in system failures or miscalculations causing
disruptions of operations, including disruptions of our Web site. We have
obtained confirmation from all but three of our third-party vendors that they
have resolved their year 2000 issues. Until we have received responses from all
of these vendors and completed our testing, we will not know the extent of our
exposure to year 2000 risks. In addition, the systems and services provided by
these vendors may fail to be year 2000 compliant despite their representations
to the contrary. Failure of these systems or services to be year 2000 compliant
could result in a systemic failure
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beyond our control and prevent us from delivering our services to our customers,
prevent users from accessing our Web site and decrease the use of the Internet
generally. Our limited contingency plans to address the year 2000 problem
include replacing noncompliant vendors and distributing our workload to servers
located at various cities around the country to minimize the risk of systems
failure. We do not intend to develop any further contingency plans. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Issues."
WE FACE INTENSE COMPETITION FROM MARKETING-FOCUSED COMPANIES FOR MARKETER
CLIENTS AND MAY BE UNABLE TO COMPETE SUCCESSFULLY.
We may be unable to compete successfully with current or future
competitors. We face intense competition from many companies, both traditional
and online, to provide marketing and advertising services for marketer clients.
Among the free-offer Web sites, our primary competitors include Volition.com and
Free2Try.com. Among the lead-generation Web sites, our primary competitors are
eNews, Cataloglink and Catalogcity. We expect competition from online
competitors to increase significantly because there are no substantial barriers
to entry in our industry. Increased competition could result in price reductions
for online advertising space and marketing services, reduced gross margins and
loss of our market share.
Many of our existing competitors, as well as a number of potential new
competitors, have longer operating histories, greater name recognition, larger
customer bases and significantly greater financial, technical and marketing
resources than FreeShop. These advantages may allow them to respond more quickly
and effectively to new or emerging technologies and changes in customer
requirements. It may also allow them to engage in more extensive research and
development, undertake farther-reaching marketing campaigns, adopt more
aggressive pricing policies and make more attractive offers to potential
employees, strategic partners and advertisers. In addition, current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products or services to address the needs of our prospective marketer
clients.
Online marketing is a rapidly developing industry, and new types of
products and services may emerge that are more attractive to consumers and
marketers than the types of services we offer. As a result, it is possible that
new competitors may emerge and rapidly acquire significant market share. See
"Business -- Competition."
IF OUR CUSTOMERS REQUEST PRODUCTS AND SERVICES DIRECTLY FROM OUR MARKETER
CLIENTS INSTEAD OF REQUESTING THE PRODUCT OR SERVICE FROM US, OUR BUSINESS COULD
SUFFER.
Our marketer clients may offer the same free or trial products or services
on their own Web sites that we offer on our Web site. Our customers may choose
to request products or services directly from our marketer clients instead of
requesting the product or service from us, which would result in lower revenues
to FreeShop from lead generation and cause our business to suffer.
WE MAY NEED TO INCUR LITIGATION EXPENSES IN ORDER TO DEFEND OUR INTELLECTUAL
PROPERTY RIGHTS, AND MIGHT NEVERTHELESS BE UNABLE TO ADEQUATELY PROTECT THESE
RIGHTS.
We may need to engage in costly litigation to enforce our intellectual
property rights, to protect our trade secrets or to determine the validity and
scope of the intellectual property rights of others. We cannot assure you that
our efforts to prevent misappropriation or infringement of our intellectual
property will be successful. An adverse determination in any litigation of this
type could require us to make significant changes to the structure and operation
of our online services and features or to license alternative technology from
another party. Implementation of any of these alternatives could be costly and
time-consuming and may not be successful. Any intellectual property litigation
would likely result in substantial costs and diversion of resources and
management attention.
12
<PAGE> 13
Our success largely depends on our trademarks, including "Free Shop," and
internally developed technologies, including our email systems and our
collection, order-processing and lead-delivery systems, which we seek to protect
through a combination of trademark, copyright and trade secret laws. Protection
of our trademarks is crucial as we attempt to build our brand name and
reputation. Despite actions we take to protect our intellectual property rights,
it may be possible for third parties to copy or otherwise obtain and use our
intellectual property without authorization or to develop similar technology
independently. In addition, legal standards relating to the validity,
enforceability and scope of protection of intellectual property rights in
Internet-related businesses are uncertain and still evolving. Although we are
not currently engaged in any lawsuits for the purpose of defending our
intellectual property rights, we may need to engage in such litigation in the
future. Moreover, we may be unable to maintain the value of our intellectual
property rights in the future.
IF THIRD PARTIES ACQUIRE DOMAIN NAMES THAT ARE SIMILAR TO OUR DOMAIN NAMES, THEY
COULD DECREASE THE VALUE OF OUR TRADEMARKS AND TAKE CUSTOMERS AWAY FROM OUR WEB
SITE.
We currently hold the Internet domain names "freeshop.com,"
"catalogsite.com," "wwb.com" and "clubfreeshop.com" as well as various other
related names. We may be unable to prevent third parties from acquiring similar
domain names, which could reduce the value of our trademarks, potentially weaken
our brand name and take customers away from our Web site. Domain names generally
are regulated by Internet regulatory bodies. The regulation of domain names in
the United States and in foreign countries is subject to change in the near
future. Regulatory bodies could establish additional top-level domains, appoint
additional domain name registrars or modify the requirements for holding domain
names. The relationship between regulations governing domain names and laws
protecting trademarks and similar intellectual property rights is unclear.
Therefore, we may be unable to prevent third parties from acquiring domain names
that infringe on, or otherwise decrease the value of, our trademarks and other
intellectual property rights. We believe there are online companies in other
countries using domain names that potentially infringe on our trademarks. We may
be unable to prevent them from using these domain names, and this use may
decrease the value of our trademarks and our brand name.
WE MAY FACE LITIGATION AND LIABILITY FOR INFORMATION DISPLAYED ON OUR WEB SITE.
We may be subjected to claims for defamation, negligence, copyright or
trademark infringement and various other claims relating to the nature and
content of materials we publish on our Web site. These types of claims have been
brought, sometimes successfully, against online services in the past. We could
also face claims based on the content that is accessible from our Web site
through links to other Web sites. Any litigation arising from these claims would
likely result in substantial costs and diversion of resources and management
attention, and an unsuccessful defense to one or more such claims could result
in material damages. We have no insurance coverage for these types of claims.
SECURITY AND PRIVACY BREACHES COULD SUBJECT US TO LITIGATION AND LIABILITY AND
DETER CONSUMERS FROM USING OUR WEB SITE.
We could be subject to litigation and liability if third parties penetrate
our network security or otherwise misappropriate our users' personal or credit
card information. This liability could include claims for unauthorized purchases
with credit card information, impersonation or other similar fraud claims. It
could also include claims for other misuses of personal information, such as for
unauthorized marketing purposes. In addition, the Federal Trade Commission and
other federal and state agencies have been investigating various Internet
companies in connection with their use of personal information. We could be
subject to investigations and enforcement actions by these or other agencies. In
addition, we rent customer names and street addresses to third parties. Although
we provide an opportunity for our customers to remove their names from our
rental list, we nevertheless may receive complaints from customers for these
rentals.
The need to transmit confidential information securely has been a
significant barrier to electronic commerce and communications over the Internet.
Any compromise of security could deter people
13
<PAGE> 14
from using the Internet in general or, specifically, from using the Internet to
conduct transactions that involve transmitting confidential information, such as
purchases of goods or services. Many marketers seek to offer their products and
services on our Web site because they want to encourage people to use the
Internet to purchase their goods or services. Internet security concerns could
frustrate these efforts. Also, our relationships with consumers may be adversely
affected if the security measures we use to protect their personal information
prove to be ineffective. We cannot predict whether events or developments will
result in a compromise or breach of the technology we use to protect customers'
personal information. We have no insurance coverage for these types of claims.
Furthermore, our computer servers may be vulnerable to computer viruses,
physical or electronic break-ins and similar disruptions. We may need to expend
significant additional capital and other resources to protect against a security
breach or to alleviate problems caused by any such breaches. We may be unable to
prevent or remedy all security breaches. If any of these breaches occur, we
could lose marketing clients and visitors to our Web site.
WE MAY NEED ADDITIONAL FINANCING, AND OUR PROSPECTS FOR OBTAINING IT ARE
UNCERTAIN.
We may be unable to obtain necessary additional financing in the future.
Our business does not generate the cash necessary to fund our operations. We
currently anticipate that our available cash resources combined with the net
proceeds from this offering will be sufficient to meet our anticipated capital
expenditures and working capital requirements through the next twelve months.
Thereafter, we expect we will need to raise additional funds to develop or
enhance our services or products, fund expansion, respond to competitive
pressures or acquire businesses or technologies. Unanticipated expenses, poor
financial results or unanticipated opportunities that require financial
commitments could give rise to earlier financing requirements. 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. Additional financing may not be available on terms favorable
to us, or at all. If adequate funds are not available or are not available on
acceptable terms, our ability to fund our expansion, take advantage of business
opportunities, develop or enhance services or products or otherwise respond to
competitive pressures would be significantly limited, and we might need to
significantly restrict our operations.
RISKS RELATED TO OUR INDUSTRY
IF THE ACCEPTANCE OF ONLINE ADVERTISING AND ONLINE DIRECT MARKETING DOES NOT
CONTINUE TO INCREASE, OUR BUSINESS WILL SUFFER.
The demand for online marketing may not develop to a level sufficient to
support our continued operations or may develop more slowly than we expect. We
expect to derive almost all of our revenues from contracts with marketer clients
under which we provide online marketing services through our Web site and email
newsletters. The Internet has not existed long enough as a marketing medium to
demonstrate its effectiveness relative to traditional marketing methods.
Marketers that have historically relied on traditional marketing methods may be
reluctant or slow to adopt online marketing. Many marketers have limited or no
experience using the Internet as a marketing medium. In addition, marketers that
have invested substantial resources in traditional methods of marketing may be
reluctant to reallocate these resources to online marketing. Those companies
that have invested a significant portion of their marketing budgets in online
marketing may decide after a time to return to more traditional methods if they
find that online marketing is a less effective method of promoting their
products and services than traditional marketing methods.
We do not know if accepted industry standards for measuring the
effectiveness of online marketing will develop. An absence of accepted standards
for measuring effectiveness could discourage companies from committing
significant resources to online marketing. There are a variety of pricing models
for marketing on the Internet. We cannot predict which, if any, will emerge as
the industry standard. Absence of such a standard makes it difficult to project
our future pricing and revenues.
14
<PAGE> 15
Email marketing is also vulnerable to potential negative public perception
associated with unsolicited email, known as "spam." Although we do not send
unsolicited email, public perception, press reports or governmental action
related to spam could reduce the overall demand for email marketing in general
and our Club FreeShop email newsletters in particular.
IF WE ARE UNABLE TO ADAPT TO RAPID CHANGES IN THE ONLINE MARKETING INDUSTRY, OUR
BUSINESS WILL SUFFER.
Online marketing is characterized by rapidly changing technologies,
frequent new product and service introductions, short development cycles and
evolving industry standards. We may incur substantial costs to modify our
services or infrastructure to adapt to these changes and to maintain and improve
the performance, features and reliability of our services. We may be unable to
successfully develop new services on a timely basis or achieve and maintain
market acceptance.
WE FACE RISKS FROM POTENTIAL GOVERNMENT REGULATION AND OTHER LEGAL UNCERTAINTIES
RELATING TO THE INTERNET.
Laws and regulations that apply to Internet communications, commerce and
advertising are becoming more prevalent. The adoption of such laws could create
uncertainty in use of the Internet and reduce the demand for our services.
Recently, Congress enacted legislation regarding children's privacy on the
Internet. Additional laws and regulations may be proposed or adopted with
respect to the Internet, covering issues such as user privacy, freedom of
expression, pricing, content and quality of products and services, taxation,
advertising, intellectual property rights and information security. The passage
of legislation regarding user privacy or direct marketing on the Internet may
reduce demand for our services or limit our ability to provide customer
information to marketers. Furthermore, the growth of electronic commerce may
prompt calls for more stringent consumer protection laws. For example, the
European Union recently adopted a directive addressing data privacy that may
result in limits on the collection and use of consumer information. The adoption
of consumer protection laws that apply to online marketing could create
uncertainty in Internet usage and reduce the demand for our services.
In addition, we are not certain how our business may be affected by the
application of existing laws governing issues such as property ownership,
copyrights, encryption and other intellectual property issues, taxation, libel,
obscenity and export or import matters. It is possible that future applications
of these laws to our business could reduce demand for our services or increase
the cost of doing business as a result of litigation costs or increased service
delivery costs.
Our services are available on the Internet in many states and foreign
countries, and these states or foreign countries may claim that we are required
to qualify to do business in their jurisdictions. Currently, we are qualified to
do business only in Washington, Minnesota and California. Our failure to qualify
in other jurisdictions if we were required to do so could subject us to taxes
and penalties and could restrict our ability to enforce contracts in those
jurisdictions.
RISKS RELATED TO THIS OFFERING
WE WILL HAVE BROAD DISCRETION IN THE USE OF THE NET PROCEEDS FROM THIS OFFERING,
AND THERE IS A RISK THAT WE MIGHT USE THEM INEFFECTIVELY.
We will have broad discretion over how we use the net offering proceeds,
and we could spend the proceeds in ways with which you might not agree. We
cannot assure you that we will use these proceeds effectively. We plan to use
the proceeds from this offering for marketing, working capital and general
corporate purposes. We have not determined how we will allocate proceeds among
these uses. Our business strategy includes growth through acquisitions, and we
may use a substantial portion of the offering proceeds to buy businesses we have
not yet identified. See "Use of Proceeds."
15
<PAGE> 16
VIRTUALLY ALL OF OUR SHARES WILL BE ELIGIBLE FOR SALE SHORTLY AFTER THIS
OFFERING, WHICH COULD RESULT IN A DECLINE IN OUR STOCK PRICE.
If our shareholders sell substantial amounts of common stock in the public
market following this offering, the market price of our common stock could fall.
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 July 31, 1999, upon completion of
this offering, we will have 14,955,155 shares of common stock outstanding. Of
these shares, the 3,200,000 shares being offered by this prospectus will be
freely tradable, and the remaining 11,755,155 shares will become eligible for
sale in the public market as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES DATE
- ---------------- ----
<C> <S>
123,530..... September 27, 1999 (the date of this prospectus)
133,993..... December 26, 1999 (90 days after the date of this
prospectus)
7,838,844... March 25, 2000 (180 days after the date of this prospectus)
3,658,788... At various times thereafter upon the expiration of one-year
holding periods
</TABLE>
This table reflects "lock-up agreements" in which the holders of
approximately 11,497,632 shares have agreed not to offer or sell their shares
until 180 days after the date of this prospectus, without the consent of
Deutsche Bank Securities Inc.
In addition, shortly after the effective date of this offering, we expect
to register for sale up to 2,400,000 shares of common stock reserved for
issuance under the 1997 Stock Option Plan. As of July 31, 1999, options to
purchase 953,289 shares of common stock were outstanding. Shares acquired upon
exercise of these options will be eligible for sale in the public market from
time to time, subject to vesting. Holders of 94% of the outstanding option
shares are subject to 180-day lockup restrictions that apply to the outstanding
stock. These stock options generally have exercise prices significantly below
the initial public offering price of our common stock. Also, at the completion
of this offering, we will have 27,700 shares of common stock issuable upon the
exercise of outstanding warrants. The possible sale of a significant number of
these shares may cause the price of our common stock to decline.
None of Fingerhut, Timothy C. Choate or John P. Ballantine, who in the
aggregate beneficially own approximately 78.2% of our capital stock as of July
31, 1999, are restricted from selling any of their FreeShop securities, other
than as provided by lock-up agreements with Deutsche Bank Securities Inc., a
stockholders agreement and applicable securities laws. Also, shareholders and
warrant holders holding securities that represent approximately 5,184,175 shares
of common stock may have the right to include their shares in registration
statements relating to our securities. By exercising their registration rights
and causing a large number of shares to be registered and sold in the public
market, these holders could cause the price of our common stock to decline.
OUR SECURITIES HAVE NO PRIOR MARKET, AND WE CANNOT PREDICT WHETHER AN ACTIVE
TRADING MARKET WILL DEVELOP.
There has not been a public market for our common stock. We cannot predict
the extent to which investor interest in our common stock will lead to the
development of an active trading market or how liquid that market might become.
The initial public offering price for the shares was determined by negotiations
between us and the representatives of the underwriters and may not be indicative
of prices that will prevail in the trading market.
THE PRICE OF OUR COMMON STOCK AFTER THIS INITIAL PUBLIC OFFERING IS LIKELY TO BE
VOLATILE AND MAY FALL BELOW THE INITIAL PUBLIC OFFERING PRICE.
The stock market has experienced significant price and volume fluctuations,
and the market prices of securities of Internet-related companies have been
particularly volatile. Investors may be unable to resell their shares at or
above the initial public offering price. In the past, companies that have
experienced volatility in the market price of their stock have been subject to
securities class action
16
<PAGE> 17
litigation. A securities class action lawsuit against us could result in
substantial costs and a diversion of management's attention and resources.
EXISTING SHAREHOLDERS WILL BE ABLE TO EXERCISE CONTROL OF OUR COMMON STOCK AND
MAY MAKE DECISIONS THAT ARE NOT IN THE BEST INTERESTS OF ALL SHAREHOLDERS.
Insider control of a large amount of our common stock could have an adverse
effect on the market price of our common stock. At the completion of this
offering, Fingerhut will own approximately 34.3% of the outstanding shares of
our common stock. In addition, following this offering, our founders, Messrs.
Choate and Ballantine, will beneficially own or control approximately 26.2% of
the outstanding shares of our common stock, and our executive officers and
directors, including Messrs. Choate and Ballantine, will beneficially own or
control approximately 27.6% of the outstanding shares of our common stock.
Although they are under no obligation to do so, if our officers, directors,
founders, their affiliates and Fingerhut were to vote together they would have
the ability to control the election of our board of directors and the outcome of
corporate actions requiring shareholder approval, including mergers and other
changes of corporate control, going private transactions and other extraordinary
transactions. This concentration of ownership may have the effect of delaying or
preventing a change of control of FreeShop, even if this change of control would
benefit shareholders.
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements based on our current
expectations, assumptions, estimates and projections about our business and
industry. These forward-looking statements involve risks and uncertainties. Our
actual results could differ materially from those anticipated in such
forward-looking statements as a result of numerous factors, as more fully
described in "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business" and elsewhere in this
prospectus. You should not unduly rely on these forward-looking statements,
which apply only as of the date of this prospectus.
17
<PAGE> 18
USE OF PROCEEDS
We estimate the net proceeds from the sale of the 3,200,000 shares of
common stock offered hereby at the initial public offering price of $12.00 per
share, after deducting the underwriting discounts and commissions and estimated
offering expenses, will be $35.0 million, or $40.3 million if the underwriters'
over-allotment option is exercised in full.
We intend to use at least $20.0 million of the net proceeds from this
offering to significantly expand marketing and brand name promotion spending
over the next twelve months. We expect to use the remaining net proceeds of this
offering for other general corporate purposes, including working capital and
capital expenditures, and also for possible acquisitions of complementary
businesses and technologies that increase the number and variety of offers on
our Web site or increase the capability of our Web site. We have no current
understandings, commitments or agreements with respect to any material
acquisitions. Pending such uses, we will invest the net proceeds of this
offering in short-term, interest-bearing, investment-grade securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock and
do not anticipate doing so in the foreseeable future. We may incur indebtedness
in the future that may prohibit or effectively restrict the payment of
dividends, although we have no current plans to do so.
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<PAGE> 19
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999,
- on an actual basis;
- on a pro forma basis to reflect
(1) the issuance of series B convertible preferred stock upon the
exercise of warrants,
(2) the issuance of 8,820 additional shares of convertible preferred
stock, and
(3) the conversion of all series B convertible preferred stock into
shares of common stock no later than the completion of this
offering; and
- on a pro forma as adjusted basis to reflect the estimated net proceeds
from the sale of 3,200,000 shares of common stock in this offering at an
initial public offering price of $12.00 per share, after deducting
underwriting discounts and commissions and estimated offering expenses.
<TABLE>
<CAPTION>
AS OF
JUNE 30, 1999
(UNAUDITED)
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Current portion of long-term obligations.................... $ 122 $ 122 $ 122
======= ======= =======
Long-term obligations, less current portion................. $ 81 $ 81 $ 81
------- ------- -------
Shareholders' equity:
Preferred stock, undesignated, no par value; 6,814,516
shares authorized and no shares issued and outstanding
actual, pro forma and pro forma as adjusted(1)......... -- -- --
Series A convertible preferred stock, no par value;
1,935,484 shares authorized and issued; no shares
outstanding, actual, pro forma and pro forma as
adjusted(2)............................................ -- -- --
Series B convertible preferred stock, no par value;
1,250,000 shares authorized, 472,608 issued and
outstanding, actual; 1,250,000 shares authorized, no
shares issued or outstanding pro forma and pro forma as
adjusted(3)............................................ 8,615 -- --
Common stock, no par value, 100,000,000 shares authorized;
8,923,287 issued and 8,243,287 outstanding, 12,435,155
issued and 11,755,155 outstanding and 15,635,155 issued
and 14,955,155 outstanding, actual, pro forma and pro
forma as adjusted, respectively(4)..................... 8,956 26,450 61,412
Additional paid-in capital................................ 1,976 1,976 1,976
Deferred stock compensation............................... (1,076) (1,076) (1,076)
Accumulated deficit....................................... (9,964) (9,964) (9,964)
------- ------- -------
Total shareholders' equity............................. 8,507 17,386 52,348
------- ------- -------
Total capitalization.............................. $ 8,588 $17,467 $52,429
======= ======= =======
</TABLE>
- ---------------
(1) Ten million shares of undesignated preferred stock are authorized, of which
1,935,484 shares were designated as series A convertible preferred stock and
1,250,000 shares were designated as series B convertible preferred stock.
(2) Shares of series A convertible preferred stock were issued on June 30, 1997.
On July 18, 1997, all of the shares of series A convertible preferred stock
were converted into common stock.
(3) The shares of series B convertible preferred stock were designated on May
21, 1999. As of June 30, 1999, 472,608 shares have been issued pursuant to
the exercise of warrants. Prior to the completion of this offering, 396,539
additional shares of series B convertible preferred stock will be issued
pursuant to the exercise of warrants and 8,820 shares of series B
convertible preferred stock will be issued and sold. Upon completion of this
offering, each share of series B convertible preferred stock will be
converted into four shares of common stock.
(4) Based on the number of shares outstanding as of June 30, 1999. Excludes
953,289 shares of common stock issuable upon the exercise of options then
outstanding with a weighted average exercise price of $1.50 per share, and
27,700 shares of common stock issuable upon exercise of warrants then
outstanding with a weighted average exercise price of $1.19 per share. See
"Management -- Stock Option Plan" and Note 10 to FreeShop's audited
financial statements included in this prospectus.
19
<PAGE> 20
DILUTION
The pro forma net tangible book value of FreeShop as of June 30, 1999, was
approximately $14,889,000, or $1.27 per share of common stock. Pro forma net
tangible book value per share represents the amount of total pro forma tangible
assets less total pro forma liabilities, divided by the number of shares of
common stock outstanding on a pro forma basis after giving effect to the
conversion of the Series B convertible preferred stock into 3,511,868 shares of
common stock concurrent with the closing of this offering. After giving effect
to the sale of shares of common stock offered by FreeShop at an initial public
offering price of $12.00 per share and after deducting underwriting discounts
and commissions and estimated offering expenses, the pro forma net tangible book
value of FreeShop as of June 30, 1999 would have been $3.33 per share of common
stock. This represents an immediate increase in pro forma net tangible book
value of $2.06 per share to existing shareholders and an immediate dilution of
$8.67 per share to new investors. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $12.00
Pro forma net tangible book value per share before this
offering............................................... $ 1.27
Increase per share attributable to new investors.......... 2.06
------
Pro forma net tangible book value per share after this
offering.................................................. 3.33
------
Dilution per share to new investors......................... $ 8.67
======
</TABLE>
The following table summarizes, on a pro forma basis as of June 30, 1999,
the differences between existing shareholders and new investors with respect to
the number of shares of common stock purchased from FreeShop, the total
consideration paid to FreeShop and the average price per share paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
-------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders......................... 11,755,155 78.6% $26,450,036 40.8% $ 2.25
New investors................................. 3,200,000 21.4 38,400,000 59.2 12.00
---------- ----- ----------- ----- ------
Total.................................... 14,955,155 100.0% $64,850,036 100.0% $ 4.34
========== ===== =========== ===== ======
</TABLE>
The foregoing discussion and tables assume no exercise of any stock options
outstanding as of June 30, 1999. As of June 30, 1999, there were options
outstanding to purchase a total of 953,289 shares of common stock with a
weighted average exercise price of $1.50 per share and warrants outstanding to
purchase a total of 27,700 shares of common stock with a weighted average
exercise price of $1.19 per share. To the extent that any of the options or
warrants are exercised, there will be further dilution to new investors. See
"Management -- Stock Option Plan" and Note 10 to FreeShop's audited financial
statements included in this prospectus.
20
<PAGE> 21
SELECTED UNAUDITED PRO FORMA FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following unaudited pro forma statement of operations data reflects the
acquisitions of the Catalog Site and Worldwide Brochures Web sites and related
assets as if they had occurred on January 1, 1998. The following unaudited pro
forma financial data is presented for informational purposes only and has been
derived from the unaudited pro forma financial statements and accompanying notes
appearing in this prospectus and should be read in conjunction with those
financial statements. The selected unaudited pro forma financial data does not
purport to be indicative of future operations and should not be construed as
representative of future operations of the combined businesses. See Note 7 to
FreeShop's unaudited pro forma combined financial information for a description
of the method we used to compute our basic and diluted net loss per share of
common stock.
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
YEAR ENDED SIX MONTHS ENDED
DEC. 31, 1998 JUNE 30, 1999
----------------- ------------------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................................. $ 1,893 $ 2,381
Cost of revenues.......................................... 438 246
----------- -------
Gross profit........................................... 1,455 2,135
Operating expenses:
Sales and marketing.................................... 3,269 4,197
Research and development............................... 387 321
General and administrative............................. 605 598
Equity based compensation.............................. 174 622
Depreciation and amortization.......................... 1,253 552
----------- -------
Total operating expenses.......................... 5,688 6,290
Operating loss............................................ (4,233) (4,155)
Interest expense.......................................... 66 24
Other (income) expense.................................... (3) (87)
----------- -------
Net loss.................................................. $ (4,296) $(4,092)
=========== =======
Basic and diluted net loss per common share............... $ (0.68) $ (0.46)
=========== =======
Shares used to compute pro forma basic and diluted net
loss per common share.................................. 6,277 8,858
</TABLE>
21
<PAGE> 22
SELECTED ACTUAL FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected actual financial data are qualified in their
entirety by reference to, and you should read them in conjunction with,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and FreeShop's audited financial statements and accompanying notes
appearing in this prospectus. We have derived the statements of operations data
for December 31, 1998 from our audited financial statements that appear in this
prospectus, and this data is qualified by reference to the financial statements.
Prior to June 30, 1997, FreeShop's business operations were conducted as a
division of Online Interactive. On June 30, 1997, Online Interactive contributed
the FreeShop division to its wholly owned subsidiary, FreeShop International,
which began operating as an independent entity with a fiscal year end of
December 31. The statements of operations and balance sheet information for the
three fiscal years ended June 30, 1995, 1996 and 1997 reflect the data of the
FreeShop division of Online Interactive. The statements of operations and
balance sheet information for the six months ended December 31, 1997, the fiscal
year ended December 31, 1998 and the six-month periods ended June 30, 1998 and
June 30, 1999 reflect data compiled since FreeShop began operating as an
independent entity. See Note 1 to FreeShop's audited financial statements
included in this prospectus.
<TABLE>
<CAPTION>
FREESHOP DIVISION
OF ONLINE INTERACTIVE, INC. FREESHOP
---------------------------- --------------------------------------------------------------
SIX MONTHS 12 MONTHS YEAR SIX MONTHS ENDED
YEAR ENDED JUNE 30, ENDED ENDED ENDED JUNE 30,
---------------------------- DEC. 31, DEC. 31, DEC. 31, -----------------
1995 1996 1997 1997 1997(1) 1998 1998 1999
-------- ------- ------- ------------ ------------ ------------ ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues........................ $ 313 $ 1,271 $ 1,198 $ 535 $ 1,037 $ 1,251 $ 429 $ 2,147
Cost of revenues................ 85 310 314 140 259 217 76 190
-------- ------- ------- ------- ------- ------- ------- -------
Gross profit.................. 228 961 884 395 778 1,034 353 1,957
Operating expenses:
Sales and marketing........... 134 624 1,810 1,175 2,225 3,088 1,030 4,141
Research and development...... 2 65 135 182 259 387 194 322
General and administrative.... 126 291 353 83 298 417 172 462
Equity-based compensation..... -- -- -- 63 64 174 122 622
Depreciation and
amortization................ -- 9 30 35 52 104 49 260
-------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses................ 262 989 2,328 1,538 2,898 4,170 1,567 5,807
Operating loss.................. (34) (28) (1,444) (1,143) (2,120) (3,136) (1,214) (3,850)
Interest expense................ -- -- -- 6 6 66 28 23
Other (income) expense.......... -- -- -- 0 0 (3) 1 (87)
-------- ------- ------- ------- ------- ------- ------- -------
Net loss........................ $ (34) $ (28) $(1,444) $(1,149) $(2,126) $(3,199) $(1,243) $(3,786)
======== ======= ======= ======= ======= ======= ======= =======
Basic and diluted net loss per
common share.................. $ (0.01) $ (0.01) $ (0.31) $ (0.22) $ (0.51) $ (0.21) $ (0.46)
======== ======= ======= ======= ======= ======= =======
Shares used to compute basic and
diluted net loss per common
share......................... 4,601 4,601 4,601 5,189 6,224 5,822 8,183
</TABLE>
<TABLE>
<CAPTION>
AS OF JUNE 30, AS OF DEC. 31,
---------------------------- --------------------------- AS OF JUNE 30,
1995 1996 1997 1997 1998 1999
-------- ------- ------- ------------ ------------ ------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents...... $ -- $ -- $ -- $ 26 $ 2,892 $ 4,330
Working capital (deficiency)... 3 80 322 (158) 2,014 5,190
Total assets................... 48 207 536 645 3,687 10,613
Long-term obligations, less
current portion.............. -- -- 5 160 195 81
Total shareholders' equity..... 8 105 432 82 2,244 8,507
</TABLE>
- ---------------
(1) The financial information presented for the 12 months ended December 31,
1997 is an unaudited 12-month period prepared by our management for
comparative purposes only.
22
<PAGE> 23
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We began our direct marketing business in 1994 as the FreeShop division of
Online Interactive, Inc., a company founded by Timothy C. Choate and John P.
Ballantine. In addition to operating the FreeShop division, Online Interactive
was also engaged in the business of selling software over the Internet. In July
1997, Micro Warehouse, Inc., a catalog retailer and direct marketer of
computers, software and related products, purchased all of the stock of Online
Interactive from its shareholders. Before the purchase was completed, Online
Interactive transferred the FreeShop division to FreeShop International, Inc., a
newly formed, wholly owned subsidiary, and spun off FreeShop International
through a distribution to its shareholders. On February 19, 1999, FreeShop
International changed its name to FreeShop.com, Inc.
We began our online marketing operations in 1994 through a relationship
with Prodigy Communications Corporation, a proprietary online service. In 1995,
we also began a marketing relationship with America Online, Inc., another
proprietary online service. We came to believe proprietary online environments,
which provide content exclusively to their fee-paying members, were limiting our
ability to develop the FreeShop brand and to access the growing number of people
using the Internet. As a result, we terminated our relationship with Prodigy in
August 1997 and our relationship with America Online in March 1998. Since March
1998, we have focused exclusively on our FreeShop.com Web site.
With the Micro Warehouse purchase of Online Interactive in July 1997, Mr.
Choate joined Micro Warehouse as a vice president. In March 1998, Mr. Choate
rejoined FreeShop as chief executive officer and began initiatives to expand our
sources of revenue beyond our primary business of lead generation by offering
multiple advertising vehicles, such as banner advertising, site sponsorships and
sponsorships of our Club FreeShop email newsletters. We also increased our
efforts to expand consumer awareness of and visits to our Web site. We have
continued our efforts to improve the attractiveness of the FreeShop.com Web site
and to develop technology to improve our ability to offer services to clients
and to monitor and manage our Web site.
We derive our revenues primarily from online lead generation and
advertising contracts. We receive lead generation revenues when we deliver
customer information to a marketer in connection with an offer on our Web site.
We receive advertising revenues from sales of banner advertising, site
sponsorships and newsletter sponsorships. We also derive a small portion of our
lead generation revenues from the rental of customer names and street addresses
to third parties. Lead generation pricing is based on cost per lead and varies
depending on the type of offer. Generally, pricing of advertising is based on
cost per impression or cost per click through. The services we deliver are
primarily sold under short-term agreements that are subject to cancellation. We
recognize revenues in the period in which we deliver the service. See
"Business -- Client Services" and Note 2 to FreeShop's audited financial
statements included in this prospectus.
Our ten largest clients accounted for 25.0% of our revenues in the year
ended December 31, 1998 and 29.1% of our revenues in the six months ended June
30, 1999. No single client accounted for more than 6.7% of our revenues in the
six months ended June 30, 1998, 3.8% of our revenues in the year ended December
31, 1998 or 8.3% of revenues in the six months ended June 30, 1999.
In December 1998, Fingerhut invested $4.0 million in our business and
received common stock and warrants. As of June 30, 1999, Fingerhut had exercised
warrants for an additional investment of $8.6 million. Pursuant to the terms of
a letter agreement and an escrow agreement, Fingerhut has agreed to exercise the
remainder of its warrants for an additional investment of $8.9 million if this
offering is completed on or before October 31, 1999. Assuming the exercise
23
<PAGE> 24
of the warrants and conversion of the series B convertible preferred stock,
Fingerhut will hold approximately 43.7% of the common stock immediately prior to
the completion of this offering. Fingerhut's investments have given us more
resources to accelerate the growth of our business and have permitted us to add
experienced management, marketing and technical personnel. Apart from the
exercise by Fingerhut of these warrants, however, Fingerhut has no obligation to
make equity or other capital resources available to us in the future. See
"Business -- Strategy" and "Related Party Transactions."
Part of our strategy involves growth through the acquisition of businesses
that will expand our offerings to consumers and our services to marketers. In
May 1999, we purchased the Web sites and related assets of two companies,
Commonsite, LLC, whose Catalog Site Web site offers more than 200 catalogs, and
Travel Companions International, Inc., whose Worldwide Brochures Web site offers
consumers more than 15,000 free travel brochures. Revenues generated by the
Catalog Site and Worldwide Brochures Web sites primarily come from flat-fee
advertising contracts. We intend to transition these advertising contracts to
lead generation contracts. We accounted for these acquisitions as asset
purchases and have included the results of the acquired businesses in our
financial statements from the date we completed the acquisitions. These
acquisitions resulted in the allocation of $2.7 million to goodwill and other
intangible assets in May 1999. We are amortizing these intangible assets over
periods ranging from one to five years. We have included unaudited pro forma
combined financial information in this prospectus reflecting these acquisitions
as if the acquisitions had occurred on January 1, 1998. Pro forma revenues were
$2.4 million for the six months ended June 30, 1999 and $1.9 million for the
year ended December 31, 1998. See our unaudited pro forma combined financial
statements, the Commonsite audited financial statements and the Travel
Companions International audited financial statements included in this
prospectus.
Our business has been operating at a loss and generating negative cash flow
since inception. As of June 30, 1999, we had accumulated losses of approximately
$9.6 million. After the completion of this offering, we plan to increase further
the level of our investment in marketing and promotion, development of
technology and expansion of our business. As a result, our losses and negative
cash flow are likely to continue to increase.
RESULTS OF OPERATIONS
We changed our fiscal year end from June 30 to December 31 in connection
with our spin-off from Online Interactive in June 1997. Due to this change, we
believe comparison of the year ended December 31, 1998 to the six months ended
December 31, 1997 is not appropriate. Therefore, management prepared financial
information for the 12-month period ended December 31, 1997 for the purposes of
comparison only. The following discussion compares the results of operations for
the year ended December 31, 1998 to the unaudited 12-month period ended December
31, 1997 and compares the results of operations for the year ended June 30, 1997
to the year ended June 30, 1996.
Our financial statements for the years ended June 30, 1996 and 1997 reflect
the assets and liabilities and the revenues, expenses and cash flow of the
FreeShop division of Online Interactive. Certain expenses of Online Interactive
were allocated to us on a basis we believe reflects a reasonable allocation of
expenses to present FreeShop as a stand-alone company. See Note 1 to FreeShop's
audited financial statements included in this prospectus.
24
<PAGE> 25
The following table sets forth statement of operations data for the periods
indicated as a percentage of revenues:
<TABLE>
<CAPTION>
YEAR ENDED 12 MONTHS YEAR SIX MONTHS ENDED
JUNE 30, ENDED ENDED JUNE 30,
--------------- DEC. 31, DEC. 31, ----------------
1996 1997 1997(1) 1998 1998 1999
----- ------ ------------ ---------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues....................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues............... 24.4 26.2 25.0 17.3 17.6 8.8
----- ------ ------ ------ ------ ------
Gross profit................. 75.6 73.8 75.0 82.7 82.4 91.2
Operating expenses:
Sales and marketing.......... 49.1 151.1 214.7 246.9 240.1 192.9
Research and development..... 5.1 11.3 25.0 30.9 45.2 15.0
General and administrative... 22.9 29.5 28.7 33.4 40.1 21.5
Equity-based compensation.... 0.0 0.0 6.1 13.9 28.6 29.0
Depreciation and
amortization.............. 0.7 2.5 5.0 8.3 11.4 12.1
----- ------ ------ ------ ------ ------
Total operating
expenses................ 77.8 194.4 279.5 333.4 365.4 270.5
----- ------ ------ ------ ------ ------
Operating loss................. (2.2) (120.6) (204.5) (250.7) (283.0) (179.3)
Interest expense............... 0.0 0.0 0.7 5.2 6.6 1.1
Other (income) expense......... 0.0 0.0 0.0 (0.2) 0.2 (4.1)
----- ------ ------ ------ ------ ------
Net loss....................... (2.2)% (120.6)% (205.2)% (255.7)% (289.8)% (176.3)%
===== ====== ====== ====== ====== ======
</TABLE>
- ---------------
(1) The financial information for the 12 months ended December 31, 1997 is an
unaudited 12-month period prepared by our management for comparative
purposes only.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
(UNAUDITED)
Revenues. We derive our revenues primarily from online lead generation and
advertising contracts. Our revenues increased by $1.7 million, or 400%, to $2.1
million in the six months ended June 30, 1999, compared to $429,000 in the six
months ended June 30, 1998. This growth in revenue was attributable to the
introduction of advertising revenue in June 1998 and an increase in the number
of visits to our Web site, which increased lead generation revenues. We
introduced advertising, including banner ads, site sponsorships and newsletter
sponsorships, in the second and third quarters of 1998. Revenues from
advertising services were $839,000 in the six months ended June 30, 1999,
compared to $13,000 in the six months ended June 30, 1998. Over the same period,
lead generation revenues increased to $1.3 million from $416,000.
Cost of revenues. Cost of revenues consists of expenses associated with the
production and usage of the FreeShop.com Web site, including Internet connection
charges, banner ad serving fees, equipment and software depreciation and
personnel costs. Cost of revenues increased to $190,000 in the six months ended
June 30, 1999 from $76,000 in the six months ended June 30, 1998. The increase
was primarily due to costs related to additional Internet connection capacity
and personnel costs to support our growth. Gross margin increased to 91.2% in
the six months ended June 30, 1999, from 82.4% in the six months ended June 30,
1998. This increase in gross margin was primarily due to cost of revenues
increasing at a lesser rate than revenues.
Sales and marketing. Sales and marketing expenses consist primarily of
marketing and promotional costs related to developing our brand, as well as
personnel and other costs. Sales and marketing expenses increased by $3.1
million, or 302%, to $4.1 million in the six months ended June 30, 1999,
compared to $1.0 million in the six months ended June 30, 1998. The increase was
due primarily to a $1.9 million, or 626%, increase in advertising and brand
awareness spending and a $726,000, or 131%, increase in personnel costs. We
expect to continue to increase our advertising and brand awareness spending in
the future. As a percentage of
25
<PAGE> 26
revenues, sales and marketing expenses decreased to 192.9% in the six months
ended June 30, 1999, from 240.1% in the six months ended June 30, 1998. This
decrease was primarily due to sales and marketing expenses, other than
advertising spending, increasing at a lesser rate than revenues.
Research and development. Research and development expenses primarily
include personnel costs related to maintaining and enhancing the features,
content and functionality of our Web site and related systems. Research and
development expenses increased by $128,000, or 66%, to $322,000 in the six
months ended June 30, 1999, compared to $194,000 in the six months ended June
30, 1998. The increase was primarily due to hiring additional staff to support
our growth. As a percentage of revenues, research and development expenses
decreased to 15% in the six months ended June 30, 1999, from 45.2% in the six
months ended June 30, 1998. The decrease was primarily due to research and
development expenses increasing at a lesser rate than revenues.
General and administrative. General and administrative expenses primarily
consist of management, financial and administrative personnel expenses and
related costs and professional service fees. General and administrative expenses
increased by $290,000, or 169%, to $462,000 in the six months ended June 30,
1999, compared to $172,000 in the six months ended June 30, 1998. The increase
was primarily due to increased personnel costs and professional service fees
necessary to support our growth. As a percentage of revenues, general and
administrative expenses decreased to 21.5% in the six months ended June 30,
1999, from 40.1% in the six months ended June 30, 1998. The decrease is
primarily due to general and administrative expenses increasing at a lesser rate
than revenues.
Equity-based compensation. Equity-based compensation expenses consist of
amortization of unearned compensation recognized in connection with stock
options and recognition of expenses when our principal shareholders sell our
stock to employees and directors at a price below the estimated fair market
value of our common stock. Unearned compensation is recorded based on the
intrinsic value when we issue stock options to employees at an exercise price
below the estimated fair market value of our common stock at the date of grant.
Unearned compensation is also recorded based on the fair value of the option
granted as calculated using the Black-Scholes option pricing model when options
or warrants are issued to advisors and other service providers. Unearned
compensation is amortized over the vesting period of the option or warrant.
Equity-based compensation expenses increased by $500,000, or 410%, to $622,000
in the six months ended June 30, 1999, compared to $122,000 in the six months
ended June 30, 1998. This increase resulted primarily from recognition of
$406,000 of expenses related to the sale of securities to an employee by a
principal shareholder at a price below the estimated fair market value as an
inducement for the employee to come to work for FreeShop. As a percentage of
revenue, equity-based compensation expenses increased to 29.0% in the six months
ended June 30, 1999, from 28.6% in the six months ended June 30, 1998.
Depreciation and amortization. Depreciation and amortization expenses
consist of depreciation on leased and owned computer equipment, software, office
equipment and furniture and amortization on intellectual property, noncompete
agreements and goodwill from acquisitions. Depreciation and amortization
expenses increased by $211,000, or 431%, to $260,000 in the six months ended
June 30, 1999, compared to $49,000 in the six months ended June 30, 1998. This
increase resulted from the depreciation of approximately $700,000 in furniture
and equipment acquired from July 1998 through June 1999 and the amortization of
approximately $2.7 million in intangible assets related to the acquisition of
substantially all of the assets of Commonsite and Travel Companions
International. As a percentage of revenue, depreciation and amortization
expenses increased to 12.1% in the six months ended June 30, 1999, from 11.4% in
the six months ended June 30, 1998.
26
<PAGE> 27
Interest expense. Interest expense primarily relates to capital equipment
leases, and totaled $23,000 in the six months ended June 30, 1999 and $28,000 in
the six months ended June 30, 1998.
Other (income) expense. Other (income) expense consists primarily of
interest income. Interest income increased to $87,000 in the six months ended
June 30, 1999 from no interest income in the six months ended June 30, 1998, due
to higher cash balances resulting from the investment by Fingerhut in December
1998.
Income taxes. No provision for federal income taxes has been recorded for
any of the periods presented. As of June 30, 1999, we had approximately $7.3
million of federal net operating loss carryforwards that are available to offset
future taxable income; these carryforwards expire in various years beginning in
2012, if not previously utilized. We expect that Fingerhut will increase its
ownership of our common stock prior to the completion of this offering which
will limit, under the Tax Reform Act of 1986, the amounts of and benefits from
our net operating loss carryforwards. Based on preliminary estimates, we believe
the effect of such limitation, if imposed, will not have a material adverse
effect on our business, results of operations and financial condition.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO UNAUDITED 12 MONTHS ENDED DECEMBER 31,
1997
Revenues. Our revenues increased by $214,000, or 21%, to $1.3 million in
the year ended December 31, 1998, compared to $1.0 million in the 12 months
ended December 31, 1997. The growth in revenue in 1998 was primarily
attributable to the introduction of new revenue streams. We introduced
advertising, including banner ads, site sponsorships and newsletter sponsorships
in the second and third quarters of 1998. Revenues from advertising were
$288,000 in 1998, compared to no advertising revenues in 1997. Revenues from
lead generation were $963,000 in 1998, compared to $1.0 million in 1997. The
overall growth in revenues was partially offset by a reduction in lead
generation revenues resulting from the termination of our relationships with
Prodigy in August 1997 and America Online in March 1998.
Cost of revenues. Cost of revenues decreased to $217,000 in 1998 from
$259,000 in 1997. The decrease in cost of revenues was primarily due to lower
access charges for the Internet compared to the proprietary Prodigy and America
Online environments. As a result, gross margin increased to 82.7% in 1998, from
75.0% in 1997.
Sales and marketing. Sales and marketing expenses increased by $863,000, or
39%, to $3.1 million in 1998, compared to $2.2 million in 1997. The increase was
primarily due to a $988,000, or 405%, increase in advertising and brand
awareness spending which was partially offset by reduced contract labor
spending. As a percentage of revenues, sales and marketing expenses increased to
246.9% in 1998, from 214.7% in 1997.
Research and development. Research and development expenses increased by
$128,000, or 49%, to $387,000 in 1998, compared to $259,000 in 1997. The
increase was primarily due to hiring of additional staff to support our growth.
As a percentage of revenues, research and development expenses increased to
30.9% in 1998, from 25.0% in 1997.
General and administrative. General and administrative expenses increased
by $119,000, or 40%, to $417,000 in 1998, compared to $298,000 in 1997. The
increase was primarily a result of increased personnel costs and professional
service fees necessary to support our growth. As a percentage of revenues,
general and administrative expenses increased to 33.4% in 1998, from 28.7% in
1997.
Equity-based compensation. Equity-based compensation expenses increased by
$110,000, or 172%, to $174,000 in 1998, compared to $64,000 in 1997. This
increase resulted primarily from option grants made to advisors and directors
and four gifts of common stock made to employees
27
<PAGE> 28
by principal shareholders. As a percentage of revenue, equity-based compensation
expense increased to 13.9% in 1998, from 6.1% in 1997.
Depreciation and amortization. Depreciation and amortization expense
increased by $52,000, or 100%, to $104,000 in 1998, compared to $52,000 in 1997.
This increase resulted from the depreciation of approximately $171,000 in
furniture and equipment acquired during 1998. As a percentage of revenue,
depreciation and amortization expense increased to 8.3% in 1998, from 5.0% in
1997.
Interest expense. Interest expense increased by $60,000, to $66,000 in
1998, compared to $6,000 in 1997. The increase was due to the addition of leased
capital equipment in the third and fourth quarters of 1997 and throughout 1998.
Other (income) expense. Other (income) expense in 1998 consisted primarily
of interest income in the amount of $11,000 offset by the write-off of obsolete
assets in the amount of $9,000. There was no other (income) expense in 1997.
YEAR ENDED JUNE 30, 1997 COMPARED TO YEAR ENDED JUNE 30, 1996
Revenues. Our revenues decreased by $73,000, or 6%, to $1.2 million in the
year ended June 30, 1997, compared to $1.3 million in the year ended June 30,
1996. The decrease was primarily due to the decline in Prodigy's membership
base. Revenues related to the Prodigy relationship were $396,000, or 33% of
total revenue, in 1997 and $484,000, or 38% of total revenue, in 1996.
Cost of revenues. Cost of revenues increased to $314,000 in 1997 from
$310,000 in 1996. As a result, gross margin decreased to 73.8% in 1997 from
75.6% in 1996.
Sales and marketing. Sales and marketing expenses increased by $1.2
million, or 190%, to $1.8 million in 1997, compared to $624,000 in 1996. The
increase was primarily due to increased personnel costs related to building our
own internal sales and marketing staff in 1997 and costs associated with
termination of a contract with a third-party sales agent. As a percentage of
revenues, sales and marketing expenses increased to 151.1% in 1997 from 49.1% in
1996.
Research and development. Research and development expenses increased by
$70,000, or 108%, to $135,000 in 1997, compared to $65,000 in 1996. The increase
was primarily due to hiring of additional staff. As a percentage of revenues,
research and development expenses increased to 11.3% in 1997 from 5.1% in 1996.
General and administrative. General and administrative expenses increased
by $62,000, or 21%, to $353,000 in 1997, compared to $291,000 in 1996. The
increase was primarily a result of increased personnel costs and professional
service fees. As a percentage of revenues, general and administrative expenses
increased to 29.5% in 1997 from 22.9% in 1996.
Equity-based compensation. No equity-based compensation expense was
recognized in either period because FreeShop was operating as a division of
Online Interactive during both periods.
Depreciation and amortization. Depreciation and amortization expense
increased by $21,000, or 233%, to $30,000 in 1997, compared to $9,000 in 1996.
This increase resulted from the depreciation of approximately $109,000 in
furniture and equipment acquired during 1997. As a percentage of revenue,
depreciation and amortization expense increased to 2.5% in 1997 from 0.7% in
1996.
28
<PAGE> 29
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth FreeShop's unaudited quarterly statement of
operations data for the six quarters ended June 30, 1999. In the opinion of our
management, this information was prepared on substantially the same basis as
FreeShop's audited financial statements and accompanying notes included in this
prospectus.
In the opinion of our management, all necessary adjustments, consisting
only of normal recurring adjustments and the adjustments necessary to record the
acquisition of substantially all of the assets of the Catalog Site and Worldwide
Brochures Web sites in May 1999, have been included in the amounts stated below
to present fairly the unaudited quarterly results. You should read this
quarterly data in conjunction with FreeShop's audited financial statements and
accompanying notes included in this prospectus. Our operating results for any
quarter are not necessarily indicative of the operating results for any future
period.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1998 1998 1998 1998 1999 1999
--------- -------- --------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues.................. $ 220 $ 209 $ 321 $ 501 $ 667 $ 1,480
Cost of revenues.......... 39 37 65 76 83 107
----- ----- ------ ------ ------- -------
Gross profit........... 181 172 256 425 584 1,373
Operating expenses:
Sales and marketing.... 459 571 981 1,077 1,496 2,645
Research and
development.......... 113 81 86 107 141 181
General and
administrative....... 89 83 94 151 210 252
Equity-based
compensation......... 69 53 39 13 79 543
Depreciation and
amortization......... 24 25 26 29 36 224
----- ----- ------ ------ ------- -------
Total operating
expenses.......... 754 813 1,226 1,377 1,962 3,845
----- ----- ------ ------ ------- -------
Operating loss............ (573) (641) (970) (952) (1,378) (2,472)
Interest expense.......... 12 16 16 22 13 10
Other (income) expense.... -- 1 6 (10) (25) (62)
----- ----- ------ ------ ------- -------
Net loss.................. $(585) $(658) $ (992) $ (964) $(1,366) $(2,420)
===== ===== ====== ====== ======= =======
</TABLE>
29
<PAGE> 30
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1998 1998 1998 1998 1999 1999
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
AS A PERCENTAGE OF REVENUES:
Revenues.................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues.......... 17.5 17.8 20.2 15.2 12.5 7.2
------ ------ ------ ------ ------ -------
Gross profit........... 82.5 82.2 79.8 84.8 87.5 92.8
Operating expenses:
Sales and marketing.... 208.4 273.4 305.6 215.2 224.4 178.7
Research and
development.......... 51.4 38.7 26.8 21.2 21.1 12.2
General and
administrative....... 40.3 39.8 29.3 30.1 31.5 17.1
Equity-based
compensation......... 31.6 25.5 12.2 2.5 11.9 36.7
Depreciation and
amortization......... 10.9 11.9 8.1 5.9 5.4 15.1
------ ------ ------ ------ ------ -------
Total operating
expenses.......... 342.6 389.3 382.0 274.9 294.3 259.8
------ ------ ------ ------ ------ -------
Operating loss............ (260.1) (307.1) (302.2) (190.1) (206.8) (167.0)
Interest expense.......... 5.5 7.8 4.9 4.3 2.0 0.7
Other (income) expense.... 0.0 0.4 2.0 (1.9) (3.8) (4.2)
------ ------ ------ ------ ------ -------
Net loss.................. (265.6)% (315.3)% (309.1)% (192.5)% (205.0)% (163.5)%
====== ====== ====== ====== ====== =======
</TABLE>
Revenues. Our revenues increased in each quarter presented, except for the
second quarter of 1998. Our revenues decreased by $11,000, or 5%, to $209,000 in
the second quarter of 1998, compared to $220,000 in the first quarter of 1998.
This decrease was due to the termination of our relationship with America Online
in March 1998. The relationship with America Online had accounted for $111,000,
or 50%, of total revenues in the first quarter of 1998. Revenues unrelated to
America Online increased by $94,000, or 86%, to $203,000 in the second quarter
of 1998 compared to $109,000 in the first quarter of 1998. In addition, our
current chief executive officer, Timothy C. Choate, rejoined FreeShop in March
1998 and focused on creating new revenue streams and accelerating the growth of
our business.
Cost of revenues. As a percentage of revenues, cost of revenues increased
during the first three quarters of 1998 as we built our infrastructure in
anticipation of future revenues. Since the third quarter of 1998, we have
recognized significant increases in gross margin due to cost of revenues
increasing at a lesser rate than revenues.
Sales and marketing. Sales and marketing expenses increased in absolute
dollars in each quarter presented. As a percentage of revenues, there was a
decrease in sales and marketing expenses in the fourth quarter of 1998 and the
second quarter of 1999. The decrease as a percentage of revenues in the fourth
quarter of 1998 resulted from an increase in revenues in the fourth quarter of
1998 without a corresponding increase in advertising and brand awareness
spending. As a percentage of revenue, sales and marketing expenses have
decreased in the second quarter of 1999. This decrease was primarily due to
sales and marketing expenses, other than advertising spending, increasing at a
lesser rate than revenues.
Research and development. Research and development expenses decreased in
the second quarter of 1998 primarily due to higher personnel costs and
recruiting fees paid in the first quarter of 1998. Research and development
expenses have increased steadily since the third quarter of 1998 as a result of
increased personnel costs related to the continued enhancement of our systems
and Web site.
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General and administrative. General and administrative expenses decreased
in the second quarter of 1998 primarily due to a decrease in personnel costs and
one-time severance costs incurred in the first quarter of 1998 resulting from
the departure of our former chief executive officer and another senior officer.
General and administrative expenses have increased steadily since the second
quarter of 1998 due primarily to additional personnel costs and professional
service fees necessary to support our growth.
Equity-based compensation. Equity-based compensation expenses for the first
three quarters of 1998 relate primarily to recognition of compensation for gifts
of stock made by a significant shareholder to some of our employees.
Compensation expenses in the fourth quarter of 1998 and the first quarter of
1999 relate to options granted. Compensation expenses in the second quarter of
1999 include both amounts related to grants of options and $406,000 of expense
related to the sale of securities to an employee by a significant shareholder at
a price below the estimated fair market value of the stock.
Depreciation and amortization. Depreciation and amortization expenses have
increased during each quarter presented primarily due to the acquisition of
additional computer equipment, software, office equipment and furniture. In the
second quarter of 1999, depreciation and amortization expenses increased in
absolute dollars and as a percentage of revenues. A significant portion of this
increase resulted from the amortization of intangible assets related to the
acquisition of substantially all of the assets of Commonsite, LLC and Travel
Companions International, Inc.
We anticipate our revenues may be subject to seasonal fluctuations. We
believe advertisers generally place fewer advertisements during the first and
third calendar quarters of each year. In addition, expenditures by advertisers
tend to be cyclical, reflecting overall economic conditions as well as budgeting
and buying patterns. Our results of operations may fluctuate significantly in
the future as a result of a variety of factors, many of which are beyond our
control.
STOCK OPTIONS GRANTED IN 1999
From January 1, 1999 to June 30, 1999, we granted options to purchase
191,616 shares of common stock under the 1997 Stock Option Plan. These options
were granted to employees, directors and service providers at exercise prices of
$2.50 to $4.27 per share which were below the fair market value of our common
stock at the date of grant. In relation to these grants, we will recognize
estimated compensation expenses of approximately $1.3 million over the vesting
terms of one to four years. Compensation expense related to the options of
approximately $566,000, $401,000, $207,000, $96,000 and $20,000 will be
classified as operating expenses in the years ending 1999, 2000, 2001, 2002 and
2003, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Since we began operating as an independent company in June 1997, we have
financed our operations primarily through the issuance of capital stock. Gross
proceeds from the issuance of stock through June 30, 1999 totaled $14.9 million,
including $4.0 million raised in December 1998 and $8.6 million raised in May
and in June 1999. As of June 30, 1999, we had a $500,000 bank line-of-credit
available at prime plus 1.5%. As of June 30, 1999, we had approximately $5.8
million in cash and cash equivalents and short-term investments and working
capital of $5.2 million.
Net cash used in operating activities was $3.4 million in the six months
ended June 30, 1999, $2.2 million in the year ended December 31, 1998 and
$595,000 in the six months ended December 31, 1997. Cash used in operating
activities for each period resulted primarily from net losses and increases in
accounts receivable, which were partially offset by increases in accounts
payable and accrued liabilities.
Net cash used in investing activities was $3.7 million in the six months
ended June 30, 1999, $67,000 in the year ended December 31, 1998 and $56,000 in
the six months ended
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December 31, 1997. In the six months ended June 30, 1999, $1.7 million was used
to acquire substantially all of the assets of Commonsite, LLC and Travel
Companions International, Inc., $1.5 million was used to purchase short-term
commercial paper and $500,000 was used to purchase equipment and furniture. For
the year ended December 31, 1998 and the six months ended December 31, 1997,
cash used in investing activities was primarily related to purchases of property
and equipment.
Net cash provided by financing activities was $8.6 million in the six
months ended June 30, 1999, $5.2 million in the year ended December 31, 1998 and
$677,000 in the six months ended December 31, 1997. Net cash provided by
financing activities resulted primarily from issuance of capital stock, which
was partially offset by principal payments made on capital leases.
We believe our current cash and cash equivalents, including expected net
proceeds from this offering, will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures for at least the next 12
months. Thereafter, we expect we will need to raise additional capital to meet
our long-term operating requirements. Although we have increased revenues, our
expenses also have continued to increase, and we expect to increase our expenses
significantly in future periods, such that our expenses will exceed our revenues
for the foreseeable future. Accordingly, we do not expect to be able to fund our
operations from internally generated funds for the foreseeable future. Our cash
requirements depend on several factors, including the level of expenditures on
advertising and brand awareness, the rate of market acceptance of our services,
and the extent to which we use cash for acquisitions and strategic investments.
Unanticipated expenses, poor financial results or unanticipated opportunities
that require financial commitments could give rise to earlier financing
requirements. If we raise additional funds through the issuance of equity or
convertible debt securities, the percentage ownership of our shareholders would
be reduced, and these securities might have rights, preferences or privileges
senior to those of our common stock. Additional financing may not be available
on terms favorable to us, or at all. If adequate funds are not available or are
not available on acceptable terms, our ability to fund our expansion, take
advantage of business opportunities, develop or enhance services or products or
otherwise respond to competitive pressures would be significantly limited, and
we might need to significantly restrict our operations. We believe we do not
have material market risk exposure due to the fact that we own no derivative
instruments, engage in no hedging transactions, have a minimal amount of
outstanding long-term debt and currently invest our excess cash in short-term
commercial paper.
YEAR 2000 ISSUES
Because many computer applications have been written using two digits
rather than four to define the applicable year, some date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. The year
2000 issue could result in system failures or miscalculations causing
disruptions of operations, including disruptions of our Web site.
We have completed a review of our internal information technology and
non-information technology systems for year 2000 compliance. We do not believe
that we have material exposure to the year 2000 issue with respect to our
systems.
We are in the process of obtaining confirmation from all of our third-party
vendors that they have resolved their year 2000 issues. All of our vendors,
except three, have responded either orally or in writing and either confirmed
their compliance or provided patches for their affected software. We expect to
receive a reply from one remaining third-party vendor by October 31, 1999. We do
not expect the other two vendors to certify that their software or services are
year 2000 compliant. The vendors who have already responded include all vendors
related to our critical systems.
We have completed an initial test of our internal systems and anticipate
conducting tests with the cooperation of our vendors after September 30, 1999 to
simulate the year 2000 rollover with hardware, software and key vendors. We plan
to make any modifications resulting from the test by the fourth quarter of 1999.
Based on the test results, if any vendor is found to be noncompliant,
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our contingency plan is to attempt to find a replacement vendor. In addition, we
have developed a limited contingency plan related to the functioning of our Web
site and order processing systems. We plan to establish a number of servers in
different cities to help prevent systems failures and slow response times on our
Web sites and to provide backup in the event there is a power or other
electrical failure that affects our computer servers and systems located in the
Seattle area. Aside from the identification of new vendors and the establishment
of offsite servers, we do not currently have any other contingency plans, and we
do not anticipate developing any.
To date, we have spent approximately $30,000 on year 2000 compliance. We
expect total expenditures to be between $40,000 and $50,000. Most of our future
expenses are expected to be operating expenses associated with the time spent by
employees working on year 2000 compliance matters.
The worst-case scenario pertaining to the year 2000 issue would be an
overall failure of the Internet, electronic and telecommunications
infrastructures. In addition, the systems and services provided by our
third-party vendors may fail to be year 2000 compliant despite their
representations to the contrary. The failure by these entities or systems to be
year 2000 compliant could result in a systemic failure beyond our control, which
could also prevent us from delivering our services to our customers or generally
prevent users from accessing our Web site. This would have a material adverse
effect on our business, results of operations and financial condition.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use," which is effective
for fiscal years beginning after December 15, 1998. SOP 98-1 provides guidance
on accounting for the costs of computer software developed or obtained for
internal use and defines specific criteria that determine when such costs are
required to be expensed, and when such costs may be capitalized. The adoption of
this standard has not had a material effect on our capitalization policy,
results of operations, financial position or cash flows.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities," which is effective for fiscal years beginning after
December 15, 1998. SOP 98-5 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. As we have expensed these
costs historically, the adoption of this standard has not had a significant
impact on our results of operations, financial position or cash flows.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) 133, "Accounting for Derivative
Instruments, and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities. SFAS 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 2000. We do not expect the adoption of this
statement to have a significant impact on our results of operations, financial
position or cash flows.
LIMITATION ON NET OPERATING LOSS CARRYFORWARDS
We have approximately $7.3 million of federal net operating loss
carryforwards as of June 30, 1999 which may be available to reduce the amount of
U.S. federal income taxes payable by us in the future. The exercise of
Fingerhut's warrants in May 1999 resulted in an ownership change for purposes of
Section 382 of the Internal Revenue Code. As a result, the use of our
pre-ownership change federal net operating loss carryforwards will be limited
annually by Section 382 of the Internal Revenue Code. Section 382 of the
Internal Revenue Code limits the amount of net operating losses that may be
utilized from pre-ownership change years to offset taxable income in any post-
ownership change year. The limitation on the utilization of federal net
operating loss carryforwards in future years is not expected to be material.
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BUSINESS
OVERVIEW
FreeShop provides online direct marketing services, giving consumers access
to over 1,000 free, trial and promotional offers through our Web site and email
newsletters. Consumers seeking to discover, learn about or try new products can
choose from a collection of offers from over 100 companies. FreeShop enables
consumers to seek out new products of specific interest to them, unlike the
traditional direct marketing model, in which marketers communicate to broad
audiences in search of new customers.
Our primary source of revenue is lead generation. We post offers from our
marketer clients for catalogs, magazine and newsletter subscriptions, product
samples, coupons, and trial periods for services, software and publications.
These clients pay us for each lead generated. We also offer marketers
opportunities to advertise on our Web site and to sponsor the Club FreeShop
newsletters. Club FreeShop members, who accounted for over 41% of our orders
generated in July 1999, receive regular email newsletters informing them of
special offers, exclusive contests and other opportunities. We believe our
consumer-directed process creates a highly effective method of direct marketing
in terms of cost, targeting, efficiency and consumer satisfaction.
INDUSTRY BACKGROUND
GROWTH OF THE INTERNET AND ONLINE COMMERCE
Over the past several years, the Internet has emerged as a powerful and
efficient new medium, enabling people worldwide to exchange information,
communicate and conduct business electronically. The number of people using the
Internet continues to expand rapidly. International Data Corporation (IDC)
estimates that the number of people using the Internet will grow from
approximately 160 million worldwide in 1998 to over 500 million worldwide by the
end of 2003.
Businesses have recognized the online commerce opportunity and are
increasingly using the Internet to sell and distribute products and services.
According to IDC, online commerce will increase from approximately $50 billion
worldwide in 1998 to approximately $1.3 trillion worldwide in 2003, representing
a compound annual growth rate of approximately 92%. As online commerce and the
number of people using the Internet grow, advertisers and direct marketers are
increasingly using the Internet to locate customers, advertise products or
services and facilitate transactions. Forrester Research estimates that
approximately $1.5 billion was spent on Internet advertising worldwide in 1998
and that this amount will grow to approximately $15.3 billion in 2003.
DIRECT MARKETING
Advertising expenditures can be broadly categorized as either brand
advertising or direct marketing. Brand advertising is intended to generate brand
name awareness and create a specific image for a particular company, product or
service. Direct marketing involves any direct communication to a consumer
intended to generate a specific response or action, generally the purchase of a
product or service. The Direct Marketing Association estimates that direct
marketing accounts for over 57% of total U.S. advertising expenditures and that
in 1998, marketers spent $80.1 billion in the United States on direct marketing
to consumers.
Traditional Direct Marketing. Traditional direct marketing media include
direct mail, telemarketing and newspaper, magazine, radio and television
advertisements. Although traditional direct marketing is effective and widely
used, it presents a number of challenges for marketers and consumers alike.
Traditional direct marketers generally lack specific and timely information on a
particular consumer's immediate interests. As a result, marketers spend
considerable
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resources on communications most consumers don't want or need. For example,
according to BAIGlobal, Inc., the average response rate to the nearly 3.5
billion mailings of credit card solicitations in 1998 was only 1.2%. Given the
costs associated with traditional direct marketing, which include
telecommunications, postage, printing, assembly, labor and facilities, we
believe the often low response rates make the process inefficient.
Online Direct Marketing. Online direct marketing media include banner
advertisements, targeted email solicitations and Web site sponsorships. We
believe online direct marketing is more attractive than traditional direct
marketing because it requires lower production costs and provides easier and
faster customer response features. In addition, online direct marketing allows
marketers to easily:
- develop one-to-one relationships with consumers;
- collect data and feedback on marketing campaigns; and
- customize marketing campaigns to broad audiences or specific groups.
Even with these advantages, direct marketers face challenges in realizing
the full potential of the Internet as a marketing medium. With millions of Web
sites, only a fraction of which have significant audiences, it is difficult for
marketers to decide where to spend their marketing dollars. Even leading brand
name marketers who build their own Web sites must find ways to attract a
sizeable audience of visitors. In addition, technological hurdles may impede
conventional direct marketers from successfully extending their activities to
the Internet. In order to participate in most online marketing efforts,
marketers must build and maintain Web sites as well as incorporate order-taking
capabilities and develop systems to integrate online ordering with their
traditional databases.
We believe marketers desire a solution that benefits from the effectiveness
of direct marketing while overcoming the challenges presented by both
traditional and online marketing methods.
THE FREESHOP SOLUTION
FreeShop acts as an intermediary between consumers and marketers, through
which consumers seeking to try new products are presented with a collection of
free, trial and promotional offers from marketers seeking an audience of
potential customers. We offer a consumer-directed process in which consumers
select only those offers of immediate interest to them. We then forward those
orders to our marketer clients. We believe FreeShop's solution creates a highly
effective method of direct marketing in terms of cost, targeting, efficiency and
consumer satisfaction. Marketers pay us for the number of customer leads
delivered, the number of visitors we direct to their Web site, or the number of
times an advertisement is viewed.
Benefits to Consumers. FreeShop puts consumers in control of the direct
marketing process by empowering them to select offers that most interest them
and meet their individual needs. Through our FreeShop.com Web site, we bring
together consumers and marketers in an interactive environment. FreeShop has
more than 1,000 offers from over 100 companies. The offers include items such as
catalogs, magazines, product samples, software and coupons, covering a variety
of interests such as travel, personal finance, entertainment, automobiles and
sports. In addition, because many offers are free samples or trial offers,
consumers are able to try new products and services before making purchase
decisions. Furthermore, because credit card information is not required for many
offers, we believe FreeShop is attractive for visitors new to online shopping
who may otherwise be reluctant to shop online.
Benefits to Marketers. We believe FreeShop benefits marketers by offering
an effective way to acquire customers. Our clients receive visibility from our
traffic base of new and repeat customers. FreeShop offers marketers a diversity
of programs designed to meet their objectives
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throughout the entire marketing process, from awareness to interest to trial to
sale. Our services include lead generation, advertising and sponsorship of the
Club FreeShop newsletters. In addition, because set-up costs are minimal,
marketers can test our direct marketing services with little risk. Most
importantly, because consumers select the offers they receive, we believe
marketers acquire higher quality leads and avoid the risk of tarnishing their
brand image as a result of making numerous unwanted solicitations.
STRATEGY
Our objective is to be the dominant provider of online direct marketing
services. We intend to achieve this objective through the following key
strategies:
Increase Traffic and Transactions. Our strategy of rapidly increasing
consumer traffic to our Web site is focused on both new and repeat visitors. New
visits will be driven primarily by our online and traditional advertising
programs, our Associates Program of over 20,000 member sites, other traffic
relationships, including our "Powered by FreeShop" participants, and
word-of-mouth referrals. Our top four traffic relationships, based on the number
of orders generated in July 1999, are Excite, Inc., Go2Net, Inc., Microsoft
Corporation and Xoom.com, Inc.
Under our traffic relationships, including our Associates Program, we
configure a link to our Web site for the other party to place on its Web site,
and we pay a fee for traffic and orders generated from that site. "Powered by
FreeShop" is a program in which we contract with larger sites to create free
offer content sites or promotions, which are co-branded with the brands of
FreeShop and our partner. We provide the free offer content, our partner
provides the promotion for the co-branded area, and we share any revenues
generated from the co-branded area.
We promote repeat visits through regular email communications to the over
1.5 million members of Club FreeShop. In addition, we encourage repeat visits
and additional transactions by seeking to continually improve the consumer's
experience with FreeShop by increasing the volume and quality of our offers and
by improving the speed and overall ease-of-use of our Web site. In July 1999,
over 50% of our orders came from repeat visitors. Finally, to help retain our
loyal base of consumers, we monitor the performance of our client marketers in
fulfilling orders generated through our Web site.
Increase Client Base. We believe FreeShop offers marketers a cost-effective
alternative to traditional direct marketing and, as a result, we believe we have
a significant opportunity to increase the number of marketer clients we serve.
In particular, we believe more and more companies with national consumer brand
names are seeking Internet-based direct marketing vehicles, and we plan to
initiate new relationships and expand our existing relationships with these
companies. We are rapidly increasing our sales staff in order to drive this
client growth. We plan to continue expanding the services we offer our clients,
including enhanced marketing programs, new methods of presenting offers,
expanded and customized data-gathering options and increased opportunities for
following up on initial lead generation. In addition to enhancing our existing
marketing programs, we will be developing new programs in an effort to meet the
needs of new and different marketers. Finally, we are focusing on marketing our
services to larger advertising agencies as a solution for their client companies
to access the rapidly increasing number of consumers on the Internet.
Continue to Build the FreeShop Brand Name. We intend to continue to
increase the awareness and strength of the FreeShop brand name among both
consumers and marketers through site design and focused and aggressive
advertising. Because consumers and marketers tend to favor well-known Web sites,
a strong brand name is critical to our efforts to grow visitor traffic, attract
marketing clients and increase the number and quality of free, trial and
promotional offers on our Web site. To date, we have used our Associates
Program, other traffic partnerships, online advertising and public relations in
an effort to create a leading brand name in our sector.
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We plan to initiate a major traditional marketing campaign that will include
outdoor, radio and print advertising in key metropolitan markets.
Expand Offers. The number and quality of offers on our site are critical to
our ability to attract visitors and increase revenues from our marketer client
base. We believe we have a significant competitive advantage in attracting
additional marketer clients with national consumer brand names due to the large
number of consumers visiting our Web site and our selection of offers across
multiple categories. We plan to expand the number of categories and increase the
number of offers within each category. We will drive this content expansion
through a combination of internal sales efforts, partnerships and acquisitions.
As part of this strategy, we have recently entered into an agreement with NewSub
Services, Inc., a magazine distributor, to offer consumers access to over 600
magazine titles. We have also greatly increased the number and quality of the
catalog offers we provide through our recent acquisition of the Catalog Site Web
site. In addition, the acquisition of the Worldwide Brochures Web site has
dramatically increased the number of travel offers we provide. Other categories
we intend to expand in the near future include product samples, coupons and
personal finance.
Continue to Develop and Use Technology to Enhance Web Site Capabilities. We
have designed and implemented numerous proprietary systems that enable us to
process orders from consumers within one business day of receipt and regularly
deliver lead information to marketers. We regularly update our Web site and
related system technologies to encourage consumers to place orders and
frequently revisit FreeShop.com. As part of our effort to promote repeat visits
and additional transaction volume, we continue to develop features that will
make the FreeShop experience faster, easier and more personalized.
Develop Relationship With Fingerhut and Federated. Fingerhut is the eighth
largest cataloger and second largest general merchandise cataloger in the United
States, selling general merchandise through catalogs and various Web sites. In
1999, we initiated a noncontractual direct marketing relationship with
Fingerhut. As a result of this relationship, at no cost to FreeShop, Fingerhut
places FreeShop advertisements and inserts cards listing Fingerhut's partner Web
sites, including FreeShop.com, in some of Fingerhut's catalogs and order
delivery packages. In addition, both FreeShop and Fingerhut have placed links on
their Web sites to the other's Web sites. These links provide each company with
additional sources of customers and customer information. A portion of the
revenues generated by FreeShop and Fingerhut as a result of these links is
shared with the other, based on fees prevailing in the market at the time.
FreeShop hopes to initiate similar efforts with Federated Department Stores,
Inc., which operates over 400 full-line department stores, direct mail catalog
businesses and an electronic commerce business. Federated acquired Fingerhut in
March 1999.
OUR WEB SITE
We have designed our Web site in an effort to make it fast and easy for
consumers to use, to enhance the FreeShop brand name and to encourage consumers
to request an offer. The site is organized around categories and promotions and
is regularly updated to refresh the content and encourage repeat visits by
consumers. The key features of FreeShop.com include offers, promotions,
highlighted offers and Club FreeShop.
Offers. Visitors are attracted to our Web site by the aggregation of free,
trial and promotional offers. Our base of more than 1,000 offers is organized
around categories, currently including:
<TABLE>
<S> <C>
Auto Entertainment
Business & Career Family
Catalogs Health & Sports
Computing & Electronics Hobbies
</TABLE>
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<TABLE>
<S> <C>
Home & Living New Offers
Image & Fashion Personal Finance
International Software
Magazines Travel
Men's Style
</TABLE>
By organizing content into categories, we allow customers to review offers
in their self-selected areas of interest, which provides our clients the ability
to do more targeted direct marketing.
Each offer page provides a description of the product offered, delivery
information and any cancellation details for trial offers. The ordering process
is straightforward and requires the customer to provide basic information only
once. FreeShop saves this information, which allows the customer to order any
additional offers in subsequent visits by clicking the "Express Order" button.
Trial offers, such as magazines, may require the customer to enter credit card
information, which we pass on to our marketer client who processes any charges.
After a customer has ordered, we send emails to thank the customer for the order
and, later, to confirm that the order was received. The emails include
information on additional related offers, providing an opportunity to
cross-promote and "upsell" other offers.
Promotions. We organize offers from our clients around seasonal or other
events. Promotions run for limited time periods and include both special offers
created solely for individual promotions and offers listed under other
categories elsewhere on the site. Promotions function much like categories,
aggregating offers around a central theme.
Highlighted Offers. We have the ability to highlight offers and manage the
traffic directed to individual offers in various ways. Highlighted offers on our
home page are selected and regularly updated by our staff. These offers are
intended to provide a representation of the wide range of offers available on
our Web site. On subsequent pages, offers are highlighted based on an automated
ranking system.
We also create a list of our site's top offers based on our own assessment
of broad consumer appeal. This allows customers to review several of the site's
best offers without having to explore every category. The list provides a type
of "recommended viewing" guide for customers, which results in increased orders
for such offers.
Club FreeShop. We designed Club FreeShop to communicate with our most
valued customers. Club members, totalling over 1,500,000 as of August 1999,
regularly receive email newsletters informing them of special offers, exclusive
contests and other opportunities. Membership in the club is free and available
to any visitor who chooses to provide an email address to FreeShop. We invite
customers who place orders on FreeShop to join Club FreeShop as a way of
receiving updates about additional items of interest. We anticipate providing
more personalized and targeted offers to Club FreeShop members in the future,
which will allow for more focused marketing.
Other Features. As part of our effort to increase traffic on our Web site
from word-of-mouth advertising, we created Tell-a-Friend. This feature,
available throughout our site, allows a customer to send an email to a friend
with a link to a specific page or offer. In addition, to make our customers'
shopping experience more comfortable, FreeShop has adopted strong privacy and
customer service policies. Our privacy policy specifies that we disclose how
customer information is used by FreeShop and our marketing customers, allows
customers to remove their information from our customer databases and fully
complies with the standards of the Direct Marketing Association. The Direct
Marketing Association standards, among other things, allow customers to remove
their information from our database, to refuse to allow us to sell, rent or
exchange their customer information and to request that we not contact them in
the future. Our privacy policy
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also complies with the standards of TRUSTe, an independent, nonprofit entity
which has established a recognized privacy standard for the Internet. In
accordance with TRUSTe standards, we post disclosure on our Web site regarding
our use of customer information, give our customers a choice on how their
information is used and have implemented data security, quality and access
measures to safeguard, update and correct customer information. In addition to
enabling customers to limit use of their personal information by FreeShop, we
provide our customers with access to general information about methods of
limiting use of their personal information by other direct marketers.
CLIENT SERVICES
We offer marketers a diversity of services designed to meet their
objectives throughout the entire marketing process, from awareness to interest
to trial to sale. Our primary business is generating customer leads through
free, trial and promotional offers. We also provide a number of advertising
services on our Web site and within our Club FreeShop newsletters. In addition,
we offer the rental of our customer lists to other marketers.
- Lead Generation. We post offers from our clients for:
- catalogs;
- magazine and newsletter subscriptions;
- product samples and information;
- coupons and discounts; and
- trial periods for services, software and publications.
Consumers are able to place orders with us for these offers, and we
deliver this information to our clients, who are responsible for
fulfilling these orders. Information sent to our clients includes
information required for order fulfillment as well as additional
information requested by the marketer. Marketers pay us for each customer
order, or lead, we generate. Through the aggregation of commerce
opportunities on our Web site, we provide another form of lead generation
to our clients. We group these commerce offers in the same categories as
free and trial offers. When consumers decide to purchase a particular
item, they click through from our site to the actual commerce site
sponsoring the offer. In this way, we generate valuable leads to our
commerce partners and are not responsible for processing and fulfilling
orders for products.
- Advertising. We provide advertising opportunities through banner ads,
site sponsorships and sponsorships of our Club FreeShop newsletters.
Banner advertising clients benefit from our high traffic volume of
consumers likely to be in a shopping mode. Marketer clients can also
receive high-profile placement on our homepage and on specific category
pages through our Web site sponsorship program. We believe Club FreeShop
newsletter sponsorships appeal to marketers due to the receptive audience
the newsletters reach.
- List Rental. We also rent our consumer names and street addresses to
third parties, unless the consumer has requested that they be excluded
from any such use. We add consumer information to our database the first
time a consumer requests an offer.
During the three months ended June 30, 1999, approximately 90% of our
contracts were month-to-month with automatic renewal unless terminated by either
party with ten days' notice. Some of our advertising contracts have longer terms
of up to eight months. In the first half of 1999, our top ten clients accounted
for 29.1% of revenues, and no client accounted for more than 8.3% of revenues.
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SALES AND MARKETING
CONSUMER BASE DEVELOPMENT
To encourage consumers to visit our Web site and increase transactions, we
must continue to enhance the recognition of the FreeShop brand name and
strengthen our position as a leader in the online direct marketing industry.
Additional visitor traffic to our Web site provides increased opportunities to
add members to our consumer base. The primary methods we use to build our
traffic are online advertising, our Associates Program and other traffic
relationships, traditional advertising and Club FreeShop.
Online Advertising. We recognize the importance of well-placed advertising
in building traffic and strengthening our brand name. FreeShop has a number of
marketing relationships with leading Web sites that promote the FreeShop brand
and specific offers to targeted audiences. We continue to seek new
cost-effective advertising vehicles and to enhance our existing ones.
Associates Program and Traffic Relationships. We launched our Associates
Program in the fourth quarter of 1998 and, as of July 1999, we had over 20,000
associates. In July 1999, the Associates Program provided over 12.6% of our
traffic and 10.8% of our orders. Under our "Powered by FreeShop" program, we
have contracted with larger Web sites, including Go2Net and Excite, to create
free-offer content sites or promotions, which are co-branded with the brands of
FreeShop and our partners. We share revenues generated from the co-branded site,
but we own any customer information generated. In July 1999, approximately 6.8%
of our traffic and 8.0% of our orders were provided by other non-Associates
Program traffic relationships, including the "Powered by FreeShop" program.
Traditional Advertising. We plan to supplement our online presence with an
increase in our traditional marketing efforts, which will include outdoor, radio
and print advertising in key metropolitan markets. We recently hired a creative
director and engaged an advertising agency to assist with campaign development
and provide media placement services. Additionally, we have initiated direct
marketing efforts with Fingerhut that will include package and catalog inserts.
We also use public relations as a way to create customer awareness of the
FreeShop brand name. We have been the subject of newspaper, magazine and
television stories. Articles about FreeShop have appeared in Wired Magazine,
Advertising Age and PC World, among other publications, and television stories
featuring us have been aired nationally on CNBC and CNNfn. We believe ongoing
media coverage will be essential to increase general brand name awareness and to
attract new traffic to our site.
Club FreeShop. We created Club FreeShop to communicate with our most valued
customers. Consumers who join Club FreeShop regularly receive email newsletters
informing them of special offers, exclusive contests and other opportunities.
Consumer response to offers contained in the Club FreeShop newsletters is a
significant source of repeat orders.
CLIENT BASE DEVELOPMENT
We sell our services to our marketer clients primarily through our direct
sales force. The majority of FreeShop's sales organization, which included 13
salespeople as of July 31, 1999, focuses on small and medium-sized clients. Two
of our salespeople target larger national clients and advertising agencies. By
marketing directly to advertising agencies, we are able to position FreeShop as
the online marketing solution for their numerous clients. Our salespeople are
located in Washington, New York, Virginia and California. As part of our
strategy to increase our client base, we intend to significantly increase our
sales force in the near future. In addition, we have an ongoing advertising
campaign designed to promote the FreeShop brand name to marketers through
various trade and industry publications.
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RECENT ACQUISITIONS
In order to increase the number and types of offers available on our Web
site and increase our visitor and client bases, we acquired two businesses in
May 1999 which expanded our catalog and travel-related offerings. We acquired
the Catalog Site Web site and substantially all of the related assets of
Commonsite, LLC for $441,000 and 52,920 shares of our common stock. The Catalog
Site Web site (www.catalogsite.com) offers over 200 catalogs. The business
acquired had revenues of $540,000 for the fiscal year ended December 31, 1998
and generated 194,000 leads in the quarter ended March 31, 1999. We also
acquired the Worldwide Brochures Web site and substantially all of the related
assets of Travel Companions International, Inc. for $1.4 million. The Worldwide
Brochures Web site (www.wwb.com) offers a selection of over 15,000 travel
brochures for locations around the world. The business acquired had revenues of
$220,000 for the fiscal year ended December 31, 1998 and generated 167,000 leads
in the quarter ended March 31, 1999.
OPERATIONS AND TECHNOLOGY
We have implemented a broad array of site management, customer service,
transaction processing and fulfillment systems using both proprietary and
licensed technologies. During July 1999, we received a total of approximately
350,000 orders and transmitted order data in various formats and media to over
100 clients on a regular basis. In July 1999, we received approximately 2.7
million visitors to our FreeShop.com Web site. We believe our systems can
currently accommodate approximately 10 million visitors over the course of a
month and, as our traffic increases, we intend to increase our capacity by
adding servers. All order information is integrated with our customer and Club
FreeShop member databases to provide for high levels of internal data analysis.
We have developed sophisticated databases and technology supporting these
systems that are not available commercially to our competitors.
Our systems are built around Microsoft Backoffice components to provide for
a scalable and redundant platform. In addition to in-house software, we use a
variety of third-party software and service solutions to support our business.
LinkShare Corporation provides software and support for our Associates Program,
DoubleClick Inc. provides banner ad serving and reporting, and Marketwave
Corporation software is used for Web site traffic analysis. These tools are used
in conjunction with in-house developed tools to enhance marketing efforts and to
determine the effectiveness of various campaigns and content on our Web site.
Performance monitoring of our Web site is provided by multiple sources,
including Keynote Systems and our Internet service and Web site hosting
partners.
Web site content is posted and modified from our headquarters in Seattle
and offices in Minnesota through a combination of internally developed
applications. Visits to FreeShop.com are directed to a network of Microsoft IIS
Web servers at the Mead Group, a hosting facility in Seattle. The Mead Group
provides redundant power and environmental controls. In order to provide a high
level of security, all order information is gathered using secure servers at our
Seattle headquarters. The Internet connection to both facilities is provided by
Savvis Communications in the form of DS-3 and multiple T-1 redundant services.
In the near future we plan to establish a number of servers in different cities
to help prevent systems failures and slow response times on our Web sites.
COMPETITION
We face intense competition from both traditional and online advertising
and direct marketing companies. We also face competition from established online
portals and community Web sites that engage in direct marketing. Although we
believe no other company offers the
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combination and quality of services we offer, we compete directly and indirectly
for marketers and consumers with companies in various categories, including:
- Free-Offer Web Sites. There are a number of sites, both large and small,
that give consumers access to free offers, including Volition.com and
Free2Try.com.
- Specialty Lead-Generation Web Sites. Various sites focus on generating
leads for a specific segment of the direct marketing industry, such as
the catalog, magazine or coupon segments. While these sites typically
provide a depth of offerings within their specific sector, they may not
offer promotions across a broad spectrum of product categories. These
sites include eNews, Cataloglink and Catalogcity. In some instances, we
include their offerings on our Web site.
- Other Web Sites. We also compete with a number of "community" sites that
offer content, services or information about a particular topic, as well
as other advertising networks. In addition, we compete with sites
featuring loyalty programs that reward consumers for taking specific
actions.
The number of Web sites competing for consumer attention and marketers'
dollars has proliferated, and we expect that competition will continue to
intensify. We also compete with traditional media such as television, radio and
print for a share of marketers' total marketing budgets. We may be unable to
compete successfully against current or future competitors, many of which have
significantly greater financial, technical and marketing resources.
We believe that the principal competitive factors in our markets are:
- brand recognition;
- Web site speed and ease of use;
- quality and diversity of offers; and
- the volume of online visitors, duration and frequency of visits and their
demographic profiles.
GOVERNMENT REGULATION
Laws and regulations that apply to Internet communications, commerce and
advertising are becoming more prevalent. The adoption of such laws could create
uncertainty in Internet usage and reduce the demand for all products and
services offered on the Internet. Recently, Congress enacted legislation
regarding children's privacy on the Internet. It is possible that additional
laws and regulations may be proposed or adopted with respect to the Internet,
covering issues such as user privacy, taxation, advertising, intellectual
property rights and information security. Several states have proposed
legislation to limit the use of personal user information gathered online or to
require online services to establish privacy policies.
The Federal Trade Commission recently reported that it has no present
intention of proposing legislation to address online privacy in the near future,
and that it believes self-regulation to be the best course of action, except for
rules enacted to implement the Children's Online Privacy Protection Act, which
governs the collection of personal information from children and the
confidentiality of such information. However, the FTC has initiated action
against at least one online service regarding the manner in which personal
information was collected from users and provided to third parties.
Legislation has recently been enacted in several states relating to sending
unsolicited emails, a practice commonly referred to as "spamming." The federal
government and several other states, including New York, are considering, or
have considered, similar legislation. Although the provisions of these current
and contemplated laws vary, generally they limit or prohibit both the
transmission of unsolicited emails and the use of familiar spamming techniques,
such as the use
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of forged or fraudulent routing and header information. Some states, including
California, require that unsolicited emails include opt-out instructions and
that senders of such emails honor any opt-out requests. We believe that neither
our email newsletters nor our email order confirmations will be affected by
legislation directed at unsolicited emails because we do not send unsolicited
messages and because our current practices are intended to comply with current
and proposed legislation. However, if we are required to change our business
practices as a result of new legislation, our business could suffer.
We do not know how our business may be affected by the application to the
Internet of existing laws governing issues such as property ownership,
copyrights, encryption and other intellectual property issues, taxation, libel,
obscenity and export or import matters. Most of these laws were adopted before
the advent of the Internet and do not contemplate or address the unique issues
of the Internet and related technologies. Changes in laws intended to address
such issues could create uncertainty in the Internet marketplace. That
uncertainty could reduce demand for our service or increase the cost of doing
business as a result of litigation costs or increased service delivery costs.
In addition, because our services are available on the Internet in multiple
states and foreign countries, these states and countries may claim that we are
required to qualify to do business in their jurisdictions. Currently, we are
qualified to do business only in Washington, Minnesota and California. Our
failure to qualify in other jurisdictions where we are required to do so could
subject us to taxes and penalties. It could also restrict our ability to enforce
contracts in those jurisdictions. The application of laws or regulations from
jurisdictions whose laws do not currently apply to our business could have a
material adverse effect on our business, results of operations and financial
condition.
The European Union has adopted a privacy directive that went into effect in
1998. Under this directive, business entities domiciled in member states of the
EU are limited with respect to the transactions in which they may engage with
business entities domiciled outside the EU, unless the non-EU entities are
domiciled in jurisdictions with privacy laws comparable to the EU privacy
directive. The United States presently does not have laws that satisfy the EU
privacy directive. Discussions between representatives of the EU and the United
States are ongoing and may lead to certain safe harbor provisions which, if
adhered to, would allow business entities in the EU and the United States to
continue doing business without limitation. If these negotiations are not
successful and the EU begins enforcing the privacy directive, there could be an
adverse impact on international Internet business. If we do business directly in
the EU in the future, we will be required to comply with the EU privacy
directive.
INTELLECTUAL PROPERTY
We regard our copyrights, service marks, trademarks, trade secrets,
proprietary technology and similar intellectual property as critical to our
success, and we rely on trademark and copyright law, trade secret protection and
confidentiality and license agreements with our employees, customers,
independent contractors, partners and others to protect our intellectual
property rights. We have registered the trademark "Free Shop" in the United
States and may apply for registration in the United States for other trademarks
and service marks, including Club FreeShop, FreeShop Savings Club, Savings
Central, FreeShop shopping assistant, Catalog Site, Catalog Channel, The Catalog
Site and Worldwide Brochures. "Find It! Try It! Buy It!", "The starting point
for smart online shopping," "Powered by FreeShop" and "FreeShop by Email" are
service marks of FreeShop. However, effective trademark, service mark, copyright
and trade secret protection may not be available in every country in which
FreeShop's products and services are made available online.
We have registered a number of domain names, including freeshop.com,
catalogsite.com, wwb.com, and clubfreeshop.com, among others. Domain names
generally are regulated by
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Internet regulatory bodies. The regulation of domain names in the United States
and in foreign countries is subject to change in the near future. Regulatory
bodies could establish additional top-level domains, appoint additional domain
name registrars or modify the requirements for holding domain names. The
relationship between regulations governing domain names and laws protecting
trademarks and similar intellectual property rights is unclear. Therefore, we
could be unable to prevent third parties from acquiring domain names that
infringe on or otherwise decrease the value of our trademarks and other
proprietary rights. We believe there are online companies in other countries
using domain names that potentially infringe on our trademarks.
FreeShop may be required to obtain licenses from others to refine, develop,
market and deliver new services. We may be unable to obtain any such license on
commercially reasonable terms, if at all, or guarantee that rights granted by
any licenses will be valid and enforceable.
EMPLOYEES
As of July 31, 1999, FreeShop had a total of 102 employees, including 76 in
sales and marketing, 17 in technology and development, and nine in finance and
administration. None of our employees are represented by unions, and we consider
relations with our employees to be good.
FACILITIES
We currently occupy 20,920 square feet in a leased facility in Seattle,
Washington and 2,240 square feet in a leased facility in Detroit Lakes,
Minnesota. We expect that these facilities will be adequate for our needs over
the next 12 months. Our current lease for our Seattle space expires in May 2003.
Our current lease for our Detroit Lakes space expires in May 2000.
LEGAL PROCEEDINGS
FreeShop is not currently a party to any material legal proceeding.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth certain information, as of July 31, 1999,
regarding the executive officers, directors and key employees of FreeShop:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Timothy C. Choate...................... 34 Chairman, President and Chief Executive
Officer
William H. Fritsch..................... 47 Executive Vice President, Marketing
John A. Wade........................... 37 Secretary, Vice President, Finance and
Chief Financial Officer
Ronald C. Christiansen................. 46 Vice President, Sales
Lisa C. Wolff.......................... 30 Vice President, Business Development
Karen M. Leathers...................... 35 Vice President, Operations and Planning
Mark S. Noblitt........................ 36 Vice President, Technology
John P. Ballantine..................... 36 Director
John B. Balousek....................... 54 Director
William J. Lansing..................... 41 Director
Kirk M. Loevner........................ 41 Director
</TABLE>
Timothy C. Choate has served as Chairman, President and Chief Executive
Officer since March 1998. From July 1997 to March 1998, Mr. Choate served as a
Vice President of Micro Warehouse, Inc. In 1994, Mr. Choate co-founded Online
Interactive, Inc., the former parent of FreeShop, and served as its Chairman,
President and Chief Executive Officer until June 1997. Before 1994, Mr. Choate
served as President of Softdisk Publishing LLC, a software publishing company.
Mr. Choate's prior experience includes serving as a Senior Marketing Manager at
Prodigy Communications Corporation, an Internet access and content provider, and
developing and launching the New Products Division for Business Week, a division
of the McGraw-Hill Companies Inc. Mr. Choate serves on the boards of directors
of Digital River, Inc., a provider of electronic commerce outsourcing solutions,
and Traveling Software, Inc., a software publishing company. Mr. Choate holds a
B.S.E. degree in Marketing and Entrepreneurial Management from the Wharton
School of Business at the University of Pennsylvania.
William H. Fritsch has served as Executive Vice President, Marketing since
February 1999. Mr. Fritsch joined FreeShop in January 1999 as Vice President,
Sales and Marketing. In 1988, Mr. Fritsch co-founded CF2GS, a Seattle-based
direct marketing agency, and served as its president until 1998. Before 1988,
Mr. Fritsch served as Vice President for Sharp Hartwig Advertising, as the
Director of Marketing Services at Walt Disney Productions, as Marketing
Coordinator of The Smithers Company and as an auditor for Ernst & Ernst. Mr.
Fritsch holds a B.S. degree in Accounting from the University of Akron in Ohio.
John A. Wade has served as Secretary, Vice President, Finance and Chief
Financial Officer since May 1998. From 1992 to May 1998, Mr. Wade served as the
Chief Financial Officer and Chief Operating Officer of Buzz Oates Enterprises, a
real estate development company. Prior to 1992, Mr. Wade served as the
Controller of A&A Properties, Inc., an asset management corporation, the
Controller of Labels West, a manufacturing concern, and as an auditor and
taxation specialist at McGladrey and Pullen, an international accounting firm.
Mr. Wade holds a B.S. degree in Business Administration with a concentration in
Accounting from the San Diego State University School of Business.
Ronald C. Christiansen has served as Vice President, Sales since January
1999. In 1988, Mr. Christiansen co-founded CF2GS and served as its New Business
Development Director until 1998. Prior to 1988, Mr. Christiansen worked at
several large national advertising agencies,
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including Cole & Weber, an Ogilvy Mather company, and McCann Erickson. Mr.
Christiansen holds an undergraduate degree in Advertising from Washington State
University.
Lisa C. Wolff has served as Vice President, Business Development since July
1998. Ms. Wolff joined FreeShop as Director of Business Development in July
1997. From 1995 to 1997, Ms. Wolff served as Director of Consumer Marketing and
as Product Manager for Online Interactive. From May 1994 to August 1994, Ms.
Wolff served as an Associate Product Manager for Microsoft Corporation's
TechNet. Prior to May 1994, Ms. Wolff worked for two years in corporate sales
and marketing at NeXT Computer, Inc., a computer software and hardware company.
Ms. Wolff holds an M.B.A. degree from the University of Washington and a B.A.
degree in Business Economics from the University of California at Santa Barbara.
Karen M. Leathers has served as Vice President, Operations and Planning
since July 1998. Since joining FreeShop in September 1997, Ms. Leathers has also
served as Director, Operations and Human Resources and Manager of Operations.
From March 1997 to August 1997, Ms. Leathers managed the Web-based data
acquisition team at Affinity Publishing, a partner marketing technology services
company. From 1993 to March 1997, Ms. Leathers managed the corporate Membership
Services Department at Recreational Equipment Incorporated. Prior to 1993, Ms.
Leathers served as a market analyst for Weyerhaeuser Company. Ms. Leathers holds
a B.A. degree in Business Management and Computers from The Evergreen State
College in Washington.
Mark S. Noblitt has served as Vice President, Technology since February
1999. From July 1997 to February 1999, Mr. Noblitt served as Director of
Technology, Production Engineering Manager and SQL Developer. From October 1996
to July 1997, Mr. Noblitt served as SQL Database Administrator for Online
Interactive. From June 1987 to January 1996, Mr. Noblitt served as Project
Manager and Lead Estimator for Leewens Corporation, a company specializing in
hazardous waste containment projects. Mr. Noblitt also serves on the Board of
Advisors for International Barter Corporation, an international commercial
barter exchange company. Mr. Noblitt is a Microsoft Certified Systems Engineer
with specialties in SQL, NT, Microsoft BackOffice, Microsoft Office and TCP/IP.
John P. Ballantine has served as a Director since July 1997. Since March
1999, Mr. Ballantine has served as Chairman and Chief Executive Officer of
iStart Ventures LLC, a developer of early-stage e-commerce concepts. From July
1997 to March 1998, Mr. Ballantine served as a Vice President of Micro
Warehouse. In 1994, Mr. Ballantine co-founded Online Interactive and served as
its Executive Vice President and later as President and Chief Executive Officer.
From February 1993 to June 1994, Mr. Ballantine served as Vice President of
Softdisk Publishing, where he managed online shopping applications with America
Online, CompuServe, Prodigy and GEnie. From March 1989 to February 1993, Mr.
Ballantine served as Vice President of Sales for DataEnvelope, a full-service
software marketing and distribution company. Mr. Ballantine holds a B.S.E.
degree in Finance and International Business from the San Diego State University
School of Business.
John B. Balousek has served as a Director since February 1999. In 1998 Mr.
Balousek co-founded PhotoAlley.com, an online retailer of photographic
equipment, supplies and services. From 1979 to 1997, Mr. Balousek served in
various positions, including President/Chief Operating Officer and Director of
Foote, Cone & Belding Communications, Inc., a global advertising and
communications company. In 1996, Mr. Balousek served as Chairman/Chief Executive
Officer of True North Technologies, a digital and interactive service of True
North Communications, Foote, Cone & Belding's parent company. Mr. Balousek
currently serves as a director for Geoworks Corporation, a provider of
end-to-end solutions for the wireless communications market; Transilluminant
Corporation, a privately held company focusing on electronic data marketing; and
EDB Holdings, Inc., a superoptical retailing company.
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Mr. Balousek holds an undergraduate degree from Creighton University and a
graduate degree from Northwestern University.
William J. Lansing has served as a Director since January 1999 and was
appointed by Fingerhut pursuant to the terms of a stockholders agreement between
us, Mr. Choate, Mr. Ballantine and Fingerhut. Mr. Lansing is the President and
Chief Executive Officer of Fingerhut. From May 1998 to May 1999, Mr. Lansing
served as President of Fingerhut. From November 1996 to May 1998, Mr. Lansing
served as a Vice President for Business Development of General Electric Corp.
From January 1996 to October 1996, he served as Chief Operating Officer of
Prodigy. From 1986 to 1996, Mr. Lansing was a principal at McKinsey & Co., a
management consulting company. Mr. Lansing also serves as a director of Digital
River, Inc., an electronic commerce solutions provider, Select Comfort Corp., a
specialty retailer and direct marketer of air beds, Net Perceptions, Inc., a
developer of Internet marketing solutions, and BigStar Entertainment, Inc., an
online filmed entertainment superstore. Mr. Lansing holds a B.A. degree in
English from Wesleyan University and a J.D. degree from Georgetown University.
Kirk M. Loevner has served as a Director since November 1998. In February
1999, Mr. Loevner founded PublishOne Inc., an online publishing service for
businesses, of which he is currently President and Chief Executive Officer. From
August 1996 to August 1998, Mr. Loevner served as President and Chief Executive
Officer of the Internet Shopping Network, Inc., an online retailer and auction
house. From November 1993 to July 1996, Mr. Loevner served as a Vice President
and General Manager of Silicon Graphics Inc., a leading supplier of visual
computing and high-performance computer systems. Before November 1993, Mr.
Loevner served as a Vice President and General Manager of Apple Computer Inc., a
computer manufacturing company. Mr. Loevner currently serves on the board of
directors of the Software Industry and Information Association, a software
industry association. Mr. Loevner holds a B.S.E. degree in Computer Science from
Tufts University and an M.B.A. degree in General Management from Harvard
University.
FreeShop currently has authorized six directors. Each director is elected
for a period of one year at our annual meeting of shareholders and serves until
the next annual meeting or until his successor is duly elected and qualified.
The executive officers serve at the discretion of the board. There are no family
relationships among any of the directors and executive officers of FreeShop.
BOARD COMMITTEES
In May 1999, the board of directors established two standing board
committees, an audit committee and a compensation committee.
Audit Committee. The audit committee's responsibilities include reviewing
our internal accounting procedures and consulting with and reviewing the
services provided by our independent accountants. The audit committee currently
consists of Messrs. Ballantine and Balousek.
Compensation Committee. The compensation committee's responsibilities
include reviewing and recommending to the board of directors the compensation
and benefits of all our executive officers, administering our stock option plans
and establishing and reviewing general policies relating to compensation and
benefits of our employees. The compensation committee currently consists of
Messrs. Ballantine, Lansing and Loevner.
No interlocking relationships exist between our board of directors or
compensation committee and the board of directors or compensation committee of
any other company, nor has any such interlocking relationship existed in the
past.
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<PAGE> 48
DIRECTOR COMPENSATION
Directors do not currently receive cash compensation from FreeShop for
their services as members of the board of directors, although they may be
reimbursed for certain expenses in connection with attendance at board and
committee meetings. We do not provide additional compensation for committee
participation or special assignments of the board of directors. From time to
time, certain of our directors have received grants of options to purchase
shares of our common stock pursuant to the 1997 Stock Option Plan. In January
1998, we granted to Messrs. Choate and Ballantine options to purchase 16,000
shares of common stock at an exercise price of $1.02 per share. In addition,
since March 1998, we have paid health insurance premiums on behalf of Mr.
Ballantine of approximately $250 per month. In September 1998, we granted to Mr.
Loevner an option to purchase 16,000 shares of common stock at an exercise price
of $1.50 per share. In February 1999, we granted to Mr. Balousek an option to
purchase 16,000 shares of common stock at an exercise price of $2.50 per share.
See "-- Stock Option Plan."
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid to our Chief Executive
Officer and former Chief Executive Officer for the year ended December 31, 1998.
No other executive officer of FreeShop earned compensation for such fiscal year
in excess of $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION
COMPENSATION ------------------
------------ SECURITIES ALL OTHER
NAME AND PRINCIPAL POSITION SALARY UNDERLYING OPTIONS COMPENSATION
--------------------------- ------------ ------------------ ------------
<S> <C> <C> <C>
Timothy C. Choate(1)....................... $26,825(2) 16,000 $ 5,085(3)
Chairman, President and Chief Executive
Officer
Mike Schutzler(4).......................... $26,951 136,000 $43,488(5)
</TABLE>
- ---------------
(1) Mr. Choate became our Chief Executive Officer in March 1998.
(2) Includes $19,220 in deferred compensation paid in January 1999.
(3) Represents health insurance premiums paid by us on behalf of Mr. Choate.
(4) Mr. Schutzler was the Chief Executive Officer until March 1998.
(5) Represents a $7,000 cash payment for severance and $36,488 worth of common
stock, at fair value, that Mr. Schutzler received on exercise of certain
options.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information regarding stock option
grants to our Chief Executive Officer and former Chief Executive Officer during
the fiscal year ended December 31, 1998. The potential realizable value is
calculated based on the assumption that the common stock appreciates at the
annual rate shown, compounded annually, from the date of grant until the
expiration of its term. These numbers are calculated based on Securities and
Exchange Commission requirements and do not reflect our projection or estimate
of future stock price growth. Potential realizable values are computed by:
- multiplying the number of shares of common stock subject to a given
option by the exercise price;
- assuming that the aggregate stock value derived from that calculation
compounds at the annual 5% or 10% rate shown in the table for the entire
ten-year term of the option; and
- subtracting from that result the aggregate option exercise price.
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<PAGE> 49
OPTION GRANTS IN 1998
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
---------------------------------------------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION -----------------------
NAME GRANTED FISCAL YEAR(1) (PER SHARE)(2) DATE 5% 10%
---- ---------- -------------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Timothy C. Choate(3)...... 16,000(4) 2.78% $1.02 1/15/08 $10,314 $26,137
Mike Schutzler(5)......... 120,000(6) 20.82% $1.02 3/16/01 $12,608 $25,830
16,000(7) 2.78% $1.02 1/15/08 $10,314 $26,137
</TABLE>
- ---------------
(1) During 1998, 140,000 options were issued as severance compensation, 80,000
options were issued as compensation to directors for their services on the
board and 356,420 options were issued to employees.
(2) The exercise price per share of each option was equal to the fair market
value of the common stock on the date of grant as determined by the board of
directors.
(3) Mr. Choate became the Chief Executive Officer in March 1998.
(4) Represents options vesting according to the following schedule: 50% vesting
immediately and 6.25% vesting each following quarter over a period of two
years.
(5) Mr. Schutzler was the Chief Executive Officer until March 1998.
(6) Represents fully vested options exercisable at any time after March 18,
1998.
(7) Mr. Schutzler has forfeited these options.
OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table sets forth for our Chief Executive Officer and former
Chief Executive Officer the number of shares acquired upon exercise of stock
options during the fiscal year ended December 31, 1998 and the number of shares
subject to exercisable and unexercisable stock options held at December 31,
1998.
AGGREGATED OPTION EXERCISES IN 1998
AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1998 DECEMBER 31, 1998(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Timothy C. Choate.......... -- $ -- 11,000 5,000 $ 40,700 $18,500
Mike Schutzler............. 41,700 $36,488 120,000 -- $440,000 $ --
</TABLE>
- ---------------
(1) The value of unexercised in-the-money options at December 31, 1998 is based
on $4.72 per share, the assumed fair market value of the common stock at
such time, less the exercise price per share.
STOCK OPTION PLAN
On June 30, 1997, we adopted our 1997 Stock Option Plan, which was
subsequently approved by our shareholders. The plan authorizes the board of
directors, or a committee of independent directors, to act as the plan
administrator.
The plan provides for the grant of incentive stock options and nonqualified
stock options to purchase up to 2,400,000 shares of common stock. The plan
administrator may grant incentive stock options to our full-time employees or to
our nonemployee directors only. Nonqualified stock options are available to
employees, directors and other persons as the plan administrator shall select.
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<PAGE> 50
The plan authorizes the plan administrator to, among other things:
- set the number of shares of common stock to be issued upon exercise of
the options;
- set the exercise price of the options, provided that, for incentive stock
options granted to greater than 10% shareholders, the price cannot be
less that 110% of the fair market value per share of common stock at the
date of grant of such options;
- designate the expiration date of the options, which, for incentive stock
options, cannot be later than ten years from the date such options were
granted; and
- accelerate the vesting of the options, which otherwise vest over four
years according to a set schedule.
The 1997 Stock Option Plan will expire on June 30, 2007. The expiration of
the plan, however, will not affect the exercisability of options granted under
the plan prior to its expiration.
401(k) PLAN
Our employees participate in the FreeShop.com, Inc. 401(k) plan, a
tax-qualified savings and retirement plan intended to qualify under Section 401
of the Internal Revenue Code. All employees who satisfy the eligibility
requirements relating to minimum age and length of service are eligible to
participate in the plan and may enter the plan on the first day of any month
after they become eligible to participate. Participants may make pre-tax
contributions to the plan of up to 15% of their eligible earnings, subject to a
statutorily prescribed annual limit. At our discretion, we may make matching
contributions of up to 100% of the first 6% of the compensation elected for
contribution to the plan by an employee. Each participant is fully vested in his
or her contributions and the investment earnings thereon, but vesting in any
matching contributions by us takes place over a period of five years.
Contributions by the participants or us, and the income earned on such
contributions, are generally not taxable to the participants until withdrawn.
Contributions by us, if any, are generally deductible by us when made.
Contributions are held in trust as required by law. Individual participants may
direct the trustee to invest their accounts in authorized investment
alternatives. We have made no matching contributions to the plan as of July 31,
1999.
DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY
Our amended and restated articles of incorporation limit the liability of
our directors to the fullest extent permitted by Washington law, and our
articles incorporate by reference any later amendments to the Washington
Business Corporation Act. This act provides that a corporation's articles of
incorporation may contain a provision eliminating or limiting the personal
liability of directors for monetary damages for breach of their fiduciary duty
as directors, except for liability for:
- acts or omissions that involve intentional misconduct or a knowing
violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 23B.08.310 of the Washington Business
Corporation Act; or
- any transaction from which the director derived an improper personal
benefit.
Our bylaws provide that:
- we must indemnify our directors and officers against all reasonable
expenses incurred in a proceeding in which they are a party because they
are or were directors or officers;
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<PAGE> 51
- we must indemnify our directors and officers against liability incurred
in a proceeding in which they are a party because they are or were a
directors or officers if:
1. they acted in good faith, and they reasonably believed, in the case
of conduct in the individuals' official capacities, that their
conduct was in our best interests and, in all other cases, that their
conduct was at least not opposed to our best interests; and
2. in the case of a criminal proceeding, the individual had no
reasonable cause to believe that his or her conduct was unlawful;
- we may indemnify other employees and agents to the same extent that we
indemnify our directors and officers, unless otherwise required by law,
our articles of incorporation, our bylaws or agreements; and
- we must advance expenses, as incurred, to our directors and officers in
connection with a legal proceeding to the fullest extent permitted by
Washington law.
We have entered into agreements with each of our directors that, among
other things, indemnify the director for reasonable expenses incurred in legal
proceedings if the director acted in good faith and with a reasonable belief
that such director's official conduct was in the best interests of FreeShop or,
if not taken in an official capacity, not opposed to FreeShop's best interests.
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<PAGE> 52
RELATED-PARTY TRANSACTIONS
TRANSACTIONS WITH MANAGEMENT AND OTHERS
TRANSACTIONS WITH DIRECTORS AND OFFICERS
In January and February 1998, Mr. Choate, our Chairman, President and Chief
Executive Officer, who held approximately 18.2% of our common stock as of July
31, 1999, made three loans to us for a total of $55,000. The loans bore interest
at a rate of 10% per year. We repaid these loans in full with interest in
September 1998.
In January and February 1998, Mr. Ballantine, a member of our board of
directors, who held approximately 16.3% of our common stock as of July 31, 1999,
made two loans to us for a total of $30,000. The loans bore interest at a rate
of 10% per year. We repaid these loans in full with interest in September 1998.
From May 1998 through August 1998, Messrs. Ballantine and Choate
transferred shares of our common stock owned by them to our employees as
compensation for services. Mr. Ballantine transferred a total of 46,000 shares
with an estimated value of $69,000, and Mr. Choate transferred a total of 10,000
shares with an estimated value of $15,000.
We have entered into indemnification agreements with each of our directors
and officers containing provisions that may require us, among other things, to
indemnify our directors and officers against liabilities that may arise by
reason of their status or service as directors and officers, other than
liabilities arising from willful misconduct of a culpable nature, and to advance
their expenses incurred as a result of any proceeding against them as to which
they could be indemnified. See "Management -- Director and Officer
Indemnification and Liability."
TRANSACTIONS WITH FINGERHUT
On December 10, 1998, we issued 1,619,387 shares of our common stock to
Fingerhut for $4.0 million, or $2.47 per share. Immediately following the
issuance of the shares, Fingerhut owned 19.9% of our issued and outstanding
common stock.
On December 10, 1998, we entered into a warrant agreement with Fingerhut,
pursuant to which we granted Fingerhut the following warrants to purchase our
common stock. Subsequently, in May of 1999 we agreed to issue Fingerhut shares
of our series B convertible preferred stock in lieu of common stock upon the
exercise of these warrants.
(1) Irrevocable "percentage warrants"
The percentage warrants are designed to allow Fingerhut to increase
its percentage ownership in us. If Fingerhut were to exercise all the
percentage warrants and convert the series B convertible preferred stock,
and if no dilution in Fingerhut's ownership percentage were to occur,
Fingerhut would own approximately 40.0% of our common stock immediately
prior to this offering. Fingerhut may exercise the percentage warrants at
any time. The percentage warrants expire on the earlier of December 31,
2000 or the completion of a qualified public equity offering, which
includes this offering, and include:
- a warrant to purchase 293,536 shares of our series B convertible
preferred stock at $17.18 per share;
- a warrant to purchase 179,072 shares of our series B convertible
preferred stock at $19.94 per share; and
- a warrant to purchase 208,918 shares of our series B convertible
preferred stock at $22.09 per share.
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<PAGE> 53
(2) "Anti-dilution" warrants
The anti-dilution warrants are designed to allow Fingerhut to maintain
its percentage ownership in us if the number of issued and outstanding
shares increases due to the exercise of outstanding options and warrants or
the exercise of options to be granted under our stock option plan. Upon any
such dilutive event, the anti-dilution warrants may be exercised by
Fingerhut at its discretion for up to 184,288 shares of our series B
convertible preferred stock at $22.09 per share. As a result of this
offering, all of the anti-dilution warrants are currently exercisable. The
anti-dilution warrants expire on the earlier of December 31, 2000 or the
completion of a qualified public equity offering, which includes this
offering.
(3) "Third-party agreement" warrants
The third-party agreement warrants are designed to allow Fingerhut to
maintain its ownership percentage in us if the number of issued and
outstanding shares increases due to the exercise of rights to purchase
additional shares of our common stock that are held by two parties. We
agreed with Fingerhut that the third-party agreement warrants may be
exercised by Fingerhut at its discretion in proportion to the exercise by
one or both of the other parties for a total of up to 12,153 shares of our
series B convertible preferred stock at $15.86 per share. The third-party
agreement warrants expire on the earlier of December 31, 2000 or the
completion of a qualified public equity offering, which includes this
offering.
On December 10, 1998, we entered into a stockholders agreement with Mr.
Ballantine, Mr. Choate and Fingerhut. Under the terms of the stockholders
agreement, we granted Fingerhut:
- a preemptive right to purchase shares in the event of additional
share issuances by us;
- a right to approve any pledge of all of our assets, amendment to our
articles of incorporation or bylaws, merger with another corporation
or sale of substantially all of our assets;
- a one-time right to demand registration of shares owned by Fingerhut,
exercisable after June 30, 2001;
- a right to "piggyback," or include shares owned by Fingerhut, in two
registrations of shares initiated by us; and
- a right to appoint up to two members of our board of directors. To
date, Fingerhut has appointed only one director, William J. Lansing.
Fingerhut's preemptive rights, special approval rights and board appointment
rights expire upon the completion of this offering.
In addition, Fingerhut, Mr. Choate and Mr. Ballantine have agreed not to
make any public sale of any of our equity securities, or any securities
convertible into any of our equity securities, during the 30-day period before,
and the 180-day period after, the effective date of this offering or of any
underwritten demand registration or piggyback registration in which their shares
are included. The stockholders agreement terminates generally on the earlier of
December 10, 2008 or the closing of the sale of all of our assets or the
acquisition of us by merger or consolidation.
In May and June of 1999, Fingerhut exercised the first two tranches of its
percentage warrants, consisting of its $17.18 percentage warrants and its $19.94
percentage warrants for a total of 472,608 shares of series B convertible
preferred stock, which are convertible into 1,890,432 shares of common stock.
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<PAGE> 54
On June 18, 1999, we entered into a letter agreement with Fingerhut under
which Fingerhut agreed to exercise all of its remaining exercisable warrants
upon completion of this offering, which consist of:
- percentage warrants to purchase 208,918 shares of our series B
convertible preferred stock at $22.09 per share;
- anti-dilution warrants to purchase 184,288 shares of our series B
convertible preferred stock at $22.09 per share; and
- third-party warrants to purchase 3,333 shares of our series B convertible
preferred stock at $15.86 per share.
Additionally, Fingerhut agreed to purchase 8,820 shares of our series B
convertible preferred stock at $15.86 per share. Upon completion of this
offering, the series B convertible preferred stock will convert into common
stock for a total of 3,511,868 shares of our common stock.
In connection with the letter agreement, we entered into an escrow
agreement with Fingerhut, pursuant to which Fingerhut agreed to deposit into
escrow the full purchase price for the exercised warrants and the additional
shares of series B convertible preferred stock to be purchased by Fingerhut, in
exchange for the deposit into escrow by us of the warrant shares and the
additional shares. The escrow agreement provides for the release of the escrowed
funds to us and the shares to Fingerhut upon the completion of this offering.
CERTAIN BUSINESS RELATIONSHIPS
William J. Lansing, a member of our board of directors, is the President
and Chief Executive Officer of Fingerhut. During the first two quarters of 1999,
we provided approximately $23,000 in lead-generation services to Fingerhut. Mr.
Lansing is also a director of BigStar Entertainment, Inc., a client of FreeShop.
In 1998 and the first two quarters of 1999, we billed BigStar approximately
$9,000 and $70,000, respectively, for our services.
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<PAGE> 55
PRINCIPAL SHAREHOLDERS
The following table sets forth information concerning the beneficial
ownership of our outstanding common stock as of July 31, 1999 and as adjusted to
reflect the sale of the shares of common stock in this offering for:
- each person or group that we know owns beneficially 5% or more of our
common stock;
- each of our directors and executive officers individually; and
- all directors and executive officers as a group.
The term "beneficial ownership" includes shares over which the indicated
beneficial owner exercises voting and/or investment power. The rules also deem
common stock subject to options or warrants currently exercisable, or
exercisable within 60 days, to be outstanding for purposes of computing the
percentage ownership of the person holding the options or warrants, but they do
not deem such stock to be outstanding for purposes of computing the percentage
ownership of any other person. The applicable percentage of ownership for each
shareholder is based on 10,133,719 shares of common stock outstanding as of July
31, 1999 (including shares issuable upon conversion of all outstanding series B
convertible preferred stock), together with applicable options and warrants for
that shareholder. Except as otherwise indicated, we believe the beneficial
owners of the common stock listed below, based on information furnished by them,
have sole voting and investment power over the number of shares listed opposite
their names. The information provided in the table below assumes no exercise of
the underwriters' over-allotment option.
<TABLE>
<CAPTION>
PERCENT OF
SHARES OUTSTANDING
--------------------
NAME AND ADDRESS NUMBER OF SHARES BEFORE AFTER
OF BENEFICIAL OWNER BENEFICIALLY OWNED OFFERING OFFERING
------------------- ------------------ -------- --------
<S> <C> <C> <C>
Fingerhut Companies, Inc.(1)..................... 5,131,255 43.7% 34.3%
4400 Baker Road
Minnetonka, MN 55343
Timothy C. Choate(2)............................. 1,843,121 18.2% 13.8%
95 South Jackson Street, Ste. 300
Seattle, WA 98104
John P. Ballantine(3)............................ 1,655,739 16.3% 12.4%
95 South Jackson Street, Ste. 300
Seattle, WA 98104
Kirk M. Loevner(4)............................... 85,171 * *
John B. Balousek(5).............................. 50,000 * *
John A. Wade(6).................................. 45,481 * *
William H. Fritsch(7)............................ 25,767 * *
William J. Lansing............................... -- * *
All directors and officers as a group
(11 persons)(8)................................ 3,705,279 36.3% 27.6%
</TABLE>
- ---------------
* Less than one percent of the outstanding shares of common stock.
(1) Represents 3,509,819 shares (including 472,608 shares of series B
convertible preferred stock, which will be converted into 1,890,432 shares
of common stock upon the completion of this offering) held by Fingerhut
directly and 1,586,156 shares of common stock that Fingerhut has a right to
acquire pursuant to warrants exercisable into series B convertible
preferred stock and 35,280 shares of common stock issuable upon conversion
of series B convertible preferred stock to be issued to Fingerhut within 60
days of July 31, 1999. Federated Department Stores, Inc. may be deemed to
control Fingerhut by virtue of its ownership of 100% of Fingerhut's capital
stock and its corresponding right to elect
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<PAGE> 56
Fingerhut's directors, and, therefore, our capital stock owned by Fingerhut
may also be deemed to be beneficially owned by Federated.
(2) Represents 1,817,121 shares held by Mr. Choate directly, 12,000 shares held
by a trust established for Mr. Choate's children and 14,000 shares that Mr.
Choate has a right to acquire pursuant to options exercisable within 60
days of July 31, 1999.
(3) Represents 1,641,739 shares held by Mr. Ballantine directly and 14,000
shares that Mr. Ballantine has a right to acquire pursuant to options
exercisable within 60 days of July 31, 1999.
(4) Represents 73,171 shares held by Kirk Loevner Trust w/d/t dated 8/5/96
directly and 12,000 shares that Mr. Loevner has a right to acquire pursuant
to options exercisable within 60 days of July 31, 1999.
(5) Represents 30,000 shares held by the Balousek Family Limited Partnership,
10,000 shares held by the Balousek 1994 Irrevocable Trust and 10,000 shares
that Mr. Balousek has a right to acquire pursuant to options exercisable
within 60 days of July 31, 1999.
(6) Represents 20,000 shares held by Mr. Wade directly and 25,481 shares that
Mr. Wade has a right to acquire pursuant to options exercisable within 60
days of July 31, 1999.
(7) Represents 16,667 shares held by Mr. Fritsch directly and 9,100 shares that
Mr. Fritsch has a right to acquire pursuant to options exercisable within
60 days of July 31, 1999.
(8) Represents 3,620,698 shares listed as to all current directors and
executive officers and 84,581 shares issuable within 60 days of July 31,
1999 upon the exercise of outstanding options.
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<PAGE> 57
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 100,000,000 shares of common
stock, no par value per share, and 10,000,000 shares of preferred stock, no par
value per share.
COMMON STOCK
As of July 31, 1999, there were 10,133,719 shares of our common stock
issued and outstanding (including shares issuable upon conversion of outstanding
series of preferred stock), held of record by 117 shareholders. Holders of
common stock are entitled to one vote per share on all matters to be voted upon
by the shareholders. The articles of incorporation do not authorize cumulative
voting for the election of directors, which means that the holders of a majority
of the shares voted can elect all of the directors then standing for election.
Subject to preferences of any outstanding shares of preferred stock, 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 we are liquidated, dissolved or wound up, the holders of common stock are
entitled to share in proportion to the percentage of their ownership all assets
remaining after payment of liabilities and liquidation preferences of any
outstanding shares of preferred stock. Holders of shares of common stock have no
preemptive or conversion rights or other subscriptive rights, and there are no
redemption or sinking fund provisions that apply to the common stock. All
outstanding shares of common stock are fully paid and nonassessable, and the
shares of common stock in this offering will be fully paid and nonassessable.
PREFERRED STOCK
In June 1997, we designated 1,935,484 shares of series A convertible
preferred stock, all of which was issued and later converted into common stock
in July 1997. In May 1999, we designated 1,250,000 shares of series B
convertible preferred stock. As of July 31, 1999, we had outstanding 472,608
shares of series B convertible preferred stock. We have agreed to issue an
additional 405,359 shares prior to the completion of this offering, as long as
this offering is completed on or before October 31, 1999. The series B
convertible preferred stock has identical rights and preferences as our common
stock, except that it has no voting rights. Each share of series B convertible
preferred stock is convertible into four shares of common stock at the option of
the holder or upon the completion of this offering.
Subject to the provisions of the articles of incorporation and limitations
prescribed by law, the board of directors has the authority to issue, without
further vote or action by the shareholders, up to 6,814,516 additional shares of
preferred stock in one or more series. The board has the authority to fix the
rights, preferences, privileges and restrictions of the shares of each series,
including dividend rights, convertibility, voting rights, redemption rights,
liquidation preferences and the number of shares constituting any series and the
designation of such series. Issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, a majority of our outstanding voting stock.
WARRANTS
As of July 31, 1999, Fingerhut held irrevocable "percentage warrants" to
purchase 208,918 shares of our series B convertible preferred stock;
"anti-dilution warrants" to purchase 184,288 of our series B convertible
preferred stock; and "third-party agreement warrants" to purchase 3,333 shares
of our series B convertible preferred stock. All Fingerhut warrants will expire
at the closing of this offering, if not previously exercised. Pursuant to the
terms of a letter agreement, Fingerhut has agreed to exercise the remainder of
its warrants prior to the completion
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<PAGE> 58
of this offering, as long as this offering is completed on or before October 31,
1999. See "Related-Party Transactions."
In addition to the warrants held by Fingerhut, as of July 31, 1999, we had
warrants outstanding to purchase 27,700 shares of common stock. Generally, each
warrant contains provisions for the adjustment of the exercise price and the
number of shares issuable upon the exercise of the warrant upon the occurrence
of events such as stock dividends, stock splits, reorganizations,
reclassifications and consolidations.
REGISTRATION RIGHTS
According to the terms of a stockholders agreement between us, Fingerhut
and Messrs. Choate and Ballantine, Fingerhut is entitled to make a one-time
demand that we file a registration statement with respect to shares of common
stock owned by Fingerhut. However, we are not required to effect this "demand
registration" before June 30, 2001, and may postpone the registration for up to
180 days for bona fide business reasons. In addition, under the stockholders
agreement, Fingerhut is entitled to "piggyback" registration rights in
connection with any registration by us of our securities for our own account or
for the account of other security holders (other than in this offering and in
any registration of securities to be issued in connection with an acquisition or
under our employee compensation plans). If we propose to register any shares of
common stock under the Securities Act of 1933, as amended, Fingerhut is entitled
to receive notice and to include its shares in the registration statement,
subject to certain limitations. Fingerhut is entitled to two piggyback
registrations under the agreement.
We have also granted piggyback registration rights to Commonsite with
respect to 52,920 shares of common stock in connection with our acquisition of
substantially all of the assets of Commonsite. Under the terms of the
registration rights agreement, after completion of this offering, Commonsite is
entitled to one piggyback registration in connection with any registration by us
of our securities for our own account or for the account of other security
holders (other than any registration of securities to be issued in connection
with an acquisition or under our employee compensation plans). If we propose to
register any shares of common stock under the Securities Act, Commonsite is
entitled to receive notice and to include its shares in the registration
statement, subject to certain limitations.
ANTITAKEOVER EFFECTS OF CERTAIN ARTICLES AND BYLAW PROVISIONS AND THE WASHINGTON
BUSINESS CORPORATION ACT
Articles and Bylaws. Our articles of incorporation and bylaws contain
provisions that may have the effect of delaying, deferring or preventing a
change in control. Neither the articles of incorporation nor the bylaws provide
for cumulative voting in the election of directors. Furthermore, the
authorization of undesignated preferred stock makes it possible for the board of
directors to issue preferred stock with voting or other rights or preferences
that could impede any attempt to change control of FreeShop.
Washington Business Corporation Act. Washington law imposes restrictions on
certain transactions between a corporation and certain significant shareholders.
Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target
corporation," with some exceptions, from engaging in certain significant
business transactions with a person or group of persons that beneficially owns
10% or more of the voting securities of the target corporation (an Acquiring
Person) for a period of five years after such acquisition, unless the
transaction or acquisition of shares is approved by a majority of the members of
the target corporation's board of directors prior to the time of acquisition.
Transactions prohibited by this statute include, among others:
- 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> 59
- 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 certain "fair price" provisions of the statute. A
public corporation may not "opt out" of this statute. This provision may have
the effect of delaying, deferring or preventing a change in control of FreeShop.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services, L.L.C. Its address is 400 South Oak Street, 4th Floor, Los
Angeles, California 90071, and its telephone number at this location is (213)
553-9731 .
LISTING
Our common stock has been approved for quotation on the Nasdaq National
Market under the trading symbol "FSHP."
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<PAGE> 60
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of our common stock in the public
market could adversely affect prevailing market prices of our common stock.
Furthermore, because no shares will be available for sale shortly after this
offering because of certain contractual and legal restrictions on resale
described below, sales of substantial amounts of common stock in the public
market after these restrictions lapse could adversely affect the prevailing
market price and our ability to raise equity capital in the future.
Upon completion of this offering and based on shares of common stock
outstanding as of July 31, 1999, we will have outstanding an aggregate of
14,955,155 shares of our common stock, assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options, and assuming the
exercise of all warrants held by Fingerhut and the conversion of all the series
B convertible preferred stock. Of these shares, the 3,200,000 shares sold in
this offering will be freely tradable without restriction or further
registration under the Securities Act, unless such shares are purchased by
"affiliates," as that term is defined in Rule 144 under the Securities Act. The
remaining 11,755,155 shares of common stock held by existing shareholders are
"restricted securities" as that term is defined in Rule 144 under the Securities
Act. Restricted securities may be sold in the public market only if registered
or if they qualify for an exemption from registration under Rule 144 or 701
promulgated under the Securities Act, which rules are summarized below.
Lock-Up Agreements. A majority of shareholders, including each of our
directors and officers, who hold an aggregate of 11,497,632 shares of common
stock (which includes common stock issuable upon conversion of series B
convertible preferred stock), have agreed not to offer, sell, contract to sell
or otherwise dispose of, or enter into any transaction that is designed to, or
could be expected to, result in the disposition of any portion of, any common
stock for a period of 180 days after the effective date of the registration
statement of which this prospectus is a part, without the prior written consent
of Deutsche Bank Securities Inc. This consent may be given at any time without
public notice. We have entered into a similar agreement, except that we may,
without the prior written consent of Deutsche Bank Securities Inc., issue common
stock:
- as consideration or partial consideration for business acquisitions;
- in connection with the formation of strategic alliances;
- pursuant to the exercise of outstanding options and warrants; and
- in connection with the issuance and exercise of options granted under our
stock option plan.
Any shares so issued will be subject to a lock-up agreement for a period of 180
days after the effective date of the registration statement of which this
prospectus is a part. In addition, Fingerhut, Mr. Ballantine and Mr. Choate have
entered into a cross-lock-up agreement which prevents any of the parties from
selling stock pursuant to a waiver from Deutsche Bank Securities Inc. under the
lock-up agreements unless the other parties receive similar waivers.
Before taking into account the lock-up agreements, the following shares
will be eligible for sale in the public market at the following times:
- Beginning on the effective date of the offering, 4,729,114 shares will be
immediately available for sale in the public market.
- Beginning 90 days after the effective date of this offering,
approximately 6,567,253 shares will be eligible for sale pursuant to
Rules 144 or 701.
- An additional 3,658,788 shares will become eligible for sale pursuant to
Rule 144 at various times after 90 days from the effective date of this
offering. Shares eligible to be sold by affiliates pursuant to Rule 144
are subject to volume restrictions as described below.
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<PAGE> 61
Rule 144. In general, under Rule 144 as currently in effect, beginning 90
days after the date of this prospectus, a person who has beneficially owned
shares of our common stock for at least one year would be entitled to sell
within any three-month period a number of shares that does not exceed the
greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 149,552 shares immediately after this offering; or
- the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale.
Sales under Rule 144 are also subject to certain manner of sale provisions
and notice requirements and to the availability of current public information
about us.
Rule 144(k). Under Rule 144(k), a person who is not deemed to have been one
of our affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an affiliate, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144. Therefore,
unless otherwise restricted, "144(k) shares" may be sold immediately upon the
completion of this offering.
Rule 701. In general, under Rule 701 of the Securities Act as currently in
effect, any of our employees, consultants or advisors who purchases shares from
us in connection with a compensatory stock or option plan or other written
agreement is eligible to resell such shares 90 days after the effective date of
this offering in reliance on Rule 144, but without compliance with some
restrictions, including the holding period, contained in Rule 144.
Registration Rights. Upon completion of this offering, Fingerhut and
Commonsite will be entitled to rights with respect to the registration of shares
of our common stock under the Securities Act. See "Description of Capital
Stock -- Registration Rights." After such a registration, these shares become
freely tradable without restriction under the Securities Act. Neither Fingerhut
nor Commonsite will have any obligation or other restrictions on resale with
respect to any of our securities, other than restrictions imposed by lock-up
agreements and applicable securities laws. Any sales of securities by these
shareholders could have a material adverse effect on the trading price of our
common stock.
Stock Options. Immediately after this offering, we intend to file a
registration statement under the Securities Act covering up to 2,400,000 shares
of common stock reserved for issuance under our 1997 Stock Option Plan. As of
July 31, 1999, options to purchase 953,289 shares of common stock were issued
and outstanding. Upon the expiration of the lock-up agreements described above,
at least 623,688 shares of common stock will be subject to vested options (based
on options outstanding as of July 31, 1999). Such registration statement is
expected to be filed and become effective as soon as practicable after the
effective date of this offering. Accordingly, shares registered under such
registration statement will, subject to vesting provisions and Rule 144 volume
limitations applicable to our affiliates, be available for sale in the open
market immediately after the 180-day lock-up period expires.
61
<PAGE> 62
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement, the
underwriters named below, through their representatives Deutsche Bank Securities
Inc., Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Volpe
Brown Whelan & Company, LLC and E*OFFERING Corp. have severally agreed to
purchase from us the following respective numbers of shares of common stock at
the public offering price less the underwriting discounts and commissions set
forth on the cover page of this prospectus.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Deutsche Bank Securities Inc. .............................. 1,230,000
Dain Rauscher Wessels....................................... 553,500
Volpe Brown Whelan & Company, LLC........................... 553,500
E*OFFERING Corp............................................. 123,000
BancBoston Robertson Stephens Inc........................... 60,000
CIBC World Markets Corp..................................... 60,000
Hambrecht & Quist LLC....................................... 60,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated.......... 60,000
Salomon Smith Barney Inc.................................... 60,000
SG Cowen Securities Corporation............................. 60,000
SoundView Technology Group, Inc............................. 60,000
L.H. Friend, Weinress, Frankson & Presson, Inc.............. 40,000
Jefferies & Company, Inc.................................... 40,000
Needham & Company, Inc...................................... 40,000
U.S. Bancorp Piper Jaffray Inc.............................. 40,000
The Robinson-Humphrey Company, LLC.......................... 40,000
Suntrust Equitable Securities Corporation................... 40,000
C.E. Unterberg, Towbin...................................... 40,000
First Security Van Kasper................................... 40,000
---------
Total............................................. 3,200,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the
underwriters are subject to several conditions, including the absence of any
material adverse change in our business and the receipt of certificates,
opinions and letters from us, our counsel and our experts. The agreement also
provides for the allocation of expenses incurred in the offering. In addition,
the agreement provides that the underwriters will purchase all the shares of
common stock offered by this prospectus, other than those covered by the
over-allotment option described below, if any of such shares are purchased.
Pursuant to the underwriting agreement, we have agreed to indemnify the
underwriters against liabilities under the Securities Act, and to contribute to
payments the underwriters may be required to make with respect to liabilities
under the Securities Act.
We have been advised by the representatives that the underwriters propose
to offer the shares of common stock directly to the public at the offering price
set forth on the cover page of this prospectus and to certain dealers at such
price less a concession not in excess of $0.50 per share. The underwriters may
allow, and such dealers may re-allow, a concession not in excess of $0.10 per
share to certain other dealers. After the initial public offering, the offering
price and other selling terms may be changed by the representatives.
A prospectus in electronic format is being made available on Internet Web
sites maintained by E*OFFERING Corp. and E*TRADE Securities, Inc. Internet
purchases of the common stock offered by this prospectus will be available only
to registered customers of E*TRADE Securities, Inc. who possess sufficient net
worth and investment experience. All eligible accounts may
62
<PAGE> 63
submit a conditional offer to E*TRADE Securities, Inc. to purchase shares. If
demand exceeds availability, E*TRADE Securities, Inc. will randomly allocate
shares to applicants in 100-share lots in a round-robin fashion, meaning that no
applicant will receive a second lot until all applicants have received one lot,
and so forth, until all shares available to E*TRADE Securities, Inc. have been
distributed. The common stock offered by this prospectus will not be directed to
any additional Internet customers other than the registered customers of E*TRADE
Securities, Inc.
We have granted to the underwriters an option, exercisable not later than
30 days after the date of this prospectus, to purchase up to 480,000 additional
shares of common stock at the public offering price less the underwriting
discounts and commissions set forth on the cover page of this prospectus. The
underwriters may exercise this option only to cover over-allotments made in
connection with the sale of the common stock offered in this prospectus. To the
extent the underwriters exercise the option, each of the underwriters will
become obligated, subject to certain conditions, to purchase approximately the
same percentage of additional shares of common stock as the number of shares of
common stock to be purchased by it in the above table bears to the total listed
above. We will be obligated, pursuant to the option, to sell these shares to the
underwriters to the extent the option is exercised. If any additional shares of
common stock are purchased, the underwriters will offer such additional shares
on the same terms as those on which the 3,200,000 shares are being offered.
The underwriting fee is equal to the public offering price per share of
common stock less the amount paid by the underwriters to us per share of common
stock. We anticipate that the total underwriting fee will be approximately 7% of
the aggregate initial public offering price. The following table summarizes the
underwriting compensation that will be paid in connection with this offering.
<TABLE>
<CAPTION>
TOTAL
-------------------------------
WITHOUT WITH
PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT
--------- -------------- --------------
<S> <C> <C> <C>
Underwriting discounts and commissions paid by us.... $ 0.84 $2,688,000 $3,091,200
Reimbursement of expenses to or on behalf of the
underwriters....................................... $ 0.00 $ 0.00 $ 0.00
Fees and expenses of underwriters' counsel relating
to NASD review..................................... $0.003 $ 8,400 $ 8,400
</TABLE>
We estimate that the total expenses of the offering, excluding underwriting
discounts and commissions, will be approximately $750,000.
The representatives have advised us that the underwriters do not intend to
confirm orders to any account over which they exercise discretionary authority.
A majority of our shareholders, including each of our officers and
directors, who hold an aggregate of 11,497,632 shares of common stock (which
includes common stock issuable upon conversion of series B convertible preferred
stock), have agreed not to offer, sell, contract to sell or otherwise dispose
of, or enter into any transaction that is designed to, or could be expected to,
result in the disposition of any portion of, any common stock for a period of
180 days after the effective date of the registration statement of which this
prospectus is a part, without the prior written consent of Deutsche Bank
Securities Inc. This consent may be given at any time without public notice. We
have entered into a similar agreement, except that we may, without the prior
written consent of Deutsche Bank Securities Inc., issue common stock:
- as consideration or partial consideration for business acquisitions;
- in connection with the formation of strategic alliances;
- pursuant to the exercise of outstanding options and warrants; and
- in connection with the issuance and exercise of options granted under our
stock option plan.
63
<PAGE> 64
Any shares so issued will be subject to a lock-up agreement for a period of 180
days after the effective date of the registration statement of which this
prospectus is a part.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
market price of the common stock. Specifically, the underwriters may over-allot
shares of the common stock in connection with this offering, thus creating a
short position in the common stock for their own account. Additionally, to cover
these over-allotments or to stabilize the market price of the common stock, the
underwriters may bid for, and purchase, shares of the common stock in the open
market. Finally, the representatives, on behalf of the underwriters, may reclaim
selling concessions allowed to an underwriter or dealer if the underwriting
syndicate repurchases shares distributed by that underwriter or dealer. Any of
these activities may maintain the market price of our common stock at a level
above that which might otherwise prevail in the open market. The underwriters
are not required to engage in these activities and, if commenced, may end any of
these activities at any time.
At our request, the underwriters have reserved up to 288,000 shares of
common stock for sale, at the initial public offering price, to our current
full-time employees, our current shareholders and selected marketer clients and
traffic partners, through a directed share program. In connection with this
program, Deutsche Bank Securities Inc. sends a letter and questionnaire to
potential interested participants and provides those parties from whom it has
received indications of interest the opportunity to obtain a copy of this
prospectus. The underwriters are seeking lock-up agreements from participants in
the directed share program. The number of shares of common stock available for
sale to the general public will be reduced to the extent these reserved shares
are purchased. Any reserved shares not purchased will be offered by the
underwriters to the general public on the same basis as the other shares offered
by this prospectus.
PRICING OF THE OFFERING
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price for our common stock was
determined by negotiation between FreeShop and the representatives of the
underwriters. Among the primary factors considered in determining the public
offering price were:
- prevailing market conditions;
- our results of operations in recent periods;
- the present stage of our development;
- the market capitalizations and stages of development of other companies
we and the representatives believe to the comparable to us; and
- estimates of our business potential.
LEGAL MATTERS
Dorsey & Whitney LLP, Seattle, Washington, will pass upon the legality of
the shares offered by this prospectus. Perkins Coie LLP, Seattle, Washington, is
acting as legal counsel to the underwriters in connection with this offering. A
partner of Dorsey & Whitney LLP owns an aggregate of 11,232 shares of our common
stock.
EXPERTS
The financial statements of FreeShop as of December 31, 1997 and 1998 and
for the years ended June 30, 1996 and 1997, the six months ended December 31,
1997 and the year ended December 31, 1998, included in this prospectus have been
included in reliance on the report of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of PricewaterhouseCoopers LLP as experts in
auditing and accounting.
64
<PAGE> 65
The financial statements of Commonsite as of December 31, 1998 and for the
year then ended that are included in this prospectus have been included in
reliance on the report of PricewaterhouseCoopers LLP, independent accountants,
given on the authority of PricewaterhouseCoopers LLP as experts in auditing and
accounting.
The financial statements of Travel Companions International as of December
31, 1998 and for the year then ended that are included in this prospectus have
been included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of PricewaterhouseCoopers LLP as
experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 covering the shares being sold in this offering. We have
not included in this prospectus some information contained in the registration
statement, and you should refer to the registration statement, including
exhibits and schedules filed with the registration statement, for further
information. You may review without charge a copy of the registration statement
at the public reference section of the Commission in Room 1024, Judiciary Plaza,
450 5th Street, N.W., Washington, D.C. 20549; and at the SEC's Regional Offices
located at 7 World Trade Center, Suite 1300, New York, New York 10048 and 1400
Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661. You may also
obtain copies of such materials at prescribed rates from the public reference
section at the Commission, Room 1024, Judiciary Plaza, 450 5th Street, N.W.,
Washington, D.C. 20549. In addition, the SEC maintains a Web site on the
Internet at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission.
65
<PAGE> 66
INDEX TO FINANCIAL STATEMENTS
FREESHOP.COM, INC.
FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants........................... F-2
Balance Sheet for the periods ended December 31, 1997,
December 31, 1998 and June 30, 1999 (unaudited)........... F-3
Statement of Operations for the periods ended June 30, 1996,
June 30, 1997, December 31, 1997, December 31, 1998, June
30, 1998 (unaudited) and June 30, 1999 (unaudited)........ F-4
Statement of Changes in Mandatorily Redeemable Preferred
Stock and Shareholders' Equity/Division Equity for the
periods ended June 30, 1996, June 30, 1997, December 31,
1997, December 31, 1998 and June 30, 1999 (unaudited)..... F-5
Statement of Cash Flows for the periods ended June 30, 1996,
June 30, 1997, December 31, 1997, December 31, 1998, June
30, 1998 (unaudited) and June 30, 1999 (unaudited)........ F-6
Notes to Financial Statements............................... F-7
COMMONSITE, LLC
FINANCIAL STATEMENTS
Report of Independent Accountants........................... F-20
Statement of Financial Position as of December 31, 1998 and
March 31, 1999 (unaudited)................................ F-21
Statement of Operations and Members' Deficit for the periods
ended December 31, 1998, March 31, 1998 (unaudited) and
March 31, 1999 (unaudited)................................ F-22
Statement of Cash Flows for the periods ended December 31,
1998, March 31, 1998 (unaudited) and March 31, 1999
(unaudited)............................................... F-23
Notes to Financial Statements............................... F-24
TRAVEL COMPANIONS INTERNATIONAL, INC.
FINANCIAL STATEMENTS
Report of Independent Accountants........................... F-28
Balance Sheet as of December 31, 1998 and March 31, 1999
(unaudited)............................................... F-29
Statement of Income for the periods ended December 31, 1998,
March 31, 1998 (unaudited) and March 31, 1999
(unaudited)............................................... F-30
Statement of Stockholders' Deficit for the periods ended
December 31, 1998 and March 31, 1999 (unaudited).......... F-31
Statement of Cash Flows for the periods ended December 31,
1998, March 31, 1998 (unaudited) and March 31, 1999
(unaudited)............................................... F-32
Notes to Financial Statements............................... F-33
FREESHOP.COM, INC.
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
Unaudited Pro Forma Combined Financial Information.......... F-36
Unaudited Pro Forma Combined Statement of Operations for the
year ended December 31, 1998 and the six months ended June
30, 1999.................................................. F-37
Notes to Unaudited Pro Forma Combined Financial
Statements................................................ F-38
</TABLE>
F-1
<PAGE> 67
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of FreeShop.com, Inc.
In our opinion, the accompanying balance sheet and the related statements
of operations, of changes in mandatorily redeemable convertible preferred stock
and shareholders' equity/division equity and of cash flows present fairly, in
all material respects, the financial position of FreeShop.com, Inc. at December
31, 1997 and 1998, and the results of its operations and its cash flows for the
years ended June 30, 1996 and 1997, the six-month period ended December 31, 1997
and the year ended December 31, 1998, in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
As described in Note 1, FreeShop.com, Inc. was a wholly owned subsidiary of
Online Interactive, Inc. prior to July 1, 1997.
PricewaterhouseCoopers LLP
Seattle, Washington
April 16, 1999, except as to paragraphs three through seven
of Note 13 which are as of June 18, 1999, and
paragraph eight of Note 13 which
is as of August 9, 1999.
F-2
<PAGE> 68
FREESHOP.COM, INC.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------- ------------
1997 1998 1999
----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................ $ 26,329 $ 2,892,144 $ 4,330,067
Accounts receivable, net......................... 204,691 339,179 1,019,058
Prepaid expenses................................. 13,598 30,497 380,377
Short-term investments........................... 1,485,600
----------- ----------- ------------
Total current assets........................ 244,618 3,261,820 7,215,102
Property and equipment, net...................... 354,496 381,296 857,397
Intangible assets................................ 2,496,929
Other assets and deposits........................ 45,818 43,454 43,454
----------- ----------- ------------
$ 644,932 $ 3,686,570 $ 10,612,882
=========== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable................................. $ 247,491 $ 464,872 $ 966,227
Accrued and other liabilities.................... 68,966 670,857 936,728
Payable to Online Interactive, Inc............... 27,269
Current portion of capital lease obligations..... 59,081 112,327 122,144
----------- ----------- ------------
Total current liabilities................... 402,807 1,248,056 2,025,099
----------- ----------- ------------
Long-term convertible debt....................... 50,000
Capital lease obligations, net of current
portion........................................ 159,757 144,727 81,219
Commitments (Note 9)
Mandatorily redeemable preferred stock, series A
convertible, no par value; 10,000,000 shares
authorized, none issued and outstanding at
December 31, 1997 and 1998 and June 30, 1999,
liquidation value $0.086.......................
Shareholders' equity
Series B convertible preferred stock, no par
value; no shares authorized, issued or
outstanding at December 31, 1997 and 1998,
1,250,000 shares authorized, 472,608 issued
and outstanding at June 30, 1999
(unaudited)................................. 8,615,125
Common stock, no par value; 100,000,000 shares
authorized, 6,117,595 issued and 5,597,595
outstanding at December 31, 1997, 8,660,959
issued and 8,140,959 outstanding at December
31, 1998 and 8,923,287 issued and 8,243,287
outstanding at June 30, 1999 (unaudited).... 2,699,518 7,816,328 8,955,511
Additional paid-in capital..................... 62,968 294,529 1,975,849
Note receivable from shareholder............... (25,000)
Deferred stock compensation.................... (12,927) (1,075,975)
Accumulated deficit............................ (2,655,118) (5,854,143) (9,963,946)
----------- ----------- ------------
Total shareholders' equity.................. 82,368 2,243,787 8,506,564
----------- ----------- ------------
$ 644,932 $ 3,686,570 $ 10,612,882
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 69
FREESHOP.COM, INC.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS ENDED
YEAR ENDED JUNE 30, ENDED YEAR ENDED JUNE 30,
------------------------ DECEMBER 31, DECEMBER 31, --------------------------
1996 1997 1997 1998 1998 1999
---------- ----------- ------------ ------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Net revenues........... $1,270,949 $ 1,197,757 $ 534,733 $ 1,250,940 $ 429,002 $ 2,146,662
Cost of revenues....... 310,308 313,672 139,451 216,557 75,631 189,898
---------- ----------- ----------- ----------- ------------ -----------
Gross profit........... 960,641 884,085 395,282 1,034,383 353,371 1,956,764
---------- ----------- ----------- ----------- ------------ -----------
Operating expenses
Sales and
marketing.......... 624,560 1,809,912 1,174,745 3,088,446 1,029,839 4,141,323
Research and
development........ 64,673 135,121 182,532 386,629 194,069 321,517
General and
administrative..... 290,821 352,923 83,217 416,766 171,820 462,060
Equity based
compensation....... -- -- 62,968 174,102 122,696 621,756
Depreciation and
amortization....... 9,008 30,011 34,468 104,393 48,811 259,911
---------- ----------- ----------- ----------- ------------ -----------
Total operating
expenses........ 989,062 2,327,967 1,537,930 4,170,336 1,567,235 5,806,567
---------- ----------- ----------- ----------- ------------ -----------
Operating loss......... (28,421) (1,443,882) (1,142,648) (3,135,953) (1,213,864) (3,849,803)
Interest expense....... 6,226 65,654 28,457 23,492
Other (income)
expense.............. (2,582) 761 (86,992)
---------- ----------- ----------- ----------- ------------ -----------
Loss before income tax
expense.............. (28,421) (1,443,882) (1,148,874) (3,199,025) (1,243,082) (3,786,303)
Income tax expense.....
---------- ----------- ----------- ----------- ------------ -----------
Net loss............... $ (28,421) $(1,443,882) $(1,148,874) $(3,199,025) $ (1,243,082) $(3,786,303)
========== =========== =========== =========== ============ ===========
Basic and diluted net
loss per share....... $ (0.01) $ (0.31) $ (0.22) $ (0.51) $ (0.21) $ (0.46)
========== =========== =========== =========== ============ ===========
Weighted-average shares
used in computing net
loss per share....... 4,600,840 4,600,840 5,188,910 6,223,726 5,821,924 8,182,728
========== =========== =========== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 70
FREESHOP.COM, INC.
STATEMENT OF CHANGES IN MANDATORILY REDEEMABLE PREFERRED STOCK AND
SHAREHOLDERS' EQUITY/DIVISION EQUITY
<TABLE>
<CAPTION>
MANDATORILY
REDEEMABLE CONVERTIBLE SERIES B CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK ADDITIONAL
---------------------- ----------------------- ----------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL
---------- --------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1995......... -- $ -- -- -- -- $ -- $ --
Capital contributions............
Net loss.........................
---------- --------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1996......... -- -- -- -- -- -- --
Capital contributions............
Issuance of common and Series A
preferred stock in connection
with spin-off................... 1,935,484 279,196 4,600,820 1,659,182
Net loss.........................
---------- --------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1997......... 1,935,484 279,196 4,600,820 1,659,182 --
Forfeiture of common stock....... (520,000)
Conversion of preferred stock.... (1,935,484) (279,196) 774,194 279,196
Issuance of common stock......... 718,190 736,140
Common stock issued in exchange
for a note receivable........... 24,391 25,000
Stock options issued to third
parties......................... 62,968
Net loss.........................
---------- --------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 1997..... -- -- 5,597,595 2,699,518 62,968
Issuance of common stock, net of
offering expenses of $36,563.... 2,487,670 5,108,150
Exercise of stock options........ 55,694 8,660
Repayment of note receivable from
shareholder.....................
Stock options and warrants issued
to third parties................ 147,561
Shares transferred to employees
by principal shareholders....... 84,000
Amortization of deferred
compensation....................
Net loss.........................
---------- --------- ---------- ---------- ---------- ---------- ----------
Balance at December 31, 1998..... -- -- 8,140,959 7,816,328 294,529
Repurchase of common stock
(unaudited)..................... (160,000) (76,500)
Issuance of common stock
(unaudited)..................... 160,000 400,000
Issuance of common stock upon
conversion of promissory note
(unaudited)..................... 20,000 50,000
Issuance of common stock in
connection with business
combinations (unaudited)........ 52,920 736,000
Shares sold to employees by
principal shareholders
(unaudited)..................... 406,000
Exercise of stock options and
warrants (unaudited)............ 472,608 8,615,125 29,408 29,683
Stock options and warrants issued
to third parties (unaudited).... 1,275,320
Amortization of deferred
compensation (unaudited)........
Net loss (unaudited).............
---------- --------- ---------- ---------- ---------- ---------- ----------
Balance at June 30, 1999
(unaudited)..................... -- $ -- 472,608 8,615,125 8,243,287 $8,955,511 $1,975,849
========== ========= ========== ========== ========== ========== ==========
<CAPTION>
NOTE TOTAL
RECEIVABLE SHAREHOLDERS'
FROM DEFERRED DIVISION ACCUMULATED EQUITY/
SHAREHOLDER COMPENSATION EQUITY DEFICIT DIVISION EQUITY
----------- ------------ ----------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1995......... $ -- $ -- $ 7,747 $ -- $ 7,747
Capital contributions............ 125,198 125,198
Net loss......................... (28,421) (28,421)
-------- ----------- ----------- ----------- -----------
Balance at June 30, 1996......... -- -- 104,524 -- 104,524
Capital contributions............ 1,771,492 1,771,492
Issuance of common and Series A
preferred stock in connection
with spin-off................... (1,876,016) (62,362) (279,196)
Net loss......................... (1,443,882) (1,443,882)
-------- ----------- ----------- ----------- -----------
Balance at June 30, 1997......... -- -- -- (1,506,244) 152,938
Forfeiture of common stock....... --
Conversion of preferred stock.... 279,196
Issuance of common stock......... 736,140
Common stock issued in exchange
for a note receivable........... (25,000) --
Stock options issued to third
parties......................... 62,968
Net loss......................... (1,148,874) (1,148,874)
-------- ----------- ----------- ----------- -----------
Balance at December 31, 1997..... (25,000) -- -- (2,655,118) 82,368
Issuance of common stock, net of
offering expenses of $36,563.... 5,108,150
Exercise of stock options........ 8,660
Repayment of note receivable from
shareholder..................... 25,000 25,000
Stock options and warrants issued
to third parties................ (22,677) 124,884
Shares transferred to employees
by principal shareholders....... 84,000
Amortization of deferred
compensation.................... 9,750 9,750
Net loss......................... (3,199,025) (3,199,025)
-------- ----------- ----------- ----------- -----------
Balance at December 31, 1998..... -- (12,927) -- (5,854,143) 2,243,787
Repurchase of common stock
(unaudited)..................... (323,500) (400,000)
Issuance of common stock
(unaudited)..................... 400,000
Issuance of common stock upon
conversion of promissory note
(unaudited)..................... 50,000
Issuance of common stock in
connection with business
combinations (unaudited)........ 736,000
Shares sold to employees by
principal shareholders
(unaudited)..................... 406,000
Exercise of stock options and
warrants (unaudited)............ 8,644,808
Stock options and warrants issued
to third parties (unaudited).... (1,275,320) --
Amortization of deferred
compensation (unaudited)........ 212,272 212,272
Net loss (unaudited)............. (3,786,303) (3,786,303)
-------- ----------- ----------- ----------- -----------
Balance at June 30, 1999
(unaudited)..................... $ -- $(1,075,975) $ -- $(9,963,946) $ 8,506,564
======== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 71
FREESHOP.COM, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS ENDED
YEAR ENDED JUNE 30, ENDED YEAR ENDED JUNE 30,
----------------------- DECEMBER 31, DECEMBER 31, -------------------------
1996 1997 1997 1998 1998 1999
--------- ----------- ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.................................. $ (28,421) $(1,443,882) $(1,148,874) $(3,199,025) $(1,243,082) $(3,786,303)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization......... 5,566 33,659 47,617 140,710 65,692 287,286
Bad debt expense...................... 58,907 146,310 122,485 56,551 20,156 51,040
Amortization of deferred
compensation........................ 9,750 212,272
Shares sold to an employee by a
principal shareholder............... 406,000
Shares transferred to employees by
principal shareholders.............. 84,000
Issuance of stock options and warrants
for services........................ 62,968 88,321 122,696
Issuance of stock for office rent..... 32,637
Loss on disposal of property and
equipment........................... 8,624 1,240 896
Changes in assets and liabilities:
Accounts receivable................. (198,548) (94,449) (196,560) (191,039) 19,173 (694,404)
Prepaid expenses and other assets... (17,280) (43,559) (21,074) (14,323) (349,880)
Accounts payable.................... 11,873 43,044 192,402 217,381 65,786 326,795
Accrued and other liabilities....... 50,502 (48,957) 27,545 601,891 270,017 125,109
Payable to Online Interactive,
Inc............................... (280,918) 308,187 (27,269) (7,800)
--------- ----------- ----------- ----------- ----------- -----------
Net cash used in operating
activities........................ (100,121) (1,662,473) (595,152) (2,231,179) (700,445) (3,421,189)
--------- ----------- ----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment........ (25,077) (108,894) (55,902) (67,428) (17,169) (579,965)
Payment for business combinations, net of
cash acquired........................... (1,666,440)
Purchase of short-term investments........ (1,485,660)
--------- ----------- ----------- ----------- ----------- -----------
Net cash used in investing
activities........................ (25,077) (108,894) (55,902) (67,428) (17,169) (3,732,005)
--------- ----------- ----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Contributed capital....................... 125,198 1,771,492
Proceeds from notes payable............... 135,000 135,000
Repayment of notes payable................ (85,000)
Principal payments under capital leases... (26,245) (63,951) (16,375) (53,691)
Proceeds from Shareholder Note
Receivable.............................. 25,000 25,000
Repurchase of common stock................ (400,000)
Issuance of common stock, net of issuance
costs................................... 703,503 5,153,373 743,288 429,683
Issuance of series B preferred stock...... 8,615,125
--------- ----------- ----------- ----------- ----------- -----------
Net cash provided by (used in)
financing activities.............. 125,198 1,771,492 677,258 5,164,422 886,913 8,591,117
--------- ----------- ----------- ----------- ----------- -----------
Net increase in cash and cash equivalents... -- 125 26,204 2,865,815 169,299 1,437,923
Cash and cash equivalents at beginning of
period.................................... -- -- 125 26,329 26,329 2,892,144
--------- ----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of
period.................................... $ -- $ 125 $ 26,329 $ 2,892,144 $ 195,628 $ 4,330,067
========= =========== =========== =========== =========== ===========
Cash paid during the period for interest.... $ -- $ -- $ 6,226 $ 65,654 $ 23,608 $ 24,751
========= =========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 72
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
FreeShop began as a division of Online Interactive, Inc. (Online), a
Washington corporation, incorporated in July 1994. On June 30, 1997, Online
Interactive contributed the FreeShop Division, including certain net assets, to
its wholly owned subsidiary, FreeShop International, Inc., a Washington
corporation incorporated on June 23, 1997, which then began operating as a
separate entity. In connection with the spin-off, Online issued FreeShop common
shares equal to the number of Online shares (both preferred and common)
outstanding as of June 30, 1997. Online then distributed the FreeShop common
shares to its shareholders. Each Online shareholder received a number of
FreeShop shares equal to the number of Online shares held as of the Distribution
Record Date. However, 1,300,000 shares of common stock were forfeited on July
18, 1997 in connection with agreements between Online and certain shareholders.
As a result of the distribution, FreeShop ceased to be a subsidiary of Online.
On February 19, 1999, FreeShop International, Inc. changed its name to
FreeShop.com, Inc. (FreeShop or the Company). FreeShop operates an online direct
marketing network from a Web site at http://www.freeshop.com. Essentially,
FreeShop is an online marketing service that generates sales leads, creates
product awareness, and initiates consumer purchases through multiple online
marketing vehicles, including free and trial offers, banner advertising, email
newsletter sponsorship, and others.
The financial statements for the two years ended June 30, 1997 reflect the
revenues, expenses and changes in division equity and cash flows of the FreeShop
Division of Online. Certain general and administrative costs incurred by Online
have been allocated to the Company on a basis which management believes
represents a reasonable allocation of such costs to present FreeShop as a
stand-alone company. These allocations consist primarily of corporate expenses
such as executive and other compensation, depreciation, rent and legal expenses.
The corporate expenses have been allocated based on an estimate of Online
personnel time dedicated to the operations and management of FreeShop for the
year ended June 30, 1996 and the nine months ended March 31, 1997. For the
three-month period ended June 30, 1997, these corporate expenses were generally
allocated on a specific identification basis rather than on the basis of
personnel time. A summary of these allocations are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------
1996 1997
-------- --------
<S> <C> <C>
Sales and marketing......................................... $ 97,564 $176,768
Research and development.................................... 77,147 110,230
General and administrative.................................. 282,694 362,810
-------- --------
$457,405 $649,808
======== ========
</TABLE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash equivalents consist of short-term highly liquid investments that
mature within three months of their acquisition. The Company deposits its cash
and cash equivalents in interest-bearing demand deposit accounts with high
credit quality financial institutions. The Company has not experienced any
losses on its cash and cash equivalents.
F-7
<PAGE> 73
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation and
are depreciated using the straight-line method over their estimated useful
lives. The estimated useful lives are as follows:
<TABLE>
<S> <C>
Office furniture and equipment.............................. Five years
Computer hardware and software.............................. Three years
</TABLE>
The cost of normal maintenance and repairs are charged to expense as
incurred and expenditures for major improvements are capitalized, at cost. Gains
or losses on the disposition of assets in the normal course of business are
reflected in the results of operations at the time of disposal.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates its long-lived assets for financial impairment and
continues to evaluate them as events or changes in circumstances indicate that
the carrying amount of such assets may not be fully recoverable. The Company
evaluates the recoverability of long-lived assets by measuring the carrying
amount of the assets against the estimated undiscounted future cash flows
associated with these assets. At the time such evaluations indicate that the
future undiscounted cash flows of certain long-lived assets are not sufficient
to recover the carrying value of such assets, the assets are adjusted to their
fair values. No losses for impairment have been recognized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable and accrued
liabilities, approximate fair value because of their short maturities. The
carrying amount of the Company's capital leases and other equipment financing
obligations approximates the fair value of such instruments based upon
management's estimates of interest rates that would be available to the Company
for similar debt obligations at December 31, 1998.
DEFERRED REVENUES
Deferred revenues consist of advance billings and payments on marketing
contracts and are included in accrued and other liabilities in the accompanying
balance sheet.
REVENUE RECOGNITION
The Company has several revenue sources from its online marketing service
activities, including lead generation, advertising, list rental, barter and
transaction fees.
Lead generation revenue consists of fees received, generally on a per
inquiry basis, for delivery of leads to clients. Revenue is recognized in the
period the leads are provided to the client.
Advertising revenues consist of email newsletter sponsorships, banner
advertising, and anchor positions. Newsletter sponsorship revenue is derived
from a fixed fee or a fee based on the circulation of the newsletter. Newsletter
sponsorship revenue is recognized in the period in which the newsletter is
delivered. Banner advertising and anchor positions can be based on impressions,
fixed fees, or click throughs. Fixed fee contracts, which range from three
months to two years, are recognized ratably over the term of the agreement,
provided that no significant
F-8
<PAGE> 74
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company obligations remain. Revenue from impressions or click through based
contracts is recognized based on the number of impressions or click throughs
delivered over the total number of guaranteed impressions or click throughs.
List rental revenue is revenue received from the rental of customer names
to third parties through the use of list brokers. Revenue from list rental
activities is recognized in the period the names are delivered by the list
broker to the third party.
Transaction fees are recognized in the period the transaction occurred and
was reported to the Company by the online merchant.
Also included in revenues are barter revenues generated from exchanging
lead generation and advertising services for advertising services. Such
transactions are recorded at the lower of the estimated fair value of the
advertisements received or delivered, whichever is more reliably measurable.
Revenue from barter transactions is recognized when advertising or lead
generation is provided, and services received are charged to expense when used.
From July 1, 1995 through December 31, 1997 barter transactions were not
significant. For the year ended December 31, 1998 and the unaudited six months
ended June 30, 1999, the Company recognized approximately $83,000 and $250,000,
respectively, of revenue from barter transactions.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Total advertising
expense for the years ended June 30, 1996 and 1997, the six months ended
December 31, 1997, and the year ended December 31, 1998 and the unaudited six
months ended June 30, 1999, was $13,179, $148,543, $242,919, $1,190,811 and
$2,061,978, respectively.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
INCOME TAXES
The Company accounts for income taxes under the asset and liability method,
which requires recognition of deferred tax assets and liabilities for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax bases of assets and liabilities. If it is more likely than
not that some portion of a deferred tax asset will not be realized, a valuation
allowance is recorded.
NET LOSS PER SHARE
Basic net loss per share represents net loss available to common
shareholders divided by the weighted-average number of shares outstanding during
the period. Diluted net loss per share represents net loss available to common
shareholders divided by the weighted-average number of shares outstanding,
including the potentially dilutive impact of common stock options and warrants
and series B convertible preferred stock. Common stock options and warrants are
converted using the treasury stock method. Series B convertible preferred stock
is converted using the if-converted method. Basic and diluted net loss per share
are equal for all periods presented because the impact of common stock
equivalents is antidilutive. Potentially dilutive securities totaling 528,536,
1,200,369, 4,315,977 and 4,492,857 shares for the year ended June 30, 1997, the
six months ended December 31, 1997, the year ended December 31, 1998 and the six
months ended June 30, 1999 (unaudited), respectively, were excluded from diluted
net loss per share due to their antidilutive effect.
F-9
<PAGE> 75
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Adjusted net loss per share is computed using the weighted-average number
of common shares outstanding, including the effects of the automatic conversion
of the Company's series B convertible preferred stock into shares of the
Company's common stock effective upon the closing of the Company's initial
public offering as if such conversion occurred on the date the shares were
originally issued.
The following table sets forth the computation of the numerators and
denominators in the basic and diluted and pro forma net loss per share
calculations for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS ENDED
YEAR ENDED JUNE 30, ENDED YEAR ENDED JUNE 30,
------------------------- DECEMBER 31, DECEMBER 31, -------------------------
1996 1997 1997 1998 1998 1999
----------- ----------- ------------ ------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Numerator:
Net loss............. $ (28,421) $(1,443,882) $(1,148,874) $(3,199,025) $(1,242,321) $(3,786,303)
=========== =========== =========== =========== =========== ===========
Denominator:
Weighted-average
shares used in
computing net loss
per share.......... 4,600,840 4,600,840 5,188,910 6,223,726 5,821,924 8,182,728
=========== =========== =========== ===========
Weighted-average effect
of other securities:
Series B convertible
preferred stock.... 638,456
----------- -----------
Weighted-average shares
outstanding used in
computing adjusted
net loss per share... 6,223,726 8,821,184
=========== ===========
Adjusted basic and
diluted net loss per
share................ $ (0.51) $ (0.43)
=========== ===========
</TABLE>
CONCENTRATIONS OF CREDIT RISK
Concentrations of credit risk with respect to accounts receivable are
limited due to the wide variety of customers to which the Company provides
services, as well as their dispersion across many different geographic areas. As
such, no single customer accounted for greater than 10% of total revenues or
accounts receivable balances for either the period ended December 31, 1998 or
June 30, 1999 (unaudited). The Company maintains an allowance for doubtful
accounts receivable based upon its historical experience and the expected
collectibility of all accounts receivable. Credit losses to date have been
within management's estimates.
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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-10
<PAGE> 76
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year's presentation.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The interim financial data as of June 30, 1999 and for the six months ended
June 30, 1998 and 1999 is unaudited; however, in the opinion of management, the
interim data includes all adjustments, consisting only of the adjustments
necessary to record the acquisition of substantially all of the assets of the
Catalog Site and Worldwide Brochures Web sites in May 1999 and normal recurring
adjustments necessary to present fairly the Company's financial position as of
June 30, 1999 and the results of its operations and cash flows for the six
months ended June 30, 1998 and 1999.
STOCK COMPENSATION
The Company follows SFAS No. 123, "Accounting for Stock-Based
Compensation," which establishes financial accounting and reporting standards
for stock-based employee compensation plans and for the issuance of equity
instruments to acquire goods and services from nonemployees.
The Company has elected to apply the disclosure-only provision of SFAS No.
123 for employee stock-based compensation plans. Accordingly, the Company
accounts for stock-based compensation to employees using the intrinsic-value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Compensation expense
for stock options is measured as the excess, if any, of the fair value of the
Company's common stock at the date of grant over the exercise price. The Company
records the fair value of equity instruments issued to nonemployees in
accordance with the provisions of SFAS No. 123.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting comprehensive income and its components in financial statements.
Comprehensive income, as defined, includes all changes in equity during a period
from nonowner sources. To date, the Company has not had any transactions that
are required to be reported in comprehensive income other than its net loss.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective
for financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance on accounting for computer software developed for internal
use, including the requirement to capitalize specified costs and amortization of
such costs. Adoption of this standard during the first quarter of 1999 did not
have a material effect on the Company's results of operations, financial
position or cash flows.
In April 1998, the AICPA issued 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. As the Company has
F-11
<PAGE> 77
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
expensed these costs historically, the adoption of this standard during the
first quarter of 1999 did not have a significant impact on results of
operations, financial position or cash flows.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. The Company does not expect the adoption of this
statement to have a significant impact on results of its operations, financial
position or cash flows.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1997 1998 1999
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Accounts receivable.................................... $284,410 $381,830 $1,123,058
Less: Allowance for doubtful accounts.................. (79,719) (42,651) (104,000)
-------- -------- ----------
$204,691 $339,179 $1,019,058
======== ======== ==========
</TABLE>
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1997 1998 1999
-------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Computer hardware and software....................... $310,595 $ 468,483 $ 926,839
Office furniture and equipment....................... 129,517 129,517 259,712
-------- --------- -----------
440,112 598,000 1,186,551
Less: Accumulated depreciation and amortization...... (85,616) (216,704) (329,154)
-------- --------- -----------
$354,496 $ 381,296 $ 857,397
======== ========= ===========
</TABLE>
5. ACCRUED AND OTHER LIABILITIES
Accrued and other liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ JUNE 30,
1997 1998 1999
------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Deferred revenue............................................ $20,000 $ 1,129 $ 98,232
Accrued advertising expense................................. 488,451 408,397
List rental deposit......................................... 74,538 5,446
Accrued vacation............................................ 12,802 37,169 53,163
Accrued commissions......................................... 3,313 13,918 116,000
Accrued commerce expense.................................... 164,465
Other....................................................... 32,851 55,652 91,025
------- -------- --------
$68,966 $670,857 $936,728
======= ======== ========
</TABLE>
F-12
<PAGE> 78
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. BANK LINE-OF-CREDIT FACILITY
The Company has a line-of-credit facility with a bank. Pursuant to the
terms of the facility agreement, the Company may borrow up to $500,000 at the
bank's prime rate plus 1.5%, which was 9.25% at December 31, 1998. The line of
credit is collateralized by all assets of the Company and guaranteed up to
$200,000 by the Company's President and Chief Executive Officer. The credit
facility matures September 18, 1999, contains covenants not to encumber trade
accounts receivable and requires maintenance of certain financial ratios. At
December 31, 1998, the Company was in compliance with the loan covenants, and no
balance was outstanding under the line.
7. RELATED PARTY TRANSACTIONS
In January and February 1998, the Company issued notes payable to
shareholders in the amount of $85,000. Such notes included interest at 10%. The
outstanding balance, including accrued interest of $5,745, was repaid in
September 1998.
During 1998, two of the Company's principal shareholders transferred 56,000
shares of common stock to certain employees of the Company as incentive
compensation. As a result, the Company recorded $84,000 of compensation expense
based on the fair market value of the Company's common stock on the date of
transfer.
During January 1999 (unaudited), the Company repurchased 50,000 shares of
common stock from a principal shareholder for $125,000 and subsequently retired
the shares. The repurchase price of $2.50 per share was less than the $5.20 per
share estimated fair value of the common stock at the date of repurchase.
8. LONG-TERM CONVERTIBLE DEBT
In March 1998, the Company issued an uncollateralized 10% convertible
promissory note totaling $50,000 to a third party. The note matures in March
2000. At any time prior to the maturity date, the third party may convert the
outstanding principal balance into shares of the Company's preferred stock at
the price at which such stock is being offered to other investors. During the
first quarter of 1999, the terms of the note were modified to allow conversion
into shares of common stock and the note was then converted. See Note 13 for
further discussion.
9. COMMITMENTS
In May 1998, a promotion agreement was entered into with CNET, Inc. which
provides for CNET to invest in FreeShop an amount equal to 20% of the amount
paid or payable to CNET for promotion. The agreement called for an investment to
be made on September 30, 1998 on the same terms and conditions, including price,
as FreeShop was then closing the sale of such securities to other investors.
Subsequent investments are to be made on the scheduled closing date of each
subsequent equity financing on the same terms and conditions, including price,
as FreeShop is then closing the sale of such securities to other investors. If
no equity investments are closed within nine months of the previous investment
by CNET, then one day after nine months CNET will make an equity investment
using the same terms and conditions as the previous investment made by CNET. No
investment was made by CNET during the year ended December 31, 1998.
The Company's office facilities are leased under operating leases that
provide for minimum rentals and require payment of property taxes and include
escalation clauses. In addition, the Company also rents certain equipment under
agreements treated for financial reporting purposes
F-13
<PAGE> 79
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
as capital leases. The Company's property under capital leases which is included
in property and equipment on the balance sheet at December 31, 1997 and 1998 was
$221,801 and $246,299, respectively, which is net of accumulated amortization of
$16,045 and $92,150, respectively.
Future minimum lease payments under the noncancellable leases are as
follows.
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEAR ENDING DECEMBER 31, LEASES LEASES
------------------------ --------- ----------
<S> <C> <C>
1999...................................................... $ 149,397 $ 289,105
2000...................................................... 120,798 403,730
2001...................................................... 42,969 426,648
2002...................................................... 448,397
2003...................................................... 192,055
--------- ----------
Total minimum lease payments................................ 313,164 $1,759,935
==========
Less: Amount representing interest.......................... (56,110)
---------
Present value of capital lease obligations.................. 257,054
Less: Current portion....................................... (112,327)
---------
Capital lease obligations, noncurrent portion............... $ 144,727
=========
</TABLE>
Rent expense for the years ended June 30, 1996 and 1997, the six months
ended December 31, 1997 and year ended December 31, 1998, was $42,468, $49,003,
$60,594 and $199,136, respectively.
10. SHAREHOLDERS' EQUITY
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
On June 30, 1997, the Company's Board of Directors approved the designation
and issuance of 1,935,484 shares of series A redeemable convertible preferred
stock. The preferred series A shares are convertible into one share of common
stock (subject to anti-dilution adjustments) at any time at the option of the
holder.
On July 18, 1997, subsequent to the spin-off of FreeShop from Online, all
outstanding shares of Series A redeemable convertible preferred stock were
converted into common stock at a rate of 2.5 shares of preferred to one share of
common.
COMMON STOCK
On December 10, 1998, FreeShop issued 1,619,387 shares of the Company's
common stock to Fingerhut Companies Inc. (Fingerhut) at a price of $2.47 per
share. The shares were partially paid for by surrender and cancellation of the
$500,000 Convertible Promissory Note, which the Company had issued to Fingerhut
on December 4, 1998.
The Company and Fingerhut also entered into a Stockholders Agreement on
December 10, 1998 which grants Fingerhut a right of first refusal on shares
proposed for transfer by the Company's two principal shareholders, contains
certain agreements regarding composition of the Company's Board of Directors,
requires Board approval of certain specified actions by the Company, grants
Fingerhut preemptive rights to maintain its percentage ownership interest in
connection with proposed share issuances by the Company, grants certain demand
and piggyback registration rights to Fingerhut, and provides for certain
drag-along and tag-along rights among the parties with respect to proposed sales
of shares to third parties. The Stockholders Agreement terminates on the
earliest of December 10, 2008, the closing of a sale of the Company's assets or
F-14
<PAGE> 80
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the acquisition of the Company by merger or consolidation. Certain specific
provisions of the agreement terminate upon the consummation of an underwritten
public offering of the Company's securities in which the deemed market
capitalization of the Company is at least $75 million.
WARRANTS
In connection with the sale of common stock to Fingerhut, the Company
issued to Fingerhut a series of warrants to purchase shares of the Company's
common stock as follows: a warrant to purchase 1,174,143 shares at $4.30 per
share; a warrant to purchase 716,290 shares at $4.99 per share; a warrant to
purchase 835,672 shares at $5.53 per share; warrants to purchase from time to
time at $5.53 per share a number of shares equal to specified percentages of
shares of common stock that are issued upon exercise of specified options and
warrants; and warrants to purchase at exercise prices ranging from $2.47 per
share to $5.53 per share a number of shares of common stock equal to specified
percentages of shares of common stock that are issued to certain named third
parties pursuant to existing contractual arrangements. Unless sooner exercised,
all such warrants expire on the earlier of December 31, 2000, or the
consummation of an underwritten public offering of the Company's securities in
which the deemed market capitalization of the Company is at least $75 million.
In connection with the equipment acquired under capital lease as described
in Note 9, the Company issued warrants to purchase 16,400 shares of common
stock. The warrants are exercisable at a price equal to $1.02 per share and
expire from October 2002 to January 2003. The Company determined the fair value
of the warrants to be $12,019 using the Black-Scholes option pricing model and
recognized the entire expense during 1998.
In return for recruiting services, the Company issued warrants to purchase
11,300 shares of common stock in January 1998. The warrants are exercisable at a
price equal to $1.02 per share and expire in January 2003. The Company
determined the fair value of these warrants to be $8,277 using the Black-Scholes
option pricing model and recognized the entire expense during 1998.
A warrant to purchase 10,000 shares of the Company's common stock at an
exercise price of $1.50 per share was issued to the bank in connection with the
line of credit described in Note 6. The warrant expires in September 2003. The
Company determined the fair value of the warrants to be $10,625 using the
Black-Scholes option pricing model. The fair value was recorded as prepaid loan
fees during 1998 and will be amortized over the life of the credit facility.
STOCK OPTIONS
Effective June 30, 1997, the Company approved the 1997 Stock Option Plan
(the Plan) to provide for the granting of stock options to employees, directors
and consultants of the Company to acquire ownership in the Company and provide
them with incentives for their service. Under the terms of the Plan, 1,064,306
shares of common stock have been reserved for issuance to plan participants.
The Plan is administered by the Board of Directors of the Company, which
determines the terms and conditions of the options granted, including exercise
price, number of options granted and the vesting period of such options. The
maximum term of options is ten years from the date of grant. The options are
generally granted at the estimated fair value of the underlying stock, as
determined by the Board of Directors, on the date of grant. As of December 31,
1998, options to purchase 249,286 shares of common stock were available for
future grant under the Plan. No
F-15
<PAGE> 81
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
compensation expense has been recognized relative to options issued to employees
for the years ended June 30, 1996 and 1997, the six months ended December 31,
1997, or the year ended December 31, 1998. For the year ended December 31, 1998,
$3,177 of deferred compensation was recorded and will be amortized over the
vesting period of the related options.
During the six-month period ended June 30, 1999 (unaudited), the Company
granted options to purchase 191,616 shares of common stock to employees and
service providers at an average exercise price of $3.15. Of those granted,
options to purchase 8,000 shares were forfeited. The Company recorded $1,275,320
of deferred compensation based upon the average deemed fair value of $6.95 which
will be amortized over the vesting period of the related options.
Had compensation expense for employee-related options been determined based
on the fair value at the grant dates consistent with the method of SFAS No. 123,
"Accounting for Stock Based Compensation," the Company's net loss and loss per
share for the six months ended December 31, 1997 and the year ended December 31,
1998 would have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Net loss
As reported.............................. $(1,148,874) $(3,199,025)
Pro forma................................ $(1,167,435) $(3,248,168)
Loss per share
As reported.............................. $ (0.22) $ (0.51)
Pro forma................................ $ (0.22) $ (0.52)
</TABLE>
For SFAS No. 123 pro forma disclosure, the fair value of each option is
estimated on the date of grant using the minimum value method with the following
assumptions used for grants to employees in 1998 and 1997; weighted-average
risk-free interest rates of 4.78% and 5.70%, respectively, and expected lives of
four years.
The following table presents activity under the Plan:
<TABLE>
<CAPTION>
JUNE 30, 1999
JUNE 30, 1997 DECEMBER 31, 1997 DECEMBER 31, 1998 (UNAUDITED)
------------------- --------------------- --------------------- -------------------
WEIGHTED- WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE
------- --------- --------- --------- --------- --------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
period...................... 528,536 $0.15 1,002,847 $0.56 815,021 $1.12
Granted....................... 528,536 $0.15 474,311 1.02 645,420 1.30 191,616 3.15
Exercised..................... 55,694 0.15 19,408 0.98
Forfeited..................... 777,552 0.60 33,940 2.09
------- --------- --------- ------- -----
Outstanding at end of
period...................... 528,536 $0.15 1,002,847 $0.56 815,021 $1.12 953,289 $1.50
======= ========= ========= =======
Weighted-average fair value of
options granted during the
period...................... $0.03 $0.30 $0.34 $6.95
</TABLE>
F-16
<PAGE> 82
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
under the Plan at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED-
NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED-
RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICES 1998 LIFE PRICE 1998 PRICE
- -------- -------------- ----------- --------- -------------- ---------
<S> <C> <C> <C> <C> <C>
$0.15 100,934 8.5 $0.15 50,460 $0.15
1.02 367,667 6.0 1.02 242,394 1.02
1.50 342,420 9.0 1.50 59,306 1.50
2.50 4,000 10.0 2.50 2.50
--------- -------
815,021 7.6 $1.12 352,160 $0.98
========= =======
</TABLE>
During the six months ended December 31, 1997, the Company granted options
to purchase 195,122 shares of common stock to certain investors. These grants
were made outside of the stock option plan. As of December 31, 1998, all of
these options had expired without exercise. During the year ended December 31,
1998, the Company granted options to purchase 209,000 shares of common stock to
consultants, advisors and investment managers and as severance to certain
employees.
The Company follows SFAS No. 123 in accounting for options and warrants
issued to non employees. As such, the Company recognized $62,968 of expense for
the six months ended December 31, 1997 in connection with options issued to
third parties. During the year ended December 31, 1998, the Company recognized
$67,150 of expense in connection with options issued to terminated employees and
advisors. The remaining fair value of options issued to advisors of $9,750 is
recorded as deferred compensation in the shareholders' equity section and will
be amortized over the remaining vesting period of the options. Additionally, in
connection with the sale of common stock, the Company issued options to certain
investment managers. The fair value of those options of $36,563 was netted
against the proceeds recorded in the transaction. In determining fair value of
the options and warrants on the date of grant, the Company used the
Black-Scholes option-pricing model with the following assumptions used for
grants in 1997 and 1998; no dividend yield; expected volatility of 100%;
weighted-average risk-free interest rates of 5.17% and 5.14%, respectively, and
weighted-average expected lives of .55 years and 1.3 years, respectively. The
weighted-average fair value of warrants issued during 1998 was $0.83 per share.
11. INCOME TAXES
A current provision for income taxes was not recorded for the six months
ended December 31, 1997 or the year ended December 31, 1998 due to taxable
losses incurred during such periods. A valuation allowance has been recorded for
deferred tax assets because realization is primarily dependent on generating
sufficient taxable income prior to the expiration of net operating loss
carry-forwards. Net operating losses of the FreeShop Division of Online did not
carry over to the Company.
F-17
<PAGE> 83
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets at December 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1998
--------- -----------
<S> <C> <C>
Net operating loss carryforwards............................ $ 371,326 $ 1,412,566
Nondeductible allowances.................................... 23,779 39,544
Expense related to stock options and restricted stock
rights.................................................... 21,416 30,635
Other....................................................... 2,176
--------- -----------
418,697 1,482,745
Less: Valuation allowance................................... (418,697) (1,482,745)
--------- -----------
$ -- $ --
========= ===========
</TABLE>
At December 31, 1997 and 1998, the Company had net operating loss
carry-forwards of approximately $1,092,000 and $4,155,000, respectively, for
federal income tax reporting purposes. The net operating losses will expire
beginning in 2012 if not previously utilized. As specified in Section 382 of the
Internal Revenue Code, a 50% or more ownership change by certain combinations of
the Company's shareholders during any three-year period would result in
limitations on the Company's ability to utilize its net operating loss
carry-forwards. Such an ownership change occurred as a result of the equity
issuances as described in Note 13. The limitation on the utilization of federal
net operating loss carryforwards in future years is not expected to be material.
12. SUPPLEMENTAL CASH FLOW INFORMATION
The following items are supplemental information of noncash investing and
financing activities:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS SIX MONTHS ENDED
JUNE 30, ENDED YEAR ENDED JUNE 30,
--------------- DECEMBER 31, DECEMBER 31, -----------------
1996 1997 1997 1998 1998 1999
------ ------ ------------ ------------ ------ --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Property and equipment acquired
with capital leases.......... $ -- $7,237 $237,846 $102,167 $ -- $ --
====== ====== ======== ======== ====== ========
Common stock issued in exchange
for note receivable from
shareholder.................. $ -- $ -- $ 25,000 $ -- $ -- $ --
====== ====== ======== ======== ====== ========
Common stock issued in
connection with business
combination.................. $ -- $ -- $ -- $ -- $ -- $736,000
====== ====== ======== ======== ====== ========
Conversion of preferred
stock........................ $ -- $ -- $279,196 $ -- $ -- $ --
====== ====== ======== ======== ====== ========
Conversion of note payable..... $ -- $ -- $ -- $ -- $ -- $ 50,000
====== ====== ======== ======== ====== ========
</TABLE>
13. SUBSEQUENT EVENTS
In January 1999, the Company repurchased 160,000 shares of common stock for
$2.50 per share. As described in Note 7 50,000 of these shares were repurchased
from a principal shareholder. The repurchase price of the common stock was less
than the $5.20 per share estimated fair value of the stock on the date of
repurchase. Concurrent with the repurchase, the Company retired the shares and
sold 160,000 shares to unrelated third parties for $2.50 per share.
F-18
<PAGE> 84
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
On March 1, 1999, the terms of the convertible promissory note described in
Note 8 were modified to allow conversion into shares of common stock. The note
was then retired through conversion into 20,000 shares of common stock.
In May 1999, the warrants issued to Fingerhut as described in Note 10 were
modified to provide for issuance of series B convertible preferred stock. Each
share of series B convertible preferred stock is convertible into four shares of
common stock. Each share of series B convertible preferred stock has similar
rights and obligations as four shares of common stock, except it has no voting
rights. Fingerhut then exercised one warrant to purchase 293,536 shares of
series B convertible preferred stock at a purchase price of $17.18 per share and
one warrant to purchase 179,072 shares of series B convertible preferred stock
at a purchase price of $19.94 per share on May 24, 1999 and June 18, 1999,
respectively.
In May 1999, the Board of Directors of the Company, authorized the
Company's management to file a registration statement for an initial public
offering of the Company's common stock.
In May 1999, FreeShop entered into purchase and sale agreements to acquire
substantially all of the assets of Commonsite LLC (Commonsite) and Travel
Companions International, Inc. (Travel). Total consideration for the acquired
assets of the two companies is $2,577,000, which is comprised of $1,841,000 in
cash and 52,920 shares of common stock. The aggregate purchase price will be
allocated to the net assets acquired, based upon their respective fair market
values. The excess of the purchase price over the fair market value of the
assets acquired and liabilities assumed of $1,382,247 has been allocated to cost
in excess of net assets acquired and will be amortized over three years.
In connection with the acquisition, liabilities were assumed as follows:
<TABLE>
<S> <C>
Fair value of assets acquired............................... $ 1,339,808
Cash paid................................................... (1,841,000)
Common stock issued......................................... (736,000)
Cost in excess of net assets acquired....................... 1,382,247
-----------
Liabilities assumed......................................... $ 145,055
===========
</TABLE>
The following summarizes the unaudited pro forma results of operations, on
a combined basis, as if the Company's acquisition of Commonsite and Travel
occurred as of the beginning of each of the periods presented, after including
the impact of certain adjustments such as amortization of cost in excess of net
assets acquired:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1998 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
Revenues.................................................... $ 1,893,267 $ 2,380,815
Pro forma net loss.......................................... (4,295,661) (4,091,812)
Pro forma basic and diluted net loss per share.............. $ (0.68) $ (0.50)
</TABLE>
The unaudited pro forma results are not necessarily indicative of the
results of operations which would actually have been reported had the
acquisition occurred prior to the beginning of the periods presented. In
addition, they are not intended to be indicative of future results.
On August 9, 1999, the Board of Directors declared a 1 for 2.5 reverse
stock split on the Company's common stock. Common stock issued, stock option,
warrant and convertible preferred stock information in these financial
statements have been restated to reflect this reverse split.
F-19
<PAGE> 85
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of FreeShop.com, Inc.
In our opinion, the accompanying statement of financial position and the
related statements of operations and members' deficit and of cash flows present
fairly, in all material respects, the financial position of Commonsite, LLC.
(the "Company") at December 31, 1998, and the results of its operations and its
cash flows for the year ended December 31, 1998, in conformity with generally
accepted accounting principles. 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 audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards
which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
As described in Note 6, subsequent to year-end, the members approved and
authorized the sale of substantially all of the Company's assets.
PricewaterhouseCoopers LLP
Seattle, Washington
May 6, 1999
F-20
<PAGE> 86
COMMONSITE, LLC
STATEMENT OF FINANCIAL POSITION
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash........................................................ $ 12,811 $ 23,652
Accounts receivable, net.................................... 42,358 29,151
-------- --------
Total current assets................................... 55,169 52,803
Property and equipment, net................................. 9,728 8,097
-------- --------
Total assets........................................... $ 64,897 $ 60,900
======== ========
LIABILITIES AND MEMBERS' DEFICIT
Accounts payable............................................ $ 6,536 $ 567
Related party payable....................................... 16,245 11,946
Accrued liabilities......................................... 6,609 6,046
Deferred revenue............................................ 109,337 120,422
-------- --------
Total current liabilities.............................. 138,727 138,981
-------- --------
Members' deficit............................................ (73,830) (78,081)
-------- --------
Total liabilities and members' deficit................. $ 64,897 $ 60,900
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE> 87
COMMONSITE, LLC
STATEMENT OF OPERATIONS AND MEMBERS' DEFICIT
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
DECEMBER 31, ----------------------
1998 1998 1999
------------ --------- ---------
(UNAUDITED)
<S> <C> <C> <C>
Revenues............................................ $540,114 $ 106,053 $ 106,435
Cost of revenues.................................... 180,244 47,289 21,492
-------- --------- ---------
Gross profit........................................ 359,870 58,764 84,943
-------- --------- ---------
Operating expenses
Sales and marketing............................... 276,378 73,887 36,463
General and administrative........................ 72,290 30,446 52,731
-------- --------- ---------
Total operating expenses.................. 348,668 104,333 89,194
-------- --------- ---------
Net income.......................................... 11,202 (45,569) (4,251)
Members' deficit, end of period..................... (85,032) (85,032) (73,830)
-------- --------- ---------
Members' deficit, beginning of period............... $(73,830) $(130,601) $ (78,081)
======== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE> 88
COMMONSITE, LLC
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
DECEMBER 31, ------------------
1998 1998 1999
------------ -------- -------
(UNAUDITED)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................... $ 11,202 $(45,569) $(4,251)
Adjustments to reconcile net income to net cash used in
operating activities
Depreciation.......................................... 6,525 1,631 1,631
Bad debt expense...................................... 9,999 1,150 1,422
(Increase) decrease in accounts receivable............ (35,846) (18,098) 11,785
Decrease in accounts payable.......................... (9,005) (5,572) (5,969)
Increase (decrease) in related party payable.......... 16,245 12,803 (4,299)
Decrease in accrued liabilities....................... (6,449) (440) (563)
Increase in unearned revenue.......................... 2,272 56,665 11,085
-------- -------- -------
Net cash (used in) provided by operating
activities..................................... (5,057) 2,570 10,841
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from member contributions....................... 5,000
-------- -------- -------
Net cash provided by financing activities........ 5,000 -- --
-------- -------- -------
Net (decrease) increase in cash and cash equivalents....... (57) 2,570 10,841
Cash and cash equivalents, beginning of period............. 12,868 12,868 12,811
-------- -------- -------
Cash and cash equivalents, end of period................... $ 12,811 $ 15,438 $23,652
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE> 89
COMMONSITE, LLC
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Commonsite, LLC ("Commonsite" or "the Company") is a limited liability
company in which there are seven limited partners. The Company was formed in
September 1995 to develop and operate a shopping portal focusing on catalog
companies. Essentially, the Company provides catalog companies with consumer
requests for their catalogs. In addition, the Company provides catalog companies
with the development and hosting of online stores, links directly to their
existing Web sites and a software solution for tracking online sales back to the
traffic source.
Profits and losses of the Company are allocated based upon the ownership
percentages of the members.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments purchased within 90
days or less of maturity. They are recorded at cost which approximates fair
value. The Company deposits its cash and cash equivalents with high credit
quality financial institutions. The Company has not experienced any losses on
its cash and cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment, consisting of computer hardware and software, are
stated at cost less accumulated depreciation and are depreciated using the
straight-line method over their estimated useful lives of three years. The cost
of normal maintenance and repairs are charged to expense as incurred.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates its long-lived assets for financial impairment and
continues to evaluate them as events or changes in circumstances indicate that
the carrying amount of such assets may not be fully recoverable. The Company
evaluates the recoverability of long-lived assets by measuring the carrying
amount of the assets against the estimated undiscounted future cash flows
associated with these assets. At the time such evaluations indicate that the
future undiscounted cash flows of certain long-lived assets are not sufficient
to recover the carrying value of such assets, the assets are adjusted to their
fair values. No losses from impairment have been recognized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable and accrued
liabilities, approximate fair value because of their short maturities.
DEFERRED REVENUE
Deferred revenue consists of advance billings and payments on marketing
contracts.
REVENUE RECOGNITION
Revenue is recognized based on the type of contract. Fixed fee contracts,
which range from three months to one year, are recognized ratably over the term
of the agreement, provided that no significant Company obligations remain.
Revenue from click through based contracts is
F-24
<PAGE> 90
COMMONSITE, LLC
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
recognized in the period in which the click throughs are delivered. Revenue from
catalog development is recognized under the percentage of completion method,
whereby revenue is recognized upon completion of agreed upon milestones.
CONCENTRATIONS OF CREDIT RISK
Concentrations of credit risk with respect to accounts receivable are
limited due to the wide variety of customers to which the Company provides
services, as well as their dispersion across many different geographic areas. As
such, no single customer accounted for greater than 10% of total revenues or
accounts receivable balances for the year ended December 31, 1998. The Company
maintains an allowance for doubtful accounts receivable based upon its
historical experience and the expected collectibility of all accounts
receivable. Credit losses to date have been within management's estimates.
INCOME TAXES
The Company is not subject to federal income tax. The pro rata income or
loss is included in the tax returns of the individual members.
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 reporting amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses. Actual results
could differ from those estimates.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The interim financial data as of March 31, 1999 and for the three months
ended March 31, 1998 and 1999 is unaudited; however, in the opinion of
management, the interim data includes all adjustments, consisting only of normal
recurring adjustments necessary to present fairly the Company's financial
position as of March 31, 1999 and the results of its operations and cash flows
for the three months ended March 31, 1998 and 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective
for financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance on accounting for computer software developed for internal
use, including the requirement to capitalize specified costs and amortization of
such costs. The Company does not expect the adoption of this standard to have a
material effect on its results of operations, financial position or cash flows.
In April 1998, the AICPA issued 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. As the Company has expensed
these costs historically, the adoption of this standard is not expected to have
a significant impact on its results of operations, financial position or cash
flows.
F-25
<PAGE> 91
COMMONSITE, LLC
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company does not expect the adoption of this
statement to have a significant impact on its results of operations, financial
position or cash flows.
3. RELATED PARTY TRANSACTIONS
The Company pays Bennett Company (Bennett) for services provided in
relation to the operations and management of the Company. A member of Commonsite
owns Bennett. Costs incurred by Bennett were billed to the Company based on an
estimate of Bennett personnel time dedicated to the operations and management of
Commonsite. A summary of these expenses is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
YEAR ENDED -------------------
DECEMBER 31, 1998 1998 1999
----------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Salaries.................................... $230,979 $73,123 $34,574
Equipment................................... 16,236 6,287 9,146
Connectivity................................ 22,957 5,136 4,487
Rent........................................ 12,637 2,575 3,475
Internet marketing.......................... 26,134 6,970 --
Other....................................... 5,848 1,234 841
-------- ------- -------
$314,791 95,325 52,523
======== ======= =======
</TABLE>
4. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
Accounts receivable................................... $ 66,866 $ 55,081
Less: Allowance for doubtful accounts................. (24,508) (25,930)
-------- --------
$ 42,358 $ 29,151
======== ========
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
Computer hardware and software........................ $19,578 $ 19,578
Less: Accumulated depreciation........................ (9,850) (11,481)
------- --------
$ 9,728 $ 8,097
======= ========
</TABLE>
F-26
<PAGE> 92
COMMONSITE, LLC
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. SUBSEQUENT EVENT
In May 1999, Commonsite entered into a purchase and sale agreement to sell
substantially all of its assets to FreeShop.com, Inc. Total consideration for
the assets is approximately $1,200,000 which is comprised of $441,000 in cash
and 52,920 shares of common stock.
F-27
<PAGE> 93
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of FreeShop.com, Inc.
In our opinion, the accompanying balance sheet and the related statements
of income, stockholders' equity and cash flows present fairly, in all material
respects, the financial position of Travel Companions International, Inc. (the
Company) at December 31, 1998, in conformity with generally accepted accounting
principles. 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 audit. We conducted our audit of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for the opinion expressed
above.
As described in Note 6, subsequent to year-end, the stockholders of the
Company approved and authorized the sale of substantially all of the Company's
assets.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
May 24, 1999
F-28
<PAGE> 94
TRAVEL COMPANIONS INTERNATIONAL, INC.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 5,091 $ 3,545
Accounts receivable....................................... 8,772 34,225
Prepaid expenses.......................................... 700 820
--------- ---------
Total current assets................................... 14,563 38,590
Property and equipment, net................................. 3,050 2,265
--------- ---------
Total assets........................................... $ 17,613 $ 40,855
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Liabilities:
Current liabilities:
Debt................................................... $ 52,603 $ 51,668
Accounts payable....................................... 4,600 4,600
Accrued expenses....................................... 3,038 3,296
Deferred revenue....................................... 11,299 24,956
--------- ---------
Total current liabilities.............................. 71,540 84,520
Notes payable to stockholders............................. 459,678 454,678
--------- ---------
Total liabilities...................................... 531,218 539,198
--------- ---------
Stockholders' deficit:
Common stock, no par value; 5,000 shares authorized, 5,000
shares issued and outstanding.......................... 5,000 5,000
Accumulated deficit....................................... (518,605) (503,343)
--------- ---------
Total stockholders' deficit............................ (513,605) (498,343)
--------- ---------
Total liabilities and stockholders' deficit............ $ 17,613 $ 40,855
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-29
<PAGE> 95
TRAVEL COMPANIONS INTERNATIONAL, INC.
STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------ ------------------
1998 1998 1999
------------ ------- -------
(UNAUDITED)
<S> <C> <C> <C>
Revenues................................................ $219,813 $58,380 $72,188
Cost of revenues........................................ 94,875 23,570 25,866
-------- ------- -------
124,938 34,810 46,322
-------- ------- -------
Operating expenses:
Sales and marketing................................... 9,393 3,324 1,950
General and administrative............................ 92,645 27,876 28,000
-------- ------- -------
Total operating expenses........................... 102,038 31,200 29,950
-------- ------- -------
Operating income........................................ 22,900 3,610 16,372
Interest expense........................................ 4,287 1,147 1,110
-------- ------- -------
Net income.............................................. $ 18,613 $ 2,463 $15,262
======== ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-30
<PAGE> 96
TRAVEL COMPANIONS INTERNATIONAL, INC.
STATEMENT OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
COMMON
STOCK ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
------ ------ ----------- ---------
<S> <C> <C> <C> <C>
Balances, December 31, 1997................. 5,000 $5,000 $(537,218) $(532,218)
Net income.................................. 18,613 18,613
----- ------ --------- ---------
Balances, December 31, 1998................. 5,000 $5,000 $(518,605) $(513,605)
===== ====== ========= =========
Net income (unaudited)...................... 15,262 15,262
----- ------ --------- ---------
Balance, March 31, 1999 (unaudited)......... 5,000 $5,000 $(503,343) $(498,343)
===== ====== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-31
<PAGE> 97
TRAVEL COMPANIONS INTERNATIONAL, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED MARCH 31,
DECEMBER 31, ------------------
1998 1998 1999
------------ ------- --------
(UNAUDITED)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 18,613 $ 2,463 $ 15,262
Adjustments to reconcile net income to net cash provided
by operations:
Depreciation and amortization......................... 2,790 424 785
Changes in assets and liabilities:
Accounts receivable................................. 4,159 (25,453)
Prepaid expenses.................................... 78 28 (120)
Inventory........................................... 300 (74)
Deferred revenue.................................... (40) (40) 13,657
Accrued and other liabilities....................... 1,230 693 258
-------- ------- --------
Net cash provided by operating activities........ 27,130 3,494 4,389
-------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment...................... (1,139) -- --
-------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments of debt............................... (3,209) (935)
Principal payments of notes payable to stockholders...... (19,700) (1,304) (5,000)
-------- ------- --------
Net cash used in financing activities............ (22,909) (1,304) (5,935)
-------- ------- --------
Net increase (decrease) in cash............................ 3,082 2,190 (1,546)
Cash at beginning of period................................ 2,009 2,009 5,091
-------- ------- --------
Cash at end of period...................................... $ 5,091 $ 4,199 $ 3,545
======== ======= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.............................................. $ 4,323 $ 1,250 $ 1,121
Significant non-cash financing activities:
Refinancing of accrued interest to debt............... 5,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-32
<PAGE> 98
TRAVEL COMPANIONS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS DESCRIPTION
Travel Companions International, Inc. (the Company), an S Corporation, was
incorporated in the State of Minnesota in October 1988. The Company is in the
business of distributing travel literature in conjunction with various travel
programs offered through American Express for its cardholders, as well as
programs implemented by Norvista, the global group of travel agencies and tour
operators belonging to the Finnair Group. The Company also publishes Worldwide
Brochures, a listing of over 15,000 free travel maps, guides, and brochures from
over 10,000 companies.
USE OF ESTIMATES
The preparation of the Company's 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 revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
are determined using the straight-line method over the estimated useful lives of
the assets of three to seven years. The cost and related accumulated
depreciation or amortization on asset disposals are removed from the accounts
and any gain or loss thereon is included in operations in the year of disposal.
Maintenance, repairs and minor renewals are charged to expense as incurred,
while additions and betterments are capitalized.
REVENUE RECOGNITION
Literature distribution revenue, which comprises over 80% of total revenue,
consists of fees received for delivery of travel literature to both American
Express cardholders and Norvista customers. Revenue is recognized in the period
the literature is sent to the customer.
Advertising revenue consists of banner advertising and priority listings
placed on the Company's Web site. Both banner advertising and priority listing
revenue are derived from fixed fee contracts, with no guaranteed number of
impressions. Fixed fee contracts are recognized ratably over the term of the
agreement, provided that no significant Company obligations remain. Deferred
revenue consists of payments received from customers for future advertising
services to be performed by the Company under contract.
CONCENTRATIONS OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments that potentially subject the Company to credit risk
consist primarily of accounts receivable. The Company grants credit to customers
in the ordinary course of business. Two customers accounted for approximately
59% and 21% of total revenues during 1998.
F-33
<PAGE> 99
TRAVEL COMPANIONS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Receivables from these same two customers accounted for approximately 68% and
32% of total receivables at December 31, 1998, respectively.
INCOME TAXES
The Company has elected to be taxed as an S corporation under the
provisions of the Internal Revenue Code (the Code) and comparable state income
tax law. Under those provisions, the Company's income is reported on the
individual tax returns of the Company's stockholders. As such, the Company is
generally not subject to corporate income taxes. Therefore, no provision or
liability for income taxes is reflected in the financial statements of the
Company.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The interim financial data as of March 31, 1999 and for the three months
ended March 31, 1998 and 1999 is unaudited; however, in the opinion of
management, the interim data includes all adjustments, consisting only of normal
recurring adjustments necessary to present fairly the Company's financial
position as of March 31, 1999 and the results of its operations and cash flows
for the three months ended March 31, 1998 and 1999.
2. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
Property and equipment:
Computer equipment........................................ $23,488 $ 23,488
Furniture and office equipment............................ 23,881 23,881
Leasehold improvements.................................... 878 878
------- -----------
48,247 48,247
Less accumulated depreciation and amortization.............. 45,197 45,982
------- -----------
$ 3,050 $ 2,265
======= ===========
</TABLE>
3. BORROWING ARRANGEMENTS
DEBT
The Company has a note with a local development authority. The loan bears
simple interest at a rate of 8.5% and calls for monthly principal and interest
payments of $682 per month for five years with the remaining principal and
accrued interest due in April 2003. As of December 31, 1998, the balance
outstanding under this loan agreement was $52,603. The outstanding balance has
been classified as current in accordance with the terms of the agreement due to
the pending acquisition of the majority of the Company's assets as described in
Note 6. In the event that the acquisition is not consummated, approximately
$48,700 of the outstanding debt balance would be reclassified to long-term.
Borrowings outstanding under the agreement are collateralized by all
inventory and equipment of the Company and are personally guaranteed by the
stockholders. In addition, the borrowings are collateralized by the proceeds
from life insurance policies maintained by the Company on all of its
stockholders, with a face value of $300,000.
F-34
<PAGE> 100
TRAVEL COMPANIONS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTES PAYABLE TO STOCKHOLDERS
The Company has entered into subordinated note agreements with its
stockholders. The amounts outstanding under the note agreements totaled $459,678
and $454,678 as of December 31, 1998 and March 31, 1999 (unaudited),
respectively. These amounts do not bear interest and are due on demand
subsequent to May 31, 2000.
4. RELATED PARTY TRANSACTIONS
The Company leases office space on a month-to-month basis from one of its
stockholders. The Company recognized $18,000 of rent expense related to this
arrangement during the year ended December 31, 1998 and $4,500 during the three
months ended March 31, 1999 (unaudited).
5. RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 is effective
for financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance on accounting for computer software developed for internal
use, including the requirement to capitalize specified costs and amortization of
such costs.
The Company does not expect the adoption of this standard to have a
material effect on the results of its operations, financial position or cash
flows.
6. SUBSEQUENT EVENTS
In May 1999, the Company entered into an asset purchase agreement to sell
substantially all of its assets to FreeShop.com, Inc. for a purchase price of
$1,400,000 in cash.
F-35
<PAGE> 101
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
In May 1999, FreeShop.com, Inc. (FreeShop) entered into purchase and sale
agreements to acquire substantially all of the assets of Commonsite, LLC
(Commonsite) and Travel Companions International, Inc. (Travel). Total
consideration for the two companies is $2,576,000, which is comprised of
$1,841,000 in cash and 52,920 shares of common stock. The unaudited pro forma
combined statements of operations are based on individual historical results of
operations of FreeShop, Commonsite and Travel for the year ended December 31,
1998 and for the six months ended June 30, 1999, after giving effect to the
acquisitions of Commonsite and Travel as if they had occurred on January 1,
1998. In addition, the pro forma weighted-average shares used in calculating pro
forma net loss per share include the effects of the automatic conversion of
FreeShop's series B convertible preferred stock into shares of FreeShop's common
stock effective upon the closing of FreeShop's initial public offering as if
such conversion occurred on the date the shares were originally issued.
The unaudited pro forma combined financial statements should be read in
conjunction with the historical financial statements and notes thereto of
FreeShop, Commonsite and Travel. The unaudited pro forma combined financial
statements are presented for illustrative purposes only and are not necessarily
indicative of results of operations that would have actually occurred had the
acquisitions of Commonsite and Travel been effected on the date assumed.
F-36
<PAGE> 102
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
--------------------------------------------------------------------------------
PRO FORMA
FREESHOP COMMONSITE TRAVEL COMBINED ADJUSTMENTS PRO FORMA
----------- ---------- -------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net revenues.................... $ 1,250,940 $540,114 $219,813 $ 2,010,867 $ (117,600)(3) $ 1,893,267
Cost of revenues................ 216,557 180,244 61,872 458,673 (20,547)(4) 438,126
----------- -------- -------- ----------- ----------- -----------
Gross profit.................... 1,034,383 359,870 157,941 1,552,194 (97,053) 1,455,141
Operating expenses
Sales and marketing........... 3,088,446 276,378 9,393 3,374,217 (105,000)(4) 3,269,217
Research and development...... 386,629 386,629 386,629
General and administrative.... 416,766 65,765 122,858 605,389 605,389
Equity-based compensation..... 174,102 174,102 174,102
Depreciation and
amortization................ 104,393 6,525 2,790 113,708 1,141,000(2) 1,252,393
(2,315)(6)
----------- -------- -------- ----------- ----------- -----------
Total operating expenses........ 4,170,336 348,668 135,041 4,654,045 1,033,685 5,687,730
----------- -------- -------- ----------- ----------- -----------
Loss from operations............ (3,135,953) 11,202 22,900 (3,101,851) (1,130,738) (4,232,589)
Interest expense................ 65,654 65,654 65,654
Other (income) expense.......... (2,582) 4,287 1,705 (4,287)(5) (2,582)
----------- -------- -------- ----------- ----------- -----------
Net (loss) income............... $(3,199,025) $ 11,202 $ 18,613 $(3,169,210) $(1,126,451) $(4,295,661)
=========== ======== ======== =========== =========== ===========
Basic and diluted net loss per
share......................... $ (0.51) $ (0.68)
=========== ===========
Weighted-average shares used in
computing net loss per
share......................... 6,223,726 52,920(1) 6,276,646(7)
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999
--------------------------------------------------------------------------------
PRO FORMA
FREESHOP COMMONSITE TRAVEL COMBINED ADJUSTMENTS PRO FORMA
----------- ---------- -------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net revenues.................... $ 2,146,662 $146,345 $ 87,808 $ 2,380,815 $ 2,380,815
Cost of revenues................ 189,898 25,689 30,241 245,828 245,828
----------- -------- -------- ----------- -----------
Gross profit.................... 1,956,764 120,656 57,567 2,134,987 2,134,987
Operating expenses
Sales and marketing........... 4,141,323 53,084 2,675 4,197,082 4,197,082
Research and development...... 321,517 321,517 321,517
General and administrative.... 462,060 73,476 62,260 597,796 597,796
Equity-based compensation..... 621,756 621,756 621,756
Depreciation and
amortization................ 259,911 652 240 260,803 $ 292,014(2) 552,149
(668)(6)
----------- -------- -------- ----------- ----------- -----------
Total operating expenses........ 5,806,567 127,212 65,175 5,998,954 291,346 6,290,300
----------- -------- -------- ----------- ----------- -----------
Loss from operations............ (3,849,803) (6,556) (7,608) (3,863,967) (291,346) (4,155,313)
Interest expense................ 23,492 1,155 24,647 (1,155)(5) 23,492
Other (income) expense.......... (86,992) (86,992) (86,992)
----------- -------- -------- ----------- ----------- -----------
Net loss........................ $(3,786,303) $ (6,556) $ (8,763) $(3,801,622) $ (290,191) $(4,091,813)
=========== ======== ======== =========== =========== ===========
Basic and diluted net loss per
share......................... $ (0.46) $ (0.46)
=========== ===========
Weighted-average shares used in
computing net loss per
share......................... 8,182,728 675,003(1) 8,857,731(7)
</TABLE>
F-37
<PAGE> 103
NOTES TO UNAUDITED PRO FORMA
COMBINED FINANCIAL STATEMENTS
1. Reflects the issuance of 52,920 shares of FreeShop common stock in
connection with the Commonsite acquisition.
2. Reflects the amortization of the client lists, customer lists, data base
content, covenants not to compete and goodwill acquired in their business
combinations, which are being amortized over one, two, five, two and three
years, respectively.
3. Represents the revenue stream generated by Commonsite for online catalog
development. Online catalog development services will not be provided by
FreeShop, and no assets related to this service are included in the
acquisition.
4. Represents additional programming and management service fees of Commonsite
that FreeShop would not have required due to the similarity in business
operations.
5. Represents elimination of interest expense for debt not assumed in the
acquisitions.
6. Represents elimination of depreciation expense related to property and
equipment not purchased in the Commonsite acquisition, offset by the
additional depreciation expense recorded for the increase in the value of
the property and equipment acquired in the Travel acquisition.
7. Basic and diluted net loss per share is computed using the weighted-average
number of shares of common stock outstanding after the issuance of FreeShop
common stock in connection with the Commonsite acquisition, including the
pro forma effects of the automatic conversion of the Company's series B
convertible preferred stock into shares of the Company's common stock
effective upon the closing of FreeShop's initial public offering as if such
conversion occurred on the date the shares were originally issued.
F-38
<PAGE> 104
[ON INSIDE BACK COVER]
[The FreeShop logo is centered on the page with the phrase "PUTTING CONSUMERS IN
CONTROL OF THE DIRECT MARKETING PROCESS."]
<PAGE> 105
YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS
PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR SALE OF COMMON STOCK
MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE DATE OF
THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN
OFFER TO BUY THESE SHARES OF COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH THE
OFFER OR SOLICITATION IS UNLAWFUL.
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Summary....................... 3
Risk Factors............................. 8
Forward-Looking Statements............... 17
Use of Proceeds.......................... 18
Dividend Policy.......................... 18
Capitalization........................... 19
Dilution................................. 20
Selected Unaudited Pro Forma Financial
Data................................... 21
Selected Actual Financial Data........... 22
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................. 23
Business................................. 34
Management............................... 45
Related-Party Transactions............... 52
Principal Shareholders................... 55
Description of Capital Stock............. 57
Shares Eligible for Future Sale.......... 60
Underwriting............................. 62
Legal Matters............................ 64
Experts.................................. 64
Where You Can Find More Information...... 65
Index to Financial Statements............ F-1
</TABLE>
DEALER PROSPECTUS DELIVERY OBLIGATION:
UNTIL OCTOBER 22, 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
THAT BUY, SELL OR TRADE THESE SHARES OF COMMON STOCK, 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.
FREESHOP LOGO
3,200,000 SHARES
COMMON STOCK
DEUTSCHE BANC ALEX. BROWN
DAIN RAUSCHER WESSELS
a division of Dain Rauscher Incorporated
VOLPE BROWN WHELAN
& COMPANY
E*OFFERING
Prospectus
September 27, 1999
