<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------------------
Amendment No. 1
to
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _______________.
Commission file number 000-27065
FREESHOP.COM, INC.
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1809146
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
95 SOUTH JACKSON STREET
SUITE 300
SEATTLE, WASHINGTON 98104
(Address of principal executive offices)
(206) 441-9100
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ ] No [X]
The number of outstanding shares of common stock, no par value, of the
Registrant at November 1, 1999 was 15,466,170.
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<PAGE> 2
FREESHOP.COM, INC.
INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
Balance sheet as of December 31, 1998 and September 30, 1999
(unaudited with respect to September 30, 1999)............................ 3
Unaudited Statement of Operations for the three months and nine
months ended September 30, 1998 and 1999.................................. 4
Unaudited Condensed Statement of Cash Flows for the nine months ended
September 30, 1998 and 1999 .............................................. 5
Notes to Unaudited Financial Statements................................... 6
ITEM 2. Management's Discussion and Analysis of FINANCIAL
CONDITION AND Results of Operations....................................... 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK................ 13
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings ....................................................... 13
ITEM 2. Changes in Securities AND USE OF PROCEEDS................................ 13
ITEM 3. Defaults Upon Senior Securities ......................................... 14
ITEM 4. Submission of Matters to a Vote of Security Holders...................... 14
ITEM 5. Other Information........................................................ 14
ITEM 6. Exhibits and Reports on Form 8-K......................................... 14
SIGNATURES ......................................................................... 14
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FREESHOP.COM, INC.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------ ------------
1998 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 2,892,144 $ 1,528,558
Stock subscription receivable 35,712,000
Accounts receivable, net 339,179 2,054,857
Prepaid expenses and other assets 30,497 70,264
Restricted short-term investments 50,000
------------ ------------
Total current assets 3,261,820 39,415,079
Fixed assets, net 381,296 1,235,947
Intangible assets, net 2,209,670
Deposits 43,454 43,454
------------ ------------
424,750 3,489,071
------------ ------------
$ 3,686,570 $ 42,904,750
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 464,872 $ 1,085,011
Accrued and other liabilities 670,857 1,697,608
Unearned revenue 76,824
Current portion of capital leases obligations 112,327 121,126
------------ ------------
Total current liabilities 1,248,056 2,980,569
------------ ------------
Long-term convertible debt 50,000
Capital lease obligations, net of current portion 144,727 53,565
Shareholders' equity
Series B convertible preferred stock, no par value;
no shares authorized, issued or outstanding at
December 31, 1998 and 1,250,000 shares authorized,
472,608 issued and outstanding at September 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, 1998 and 12,154,302
issued and 11,474,302 outstanding at September 30,
1999 (unaudited) 7,816,328 43,678,547
Additional paid-in capital 294,529 2,589,749
Deferred stock compensation (12,927) (1,458,010)
Accumulated deficit (5,854,143) (13,554,795)
------------ ------------
Total shareholders' equity 2,243,787 39,870,616
------------ ------------
$ 3,686,570 $ 42,904,750
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 4
FREESHOP.COM, INC.
STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
(as revised) (as revised)
Net revenues $ 320,902 $ 2,386,198 $ 749,904 $ 4,449,527
Cost of revenues 64,801 148,969 140,432 338,867
------------ ------------ ------------ ------------
Gross profit 256,101 2,237,229 609,472 4,110,660
------------ ------------ ------------ ------------
Operating expenses
Sales and marketing 980,549 4,640,257 2,010,388 8,781,580
Research and development 86,173 254,609 280,242 576,126
General and administrative 94,152 309,695 265,972 771,755
Equity-based compensation 39,000 234,522 161,696 856,278
Depreciation and amortization 25,986 366,416 74,797 626,327
------------ ------------ ------------ ------------
Total operating expenses 1,225,860 5,805,499 2,793,095 11,612,066
------------ ------------ ------------ ------------
Operating loss (969,759) (3,568,270) (2,183,623) (7,501,406)
Interest expense 15,837 8,718 44,294 32,210
Other expense (income) 6,409 (69,472) 7,170 (156,464)
------------ ------------ ------------ ------------
Loss before income tax expense (992,005) (3,507,516) (2,235,087) (7,377,152)
Income tax expense
------------ ------------ ------------ ------------
Net loss $ (992,005) $ (3,507,516) $ (2,235,087) $ (7,377,152)
============ ============ ============ ============
Basic and diluted net loss per
share $ (0.16) $ (0.42) $ (0.37) $ (0.90)
============ ============ ============ ============
Weighted-average shares used in
computing net loss per share 6,367,117 8,350,017 6,005,659 8,239,115
============ ============ ============ ============
Pro-forma basic and diluted net
loss per share $ (0.16) $ (0.34) $ (0.37) $ (0.79)
============ ============ ============ ============
Pro-forma weighted-average
shares used in computing net
loss per share 6,367,117 10,240,449 6,005,659 9,299,483
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 5
FREESHOP.COM, INC.
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
1998 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(2,235,087) $(7,377,152)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation and amortization 100,717 669,417
Bad debt expense 40,118 125,988
Amortization of deferred compensation 77,696 450,278
Shares sold to an employee by a principle
shareholder 406,000
Shares transferred to employees by principle
shareholders 84,000
Loss (gain) on disposal of property and equipment 8,622 (9,959)
Amortization of discount on short-term investments (14,400)
Changes in assets and liabilities, net of
impact of acquisitions:
Accounts receivable (52,842) (1,805,151)
Prepaid expenses and other assets 8,092 (45,907)
Accounts payable 89,665 164,164
Accrued and other liabilities 699,509 499,069
Unearned revenue 76,824
Payable to Online Interactive, Inc. (27,269)
----------- -----------
Net cash used in operating activities (1,206,779) (6,860,829)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (18,767) (1,042,532)
Payment for business combinations, net of cash acquired (1,666,440)
Purchase of short-term investments (1,535,600)
Sale of short-term investments 1,500,000
----------- -----------
Net cash used in investing activities (18,767) (2,744,572)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable 135,000
Repayment of notes payable (85,000)
Principle payments under capital leases (34,211) (82,363)
Proceeds from shareholder note receivable 25,000
Repurchase of common stock (400,000)
Issuance of common stock, net of issuance costs 1,175,943 109,053
Issuance of series B preferred stock 8,615,125
----------- -----------
Net cash provided by financing activities 1,216,732 8,241,815
----------- -----------
Net decrease in cash and cash equivalents (8,814) (1,363,586)
Cash and cash equivalents at beginning of period 26,329 2,892,144
----------- -----------
Cash and cash equivalents at end of period $ 17,515 $ 1,528,558
=========== ===========
Cash paid during the period for interest $ 44,294 $ 32,210
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> 6
FREESHOP.COM, INC.
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim condensed financial statements are unaudited and have been
prepared on the same basis as the annual financial statements. 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
September 30, 1999, results of operations for the three and nine months
ended September 30, 1998 and 1999 and cash flows for the nine months
ended September 30, 1998 and 1999.
The Company has revised its previously reported net revenues, net loss
and net loss per share for the second and third quarters of 1999
follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
------------------------------------- ------------------
June 30, 1999 September 30, 1999 September 30, 1999
<S> <C> <C> <C>
Originally reported
Net revenues 1,480,083 2,636,197 4,782,859
Net loss (2,420,225) (3,257,517) (7,043,820)
Basic and diluted net loss per share $(0.29) $(0.39) $ (0.85)
As Revised
Net revenues $1,396,750 $2,386,198 $4,449,527
Net loss (2,503,558) $(3,507,516) $(7,377,152)
Basic and diluted net loss per share $(0.30) $(0.42) $(0.90)
</TABLE>
The unaudited financial statements should be read in conjunction with
the Company's audited financial statements and the notes thereto
included in the Company's Registration Statement on Form S-1 filed with
the Securities and Exchange Commission on June 21, 1999, as amended, and
its periodic filings with the Securities and Exchange Commission
thereafter. The results of operations for the three and nine months
ended September 30, 1999 are not necessarily indicative of the results
to be expected for any subsequent quarter or the entire year ending
December 31, 1999.
2. SHAREHOLDERS' EQUITY
On October 1, 1999 the Company closed its initial public offering of
3,200,000 shares of the Company's common stock at $12.00 per share.
Total proceeds, net of offering costs of $2,688,000, were $35,712,000.
In addition, on October 29, 1999, the Company sold an additional 480,000
shares under the underwriters' overallotment option. During the nine
months ended September 30, 1999 the Company issued 472,608 shares of
series B convertible preferred stock for $8,615,125. Concurrent with the
closing of the initial public offering, Fingerhut exercised their
remaining rights to purchase 405,359 additional shares of series B
convertible preferred stock for $8,879,404. Upon the closing of the
initial public offering all of the Company's series B convertible
preferred stock converted into 3,511,868 shares of common stock.
3. BASIC AND DILUTED NET LOSS PER SHARE
Basic net loss per share represents net loss attributable to common
shareholders divided by the weighted-average number of shares
outstanding during the period. Diluted net loss per share represents net
loss attributable 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.
Pro-forma net loss per share is computed using the weighted-average
number of common shares outstanding and the effects of the automatic
conversion of the Company's series B convertible preferred stock,
outstanding at September 30, 1999, 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.
<PAGE> 7
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>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Numerator:
Net loss $ (992,005) $ (3,507,516) $ (2,235,087) $ (7,377,152)
============ ============ ============ ============
Denominator:
Weighted average shares used in
computing net loss per share 6,367,117 8,350,017 6,005,659 8,239,115
============ ============
Weighted average effect of other
securities:
Series B convertible preferred
stock 1,890,432 1,060,368
------------ ------------
Weighted average shares
outstanding used in computing
pro-forma net loss per share 10,240,449 9,299,483
============ ============
Pro-forma basic and diluted net
loss per share $ (0.34) $ (0.79)
============ ============
</TABLE>
<PAGE> 8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company contains forward-looking statements within the meaning
of section 27A of the Securities Act of 1933 and section 21E of the Securities
Exchange Act of 1934. The Company's actual results and the timing of certain
events could differ materially from those anticipated in these forward-looking
statements as a result of certain factors including, but not limited to, those
described in connection with the forward looking statement, and the factors
listed in Exhibit 99 to this report, which is hereby incorporated by reference
in this report.
In some cases, you can identify forward-looking statements by our use of
words such as "may," "will," "should," "could," "expect," "plan," "intend,"
"anticipate," "believe," "estimate," "predict," "potential" or "continue" or the
negative or other variations of these words, or other comparable words or
phrases.
Although we believe that the expectations reflected in our
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements or other future events.
Moreover, neither we nor anyone else assumes responsibility for the accuracy and
completeness of forward-looking statements. We are under no duty to update any
of our forward-looking statements after the date of this filing. You should not
place undue reliance on forward-looking statements.
OVERVIEW
FreeShop is an online direct 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. Our services are provided
through our network of Web sites at www.freeshop.com, www.wwb.com, and
www.catalogsite.com, and through direct email communications.
We began our direct marketing business in 1994 as the FreeShop division
of Online Interactive, Inc. In June of 1997 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 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.
In the quarters ended September 30, 1999 and 1998 our ten largest
clients accounted for 36.6% and 36.1% of our revenues, respectively. During the
quarters ended September 30, 1999 and 1998, no client accounted for more than
10% of our revenues. In the nine months ended September 30, 1999 and 1998 our
ten largest clients accounted for 35.0% and 32.7% of our revenues, respectively.
No client accounted for more than 10% of our revenues in the nine months ended
September 30, 1999 or 1998.
Our business has been operating at a loss and generating negative cash
flows from operations since inception. As of September 30, 1999, we had
accumulated losses of approximately $13.5 million. We plan to continue to
increase 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. We have experienced rapid growth
and have a limited operating history. Because of this we believe
period-to-period comparison of our operating results are not meaningful and the
results for any period should not be relied upon as an indication of future
performance.
We are restating our previously reported revenue related to the barter
portion of our agreement with NewSub Services. We terminated the NewSub Services
Agreement, effective March 2000, due to our new agreement with eNews.com for
similar services. The restatement resulted in a reduction in revenues for the
nine months ended September 30, 1999 from $2.6 million to $2.4 million, or 8% of
revenues. Revenues for the six months ended June 30, 1999 were reduced from $1.5
million to $1.4 million, or 7% of revenues.
<PAGE> 9
RESULTS OF OPERATIONS
Revenues
We derive our revenues primarily from online lead generation and
advertising contracts. Our revenues increased by $2.1 million, or 644%, to $2.4
million in the quarter ended September 30, 1999 compared to $320,000 in the same
quarter of 1998. On a year to date basis revenues have increased by $3.7
million, or 493%, to $4.4 million, compared to $750,000 in the first three
quarters of 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 $1.1
million in the quarter ended September 30, 1999, compared to $75,000 in the same
quarter of the prior year.
Cost of Revenues
Cost of revenues consists of expenses associated with the maintenance
and usage of the Company's Web sites, including Internet connection charges,
banner ad serving fees, equipment and software depreciation and personnel costs.
Cost of revenues increased to $149,000 in the quarter ended September 30, 1999
from $65,000 in the same quarter of 1998. On a year to date basis cost of
revenues increased to $339,000 from $140,000 in the first three quarters of
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 93.8% in the quarter ended September 30, 1999, from 79.8% in the
same quarter of 1998. On a year to date basis gross margin increased to 92.4%
from 81.3% in the first three quarters of 1998. The increase in gross margin was
primarily due to cost of revenues increasing at a slower rate than revenues.
However, we expect cost of revenues to increase on an absolute basis and
possibly as a percentage of revenue in the short-term as we continue to increase
our Internet connection capacity, hardware and software investments, and
personnel cost in order to support our growth.
Sales and Marketing
Sales and marketing expenses consist primarily of marketing and
promotional costs related to developing our brand and generating visits to our
Web sites, as well as personnel and other costs. Sales and marketing expenses
increased by $3.7 million to $4.7 million, or 195% of revenues, in the quarter
ended September 30, 1999 compared to $980,000, or 306% of revenues, in the same
quarter of 1998. On a year to date basis sales and marketing expenses have
increased by $6.8 million to $8.8 million, or 197% of revenues, compared to $2.0
million, or 268% of revenues, in the first three quarters of 1998. The increase
in absolute dollars was due primarily to increases in advertising and brand
awareness spending and increases in personnel costs. The decrease as a
percentage of revenue was primarily due to sales and marketing expenses, other
than advertising spending, increasing at a lesser rate than revenues. We expect
to continue to increase our advertising and brand awareness spending in the
future.
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
$169,000 to $255,000, or 11% of revenues, in the quarter ended September 30,
1999 compared to $86,000, or 27% of revenues, in the same quarter of 1998. On a
year to date basis research and development expenses have increased by $296,000
to $576,000, or 13% of revenues, compared to $280,000, or 37% of revenues, in
the first three quarters of 1998. The increase in absolute dollars was primarily
due to hiring additional staff to support our growth, continued improvements in
our internal systems and enhancements and modification to our Web site. The
decrease as a percentage of revenues was primarily due to research and
development expenses increasing at a slower 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
$216,000 to $310,000, or 13% of revenues, in the quarter ended September 30,
1999 compared to $94,000, or 29% of revenues, in the same quarter of 1998. On a
year to date basis general and administrative expenses have
<PAGE> 10
increased by $506,000 to $772,000, or 17% of revenues, compared to $266,000, or
36% of revenues, in the first three quarters of 1998. The increase in absolute
dollars was primarily due to increased personnel costs and professional service
fees necessary to support our growth. The decrease as a percentage of revenue is
primarily due to general and administrative expenses increasing at a slower 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 and directors 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 $196,000 to $235,000, or 10% of revenues, in
the quarter ended September 30, 1999 compared to $39,000, or 12% of revenues, in
the same quarter of 1998. On a year to date basis equity-based compensation
expenses have increased by $695,000 to $856,000, or 19% of revenues, compared to
$162,000, or 22% of revenues, in the first three quarters of 1998. The increase
in absolute dollars in the quarter resulted primarily from recognition of
expense due to issuing options with exercise prices based on the last price
received from a third party investor. An additional significant increase for the
year to date was due to recognition of $406,000 in expense 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 work for
FreeShop. The decrease as a percentage of revenue is primarily due to
equity-based compensation expenses increasing at a slower rate than revenues. We
expect equity-based compensation to increase over the next few quarters due to
the impact of recognizing expense associated with additional option grants.
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, non-compete agreements and goodwill from
acquisitions. Depreciation and amortization expenses increased by $340,000 to
$366,000, or 15% of revenues, in the quarter ended September 30, 1999 compared
to $26,000, or 8% of revenues, in the same quarter of 1998. On a year to date
basis depreciation and amortization expenses have increased by $551,000 to
$626,000, or 14% of revenues, compared to $75,000, or 10% of revenues, in the
first three quarters of 1998. The increase resulted from the depreciation of
approximately $1.1 million in equipment and furniture acquired from September
1998 through September 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.
Interest Expense
Interest expense primarily relates to capital equipment leases, and
totaled $9,000 in the quarter ended September 30, 1999 and $16,000 in the same
quarter of 1998. On a year to date basis interest expense totaled $32,000 and
$44,000 in the first three quarters of 1999 and 1998, respectively.
Other Expense (Income)
Other expense (income) consists primarily of interest income. Other
income increased by $76,000 to $69,000, or 3% of revenues, in the quarter ended
September 30, 1999 compared to other expense of $7,000, or 2% of revenues, in
the same quarter of 1998. On a year to date basis other income has increased by
$164,000 to $156,000, or 4% of revenues, compared to other expense of $7,000, or
1% of revenues, in the first three quarters of 1998. The increase was due to
higher cash balances resulting from the investments by Fingerhut in December
1998, April 1999 and June 1999. We expect interest income to increase
significantly in the next quarter and to decline thereafter as cash is used in
operating, investing and financing activities.
Income Taxes
No provision for federal income taxes has been recorded for any of the
periods presented due to the company's current loss position.
<PAGE> 11
LIQUIDITY AND CAPITAL RESOURCES
Since we began operating as an independent company in June 1997, we have
financed our operations primarily through the private placement of equity
securities. Gross proceeds from the issuance of stock through September 30, 1999
totaled $15.0 million, including $12.6 million raised from Fingerhut
Corporation. As of September 30, 1999, we had approximately $1.5 million in cash
and cash equivalents and working capital of $36.4 million. On October 1, 1999
the Company closed its initial public offering of 3,200,000 shares of the
Company's common stock. In addition, on October 29, 1999, the Company sold an
additional 480,000 shares under the underwriters' overallotment option. Total
net proceeds were $41,068,800. Concurrent with the closing of the initial public
offering, Fingerhut exercised their remaining rights to purchase 405,359
additional shares of Series B convertible preferred stock for $8,879,404.
Net cash used in operating activities was $6.9 million and $1.2 million
in the nine months ended September 30, 1999 and 1998. 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 $2.7 million and $19,000 in
the nine months ended September 30, 1999 and 1998. In the nine months ended
September 30, 1999, $1.7 million was used to acquire substantially all of the
assets of Commonsite, LLC and Travel Companions International, Inc. and $1.0
million was used to purchase equipment and furniture. For the nine months ended
September 30, 1998, cash used in investing activities was for purchases of
property and equipment.
Net cash provided by financing activities was $8.2 million and $1.2
million in the nine months ended September 30, 1999 and 1998. Net cash provided
by financing activities resulted primarily from issuance of capital stock, which
was partially offset by principal payments made on capital leases and
repurchase of common stock.
We believe our current cash and cash equivalents, including the net
proceeds from our IPO, underwriter's exercise of their overallotment option and
exercise by Fingerhut of their remaining warrants, 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.
Y2K 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 sites.
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 but two
of our vendors have responded either orally or in writing and either confirmed
their compliance or provided patches for their affected software. 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
<PAGE> 12
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 non-compliant, 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 sites and order processing systems. We are
establishing 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 $40,000 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 sites. This would have a material adverse
effect on our business, results of operations and financial condition.
<PAGE> 13
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We believe we do not have material market risk exposure. We do not own
any derivative instruments or engage in any hedging transactions. We have a
minimal amount of outstanding long-term debt and currently invest our excess
cash in short-term commercial paper.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As of the date hereof, there is no material litigation pending against
the Company. From time to time, the Company is a party to litigation and claims
incident to the ordinary course of business. While the results of litigation and
claims cannot be predicted with certainty, the Company believes that the final
outcome of such matters will not have a material adverse effect on the Company's
business, financial condition, results of operations and cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Changes in Securities
In connection with the Company's initial public offering, the Board of
Directors approved, subject to the shareholder approval, a proposal to amend the
Articles of Incorporation to effect a reverse stock split by exchanging every
2.5 outstanding shares of the Company's common stock for one new share of the
Company's common stock. At the Company's special meeting in September 1999, the
shareholders approved the amendment to the Company's Articles of Incorporation
to effect a 1-for-2.5 reverse stock split. The effective date of the reverse was
September 15, 1999. At July 31,1999, approximately 20.6 million shares of Common
Stock were outstanding, as well as options, warrants and convertible preferred
stock to acquire approximately an additional 11.2 million shares of Common
Stock. The Reverse Stock Split, decreased the number of outstanding shares of
Common Stock to approximately 8.2 million shares and approximately 4.5 million
shares are reserved for issuance upon exercise of outstanding options, warrants
and the conversion of convertible preferred stock. Approximately 87.3 million
shares of common stock are available for future issuances. Earnings per share
reflect post split shares of common stock outstanding.
On the effective date, the total number of shares of common stock held
by each stockholder converted automatically into a right to receive a number of
shares and fractions thereof of new common stock equal to the number of shares
of common stock owned immediately prior to the Reverse Stock Split divided by
2.5. No fractional shares or scrip were issued and, in lieu thereof, each
stockholder who would otherwise have been entitled to a fraction of a share of
new common stock would received a whole share of new common stock.
Approval of the Reverse Stock Split did not affect any stockholder's
percentage ownership interest in the Company or proportional voting power except
for minor differences resulting from fractional shares. The Reverse Stock Split
did not reduce the number of shareholders of the Company. The shares of new
common stock issued upon effectiveness of the Reverse Stock Split were fully
paid and nonassessable. The voting rights and other privileges of the holders of
common stock was not affected substantially by adoption of the Reverse Stock
Split or the subsequent implementation thereof.
(b) Use of proceeds
On September 27, 1999 the Securities and Exchange Commission declared
effective the Company's Registration Statement on Form S-1 (333-81151). Pursuant
to this Registration Statement on October 1, 1999 the Company closed its initial
public offering of 3,200,000 shares of the Company's common stock at an initial
public offering price of $12.00 per share (the "Offering"). The Offering was
managed by Deutsche Banc Alex. Brown, Dain Rauscher Wessels, Volpe Brown Whelan
& Company, and E*OFFERING. Net proceeds to the Company, after calculation of the
underwriters discount and commissions, from the Offering totaled $35,712,000. In
addition, on October 29, 1999, the Company sold an additional 480,000 shares
under the underwriters' overallotment option. Total net proceeds were
$5,356,800. None of the expenses incurred in the offering were direct or
indirect payments to affiliates, directors, officers or persons owning ten
percent or more of any class of equity securities of the
<PAGE> 14
Company. As of September 30, 1999 none of the proceeds from these transactions
had been used. Until the proceeds are used they will be invested in short-term
commercial paper.
(c) Sales of Unregistered Securities
During the three months ended September 30, 1999, the Company sold
31,015 shares of common stock pursuant to the exercise of stock options issued
under the Company's 1997 Stock Option Plan for aggregate proceeds of $33,742.75.
The options, and shares issued upon exercise of the options, were issued
pursuant an exemption provided by Rule 701 of the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the special meeting of the shareholders of the Company held at 10:00 am on
September 8, 1999 at the offices of the Company, the following matters were
submitted to a vote of the shareholders:
1. Amend Article 2 of the Articles of Incorporation to effect a reverse
stock split, subject to the discretion of the Board of Directors to file
the amendment to the Articles in order to effect the reverse split. The
proposal passed receiving 16,056,717 votes in favor, 626,699 votes
against and 41,667 votes abstaining.
2. Amend Article 3 of the Articles of Incorporation so that shareholders
may remove directors only for cause. The proposal did not pass receiving
11,766,997 votes in favor, 618,0782 votes against and 4,339,304 votes
abstaining.
3. Amend Article 4 of the Articles of Incorporation to increase the
percentage of outstanding shares of capital stock entitled to vote which
must be held by a shareholder from 10% to 25% in order for that
shareholder to have the right to call a special meeting of shareholders.
The proposal did not pass receiving 11,864,000 votes in favor, 625,032
votes against and 4,236,051 votes abstaining.
4. Amend Article 5 of the Articles of Incorporation to establish
shareholder voting requirements for approval of certain actions by the
Company. The proposal passed receiving 16,098,384 votes in favor,
578,782 votes against and 47,917 votes abstaining.
5. Amend Article 6 of the Articles of Incorporation to clarify the existing
limitation of liability provision in the Articles of Incorporation and
to strengthen the existing indemnification provisions currently
contained in the Bylaws and add such indemnification provisions to the
Articles of Incorporation. The proposal passed receiving 16,677,166
votes in favor and 47,917 votes abstaining.
6. Approve and ratify an increase in the number of shares of common stock
reserved for issuance under the Company's 1997 Stock Option Plan to
6,000,000 shares (2,400,000 shares following the reverse stock split).
The proposal passed receiving 16,000,384 votes in favor, 683,032 votes
against and 41,667 votes abstaining.
There were 20,608,174 common shares outstanding and entitled to vote on the
record date. The share numbers listed in this Item 4 do not reflect the reverse
stock split which was effected on September 15, 1999.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report:
<PAGE> 15
27.1 Financial Data Schedule
99 Private Securities Litigation Reform Act of 1995 Safe Harbor Compliance
Statements for Forwarding Looking Statements
(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the three months ended
September 30, 1999.
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FREESHOP.COM, INC.
Date: February 9, 2000 By: /s/ JOHN A. WADE
----------------------------------
Name: John A. Wade
Title: Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AS OF SEPTEMBER 30, 1999 AND THE STATEMENT OF OPERATIONS FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,528,558
<SECURITIES> 50,000
<RECEIVABLES> 2,214,857
<ALLOWANCES> 160,000
<INVENTORY> 0
<CURRENT-ASSETS> 39,749,011
<PP&E> 1,647,157
<DEPRECIATION> 411,210
<TOTAL-ASSETS> 42,904,750
<CURRENT-LIABILITIES> 2,980,569
<BONDS> 0
0
8,615,125
<COMMON> 43,678,547
<OTHER-SE> (12,423,056)
<TOTAL-LIABILITY-AND-EQUITY> 42,904,750
<SALES> 0
<TOTAL-REVENUES> 4,449,527
<CGS> 0
<TOTAL-COSTS> 338,867
<OTHER-EXPENSES> 11,486,078
<LOSS-PROVISION> 125,988
<INTEREST-EXPENSE> 32,210
<INCOME-PRETAX> (7,377,152)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,377,152)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,377,152)
<EPS-BASIC> (0.90)
<EPS-DILUTED> (0.90)
</TABLE>
<PAGE> 1
EXHIBIT 99
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 - SAFE HARBOR FOR
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a safe-harbor for
forward-looking statements made by public companies. This safe-harbor protects a
company from securities law liability in connection with forward-looking
statements if the company complies with the requirements of the safe-harbor. As
a public company, we have relied and will continue to rely on the protection of
the safe harbor in connection with our written and oral forward-looking
statements.
When evaluating our business, you should consider:
- - all of the information in this quarterly report on Form 10-Q;
- - the risk factors described in our Rule 424(b) prospectus filed with the
Securities and Exchange Commission on September 28, 1999; and
- - the risk factors described below.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
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. From our inception in June 1994 through June1997, 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 $7.4 million, or more than 1.6 times the amount of our
revenues, for the nine months ended September 30, 1999. As of September 30,
1999, our accumulated
<PAGE> 2
losses were $13.5 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. 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,
MAKING IT DIFFICULT TO PREDICT OUR FINANCIAL PERFORMANCE.
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 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.
The majority of our contracts are 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 112
employees on October 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.
<PAGE> 3
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.
The majority of our contracts have 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. We cannot be certain
that the acquired sites' advertisers will agree to enter into new contracts with
us as their current contracts expire.
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;
- - 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
<PAGE> 4
- - 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 have a non-contractual direct marketing relationship with
Fingerhut that includes Web site links and advertising, 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 3.0
million visitors in September 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.
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 two 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 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 non-compliant 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.
<PAGE> 5
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.
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.
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 have no assurance 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.
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
WEBSITE.
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. Internet regulatory
bodies generally regulate domain names. 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
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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 such claims would
most 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 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 that 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.
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
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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.
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 in a timely manner 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 intellectual 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
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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.
