1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended March 31, 2000 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 000-25835 MYPOINTS.COM, INC. (Exact Name of Registrant as Specified in Its Charter) Delaware 94-3255692 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 100 California Street,11th Flr, San Francisco, CA 94111 (Address of Principal Executive Offices) Registrant's Telephone Number, Including Area Code: (415) 676-3700 Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] On March 31, 2000, 29,129,721 shares of the Registrant's Common Stock, $.001 par value, were outstanding. 2 MYPOINTS.COM, INC. FORM 10-Q QUARTER ENDED MARCH 31, 2000 INDEX Part I: Financial Information Page ---- Item 1:Financial Statements (Unaudited ) Consolidated Balance Sheets at March 31, 2000 and December 31, 1999 Consolidated Statements of Operations for the three months ended March 31, 2000 and March 31, 1999 Consolidated Statement of Stockholders' Equity for the three months ended March 31, 2000 Consolidated Statements of Cash Flows for the three months ended March 31, 2000 and March 31, 1999 Notes to Unaudited Consolidated Financial Statements Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3: Quantitative and Qualitative Disclosures about Market Risk Part II: Other Information Item 1: Legal proceedings Item 2: Changes in Securities and Use of Proceeds Item 6: Exhibits and Reports on Form 8-K Item 7: Signatures 2 3 MYPOINTS.COM, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) March 31, December 31, 2000 1999 --------- ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 116,392 $ 21,792 Accounts receivable, net 15,922 12,500 Unbilled receivables, net 577 257 Notes and interest receivable 1,996 -- Deposits and prepaid expenses 1,983 1,702 Other current assets 495 484 --------- --------- Total current assets 137,365 36,735 Intangible assets 21,390 7,757 Restricted cash 2,508 2,208 Property and equipment, net 9,901 8,891 Other assets 78 78 --------- --------- Total assets $ 171,242 $ 55,669 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities $ 14,004 $ 13,842 Notes payable, current portion 326 327 Obligations under capital leases, current portion 112 105 Deferred revenue 1,636 1,873 Points redemption liability 11,458 9,640 --------- --------- Total current liabilities 27,536 25,787 Notes payable, less current portion 836 932 Obligations under capital leases, less current portion 71 97 --------- --------- 28,443 26,816 Commitments and contingencies Stockholders' equity: Preferred stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and outstanding at March 31, 2000 and December 31,1999 -- -- Common stock, $.001 par value; 100,000,000 shares authorized, 29,129,721 and 25,924,533 shares issued and outstanding at March 31, 2000 and December 31, 1999, respectively 29 26 Additional paid-in capital 220,428 96,711 Deferred compensation (8,306) (9,406) Accumulated deficit (69,352) (58,478) --------- --------- Total stockholders' equity 142,799 28,853 --------- --------- Total liabilities and stockholders' equity $ 171,242 $ 55,669 ========= ========= The accompanying notes are an integral part of these consolidated financial statements. 3 4 MYPOINTS.COM, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Three months ended March 31, ------------------------------- 2000 1999 ------------ ------------ Revenues $ 15,822 $ 1,275 Cost of revenues 4,113 878 ------------ ------------ Gross profit 11,709 397 ------------ ------------ Operating expenses: Technology costs 5,276 968 Sales and marketing expenses 11,393 2,564 General and administrative expenses 4,400 1,074 Amortization of intangible assets 1,177 832 Stock-based compensation 1,100 449 ------------ ------------ Total operating expenses 23,346 5,887 ------------ ------------ Operating loss (11,637) (5,490) Interest income 816 9 Interest expense and other, net (53) -- ------------ ------------ Net loss (10,874) (5,481) Dividend related to the beneficial conversion feature of preferred stock -- (9,800) ------------ ------------ Net loss attributable to common stockholders $ (10,874) $ (15,281) ============ ============ Net loss per share: Basic and diluted $ (0.40) $ (3.00) ============ ============ Weighted average shares--basic and Diluted 26,872 5,097 ============ ============ Pro forma net loss per share: Basic and diluted $ (0.40) $ (0.35) ============ ============ Weighted average shares--basic and Diluted 26,872 15,485 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 4 5 MYPOINTS.COM, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS) (UNAUDITED) Preferred Stock Common Stock ---------------------------- ---------------------------- Shares Amount Shares Amount ------------ ------------ ------------ ------------ Balance at December 31, 1999 -- $ -- 25,925 $ 26 Issuance of common stock for cash, net of issuance costs of $760 2,450 2 Issuance of common stock pursuant to acquisition of ADG 270 Exercise of stock options for cash 485 1 Net loss Amortization of deferred compensation ------------ ------------ ------------ ------------ Balance at March 31, 2000 -- $ -- $ 29,130 $ 29 ============ ============ ============ ============ Additional Paid-in Deferred Accumulated Capital Compensation Deficit Total ------------ ------------ ------------ ------------ Balance at December 31, 1999 $ 96,711 $ (9,406) $ (58,478) $ 28,853 Issuance of common stock for cash, net of issuance costs of $760 106,151 106,153 Issuance of common stock pursuant to acquisition of ADG 16,562 16,562 Exercise of stock options for cash 1,004 1,005 Net loss (10,874) (10,874) Amortization of deferred compensation 1,100 1,100 ------------ ------------ ------------ ------------ Balance at March 31, 2000 $ 220,428 $ (8,306) $ (69,352) $ 142,799 ============ ============ ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 5 6 MYPOINTS.COM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) Three months ended March 31, ----------------------------- 2000 1999 ------------ ------------ Cash flows from operating activities: Net loss $ (10,874) $ (5,481) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,570 964 Provision for bad debts 805 185 Points redemption liability 1,818 1,113 Barter revenues, net -- 67 Stock-based compensation 1,100 449 Changes in operating assets and liabilities: Accounts receivable and unbilled receivables (3,967) (469) Notes and interest receivable (170) -- Deposits and prepaid expenses (374) (386) Other assets -- (26) Accounts payable, accrued and other liabilities (625) 534 Deferred revenue (237) 597 ------------ ------------ Net cash used in operating activities (9,954) (2,453) ------------ ------------ Cash flows from investing activities: Purchase of property and equipment (2,013) (1,076) Acquisition of ADG, Inc., net of cash acquired (175) -- Deposit of restricted cash (300) -- ------------ ------------ Net cash used in investing activities (2,488) (1,076) ------------ ------------ Cash flows from financing activities: Proceeds from issuance of common stock, net 106,153 -- Repayment of borrowings under line of credit -- (42) Repayments of borrowings (97) -- Principal payments under capital lease obligations (19) (12) Proceeds from exercise of stock options 1,005 12 Receipt of subscription receivable -- 350 ------------ ------------ Net cash provided by financing activities 107,042 308 ------------ ------------ Net increase in cash and cash equivalents 94,600 (3,221) Cash and cash equivalents, beginning of period 21,792 5,089 ------------ ------------ Cash and cash equivalents, end of period $ 116,392 $ 1,868 ============ ============ Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 53 $ 11 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. 6 7 MYPOINTS.COM, INC. (unaudited) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements include the accounts of MyPoints.com, Inc. and its wholly owned subsidiaries ("the Company"), and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the Company's consolidated financial position, results of operations, and cash flows as of and for the dates and periods presented. The consolidated balance sheet as of December 31, 1999 has been prepared from the audited consolidated financial statements of the Company. These unaudited consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements included in its Form 10-K filed with the Securities and Exchange Commission on March 30, 2000. The results of operations for the three month period ended March 31, 2000 are not necessarily indicative of results for the entire fiscal year ending December 31, 2000. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES REVENUE RECOGNITION The Company earns revenues from corporate advertisers by charging fees for sending targeted email to its members. Under the terms of advertising contracts, the Company earns revenues generally based on three components: (1) transmission of email advertisements to enrolled members, (2) receipt of qualified responses to email sent and (3) actual purchases of goods by members over the internet. It is the Company's policy to recognize revenues when email is transmitted to members, when responses are received and when the Company is notified of purchases. Each of these activities are discrete, independent activities, which generally are specified in the advertising sales agreement entered into with the customer. As the earning activities take place, activity measurement data (e.g., number of emails sent, and number of responses received) is accumulated and the related revenues and unbilled receivables are recorded. Thus, unbilled receivables are recorded as the earning activities for a campaign are being performed. Under new and certain existing advertising contracts and partnerships, the Company sells points to private label partners and to advertisers for use in such partner's or advertiser's promotional campaigns . The Company is responsible for redeeming a member's points upon the balance reaching required thresholds and request by the member recipients of points. Revenues and estimated point costs under these contracts are deferred until the time points are redeemed and an award is provided by the Company. The Company expects that sales of points will likely represent a decreasing percentage of its business in the future but has continued to participate in the sale of points business. 7 8 3. POINTS REDEMPTION LIABILITY Points redemption liability represents the estimated costs associated with the Company's obligation to redeem outstanding points, less an allowance for points expected to expire prior to redemption, which may be converted by enrolled members into various third party gift certificates, frequent travel programs, coupons and other awards. Points are awarded to members when they respond to direct marketing offers delivered by the Company, or purchase goods from the advertisers. The Company is liable for purchasing the rewards provided to members, if and when such members seek to redeem accumulated points upon reaching required redemption thresholds. The liability for the cost of points is estimated based upon the weighted average cost of awards that may be redeemed in the future. The liability is based upon redemption cost trends and management estimates of future point redemption costs. Under the current program, points are valid through December 31st of the third calendar year following the date they are awarded to a member and may be redeemed at any time prior to expiration. The Company bases its estimate of points that will not be redeemed on an analysis of historical point earning trends, redemption activity and individual member accounts. This analysis is updated quarterly. At December 31, 1999 and March 31, 2000, the allowance for unredeemed points was $ 2.8 million and $2.9 million ( unaudited ) respectively. As of March 31, 2000, the gross points redemption liability was $14.4 million ( unaudited). Following is a summary of points redemption liability activity for the three months ended March 31, 2000 and 1999 (in thousands): Three months ended March 31, (Unaudited) ----------------------------- 2000 1999 ------------ ------------ Outstanding at beginning of period $ 9,640 $ 2,727 Accrual for new point redemption liability 3,876 2,006 Allowance for unredeemed points (266) (839) Points redemption (1,792) (54) ------------ ------------ Outstanding at end of period $ 11,458 $ 3,840 ============ ============ 4. NET LOSS PER SHARE The Company computes net loss per share in accordance with SFAS No. 128, Earnings per Share, and SEC Staff Accounting Bulletin ("SAB") No. 98. Under the provisions of SFAS No. 128 and SAB No. 98, basic net income per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of vested common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of vested common and common equivalent shares outstanding during the period. However, as the Company has generated net losses in all periods presented, common equivalent shares, composed of incremental common shares issuable upon the exercise of stock options and warrants and upon conversion of Series A, Series B, Series C, Series D and Series E 8 9 convertible preferred stock, are not included in diluted net loss per share (prior to conversion on August 19, 1999) because such shares are anti-dilutive. The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except per share amounts): Three months ended March 31, (unaudited) ----------------------------- 2000 1999 ------------ ------------ Numerator: Net loss $ (10,874) $ (5,481) Dividend related to beneficial conversion feature of preferred stock -- (9,800) ------------ ------------ Net loss available to common stockholders $ (10,874) $ (15,281) ============ ============ Denominator: Weighted average shares 27,177 6,039 Weighted average unvested common shares subject to repurchase agreements (305) (942) ------------ ------------ Denominator for basic calculation 26,872 5,097 Weighted average effect of dilutive securities: Net effect of dilutive stock options -- -- Net effect of dilutive stock warrants -- -- ------------ ------------ Denominator for diluted calculation 26,872 5,097 ============ ============ Net loss per share: Basic $ (0.40) $ (3.00) ============ ============ Diluted $ (0.40) $ (3.00) ============ ============ Pro forma net loss per share (presented earlier) has been computed by dividing net loss applicable to common shareholders by the pro forma weighted average number of shares outstanding. Pro forma weighted average shares assume the conversion of all preferred stock (which were ultimately converted to common stock in conjunction with the initial public offering, as if the conversion occurred at the beginning of the period or at date of issuance, if later). 9 10 5. ACQUISITION On January 12, 2000, the Company agreed to acquire all the outstanding shares of Alliance Development Group, Inc. ("ADG"). ADG operates offline customer reward programs including rewards based credit card loyalty programs. The total purchase price of approximately $16.7 million included 270,000 shares of the Company's common stock with an estimated fair value of $16.6 million based upon its value at the closing of the transaction. Following the acquisition, ADG is now a wholly owned subsidiary of the Company. 6. SUBSEQUENT EVENT On April 17, 2000, the Company agreed to acquire Cybergold, Inc. in a tax-free, stock-for-stock, fixed-share transaction wherein each share of Cybergold will be exchanged for 0.4800 shares of the Company. Based on closing prices on April 14, 2000, the transaction is valued at approximately $157 million. The acquisition is scheduled to close in the third quarter of 2000. 10 11 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements based upon current expectations that involve risks and uncertainties. When used in this Form 10-Q, the words "intend," "anticipate," "believe," "estimate," "plan" and "expect" and similar expressions are included to identify forward-looking statements. Our 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 those set forth under "Future Operating Results" and elsewhere in this Form 10-Q. OVERVIEW MyPoints.com, Inc. was founded as Intellipost Corporation in November 1996. In May 1997, we launched our email direct marketing and rewards program. In November and December 1998, through our acquisition of Enhanced Response Technologies, Inc. and a company affiliated with Experian, we acquired internet and electronic commerce related assets and technologies through a series of related transactions. Through these transactions, we acquired a technology license for the operation of a web-based rewards program. In early March 1999, we changed our corporate name to MyPoints.com, Inc. in order to unify our corporate and brand identities. During March and April 1999, we integrated our email and web-based direct marketing and rewards programs under the MyPoints brand. In August 1999, we completed our initial public offering and in February 2000 we completed an additional public offering of shares of our common stock. We generate substantially all of our revenues by delivering email and web-based direct marketing offers for our advertising customers. In exchange for these services, we receive fees from our advertisers based on any or all of the following: - the number of offers delivered to members; - the number of qualified responses generated; and - the number of qualified purchases made. For direct marketing services, we recognize revenues when an offer is delivered, when a qualified response is received or when a product or service is purchased, depending upon the pricing arrangement used. Pricing of our direct marketing services is not based on the issuance of points to our members. Under new and some existing advertising contracts and partnerships, we sell points to private label partners and to advertisers for use in their promotional campaigns. We initially defer revenue and estimated point costs associated with the sale of points and recognize this revenue upon the expiration or redemption of the underlying points. Under some new contracts, we may amortize some associated fees and related costs over the life of these contracts. 11 12 Our revenues depend on a number of factors. These include the number of advertisers engaging us to send direct marketing offers to our membership base, the size of our membership base, and the responsiveness of our members to these direct marketing offers. We believe that our revenues will be subject to seasonal fluctuations as a result of general patterns of retail advertising, which are typically higher during the fourth calendar quarter. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and consumer buying patterns. We also offer technology licensing arrangements to customers seeking to develop email or web-based direct marketing and loyalty programs. We entered into our first license agreement in December 1998 with Sweden Post, the Swedish postal service. Sweden Post is establishing a version of the MyPoints BonusMail program for the Swedish market. This license agreement provides for a licensing fee, technical support fees and royalties based on a percentage of revenues from the program site. We recognized revenue under this agreement when the custom development work that we performed for Sweden Post was completed and accepted by Sweden Post. In addition, we will recognize royalty revenue as it is received from Sweden Post. We expect to enter into additional licensing and royalty arrangements, particularly for international markets. We also expect to derive revenues from several pending international initiatives. We incurred a net loss of $37.5 million in 1999, and $10.9 million in the three months ended March 31, 2000. We intend to implement our strategies by spending substantial amounts on member acquisition and retention, new product offerings, sales and marketing strategic relationships, brand development and technology and operating infrastructure development. As a result, we expect to incur net losses at least through 2001 and negative cash flows for the next several quarters. Our limited operating history makes it difficult to forecast future operating results. Although we have experienced revenue growth in recent quarters, we cannot be certain that revenues will increase at a rate sufficient to achieve and maintain profitability. Even if we were to achieve profitability in any period, we might fail to sustain or increase that profitability on a quarterly or annual basis. RESULTS OF OPERATIONS Revenues Revenues increased to $15.8 million in the three months ended March 31, 2000 as compared to $1.3 million in the three months ended March 31, 1999. This increase was primarily attributable to the following: (i) an increase in the number of direct marketing offers to our members, (ii) an increase in our advertising customer base, and (iii) an increase in average spending per advertiser. Cost of Revenues Cost of revenues represents the costs of points awarded to our members for responding to advertisements and related purchasing activities associated with our direct marketing offers as well as personnel costs associated with creating, delivering and monitoring email campaigns. Cost of revenues increased to $4.1 million in the three months ended March 31, 2000 from $0.9 million in the three months ended March 31, 1999. As a percentage of revenues, these costs decreased to 26% in 12 13 the three months ended March 31, 2000 from 69% in the three months ended March 31, 1999. The decrease in the cost of revenues as a percentage of revenues in the three months ended March 31, 2000 as compared to the three months ended March 31,1999 is primarily attributable to a higher number of revenue-generating responses to direct marketing offers, the elimination of points cost associated with members' receipt of email direct marketing offers, partially offset by an increase in personnel costs associated with creating, delivering and monitoring email campaigns. The cost of personnel included in cost of revenue increased to $0.9 million in the three months ended March 31, 2000 as compared to zero in the three months ended March 31, 1999. Also contributing to a lower cost of revenue was reduced costs associated with redemption award purchases. As redemption volume has increased, we have been able to negotiate volume purchase discounts when purchasing gift awards. Technology Costs Technology costs primarily consist of compensation for personnel associated with the development of our technology and the maintenance of our proprietary database. Presently, we expense technology costs as incurred. However, in the future, certain technology costs may be capitalized, as appropriate. Technology costs increased to $5.3 million in the three months ended March 31, 2000 from $1.0 million in the three months ended March 31,1999. This increase was primarily due to increases in personnel and consulting costs and related expenses used to enhance and support our proprietary database and products. We expect our technology costs to increase in future periods as we continue to improve and enhance our direct marketing technology and expand our membership database. Sales and Marketing Expenses Sales and marketing expenses consist primarily of payroll, sales commissions and related expenses for personnel engaged in sales, marketing and customer support, as well as advertising and promotional expenditures including member acquisition costs. Member acquisition costs consist primarily of online advertising, promotional costs and payments to partners, which may be in the form of cash or points, to attract members to our email and web-based programs. Sales and marketing expenses increased to $11.4 million in the three months ended March 31, 2000 from $ 2.6 million in the three months ended March 31, 1999. This increase was primarily attributable to increases in personnel costs, including sales commissions, member acquisition costs and related expenses required to implement our sales and marketing strategy. We expect increases in sales and marketing expenses to continue in future periods as we continue to hire additional marketing and sales employees, and continue to spend more on member acquisition and promotions. General and Administrative Expenses General and administrative expenses consist primarily of payroll and related costs for general corporate functions, including finance, accounting, business development, human resources, investor relations, facilities and administration, as well as legal fees, insurance, bad debt and fees for professional services. General and administrative expenses increased to $4.4 million in the three months ended March 31, 2000 from $1.1 million in the three months ended March 31, 1999. This increase was primarily due to the expansion of our corporate infrastructure, including the addition of finance 13 14 and administrative personnel. We expect general and administrative expenses to increase in future periods as we expand our administrative staff to support the growth of our operations. Amortization of Intangible Assets The Company acquired various intangible assets as part of the acquisition of Enhanced Response Technologies, Inc. ("ERT") and a company affiliated with Experian in the fourth quarter of 1998, and the acquisition of ADG in the first quarter of 2000. In regards to the acquisition of ERT and a company affiliated with Experian, the Company recorded intangible assets of $11.2 million. These intangible assets are being amortized over their estimated useful lives of six months to five years. In regards to the acquisition of ADG in the first quarter of 2000, the Company recorded intangible assets of $14.8 million. These intangible assets are being amortized over their estimated useful lives of thirty-six to ninety months. We recorded amortization of intangible assets of $1.2 million in the three months ended March 31, 2000 as compared to $0.8 million in the three months ended March 31, 1999. The increase in amortization of intangible assets in the three months ended March 31, 2000 as compared to the three months ended March 31, 1999 relates to the acquisition of ADG in January, 2000. Stock-Based Compensation As of March 31, 2000, we recorded aggregate deferred compensation totaling $12.7 million in connection with the grant of stock options to employees and consultants. This charge is being amortized over the vesting periods of the options, which generally range from three to four years. Stock-based compensation increased to $1.1 million in the three months ended March 31, 2000 from $0.4 million in the three months ended March 31, 1999. Interest Income Interest income increased to $0.8 million in the three months ended March 31, 2000 from $9,000 in the three months ended March 31, 1999. This increase is due to interest earned on higher average cash and investment balances resulting from proceeds received from our initial public offering which was completed in August 1999 and our follow-on offering which was completed in February 2000. Income Taxes We recorded a net loss of $37.5 million for 1999 and a net loss of $10.9 million in the three months ended March 31, 2000. Accordingly, no provision for income taxes was recorded in the year and no tax benefit has been recognized due to the uncertainty of realizing a future tax deduction for these losses. 14 15 LIQUIDITY AND CAPITAL RESOURCES Since incorporation, we have financed our operations primarily from the sale of equity securities to venture capital firms and other individual, institutional and strategic investors as well as our initial public offering in August 1999 and our follow-on public offering in February 2000. We have also borrowed funds under long-term capital lease and equipment financing facilities. The total number of outstanding points issued to members for which we have a recognized liability as of March 31, 2000 was approximately 1.5 billion points with a redemption liability of $11.5 million. This liability was calculated based on certain assumptions, including the assumption that 80% of the outstanding points would be redeemed in the future. We also use historical redemption activity and individual member account activity to determine our estimated redemption liability. The factors that were considered in our estimated redemption liability include points held by terminated and inactive members, as well as those members we believe will not respond to our direct marketing offers with sufficient frequency to accumulate points to meet our minimum redemption levels. This information is updated on a quarterly basis. The total number of points redeemed by members was 227.0 million in 1999 and 179.0 million in the three months ended March 31, 2000. Points issued by us have a life of three to four years. Our current policy is that unredeemed points will expire on December 31 of the third calendar year following the calendar year in which such points are first deemed earned. Although we do not anticipate making changes to our current policy we reserve the right to alter point expiration terms at anytime. In the past, we have both extended as well as reduced expiration terms of points. Members may redeem points in their discretion at any time prior to the expiration of the points. We fund point redemptions through our working capital resources. Because we cannot control the timing of members' decisions to redeem points, should the rate of redemption of points exceed our estimates, it could be necessary for us to obtain additional working capital and our results of operations could be materially and adversely affected. Net cash used in operating activities was $10.0 million in the three months ended March 31, 2000. This cash used in operating activities was due to our expanded operations and primarily resulted from the net loss and higher accounts receivable. Net cash used in investing activities was $2.5 million in the three months ended March 31, 2000 which was primarily used to acquire property and equipment, primarily computer equipment and software. Net cash provided by financing activities was $107.0 million in the three months ended March 31, 2000 which includes net proceeds of $105.7 million from our follow-on offering in February 2000. At March 31, 2000 we had cash and cash equivalents of $116.4 million. We currently anticipate that our available cash resources will be sufficient to meet our anticipated working capital and capital expenditure 15 16 requirements for at least the next 12 months. Thereafter, we may need to raise additional funds to fund more rapid expansion, to develop new or enhance existing services or products, to respond to competitive pressures or to acquire complementary products, businesses or technologies. If adequate funds are not available on acceptable terms, our business, results of operations and financial condition could be materially and adversely affected. FACTORS AFFECTING OPERATING RESULTS All statements in this Form 10-Q that do not discuss past results are forward-looking statements. Forward-looking statements are based on management's current expectations and are therefore subject to certain risks and uncertainties. Any of the following risks could seriously harm our business, financial condition or results of operations. As a result, these risks could cause the decline of the trading price of our common stock. The risks described below, however, are not the only ones that we face. You should also refer to the other information set forth in this Form 10-Q, including our financial statements and the related notes. RISKS ASSOCIATED WITH OUR BUSINESS WE HAVE ONLY A LIMITED OPERATING HISTORY THAT INVESTORS MAY USE TO ASSESS OUR FUTURE PROSPECTS We have only a limited operating history upon which you can evaluate our business. We commenced operations in November 1996 and did not begin to generate revenues until July 1997. We have not and may never generate sufficient revenues to achieve profitability. Although we have experienced revenue growth in recent periods, these growth rates may not be sustainable or indicative of our future growth. We have limited experience addressing challenges frequently encountered by early-stage companies in the electronic commerce and direct marketing industries. We may not be successful in addressing these risks, and our business strategy may not be successful. In addition, we have never operated during a general economic downturn in the United States, which typically adversely affects advertising and marketing expenditures and retail sales. Accordingly, our limited operating history does not provide investors with a meaningful basis for evaluating an investment in our common stock. WE HAVE A HISTORY OF LOSSES AND EXPECT LOSSES TO CONTINUE AT LEAST THROUGH 2001 Our accumulated deficit as of March 31, 2000 was $69.4 million. We have never operated profitably and, given our planned level of operating expenses, we expect to continue to incur losses at least through 2001. We plan to increase our operating expenses as we continue to build infrastructure to support the expansion of our business. Our losses may increase in the future, and even if we achieve our revenue targets, we may not be able to sustain or increase profitability on a quarterly or annual basis. If our revenues grow more slowly than we anticipate, or if our operating expenses exceed our expectations and cannot be adjusted accordingly, our losses could continue beyond our present expectations. 16 17 OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS, WHICH COULD AFFECT OUR STOCK PRICE Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, some of which are outside of our control. As a result, our operating results may be below the expectations of public market analysts and investors. In this event, the price of our common stock may fall. The factors most likely to produce varied results include: - the advertising budget cycles of individual advertisers; - the number of reward points redeemed by our members and the costs associated with these redemptions; - changes in the mix of our business; - changes in marketing and advertising costs that we incur to attract and retain members; - changes in our pricing policies, the pricing policies of our competitors or the pricing policies for internet advertising generally; and - unexpected costs and delays relating to the expansion of our operations. Due to these factors, revenues and operating results are difficult to forecast and you should not rely on period to period comparisons of results of operations as an indication of our future performance. OUR OPERATING RESULTS ARE SUBJECT TO SEASONAL FLUCTUATIONS THAT COULD IMPACT OUR GROWTH AND AFFECT OUR STOCK PRICE We believe that our revenues will be subject to seasonal fluctuations as a result of general patterns of retail advertising, which are typically higher during the fourth calendar quarter. In addition, expenditures by advertisers tend to be cyclical, reflecting general economic conditions and consumer buying patterns. The extent of these seasonal fluctuations in any period may be difficult to predict and, if the fluctuations are greater than our expectations, our growth rate would decline. In this event, the price of our common stock may fall. 17 18 WE MAY HAVE DIFFICULTIES INTEGRATING RECENT AND FUTURE ACQUISITIONS AND ANY FAILURE TO SUCCESSFULLY INTEGRATE ACQUIRED COMPANIES WOULD REDUCE OUR ABILITY TO REALIZE THE ANTICIPATED VALUE OF THE ACQUISITION In the first quarter of 2000, we acquired ADG. We announced the acquisition of Cybergold in the second quarter of 2000. We may pursue other acquisitions in the future. Based on our experiences with our first acquisition in 1998, we expect to face numerous risks and uncertainties generally associated with acquisitions, including: - potentially adverse effects on our reported results of operations from acquisition-related charges and amortization of goodwill and purchased technology; - our ability to maintain customers or the reputation of the acquired businesses; - potential dilution to current stockholders from the issuance of additional equity securities; - difficulties integrating operations, personnel, technologies, products and information systems of the acquired businesses; - diversion of management's attention from other business concerns; and - potential loss of key employees of acquired businesses. In November and December 1998, through our acquisition of Enhanced Response Technologies, Inc. and a company affiliated with Experian Information Solutions, Inc., we acquired internet and electronic commerce related assets and technologies to support a web-based rewards program known as MyPoints. We integrated MyPoints with our BonusMail email service during March and April 1999. This integration involved the combination of two different marketing programs and technology platforms, as well as operations in San Francisco and Chicago. In connection with this integration, we incurred substantial costs. During the relaunch of the integrated MyPoints program, we encountered several unanticipated problems which resulted in significant periods of system downtime during April 1999. During these periods of downtime, our web site was not accessible by members. We believe that we have resolved the problems that caused this downtime; however, there can be no assurance that we will not encounter additional system-related problems. In January 2000, we acquired Alliance Development Group, Inc., a company that operates offline customer rewards programs. In connection with this acquisition, we intend to integrate our technology with ADG's offline programs to help make them more efficient. If we are unable to do this in a timely manner, we may be unable to realize the anticipated benefits of this acquisition. 18 19 In April 2000, we announced the acquisition of Cybergold. We expect to face numerous risks and uncertainties generally associated with this acquisition, including: MYPOINTS AND CYBERGOLD MAY NOT ACHIEVE THE BENEFITS THEY EXPECT FROM THE MERGER, WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON THE COMBINED COMPANY'S BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS AND/OR COULD RESULT IN LOSS OF KEY PERSONNEL. We will need to overcome significant issues in order to realize any benefits from the merger, including the timely, efficient and successful execution of a number of post-merger events. Key events include: - Integrating the operations of the two companies; - Retaining and assimilating the key personnel of each company; - Offering the existing services of each company to the other company's customers; - Retaining the existing customers and strategic partners of each company; - Developing new services that utilize the assets of both companies; and - Maintaining uniform standards, controls, procedures and policies The successful execution of these post-merger events will involve considerable risk and may not be successful. These risks include: - The potential disruption of the combined company's ongoing business and distraction of it's management; - The difficulty of incorporating acquired technology and rights into the combined company's products and services; - Unanticipated expenses related to technology integration; - The impairment of relationships with employees and customers as a result of any integration of new management personnel; and - Potential unknown liabilities associated with the acquired business. THE MARKET PRICE OF OUR COMMON STOCK MAY DECLINE AS A RESULT OF THE MERGER. The market price of our common stock may decline as a result of the merger for a number of reasons including if: - The integration of MyPoints and Cybergold is unsuccessful; - We do not achieve the perceived benefits of the merger as rapidly or to the extent anticipated by financial or industry analysts; or - The effect of the merger in our financial results is not considered with the expectations of financial or industry analysts FAILURE TO COMPLETE THE MERGER COULD NEGATIVELY IMPACT OUR STOCK PRICE, FUTURE BUSINESS AND OPERATIONS. If the merger is not completed for any reason, we may be subject to a number of material risks, including the following: - The price of our common stock may decline to the extent that the relevant current market price reflects a market assumption that the merger will be completed; and - Costs related to the merger, such a legal, accounting, and financial advisor fees, must be paid even if the merger is not completed. In addition, our customers and strategic partners, in response to the announcement of the merger, may delay or defer decisions concerning the relevant company. Any delay or deferral in those decisions by customers, strategic partners or suppliers could have a material adverse effect on business of the relevant company, regardless of whether the merger is ultimately completed. Similarly, current and prospective employees may experience uncertainty about their future roles with us until our strategies with regard to Cybergold are announced or executed. This may adversely affect our ability to attract and retain key management, sales, marketing and technical personnel. WE ARE GROWING RAPIDLY, AND THE FAILURE TO MANAGE OUR GROWTH COULD STRAIN OUR MANAGEMENT SYSTEMS AND RESOURCES As we continue to increase the scope of our operations, we may not have an effective planning and management process in place to implement our business plan successfully. We have grown from 24 employees on January 1, 1998 to 249 employees on March 31, 2000. We plan to continue the expansion of our technology, sales, marketing and administrative organizations. This growth will continue to strain our management systems and resources. We anticipate the need to continue to improve our financial and managerial controls and our reporting systems. In addition, we will need to expand, train and manage our rapidly growing work force. OUR SUCCESS DEPENDS ON OUR ABILITY TO MAINTAIN AND EXPAND AN ACTIVE MEMBERSHIP BASE Our success largely depends on our ability to maintain and expand an active membership base. Our revenues are primarily driven by fees paid by advertisers and direct marketers based on specific actions taken by our members. If we are unable to induce existing and new members to actively participate in our programs, our business, results of operations and financial condition will be harmed. We generate a significant portion of our revenues based on the activity of a small percentage of our members, and we cannot assure you that the percentage of active members will increase. In addition, some of our members have requested to limit the number of emails they receive from us. Although our membership has grown in prior periods, we cannot be sure that our membership growth will continue at current rates or increase in the future. WE FACE INTENSE COMPETITION, AND THE FAILURE TO COMPETE EFFECTIVELY COULD ADVERSELY AFFECT OUR MARKET SHARE AND RESULTS OF OPERATIONS We face intense competition from both traditional and online advertising and direct marketing businesses. We expect competition to increase due to the lack of significant barriers to entry for online business generally. As we expand the scope of our product and service offerings, we may compete with a greater number of media companies across a wide range of advertising and direct marketing services. Our ability to generate significant revenue from advertisers and loyalty partners will depend on our ability to differentiate ourselves through the technology and services we provide and to obtain adequate participation from consumers in our online direct marketing and rewards programs. Rewards providers are also a critical element of our business. The attractiveness of our program to current and potential members and loyalty partners depends in large part on the attractiveness of the rewards and point 19 20 redemption opportunities that we offer. Currently, several companies offer competitive online products or services, including Netcentives. We also expect to face competition from established online portals and community web sites that engage in direct marketing and loyalty point programs, as well as from traditional advertising agencies and direct marketing companies that may seek to offer online products or services. Many of our current competitors and potential new competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. These advantages may allow them to respond more quickly to new or emerging technologies and changes in customer requirements. It may also allow them to engage in more extensive research and development, undertake more far-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 advertisers and advertising agency customers. As a result, it is possible that new competitors may emerge and rapidly acquire significant market share. We may not be able to compete effectively, and competitive pressures may result in price reductions, reduced gross margins and loss of our market share. THE FAILURE TO ESTABLISH THE MYPOINTS BRAND WOULD IMPAIR OUR COMPETITIVE POSITION We are highly dependent on establishing and maintaining our brand. Any event or circumstance that negatively impacts our brand could have a direct and material adverse effect on our business, results of operations and financial condition. As competitive pressures in the online direct marketing industry increase, we believe that brand strength will become increasingly important. The reputation of the MyPoints brand will depend on our ability to provide a high-quality member experience. We cannot assure you that we will be successful in delivering this experience. If members are not satisfied with the quality of their experience with the MyPoints program, their negative experiences might result in publicity that could damage our reputation. If we expend additional resources to build the MyPoints brand and do not generate a corresponding increase in revenues as a result of our branding efforts, or if we otherwise fail to promote our brand successfully, our competitive position would suffer. THE FAILURE TO ACCURATELY ESTIMATE LEVELS OF POINT REDEMPTION WOULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND COULD LEAD TO THE RESTATEMENT OF HISTORICAL FINANCIAL RESULTS Our historical and forecasted financial statements reflect our assumptions as to the percentage of rewards points issued by us that will not be redeemed by members prior to expiration. This percentage of unredeemed points is known as "breakage." If our assumptions do not prove accurate, our financial statements may require restating, which could cause our stock price to decline and damage our reputation. The breakage rates we have used in preparing our financial statements and forecasts are based primarily on our limited experience with our 20 21 own program since its launch in May 1997. We have also reviewed breakage rates reported by other operators of loyalty and rewards programs, such as airlines. Although we believe that the breakage rates we have used are reasonable in light of our analysis and experience, we cannot assure you that our actual breakage rates will equal or exceed our assumed breakage rates. If our actual breakage rates are less than our assumed breakage rates, meaning that a greater number of points are actually redeemed than we had assumed would be redeemed, our results of operations could be materially and adversely affected. In addition, operators of loyalty programs have, from time to time, for competitive or other reasons, extended the expiration dates for points, miles or other rewards currencies. For example, we extended the expiration date for the points associated with the email portion of our program when we relaunched our email and web-based services. If it becomes necessary for us to extend the expiration date of a significant balance of outstanding points in the future, it is possible that our actual breakage rates would be lower than our assumed breakage rates, which could materially and adversely affect our results of operations. In addition, the timing of members' decisions to redeem points is at the discretion of members and cannot be controlled by us. Points have a life of three to four years and can be redeemed by members until their expiration date. To the extent that members redeem points at a rate that is more rapid than that anticipated by us, we would experience a need for increased working capital to fund these redemptions. Accordingly, the timing of points redemptions by members could materially and adversely affect our results of operations. A SMALL NUMBER OF OUR ADVERTISING CUSTOMERS ACCOUNTS FOR A SIGNIFICANT PORTION OF OUR REVENUES; THEREFORE THE LOSS OF PRINCIPAL CUSTOMERS COULD ADVERSELY AFFECT OUR REVENUES No single advertising customer accounted for more than 10% of our revenue in 1999 and the three months ended March 31, 2000. Our ten largest advertising customers were responsible for approximately 25% of our revenues during 1999 and 29% in the three months ended March 31, 2000. We do not have long-term contracts with most of our customers, and customers can generally terminate their relationships with us upon specified notice and without penalties. Thus, we may not be able to retain our principal customers. The loss of one or more of our principal customers could have a material adverse effect on our revenues. OUR PROSPECTS FOR OBTAINING ADDITIONAL FINANCING, IF REQUIRED, ARE UNCERTAIN AND FAILURE TO OBTAIN NEEDED FINANCING COULD AFFECT OUR ABILITY TO PURSUE FUTURE GROWTH We may need to raise additional funds to develop or enhance our services or products, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies. We cannot assure you that additional financing will be available on terms favorable to us, or at all. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and these securities might have rights, preferences or privileges senior to those of our current stockholders. If adequate funds are not available on acceptable terms, our ability to fund our expansion, take advantage of unanticipated opportunities, develop or enhance services or products, or otherwise respond to competitive pressures would be significantly limited. 21 22 WE DEPEND ON THE SERVICES OF OUR EXECUTIVE OFFICERS AND KEY EMPLOYEES TO MANAGE OUR GROWTH, AND THERE IS NO ASSURANCE WE CAN RETAIN THEIR SERVICES Our future success depends on the continued service of our key senior management and technical and sales personnel. The loss of any of these persons could have a material adverse effect on our business. We do not have key-person insurance on any of our employees. Robert C. Hoyler, our President and Chief Operating Officer, Steven E. Parker, our Senior Vice President, Marketing, and Frank J. Pirri, our Senior Vice President, Offline Commerce, joined us in December 1998 as the result of acquisition transactions that took place in the fourth quarter of 1998. Charles H. Berman, our Executive Vice President, Sales, also joined us in 1998. Thomas P. Caldwell, our Senior Vice President, Finance and Chief Financial Officer, joined us in April 1999. In addition, Eugene A. Pierce, our Senior Vice President, Technology, joined us in the fourth quarter of 1999. Our recently integrated management team has limited experience working together. Our success depends on our ability to attract, retain and motivate highly skilled employees. Competition for employees in our industry is intense. We may be unable to retain our key employees or to attract, assimilate and retain other highly qualified employees in the future. We have experienced difficulty from time to time in attracting the personnel necessary to support the growth of our business, and we may experience similar difficulty in the future. FAILURE TO SAFEGUARD OUR DATABASE AND MEMBER PRIVACY COULD AFFECT OUR REPUTATION AMONG CONSUMERS An important feature of the MyPoints program is our ability to develop and maintain individual member profiles. Security and privacy concerns may cause consumers to resist providing the personal data necessary to support this profiling capability. As a result of these security and privacy concerns, we may incur significant costs to protect against the threat of security breaches or to alleviate problems caused by such breaches. Usage of our MyPoints program could decline if any well-publicized compromise of security occurred. In addition, third parties could alter information in our database that would adversely affect our ability to target direct marketing offers to members. We could also be subject to legal claims from members. Any public perception that we engaged in unauthorized release of member information would adversely affect our ability to attract and retain members. As part of our point redemption services, we maintain a database containing information on our members' account balances. Our database may be subject to access by unauthorized users accessing our systems remotely. If we experience a security breach, the integrity of our points database could be affected. This breach could lead to financial losses through the unauthorized redemption of points. 22 23 WE ARE VULNERABLE TO SYSTEM FAILURES WHICH COULD CAUSE INTERRUPTIONS OR DISRUPTIONS IN OUR SERVICE The hardware infrastructure on which the MyPoints system operates is located at the Exodus Communications data center in Jersey City, New Jersey. In April 1999, we completed a transition to Exodus from a combination of internally maintained systems and systems maintained by another third-party service provider. We cannot assure you that we will be able to manage this relationship successfully to mitigate any risks associated with having our hardware infrastructure maintained by Exodus. Unexpected events such as natural disasters, power losses and vandalism could damage our systems. Telecommunications failures, computer viruses, electronic break-ins or other similar disruptive problems could adversely affect the operation of our systems. Our insurance policies may not adequately compensate us for any losses that may occur due to any damages or interruptions in our systems. Accordingly, we could be required to make capital expenditures in the event of damage. We do not currently have fully redundant systems or a formal disaster recovery plan. Periodically we experience unscheduled system downtime, which results in our web site being inaccessible to members. In particular, during the relaunch of the integrated MyPoints program in April 1999, we experienced significant periods of system downtime during which our web site was inaccessible. Although we did not suffer material losses during these downtimes, if these problems persist in the future, members and advertisers could lose confidence in our services. SYSTEM CAPACITY CONSTRAINTS MAY RESULT IN A LOSS OF REVENUES A substantial increase in the use of our products and services could strain the capacity of our systems, which could lead to slower response time or system failures. System failures or slowdowns adversely affect the speed and responsiveness of our rewards transaction processing. These would diminish the experience for our members and reduce the number of transactions, and thus, could reduce our revenue. Although we have designed and tested our system to handle several times the highest daily transaction volume we have experienced to date, the ability of our systems to manage this volume of transactions in a production environment is unknown. As a result, we face risks related to our ability to scale up to our expected transaction levels while maintaining satisfactory performance. If our transaction volume increases significantly, we will need to purchase additional servers and networking equipment to maintain adequate data transmission speeds. The availability of these products and related services may be limited or their cost may be significant. 23 24 WE FACE RISKS ASSOCIATED WITH THIRD PARTY CLAIMS AND PROTECTION OF OUR INTELLECTUAL PROPERTY RIGHTS, AND ANY LITIGATION RELATING TO INTELLECTUAL PROPERTY RIGHTS COULD HARM OUR BUSINESS Our business activities may infringe upon the proprietary rights of others, and other parties may assert infringement claims against us. We have received three claims of alleged infringement, one of which has been resolved through a license agreement. The second claim of infringement is with Cybergold which we announced the acquisition of in April, 2000. Also, in July 1999, we received an infringement claim from another party, along with an offer to grant a license to us at a cost that would not be material. To our knowledge, no litigation has been filed against us based on this claim. We are evaluating the claim and have not yet begun substantive discussions regarding it. Litigation may also be necessary to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. An adverse determination in any litigation of this type could require us to make significant changes to the structure and operation of our online rewards program, attempt to design around a third party's patent, or license alternative technology from another party. Implementation of any of these alternatives could be costly and time consuming, and might not be possible. In addition, any intellectual property litigation, even if successfully defended, would result in substantial costs and diversion of resources and management attention. Our success and ability to compete depends on our internally developed technologies and trademarks, which we seek to protect through a combination of patent, copyright, trade secret and trademark laws. Despite actions we take to protect our proprietary rights, it may be possible for third parties to copy or otherwise obtain and use our proprietary information without authorization or to develop similar technology independently. In addition, legal standards relating to the validity, enforceability and scope of protection of proprietary rights in internet-related businesses are uncertain and still evolving. We cannot give any assurance regarding the future viability or value of any of our proprietary rights. In addition, we cannot give any assurance that the steps taken by us will prevent misappropriation or infringement of our proprietary information. Any infringement or misappropriation, should it occur, could have a material adverse effect on any competitive advantage incident to our proprietary rights. AS WE EXPAND OUR BUSINESS INTERNATIONALLY, WE MAY NEED TO ADAPT OUR PRODUCTS AND SERVICES AND WE MAY BE SUBJECT TO FOREIGN GOVERNMENT REGULATION AND TAXATION, CURRENCY ISSUES, DIFFICULTIES IN MANAGING FOREIGN OPERATIONS AND FOREIGN POLITICAL ECONOMIC INSTABILITY An element of our growth strategy is to further introduce our services in international markets. Our participation in international markets will be subject to our potential inability to adapt, expand or enhance our products and services to suit foreign markets. In addition, international operations are generally associated with risks such as foreign government regulations, export license requirements, tariffs and taxes, fluctuations in currency exchange rates, introduction of the European Union common currency, difficulties in 24 25 managing foreign operations and political and economic instability. To the extent our potential international members or our international partners are impacted by currency devaluations, general economic crises or other macroeconomic events, the ability of our members to utilize our services could be diminished. In order to help us address some of the risks associated with introducing our services internationally, we believe it will be necessary to establish strategic relationships with international partners. We cannot assure you that electronic commerce will develop successfully in international markets or that potential members in these foreign markets will utilize incentives-based marketing programs. Furthermore, we cannot assure you that we will be able to overcome any legal restrictions related to offering rewards and incentives that may exist in foreign jurisdictions. Any failure to develop our business internationally may harm our competitive position and consequently our business. RISKS ASSOCIATED WITH THE INTERNET INDUSTRY IF THE ACCEPTANCE OF ONLINE ADVERTISING AND DIRECT MARKETING DOES NOT CONTINUE, OUR REVENUES WOULD DECLINE We expect to derive a substantial portion of our revenues from online advertising and direct marketing, including both email and web-based programs. If these services do not continue to achieve market acceptance, we cannot assure you that we will generate business at a sufficient level to support our continued operations. The internet has not existed long enough as an advertising medium to demonstrate its effectiveness relative to traditional advertising media. Advertisers and advertising agencies that have historically relied on traditional advertising may be reluctant or slow to adopt online advertising. Many potential advertisers have limited or no experience using email or the web as an advertising medium. They may have allocated only a limited portion of their advertising budgets to online advertising, or may find online advertising to be less effective for promoting their products and services than traditional advertising media. If the market for online advertising fails to develop or develops more slowly than we expect, our revenues would decline. The market for email advertising in general is vulnerable to the negative public perception associated with unsolicited email, known as "spam." We do not send unsolicited email. However, public perception, press reports or governmental action related to spam could reduce the overall demand for email advertising in general and our MyPoints BonusMail service in particular. IF ONLINE REWARDS PROGRAMS ARE NOT WIDELY ACCEPTED BY BUSINESSES AND INTERNET USERS OUR BUSINESS MODEL WILL NOT SUCCEED Our success depends in large part on the continued growth and acceptance of online rewards programs. If online rewards programs are not widely accepted by advertisers and embraced by internet users, our business model will not succeed. Although loyalty and rewards programs have been used extensively in conventional marketing and sales channels, they have only recently begun to be used online. We cannot assure you that online programs will continue to be accepted by advertisers and that we can continue to offer advertisers attractive promotions and satisfied members. The success of our business model also will depend on our 25 26 ability to attract and retain members. We cannot assure you that our marketing efforts and the quality of each member's experience, including the number and relevance of the direct marketing offers we provide and the perceived value of the rewards we offer, will generate sufficient satisfied members. TO REMAIN COMPETITIVE, WE MUST KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES IN OUR INDUSTRY Our market is characterized by rapidly changing technologies, frequent new product and service introductions, short development cycles and evolving industry standards. The recent growth of the internet and intense competition in our industry exacerbate these market characteristics. We must adapt to rapidly changing technologies by maintaining and improving the performance features and reliability of our services. We may experience technical difficulties that could delay or prevent the successful development, introduction or marketing of new products and services. In addition, any new enhancements to our products and services must meet the requirements of our current and prospective users. We could incur substantial costs to modify our services or infrastructure to adapt to rapid technological change. CONTINUED DEVELOPMENT AND USE OF THE INTERNET INFRASTRUCTURE IS CRITICAL TO OUR ABILITY TO OFFER OUR SERVICES Our members depend on internet service providers for access to our web site. Internet service providers and web sites have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. If outages or delays occur frequently in the future, internet usage, as well as electronic commerce and the usage of our products and services, could grow more slowly or decline. A number of factors may inhibit internet usage, including inadequate network infrastructure, security concerns, inconsistent quality of service, and lack of availability of cost-effective, high-speed service. If internet usage grows, the internet infrastructure may not be able to support the demands placed on it by this growth and its performance and reliability may decline. OUR BUSINESS DEPENDS ON OUR ABILITY TO COLLECT MEMBER INFORMATION; FUTURE REGULATION OF THE INTERNET COULD RESTRICT OUR ACCESS TO THIS INFORMATION Laws and regulations that apply to the internet may become more prevalent in the future. The laws governing the internet and email services remain largely unsettled. There is no single governmental body overseeing our industry, and many state laws that have been enacted in recent years have different and sometimes inconsistent application to our business. In particular, our business model could be severely damaged if regulations were enacted that restricted our ability to collect or use information about our members. The governments of foreign countries may also attempt to regulate electronic commerce. New laws could dampen the growth in use of the internet generally and decrease the acceptance of the internet as a commercial medium. In addition, existing laws such as those governing intellectual property and 26 27 privacy may be interpreted to apply to the internet. The federal government, state governments or other governmental authorities could also adopt or modify laws or regulations relating to the internet. In 1998, the United States government enacted a three-year moratorium prohibiting states and local governments from imposing new taxes on electronic commerce transactions. Upon expiration of this moratorium, if it is not extended, states or other governments might levy sales or use taxes on electronic commerce transactions. An increase in the taxation of electronic commerce transactions might also make the internet less attractive for consumers and businesses. In addition, the Federal Trade Commission is considering the adoption of regulations regarding the collection and use of personal information obtained from individuals, especially children, when accessing web sites. These regulations could restrict our ability to provide demographic data to our advertising and marketing clients. At the international level, the European Union has adopted a directive that will impose restrictions on the collection and use of personal data. This directive could affect U.S. companies that collect information over the internet from individuals in European Union member countries and may impose restrictions that are more stringent than current internet privacy standards in the United States. These developments could have an adverse effect on our business, results of operations and financial condition. OTHER RISKS ASSOCIATED WITH OWNERSHIP OF OUR COMMON STOCK SUBSTANTIAL CONTROL WILL REMAIN WITH OUR MANAGEMENT AND MAJOR STOCKHOLDERS AND THIS COULD DELAY OR PREVENT A CHANGE OF CONTROL Our executive officers, our directors and entities affiliated with them and our 5% stockholders together currently beneficially own approximately 30% of our outstanding common stock. These stockholders, if they vote together, will retain substantial control over matters requiring approval by our stockholders, such as the election of directors and approval of significant corporate transactions. This concentration of ownership might also have the effect of delaying or preventing a change in control. PROVISIONS OF OUR CORPORATE CHARTER DOCUMENTS COULD DELAY OR PREVENT A CHANGE OF CONTROL Various provisions of our certificate of incorporation and bylaws could have the effect of delaying or preventing a change in control and make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions, if used by our management, could negatively affect our stock price. FUTURE SALES OF OUR COMMON STOCK COULD CAUSE THE PRICE OF OUR SHARES TO DECLINE As a result of an offering of common stock which we completed in February 2000, approximately 13.6 million shares of our common stock are subject to lock-up agreements between the holders of those shares and the representatives 27 28 of the underwriters in the offering, under which the holders have agreed not to offer, sell, contract to sell or grant any option to purchase or otherwise dispose of their common stock until May 14, 2000, subject to limited exceptions. FleetBoston Robertson Stephens Inc., one of the managing underwriters in the offering, may release stockholders from the lockup agreement at any time and without notice. Following the expiration of this lock-up period, approximately 13.1 million shares subject to the lock-up agreements will become available for immediate resale in the public market subject, in some instances, to the volume and other limitations of Rule 144. Resales of a substantial number of shares of our common stock into the public market could cause its price to decline. This is particularly the case because a substantial portion of our outstanding shares of common stock are held by persons who purchased their shares at prices below recent market prices of our stock. OUR STOCK PRICE HAS BEEN VOLATILE, AND YOU MAY NOT BE ABLE TO SELL YOUR SHARES AT A PROFIT The stock market has experienced significant price and volume fluctuations, and the market prices of technology companies, particularly internet-related companies, have been highly volatile. Investors may not be able to resell their shares at or above the price which they paid for their shares. In addition, our results of operations during future fiscal periods might fail to meet the expectations of stock market analysts and investors. This failure could lead the market price of our common stock to decline and cause us to become the subject of securities class action lawsuits. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk for changes in interest rates is limited to the exposure related to our debt instruments which are tied to market rates. We do not plan to use derivative financial instruments in our investment portfolio. We plan to ensure the safety and preservation of our invested principal funds by limiting default risks, market risk and reinvestment risk. We plan to invest in high-credit quality securities. 28 29 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In the normal course of business, the Company is at times subject to pending and threatened legal actions and proceedings. After reviewing pending and threatened actions and proceedings with counsel, management believes that the outcome of such actions or proceedings is not expected to have a material adverse effect on the financial position or results of operations of the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On February 23, 2000 we completed a follow-on stock offering in which we sold 2,450,000 shares of common stock at $45.88 per share. The total aggregate gross proceeds amounted to $112.4 million. Underwriters' discounts and other related costs were $6.7 million resulting in net proceeds of $105.7 million. On August 19, 1999, we completed our initial public offering, in which we sold 5,750,000 shares of common stock at $8 per share. The total aggregate gross proceeds amounted to $46 million. Underwriters' discounts and other related costs were $4.8 million resulting in net proceeds of $41.2 million. From August 19,1999 to March 31, 2000, the Company estimates that it has used a portion of the net proceeds of the two offerings as follows: (i) investments in cash and cash equivalents of $116.4 million; and (ii) working capital of $ 30.5 million. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 Financial Data Schedule (b) Reports on Form 8-K: The Registrant filed Form 8-K on March 28, 2000 with respect to the acquisition of Alliance Development Group, Inc. 29 30 SIGNATURE 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, May 14, 2000 MYPOINTS.COM, INC. By /s/ THOMAS P. CALDWELL ------------------------------------------------- Thomas P. Caldwell Senior Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) 30 31 EXHIBIT INDEX Exhibit No. Description - ---------- ----------------------- Exhibit 27 Financial Data Schedule 31